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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-K


(Mark One)




|  |                                                                                                                                        
|- | ---------------------------------------------------------------------------------------------------------------------------------------
|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE 
     SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED
    MARCH 31, 2005
| 
|o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934                                           

Commission File Number


1-15681





webMethods, Inc.


(Exact name of Registrant as Specified in its Charter)


|                                                                                                |  |                                                   
|----------------------------------------------------------------------------------------------- |  | --------------------------------------------------
|Delaware(State or Other Jurisdiction of
    Incorporation or Organization)                      |  | 54-1807654(I.R.S. Employer
    Identification No.)
|                                                                                               
|3877 Fairfax Ridge Road, South Tower, Fairfax, Virginia(Address of Principal Executive Offices) |  | 22030(Zip Code)                                   

(703) 460-2500











x o


x


x o






DOCUMENTS INCORPORATED BY REFERENCE








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WEBMETHODS, INC.


ANNUAL REPORT ON FORM 10-K


FOR THE YEAR ENDED MARCH 31, 2005


TABLE OF CONTENTS


|           |  |                                                                                                                     |  |   
|---------- |  | ------------------------------------------------------------------------------------------------------------------- |  | --
|           |  |                                                                                                                     |  |   
|Part I     |  |                                                                                                                    
|Item 1.    |  | Business                                                                                                            |  | 1 
|           |  | Overview                                                                                                            |  | 1 
|           |  | Strategy                                                                                                            |  | 2 
|           |  | Products                                                                                                            |  | 4 
|           |  | Services                                                                                                            |  | 6 
|           |  | Sales and Marketing                                                                                                 |  | 7 
|           |  | Product Development                                                                                                 |  | 7 
|           |  | Partners and Strategic
    Relationships                                                                            |  | 8 
|           |  | Competition                                                                                                         |  | 9 
|           |  | Intellectual Property and Other
    Proprietary Rights                                                              |  | 9 
|           |  | Corporate Information                                                                                               |  | 11
|           |  | Available Information                                                                                               |  | 12
|           |  | Employees                                                                                                           |  | 12
|           |  | Executive Officers of
    webMethods                                                                                |  | 12
|           |  | Factors That May Affect Future
    Operating Results                                                                |  | 14
|Item 2.    |  | Properties                                                                                                          |  | 24
|Item 3.    |  | Legal Proceedings                                                                                                   |  | 24
|Item 4.    |  | Submission of Matters to a Vote of Security
    Holders                                                             |  | 24
|           |  |                                                                                                                     |  |   
|Part II    |  |                                                                                                                    
|Item 5.    |  | Market for Registrants Common Stock,
    Related Stockholder Matters and Issuer Purchases of Equity
    Securities |  | 25
|Item 6.    |  | Selected Financial Data                                                                                             |  | 26
|Item 7.    |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations                           |  | 27
|           |  | Overview                                                                                                            |  | 27
|           |  | Results of Operations                                                                                               |  | 32
|           |  | Liquidity and Capital
    Resources                                                                                 |  | 40
|           |  | Recently Issued Accounting
    Pronouncements                                                                       |  | 42
|Item 7A.   |  | Quantitative and Qualitative Disclosures
    about Market Risk                                                      |  | 42
|Item 8.    |  | Financial Statements and Supplementary
    Data                                                                     |  | 43
|Item 9.    |  | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosures                           |  | 43
|Item 9A.   |  | Controls and Procedures                                                                                             |  | 43
|Item 9B.   |  | Other Information                                                                                                   |  | 46
|           |  |                                                                                                                     |  |   
|Part III   |  |                                                                                                                    
|Item 10.   |  | Directors and Executive Officers of the
    Registrant                                                              |  | 47
|Item 11.   |  | Executive Compensation                                                                                              |  | 47
|Item 12.   |  | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder Matters                  |  | 47
|Item 13.   |  | Certain Relationships and Related
    Transactions                                                                  |  | 48
|Item 14.   |  | Principal Accountant Fees and Services                                                                              |  | 48
|           |  |                                                                                                                     |  |   
|Part IV    |  |                                                                                                                    
|Item 15.   |  | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K                                                 |  | 49
|Signatures |  | 51                                                                                                                 



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PART I







|        |         
|------- | --------
|Item 1. | BUSINESS






OVERVIEW


tm tm




1



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












STRATEGY




2



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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Focus on Customer Success. A core part of our strategy is
    to ensure that customers are successful with our solutions. We
    invest in resources and programs to improve our customers
    success by reducing the time needed to deploy our software,
    minimizing long-term cost of ownership, and maximizing their
    return on investment for their integration projects. We attempt
    to accomplish this by working closely with customers to
    understand their business needs, timelines, and associated
    project risks, and supporting them to ensure they achieve their
    goals. As a measure of success, we track the number of customer
    projects that go into production. Ensuring that our customers
    successfully implement our software in a timely manner enables
    them to achieve a greater return on their investment and, in
    many cases, encourages them to purchase additional software for
    other projects. We believe that having satisfied customers who
    are willing to serve as references for prospective customers in
    our sales efforts is a significant competitive advantage.                                                                                                                                                              
|
| |  | Extend the Value of Integration Solutions to Business
    Users. The role of integration software and solutions has
    historically been viewed as technical in nature and the
    principal domain of Information Technology personnel. However,
    through our investments and innovation in BPM and BAM, we are
    increasingly able to demonstrate and deliver value that directly
    touches business users within the enterprise. Through our
    integration and BPM capabilities, we are able to not only link
    systems together, but transparently integrate the human
    workflows involved in the business processes that span these
    systems. BAM provides real-time visibility into these business
    processes, giving users the ability to track key performance
    indicators of their business, as well as to anticipate
    exceptions requiring their attention. Together, BPM and BAM
    support a continuous process improvement cycle, with BPM
    providing the means to maximize process efficiencies and BAM
    providing the feedback necessary to enhance an
    organizations processes. We believe that our BPM and BAM
    capabilities differentiate webMethods and provide us with
    important new selling opportunities with new and existing
    customers.
|
| |  | Value Based Selling. In order to successfully market and
    sell software and service solutions to global organizations, we
    have implemented a value based sales methodology that focuses on
    the measurement and attainment of the business value being
    created by our solutions. This methodology allows us to work
    with our customers and prospects during the early stages of the
    sales cycle to identify the projects that would provide the most
    payback, or return on investment, to the individual lines of
    business. We then involve the business users in defining the
    ways the identified business process is to be improved or
    optimized. We often conduct a proof of concept, which allows the
    business owner to experience the proposed solution. This sales
    methodology enables us to build the business case or value to be
    attained from our proposed solution. Our Professional Services
    organization then provides an implementation plan targeted at
    the achievement of this value. This methodology allows our
    customers to understand the various cost components of the
    proposed solutions and the anticipated value they can receive by
    deploying it.                                                               
|
| |  | Provide the Most Compelling Solution. We believe that we
    offer one of the broadest and most comprehensive business
    integration solutions currently available on the market. We have
    used a strategy of internal product development complemented
    with strategic technology acquisitions to round out our
    offerings. Furthermore, our approach has been to integrate our
    various product capabilities into a single, unified platform. We
    believe that while each one of our products individually brings
    value and shows technical leadership, it is the combination of
    these capabilities in one solution that differentiates us from
    our competition.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|
| |  | Continued Leadership in Web Services and Service-Oriented
    Architecture. We believe that Web services will play an
    increasingly important role in integration solutions, and that
    support for related standards and SOA is an important
    requirement for success. webMethods was an early pioneer in the
    use of SOA for integration, as evidenced by our proposal to the
    World Wide Web Consortium (W3C) in 1997 to
    standardize the way that applications interact across the
    Internet using                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

3



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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | service-oriented and XML-based protocols. We believe that we
    have successfully built upon this heritage with our continued
    involvement in various Web services standards bodies, our
    acquisition in October 2003 of a unique Web services management
    framework developed by The Mind Electric, and ongoing product
    innovation in the area of Web services quality-of-service
    monitoring. webMethods has been recognized as a leader in Web
    services by industry analysts, and we currently serve on the
    Board of Directors of the Web Services Interoperability
    organization (WS-I).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | Partner with Major Systems Integrators. We continue to
    expand and strengthen our alliances with major system
    integrators to increase our sales and services leverage. We have
    established a series of formal alliance relationships with major
    system integrators such as Accenture, Atos Origin, BearingPoint,
    Capgemini, CGI-AMS, Computer Sciences Corporation
    (CSC), Crowe Chizek, Deloitte, Electronic Data
    Systems Corporation (EDS), Hewlett-Packard
    (HP) and Tata Consulting Services (TCS).
    Many of these partners have established formal webMethods
    practices, increasing the number of webMethods-trained resources
    available to assist our customers in their implementations of
    our solutions. As a result of this expanded knowledge-base, as
    well as implementation successes on which the systems integrator
    partner and webMethods have worked jointly, these alliances form
    a virtual extension of our direct sales force. This results in
    the third-party introduction and subsequent endorsement of
    webMethods solutions in opportunities of which we may not
    otherwise be aware, or with customers or prospects of the
    partner with which we may not otherwise already be engaged.
|
| |  | Leverage Strategic Software and Other Vendor
    Partnerships. We have relationships with enterprise
    application software and other vendors, such as Global eXchange
    Services (GXS), Oracle Corporation (including both
    the Peoplesoft and JD Edwards product lines), SAP AG and Siebel
    Systems, whereby they embed a limited-use implementation of
    webMethods software into their solutions and/or resell
    components of our product line. As a result, customers who
    license products in which our software is embedded receive
    access to our technology. We believe these customers are good
    candidates to purchase additional webMethods software, and that
    our association with the major enterprise application vendors
    distinguishes us from many of our competitors, providing us with
    an incumbency advantage that positions webMethods as the lowest
    risk option for customers of these software products.                                                                                                                                                                                                                                                                                                                   




PRODUCTS


webMethods Fabric






Enterprise Services Platform


tm


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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Proven business integration functionality(derived from
    our previous flagship offering, the webMethods Integration
    Platform) that provides customers a unified XML-based
    environment for addressing both application-to-application and
    business-to-business integration scenarios, including the
    ability to connect reliably to a variety of legacy systems and
    packaged applications, communicate securely across firewalls,
    perform data transformations and mappings, and manage a
    community of trading partners.                                                                                                                   
|
| |  | An extensive library of adaptersthat provides customers
    a standard mechanism for integrating applications that have
    proprietary programming interfaces, such as those from vendors
    like Oracle Corporation, SAP AG and Siebel Systems. Using
    adapters, developers do not have to learn the technical
    intricacies of each interface; instead, they have a graphical
    interface for configuring the operations to be performed against
    a software application. An adapter development kit simplifies
    the creation of custom adapters for software applications that
    are not supported within our broad library of adapters.           
|
| |  | Support for a wide range of electronic commerce
    protocols, enabling customers to integrate their information
    systems with those of their customers and business partners and
    automate inter-company interactions, such as purchasing and
    procurement, supply chain management, and vendor-managed
    inventory. Supported protocols and e-business standards include
    EDI, EDIINT (AS1, AS2, and AS3), RosettaNet, CIDX, PIDX, FIX,
    SWIFT, and ebXML.                                                                                                                                                                                          
|
| |  | High performance messaging middlewarethat serves as the
    communications layer for webMethods Fabric, and enables the
    real-time, event-driven interactions needed for BAM and other
    high-volume applications that require reliable message delivery
    and a scalable publish/subscribe architecture capable of
    processing thousands of messages per second. A Java Message
    Service (JMS)-compliant interface is also available.                                                                                                                                                                                                                  
|
| |  | webMethods Glue, a light-weight, high-performance Web
    services environmentfor creating standards-compliant Web
    services from Java. Using webMethods Glue, developers are able
    to make existing Java objects accessible as Web services without
    having to modify existing Java logic, or incurring the
    complexity and overhead of implementing these services on a J2EE
    platform.                                                                                                                                                                                                                                                              
|
| |  | Web services enablement and management featuresthat
    allow customers to make existing software application functions
    available as standard Web services, and then to manage the
    deployment of those services  and any other Web
    services in the environment, irrespective of where they
    originate, with enterprise-class quality of service. The Web
    services management capabilities, which are provided by the
    product called webMethods
    Servicenettm,
    include a UDDI-based service registry, security, load balancing,
    fail-over, and unique predictive monitoring enabled by
    webMethods patent-pending BAM technology.

Business Process Management (BPM)




5



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Business Activity Monitoring (BAM)




Composite Application Framework (CAF)


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SERVICES








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tm





SALES AND MARKETING















PRODUCT DEVELOPMENT




7



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PARTNERS AND STRATEGIC RELATIONSHIPS














8



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COMPETITION









INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS






9



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10



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CORPORATE INFORMATION




11



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AVAILABLE INFORMATION


www.webMethods.com. www.sec.gov.





EMPLOYEES







EXECUTIVE OFFICERS OF WEBMETHODS




|                       |  |     |    |  |          |                                                            
|---------------------- |  | --- | -- |  | -------- | -----------------------------------------------------------
|Name                   |  | Age |    |  | Position
|                       |  |     |    |  |         
|David Mitchell         |  |     | 40 |  |          | President and Chief Executive Officer                      
|Richard Chiarello      |  |     | 52 |  |          | Executive Vice President, Worldwide Operations             
|Mary Dridi             |  |     | 44 |  |          | Executive Vice President and Treasurer                     
|Douglas W. McNitt      |  |     | 40 |  |          | General Counsel, Executive Vice President and Secretary    
|Kristin Weller Muhlner |  |     | 34 |  |          | Executive Vice President, Product Development              
|Mark L. Wabschall      |  |     | 49 |  |          | Senior Vice President, Finance and Chief Accounting Officer

David Mitchell


12



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Richard Chiarello


Mary Dridi


Douglas W. McNitt


Kristin Weller Muhlner


Mark L. Wabschall,


13



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FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS




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






| |   |                                                                                                                                                                                                   
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | changes in demand for our software products and services;                                                                                                                                         
|
| |  | the timing and terms of large transactions with customers;                                                                                                                                        
|
| |  | the spending environment for business integration and
    optimization solutions;                                                                                                                 
|
| |  | competitive pressures;                                                                                                                                                                            
|
| |  | fluctuations in the revenue and license revenue of our
    geographic regions;                                                                                                                    
|
| |  | our ability to execute on our business strategy and sales
    strategies;                                                                                                                         
|
| |  | a low number of quota bearing sales representatives experienced
    with our solutions, software products and sales processes;                                                                    
|
| |  | the timing and amount of revenue from acquired technologies or
    businesses;                                                                                                                    
|
| |  | the amount and timing of operating costs;                                                                                                                                                         
|
| |  | delays in the availability of new products or new releases of
    existing products;                                                                                                              
|
| |  | costs of legal compliance, including compliance with the
    Sarbanes-Oxley Act of 2002 and regulatory requirements and
    investigating or resolving pending or threatened legal claims;
    and
|
| |  | changes that we may make in our business, operations and
    infrastructure.                                                                                                                      





14



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






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






| |   |                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------
| |  | the overall volatility of the stock market, particularly the
    stock prices of software and technology companies;

15



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| |   |                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------
| |  | fluctuation in the levels of total revenue, license revenue and
    operating results of competitors;                          
|
| |  | changes in securities analysts estimates and
    recommendations with respect to webMethods common stock or
    our industry;
|
| |  | rapid developments within our industry; and                                                                                    
|
| |  | changes to accounting rules.                                                                                                   



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






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




16



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




We have a history of operating losses, and our failure to
achieve and sustain profitability may impact our prospect of
achieving our growth targets and may have a material adverse
effect on the market price of webMethods common
stock.




17



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




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




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




18



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






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




19



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




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




20



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##### 



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




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




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




21



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




We intend to continue expanding our international sales
efforts, which could subject us to greater uncertainties and
additional risk.






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




22



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




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




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




23



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Item 2.     PROPERTIES









Item 3.     LEGAL
PROCEEDINGS









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




24



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PART II







|        |                                                                                                                
|------- | ---------------------------------------------------------------------------------------------------------------
|Item 5. | MARKET FOR REGISTRANTS COMMON STOCK, RELATED
    STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES



|                           |                                           |      |   |       |     |  |   |      | 
|-------------------------- | ----------------------------------------- | ---- | - | ----- | --- |  | - | ---- | 
|                           |                                           | High |   |       | Low | 
|                           |                                           |      |   |       |     | 
|Year ended March 31, 2004: |                                           |      |   |       |     |  |   |     
|                           | First Quarter (ended June 30, 2003)       |      | $ | 10.91 |     |  | $ | 8.02 | 
|                           | Second Quarter (ended September 30, 2003) |      |   | 10.25 |     |  |   | 7.24 | 
|                           | Third Quarter (ended December 31, 2003)   |      |   | 10.15 |     |  |   | 7.41 | 
|                           | Fourth Quarter (ended March 31, 2004)     |      |   | 12.17 |     |  |   | 8.76 | 

|                           |                                           |      |   |       |     |  |   |      | 
|-------------------------- | ----------------------------------------- | ---- | - | ----- | --- |  | - | ---- | 
|                           |                                           | High |   |       | Low | 
|                           |                                           |      |   |       |     | 
|Year ended March 31, 2005: |                                           |      |   |       |     |  |   |     
|                           | First Quarter (ended June 30, 2004)       |      | $ | 10.80 |     |  | $ | 7.85 | 
|                           | Second Quarter (ended September 30, 2004) |      |   | 8.57  |     |  |   | 3.94 | 
|                           | Third Quarter (ended December 31, 2004)   |      |   | 7.50  |     |  |   | 5.25 | 
|                           | Fourth Quarter (ended March 31, 2005)     |      |   | 7.30  |     |  |   | 5.25 | 





25



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Item 6.     SELECTED FINANCIAL
DATA




|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |         |         |         |         |          |         |         |         | 
|------------------------------------------------------------------------ | ------------------------------------------ | ------------------------------------------- | ------------------------ | ------ | ------ | ------- | ------- | ------ | ------ | ------- | ------- | ------- | ------ | ------- | ------- | ------- | ------- | ------- | -------- | ------- | ------- | ------- | 
|                                                                         |                                            | Year Ended March 31,                        |                         
|                                                                         |                                            |                                             |                         
|                                                                         |                                            | 2005                                        |                          |        | 2004   |         |         | 2003   |        |         | 2002    |         |        | 2001    |        
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        
|                                                                         |                                            | (In thousands, except per share amounts)    |                         
|Consolidated Statements of Operations Data:                              |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |         |         |         |         |          |        
|Revenue:                                                                 |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |         |         |         |         |          |        
|                                                                         | License                                    |                                             | $                        | 86,800 |        |         | $       | 92,740 |        |         | $       | 117,066 |        |         | $       | 121,803 |         |         | $        | 143,514 |        
|                                                                         | Professional services                      |                                             |                          | 49,218 |        |         |         | 43,634 |        |         |         | 33,378  |        |         |         | 35,800  |         |         |          | 34,945  |        
|                                                                         | Maintenance                                |                                             |                          | 64,583 |        |         |         | 53,167 |        |         |         | 46,310  |        |         |         | 38,393  |         |         |          | 23,498  |        
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        
|                                                                         |                                            |                                             | Total revenue            |        |        | 200,601 |         |        |        | 189,541 |         |         |        | 196,754 |         |         |         | 195,996 |          |         |         | 201,957 | 
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        
|Cost of revenue:                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |         |         |         |         |          |        
|                                                                         | Amortization of intangibles                |                                             |                          | 2,397  |        |         |         | 1,199  |        |         |         |        |        |         |         |        |         |         |          |        |        
|                                                                         | License                                    |                                             |                          | 1,252  |        |         |         | 2,211  |        |         |         | 1,937   |        |         |         | 2,335   |         |         |          | 5,189   |        
|                                                                         | Professional services and maintenance:     |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |         |         |         |         |          |         |        
|                                                                         |                                            | Stock based compensation                    |                          |        |       |         |         |        | 56     |         |         |         | 251    |         |         |         | 436     |         |          |         | 1,188   |        
|                                                                         |                                            | Other professional services and maintenance |                          |        | 56,954 |         |         |        | 53,457 |         |         |         | 41,937 |         |         |         | 42,124  |         |          |         | 46,304  |        
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        
|                                                                         |                                            |                                             | Total cost of revenue    |        |        | 60,603  |         |        |        | 56,923  |         |         |        | 44,125  |         |         |         | 44,895  |          |         |         | 52,681  | 
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        
|Gross profit                                                             |                                            |                                             | 139,998                  |        |        |         | 132,618 |        |        |         | 152,629 |         |        |         | 151,101 |         |         |         | 149,276  |        
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        
|Operating expenses:                                                      |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |         |         |         |         |          |        
|                                                                         | Sales and marketing:                       |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |         |         |         |         |          |         |        
|                                                                         |                                            | Stock based compensation and warrant charge |                          |        | 2,645  |         |         |        | 2,769  |         |         |         | 3,761  |         |         |         | 2,865   |         |          |         | 4,813   |        
|                                                                         |                                            | Other sales and marketing costs             |                          |        | 81,668 |         |         |        | 91,664 |         |         |         | 92,958 |         |         |         | 106,377 |         |          |         | 100,154 |        
|                                                                         | Research and development:                  |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |         |         |         |         |          |         |        
|                                                                         |                                            | Stock based compensation                    |                          |        |       |         |         |        | 15     |         |         |         | 97     |         |         |         | 12,526  |         |          |         | 12,447  |        
|                                                                         |                                            | Other research and development costs        |                          |        | 44,518 |         |         |        | 45,045 |         |         |         | 47,441 |         |         |         | 49,634  |         |          |         | 45,158  |        
|                                                                         | General and administrative:                |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |         |         |         |         |          |         |        
|                                                                         |                                            | Stock based compensation                    |                          |        |       |         |         |        | 7      |         |         |         | 47     |         |         |         | 433     |         |          |         | 1,640   |        
|                                                                         |                                            | Other general and administrative costs      |                          |        | 25,042 |         |         |        | 17,873 |         |         |         | 17,831 |         |         |         | 19,372  |         |          |         | 20,837  |        
|                                                                         | Restructuring and related charges          |                                             |                          | 5,849  |        |         |         | 3,920  |        |         |         | 2,155   |        |         |         | 7,243   |         |         |          |        |        
|                                                                         | Acquisition related expenses               |                                             |                          |       |        |         |         |       |        |         |         |        |        |         |         |        |         |         |          | 34,039  |        
|                                                                         | Amortization of goodwill and intangibles   |                                             |                          |       |        |         |         |       |        |         |         |        |        |         |         | 38,697  |         |         |          | 41,395  |        
|                                                                         | In-process research and development        |                                             |                          |       |        |         |         | 4,284  |        |         |         |        |        |         |         |        |         |         |          | 34,910  |        
|                                                                         | Settlement of intellectual property matter |                                             |                          |       |        |         |         | 2,250  |        |         |         |        |        |         |         |        |         |         |          |        |        
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        
|                                                                         |                                            |                                             | Total operating expenses |        |        | 159,722 |         |        |        | 167,827 |         |         |        | 164,290 |         |         |         | 237,147 |          |         |         | 295,393 | 
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        
|Operating loss                                                           |                                            |                                             | (19,724                  | )      |        |         | (35,209 | )      |        |         | (11,661 | )       |        |         | (86,046 | )       |         |         | (146,117 | )      
|Interest income                                                          |                                            |                                             | 2,487                    |        |        |         | 2,851   |        |        |         | 4,732   |         |        |         | 9,116   |         |         |         | 14,894   |        
|Interest expense                                                         |                                            |                                             | (98                      | )      |        |         | (205    | )      |        |         | (674    | )       |        |         | (553    | )       |         |         | (503     | )      
|Other income (expense)                                                   |                                            |                                             | (124                     | )      |        |         | (461    | )      |        |         | 18      |         |        |         | (26     | )       |         |         | 112      |        
|Impairment of equity investments in private companies                    |                                            |                                             | (1,057                   | )      |        |         |        |        |        |         | (1,000  | )       |        |         | (5,200  | )       |         |         |         |        
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        
|Loss before income taxes                                                 |                                            |                                             | (18,516                  | )      |        |         | (33,024 | )      |        |         | (8,585  | )       |        |         | (82,709 | )       |         |         | (131,614 | )      
|Provision for income taxes                                               |                                            |                                             | 235                      |        |        |         |        |        |        |         |        |         |        |         |        |         |         |         |         |        
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        
|Net loss                                                                 |                                            |                                             | (18,751                  | )      |        |         | (33,024 | )      |        |         | (8,585  | )       |        |         | (82,709 | )       |         |         | (131,614 | )      
|Basic and diluted net loss per share                                     |                                            | $                                           | (0.35                    | )      |        | $       | (0.63   | )      |        | $       | (0.17   | )       |        | $       | (1.67   | )       |         | $       | (2.81    | )      
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        
|Shares used in computing basic and diluted net loss per common
    share |                                            |                                             | 53,103                   |        |        |         | 52,137  |        |        |         | 51,282  |         |        |         | 49,493  |         |         |         | 46,860   |        
|                                                                         |                                            |                                             |                          |        |        |         |         |        |        |         |         |         |        |         |        

26



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##### 



|                                                                                                 |  |                |         |  |      |   |         |      |  |   |         |  |  |      |         |  |  |   |         | 
|------------------------------------------------------------------------------------------------ |  | -------------- | ------- |  | ---- | - | ------- | ---- |  | - | ------- |  |  | ---- | ------- |  |  | - | ------- | 
|                                                                                                 |  | March 31,      |        
|                                                                                                 |  |                |        
|                                                                                                 |  | 2005           |         |  | 2004 |   |         | 2003 |  |   | 2002    |  |  | 2001 |        
|                                                                                                 |  |                |         |  |      |   |         |      |  |   |         |  |  |      |        
|                                                                                                 |  | (In thousands) |        
|Consolidated Balance Sheet Data:                                                                 |  |                |         |  |      |   |         |      |  |   |         |  |  |      |         |  |  |   |         | 
|Cash, cash equivalents and short-term and long-term marketable
    securities available for sale |  | $              | 150,054 |  |      | $ | 155,947 |      |  | $ | 201,626 |  |  | $    | 211,842 |  |  | $ | 206,389 | 
|Working capital                                                                                  |  |                | 108,340 |  |      |   | 93,692  |      |  |   | 149,424 |  |  |      | 178,909 |  |  |   | 190,722 | 
|Total assets                                                                                     |  |                | 275,344 |  |      |   | 283,650 |      |  |   | 304,436 |  |  |      | 324,063 |  |  |   | 375,288 | 
|Long-term liabilities                                                                            |  |                | 9,884   |  |      |   | 7,439   |      |  |   | 7,267   |  |  |      | 21,653  |  |  |   | 25,409  | 
|Total stockholders equity                                                                       |  |                | 184,532 |  |      |   | 197,137 |      |  |   | 218,559 |  |  |      | 215,544 |  |  |   | 265,609 | 






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
    CONDITION AND RESULTS OF OPERATIONS






OVERVIEW


Background








| |   |                                                                                              
| | - | ---------------------------------------------------------------------------------------------
| |  | eliminating significant costs from the organizations
    information technology environment,
|
| |  | automating and streamlining interactions with their customers
    and suppliers,             

27



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##### 





| |   |                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------
| |  | becoming more competitive by capturing more market share in
    terms of increased revenue from new and existing customers,
|
| |  | gaining more timely access to information to make better
    decisions about the business, and                             
|
| |  | allowing staff to focus their attention on higher value business
    activities.                                           









Restatements






28



---



##### 









Critical Accounting Policies and Estimates






Revenue Recognition




29



---



##### 







Allowance for Doubtful Accounts




Business Combinations








Goodwill and Intangible Assets




30



---



##### 





Acquired In-process Research and Development




Foreign Currency Effects




Accounting for Income Taxes




Restructuring and Related Charges




Litigation and Contingencies




31



---



##### 






RESULTS OF OPERATIONS




|                         |  |                   |         |    |            |  |       |           |  |  |            |    |  |           |       |    |  |  |         |   
|------------------------ |  | ----------------- | ------- | -- | ---------- |  | ----- | --------- |  |  | ---------- | -- |  | --------- | ----- | -- |  |  | ------- | --
|                         |  | Fiscal Year Ended |        
|                         |  |                   |        
|                         |  | March 31,         |         |    | Percentage |  |       | March 31, |  |  | Percentage |    |  | March 31, |      
|                         |  | 2005              |         |    | Change     |  |       | 2004      |  |  | Change     |    |  | 2003      |      
|                         |  |                   |         |    |            |  |       |           |  |  |            |    |  |           |      
|                         |  | ($ in thousands)  |        
|Total revenue            |  |                   | 200,601 |    |            |  | 5.8   | %         |  |  | 189,541    |    |  |           | (3.7  | )% |  |  | 196,754 |   
|Gross profit             |  |                   | 139,998 |    |            |  | 5.6   | %         |  |  | 132,618    |    |  |           | (13.1 | )% |  |  | 152,629 |   
|% of total revenue       |  |                   | 69.8    | %  |            |  |       |           |  |  | 70.0       | %  |  |           |       |    |  |  | 77.6    | % 
|Total operating expenses |  |                   | 159,722 |    |            |  | (4.8  | )%        |  |  | 167,827    |    |  |           | 2.2   | %  |  |  | 164,290 |   
|% of total revenue       |  |                   | 79.6    | %  |            |  |       |           |  |  | 88.5       | %  |  |           |       |    |  |  | 83.5    | % 
|Operating loss           |  |                   | (19,724 | )  |            |  | (44.0 | )%        |  |  | (35,209    | )  |  |           | 202.0 | %  |  |  | (11,661 | ) 
|% of total revenue       |  |                   | (9.8    | )% |            |  |       |           |  |  | (18.6      | )% |  |           |       |    |  |  | (5.9    | )%
|Net loss                 |  |                   | (18,751 | )  |            |  | (43.2 | )%        |  |  | (33,024    | )  |  |           | 284.7 | %  |  |  | (8,585  | ) 
|% of total revenue       |  |                   | (9.3    | )% |            |  |       |           |  |  | (17.4      | )% |  |           |       |    |  |  | (4.4    | )%







32



---



##### 



Revenue




|                      |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |       |    |  |   |         | 
|--------------------- |  | ----------------- | ------- |  | ---------- |  | ---- | --------- |  | - | ---------- |  |  | --------- | ----- | -- |  | - | ------- | 
|                      |  | Fiscal Year Ended |        
|                      |  |                   |        
|                      |  | March 31,         |         |  | Percentage |  |      | March 31, |  |   | Percentage |  |  | March 31, |      
|                      |  | 2005              |         |  | Change     |  |      | 2004      |  |   | Change     |  |  | 2003      |      
|                      |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |      
|                      |  | ($ in thousands)  |        
|License               |  | $                 | 86,800  |  |            |  | (6.4 | )%        |  | $ | 92,740     |  |  |           | (20.8 | )% |  | $ | 117,066 | 
|Professional services |  |                   | 49,218  |  |            |  | 12.8 | %         |  |   | 43,634     |  |  |           | 30.7  | %  |  |   | 33,378  | 
|Maintenance           |  |                   | 64,583  |  |            |  | 21.5 | %         |  |   | 53,167     |  |  |           | 14.8  | %  |  |   | 46,310  | 
|                      |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |      
|Total revenue         |  | $                 | 200,601 |  |            |  | 5.8  | %         |  | $ | 189,541    |  |  |           | (3.7  | )% |  | $ | 196,754 | 
|                      |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |      



|              |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |       |    |  |   |         | 
|------------- |  | ----------------- | ------- |  | ---------- |  | ---- | --------- |  | - | ---------- |  |  | --------- | ----- | -- |  | - | ------- | 
|              |  | Fiscal Year Ended |        
|              |  |                   |        
|              |  | March 31,         |         |  | Percentage |  |      | March 31, |  |   | Percentage |  |  | March 31, |      
|              |  | 2005              |         |  | Change     |  |      | 2004      |  |   | Change     |  |  | 2003      |      
|              |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |      
|              |  | ($ in thousands)  |        
|Americas      |  | $                 | 119,610 |  |            |  | 4.5  | %         |  | $ | 114,507    |  |  |           | (14.4 | )% |  | $ | 133,756 | 
|EMEA          |  |                   | 50,599  |  |            |  | 12.5 | %         |  |   | 44,965     |  |  |           | 23.7  | %  |  |   | 36,351  | 
|Japan         |  |                   | 15,157  |  |            |  | (2.0 | )%        |  |   | 15,472     |  |  |           | 1.3   | %  |  |   | 15,274  | 
|Asia Pacific  |  |                   | 15,235  |  |            |  | 4.4  | %         |  |   | 14,597     |  |  |           | 28.3  | %  |  |   | 11,373  | 
|              |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |      
|Total revenue |  | $                 | 200,601 |  |            |  | 5.8  | %         |  | $ | 189,541    |  |  |           | (3.7  | )% |  | $ | 196,754 | 
|              |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |      







33



---



##### 







Gross margin




|                                      |  |                   |    |   |           |  |    |           |  |  |    |  
|------------------------------------- |  | ----------------- | -- | - | --------- |  | -- | --------- |  |  | -- | -
|                                      |  | Fiscal Year Ended |   
|                                      |  |                   |   
|                                      |  | March 31,         |    |   | March 31, |  |    | March 31, | 
|                                      |  | 2005              |    |   | 2004      |  |    | 2003      | 
|                                      |  |                   |    |   |           |  |    |           | 
|License                               |  |                   | 96 | % |           |  | 96 | %         |  |  | 98 | %
|Professional services and maintenance |  |                   | 50 | % |           |  | 45 | %         |  |  | 47 | %
|Total revenue                         |  |                   | 70 | % |           |  | 70 | %         |  |  | 78 | %







34



---



##### 



Operating expenses




|                                              |  |                   |         |   |            |  |        |           |  |   |            |   |  |           |       |    |  |   |         |  
|--------------------------------------------- |  | ----------------- | ------- | - | ---------- |  | ------ | --------- |  | - | ---------- | - |  | --------- | ----- | -- |  | - | ------- | -
|                                              |  | Fiscal Year Ended |        
|                                              |  |                   |        
|                                              |  | March 31,         |         |   | Percentage |  |        | March 31, |  |   | Percentage |   |  | March 31, |      
|                                              |  | 2005              |         |   | Change     |  |        | 2004      |  |   | Change     |   |  | 2003      |      
|                                              |  |                   |         |   |            |  |        |           |  |   |            |   |  |           |      
|                                              |  | ($ in thousands)  |        
|Operating Expenses:                           |  |                   |         |   |            |  |        |           |  |   |            |   |  |           |       |    |  |   |         |  
|Sales and marketing*                          |  | $                 | 81,668  |   |            |  | (10.9  | )%        |  | $ | 91,664     |   |  |           | (1.4  | )% |  | $ | 92,958  |  
|% of total revenue                            |  |                   | 40.7    | % |            |  |        |           |  |   | 48.4       | % |  |           |       |    |  |   | 47.2    | %
|Research and development*                     |  |                   | 44,518  |   |            |  | (1.2   | )%        |  |   | 45,045     |   |  |           | (5.1  | )% |  |   | 47,441  |  
|% of total revenue                            |  |                   | 22.2    | % |            |  |        |           |  |   | 23.8       | % |  |           |       |    |  |   | 24.1    | %
|General and administrative*                   |  |                   | 25,042  |   |            |  | 40.1   | %         |  |   | 17,873     |   |  |           | 0.2   | %  |  |   | 17,831  |  
|% of total revenue                            |  |                   | 12.5    | % |            |  |        |           |  |   | 9.4        | % |  |           |       |    |  |   | 9.1     | %
|Stock based compensation and warrant charge** |  |                   | 2,645   |   |            |  | (5.2   | )%        |  |   | 2,791      |   |  |           | (28.5 | )% |  |   | 3,905   |  
|% of total revenue                            |  |                   | 1.3     | % |            |  |        |           |  |   | 1.5        | % |  |           |       |    |  |   | 2.0     | %
|Restructuring and related charges             |  |                   | 5,849   |   |            |  | 49.2   | %         |  |   | 3,920      |   |  |           | 81.9  | %  |  |   | 2,155   |  
|% of total revenue                            |  |                   | 2.9     | % |            |  |        |           |  |   | 2.1        | % |  |           |       |    |  |   | 1.1     | %
|In-process research and development           |  |                   |        |   |            |  | (100.0 | )%        |  |   | 4,284      |   |  |           | 100.0 | %  |  |   |        |  
|% of total revenue                            |  |                   | 0.0     | % |            |  |        |           |  |   | 2.3        | % |  |           |       |    |  |   | 0.0     | %
|Settlement of intellectual property matter    |  |                   |        |   |            |  | (100.0 | )%        |  |   | 2,250      |   |  |           | 100.0 | %  |  |   |        |  
|% of total revenue                            |  |                   | 0.0     | % |            |  |        |           |  |   | 1.2        | % |  |           |       |    |  |   | 0.0     | %
|Operating expense                             |  | $                 | 159,722 |   |            |  | (4.8   | )%        |  | $ | 167,827    |   |  |           | 2.2   | %  |  | $ | 164,290 |  
|% of total revenue                            |  |                   | 79.6    | % |            |  |        |           |  |   | 88.5       | % |  |           |       |    |  |   | 83.5    | %






|   |                                                                                                                                                                                                                                       
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*  | Excludes stock based compensation and warrant charge if
    applicable.                                                                                                                                                               
|  
|** | Includes stock based compensation that would be included in
    sales and marketing, research and development and general and
    administrative expense and warrant charge that would be included
    in sales and marketing expense.







35



---



##### 



















36



---



##### 











Interest income




Interest expense




Other income (expense), net




37



---



##### 



Impairment of equity investment in private companies




Income taxes








Quarterly results of operations




|                 |                                        |                                             |                       |        |          |        |        |           |        |        |          |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |        |        |        | 
|---------------- | -------------------------------------- | ------------------------------------------- | --------------------- | ------ | -------- | ------ | ------ | --------- | ------ | ------ | -------- | ------ | ------ | -------- | ------ | ------ | -------- | ------ | ------ | --------- | ------ | ------ | -------- | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | 
|                 |                                        | Three Months Ended                          |                      
|                 |                                        |                                             |                      
|                 |                                        | Mar. 31,                                    |                       |        | Dec. 31, |        |        | Sept. 30, |        |        | June 30, |        |        | Mar. 31, |        |        | Dec. 31, |        |        | Sept. 30, |        |        | June 30, |       
|                 |                                        | 2005                                        |                       |        | 2004     |        |        | 2004      |        |        | 2004     |        |        | 2004     |        |        | 2003     |        |        | 2003      |        |        | 2003     |       
|                 |                                        |                                             |                       |        |          |        |        |           |        |        |          |        |        |          |        |        |          |        |        |           |        |        |          |       
|                 |                                        | (In thousands)                              |                      
|Revenue:         |                                        |                                             |                       |        |          |        |        |           |        |        |          |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |       
|                 | License                                |                                             | $                     | 22,190 |          |        | $      | 25,953    |        |        | $        | 23,851 |        |          | $      | 14,806 |          |        | $      | 25,679    |        |        | $        | 25,037 |        |        | $      | 20,850 |        |        | $      | 21,174 |       
|                 | Professional services                  |                                             |                       | 12,763 |          |        |        | 11,854    |        |        |          | 12,077 |        |          |        | 12,524 |          |        |        | 13,091    |        |        |          | 11,210 |        |        |        | 10,460 |        |        |        | 8,873  |       
|                 | Maintenance                            |                                             |                       | 17,982 |          |        |        | 17,156    |        |        |          | 14,838 |        |          |        | 14,607 |          |        |        | 14,066    |        |        |          | 13,785 |        |        |        | 12,766 |        |        |        | 12,550 |       
|                 |                                        |                                             |                       |        |          |        |        |           |        |        |          |        |        |          |        |        |          |        |        |           |        |        |          |       
|                 |                                        |                                             | Total revenue         |        |          | 52,935 |        |           |        | 54,963 |          |        |        | 50,766   |        |        |          | 41,937 |        |           |        | 52,836 |          |        |        | 50,032 |        |        |        | 44,076 |        |        |        | 42,597 | 
|                 |                                        |                                             |                       |        |          |        |        |           |        |        |          |        |        |          |        |        |          |        |        |           |        |        |          |       
|Cost of revenue: |                                        |                                             |                       |        |          |        |        |           |        |        |          |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |       
|                 | Amortization of intangibles            |                                             |                       | 600    |          |        |        | 599       |        |        |          | 599    |        |          |        | 599    |          |        |        | 600       |        |        |          | 599    |        |        |        |       |        |        |        |       |       
|                 | License                                |                                             |                       | 135    |          |        |        | 252       |        |        |          | 245    |        |          |        | 620    |          |        |        | 588       |        |        |          | 601    |        |        |        | 555    |        |        |        | 467    |       
|                 | Professional services and maintenance: |                                             |                       |        |          |        |        |           |        |        |          |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |        |       
|                 |                                        | Stock based compensation                    |                       |        |         |        |        |           |       |        |          |        |       |          |        |        |         |        |        |           |       |        |          |        | 12     |        |        |        | 22     |        |        |        | 22     |       
|                 |                                        | Other professional services and maintenance |                       |        | 14,637   |        |        |           | 13,764 |        |          |        | 14,280 |          |        |        | 14,273   |        |        |           | 15,781 |        |          |        | 13,614 |        |        |        | 12,403 |        |        |        | 11,659 |       
|                 |                                        |                                             |                       |        |          |        |        |           |        |        |          |        |        |          |        |        |          |        |        |           |        |        |          |       
|                 |                                        |                                             | Total cost of revenue |        |          | 15,372 |        |           |        | 14,615 |          |        |        | 15,124   |        |        |          | 15,492 |        |           |        | 16,969 |          |        |        | 14,826 |        |        |        | 12,980 |        |        |        | 12,148 | 
|                 |                                        |                                             |                       |        |          |        |        |           |        |        |          |        |        |          |        |        |          |        |        |           |        |        |          |       
|Gross profit     |                                        |                                             | 37,563                |        |          |        | 40,348 |           |        |        | 35,642   |        |        |          | 26,445 |        |          |        | 35,867 |           |        |        | 35,206   |        |        |        | 31,096 |        |        |        | 30,449 |       
|                 |                                        |                                             |                       |        |          |        |        |           |        |        |          |        |        |          |        |        |          |        |        |           |        |        |          |       

38



---



##### 



|                                                      |                                            |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |       |        |        |        |   |        |        |        |   |        |        | 
|----------------------------------------------------- | ------------------------------------------ | ------------------------------------------- | ------------------------ | ----- | -------- | ------ | ---- | --------- | ------ | ------ | -------- | ----- | ------ | -------- | ------- | - | -------- | ------ | ------ | --------- | ------ | ------ | -------- | ----- | ------ | ------ | ------ | - | ------ | ------ | ------ | - | ------ | ------ | 
|                                                      |                                            | Three Months Ended                          |                         
|                                                      |                                            |                                             |                         
|                                                      |                                            | Mar. 31,                                    |                          |       | Dec. 31, |        |      | Sept. 30, |        |        | June 30, |       |        | Mar. 31, |         |   | Dec. 31, |        |        | Sept. 30, |        |        | June 30, |      
|                                                      |                                            | 2005                                        |                          |       | 2004     |        |      | 2004      |        |        | 2004     |       |        | 2004     |         |   | 2003     |        |        | 2003      |        |        | 2003     |      
|                                                      |                                            |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |      
|                                                      |                                            | (In thousands)                              |                         
|Operating expenses:                                   |                                            |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |       |        |        |        |   |        |        |        |  
|                                                      | Sales and marketing:                       |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |       |        |        |        |   |        |        |        |   |       
|                                                      |                                            | Stock based compensation and warrant charge |                          |       | 662      |        |      |           | 661    |        |          |       | 661    |          |         |   | 661      |        |        |           | 663    |        |          |       | 689    |        |        |   | 721    |        |        |   | 696    |       
|                                                      |                                            | Other sales and marketing                   |                          |       | 18,525   |        |      |           | 22,103 |        |          |       | 19,926 |          |         |   | 21,114   |        |        |           | 23,130 |        |          |       | 24,617 |        |        |   | 21,467 |        |        |   | 22,450 |       
|                                                      | Research and development:                  |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |       |        |        |        |   |        |        |        |   |       
|                                                      |                                            | Stock based compensation                    |                          |       |         |        |      |           |       |        |          |       |       |          |         |   |         |        |        |           |       |        |          |       | 5      |        |        |   | 10     |        |        |   |       |       
|                                                      |                                            | Other research and development              |                          |       | 11,771   |        |      |           | 10,877 |        |          |       | 10,820 |          |         |   | 11,050   |        |        |           | 11,542 |        |          |       | 11,446 |        |        |   | 10,857 |        |        |   | 11,200 |       
|                                                      | General and administrative:                |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |       |        |        |        |   |        |        |        |   |       
|                                                      |                                            | Stock based compensation                    |                          |       |         |        |      |           |       |        |          |       |       |          |         |   |         |        |        |           |       |        |          |       | 1      |        |        |   | 3      |        |        |   | 3      |       
|                                                      |                                            | Other general and administrative            |                          |       | 8,008    |        |      |           | 7,093  |        |          |       | 4,868  |          |         |   | 5,073    |        |        |           | 4,593  |        |          |       | 4,333  |        |        |   | 4,524  |        |        |   | 4,423  |       
|                                                      | Restructuring and related charges          |                                             |                          | 3,093 |          |        |      |          |        |        |          | 2,756 |        |          |         |  |          |        |        | 2,605     |        |        |          | 1,315 |        |        |        |  |        |        |        |  |       
|                                                      | In-process research and development        |                                             |                          |      |          |        |      |          |        |        |          |      |        |          |         |  |          |        |        |          |        |        |          | 4,284 |        |        |        |  |        |        |        |  |       
|                                                      | Settlement of intellectual property matter |                                             |                          |      |          |        |      |          |        |        |          |      |        |          |         |  |          |        |        | 2,250     |        |        |          |      |        |        |        |  |        |        |        |  |       
|                                                      |                                            |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |      
|                                                      |                                            |                                             | Total operating expenses |       |          | 42,059 |      |           |        | 40,734 |          |       |        | 39,031   |         |   |          | 37,898 |        |           |        | 44,783 |          |       |        | 46,690 |        |   |        | 37,582 |        |   |        | 38,772 | 
|                                                      |                                            |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |      
|Operating loss                                        |                                            |                                             | (4,496                   | )     |          |        | (386 | )         |        |        | (3,389   | )     |        |          | (11,453 | ) |          |        | (8,916 | )         |        |        | (11,484  | )     |        |        | (6,486 | ) |        |        | (8,323 | )
|Interest income                                       |                                            |                                             | 787                      |       |          |        | 615  |           |        |        | 532      |       |        |          | 553     |   |          |        | 575    |           |        |        | 549      |       |        |        | 721    |   |        |        | 1,007  |  
|Interest expense                                      |                                            |                                             | (15                      | )     |          |        | (28  | )         |        |        | (29      | )     |        |          | (27     | ) |          |        | (42    | )         |        |        | (56      | )     |        |        | (17    | ) |        |        | (89    | )
|Other (expense)/income                                |                                            |                                             | (92                      | )     |          |        | (27  | )         |        |        | (116     | )     |        |          | 112     |   |          |        | (290   | )         |        |        | (196     | )     |        |        | (5     | ) |        |        | 28     |  
|Impairment of equity investments in private companies |                                            |                                             |                         |       |          |        |     |           |        |        | (1,057   | )     |        |          |        |   |          |        |       |           |        |        |         |       |        |        |       |   |        |        |       |  
|                                                      |                                            |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |      
|Net (loss)/income before taxes                        |                                            |                                             | (3,816                   | )     |          |        | 174  |           |        |        | (4,059   | )     |        |          | (10,815 | ) |          |        | (8,673 | )         |        |        | (11,187  | )     |        |        | (5,787 | ) |        |        | (7,377 | )
|                                                      |                                            |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |      
|                                                      | Provision for income taxes                 |                                             |                          | 40    |          |        |      | 126       |        |        |          | 65    |        |          |         | 4 |          |        |        |           |        |        |          |       |        |        |        |   |        |        |        |   |       
|                                                      |                                            |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |      
|Net (loss)/income                                     |                                            | $                                           | (3,856                   | )     |          | $      | 48   |           |        | $      | (4,124   | )     |        | $        | (10,819 | ) |          | $      | (8,673 | )         |        | $      | (11,187  | )     |        | $      | (5,787 | ) |        | $      | (7,377 | )
|                                                      |                                            |                                             |                          |       |          |        |      |           |        |        |          |       |        |          |         |   |          |        |        |           |        |        |          |      

|                 |                                        |                                             |                       |      |          |       |      |           |      |       |          |      |      |          |      |      |          |       |      |           |      |       |          |      |      |       |      |      |      |       |      |      |      |       | 
|---------------- | -------------------------------------- | ------------------------------------------- | --------------------- | ---- | -------- | ----- | ---- | --------- | ---- | ----- | -------- | ---- | ---- | -------- | ---- | ---- | -------- | ----- | ---- | --------- | ---- | ----- | -------- | ---- | ---- | ----- | ---- | ---- | ---- | ----- | ---- | ---- | ---- | ----- | 
|                 |                                        | As a Percentage of Total Revenue            |                      
|                 |                                        |                                             |                      
|                 |                                        | Mar. 31,                                    |                       |      | Dec. 31, |       |      | Sept. 30, |      |       | June 30, |      |      | Mar. 31, |      |      | Dec. 31, |       |      | Sept. 30, |      |       | June 30, |     
|                 |                                        | 2005                                        |                       |      | 2004     |       |      | 2004      |      |       | 2004     |      |      | 2004     |      |      | 2003     |       |      | 2003      |      |       | 2003     |     
|                 |                                        |                                             |                       |      |          |       |      |           |      |       |          |      |      |          |      |      |          |       |      |           |      |       |          |     
|                 |                                        | (In thousands)                              |                      
|Revenue:         |                                        |                                             |                       |      |          |       |      |           |      |       |          |      |      |          |      |      |          |       |      |           |      |       |          |      |      |       |      |      |      |       |      |     
|                 | License                                |                                             |                       | 41.9 | %        |       |      | 47.2      | %    |       |          | 47.0 | %    |          |      | 35.3 | %        |       |      | 48.6      | %    |       |          | 50.0 | %    |       |      | 47.3 | %    |       |      | 49.7 | %   
|                 | Professional services                  |                                             |                       | 24.1 |          |       |      | 21.6      |      |       |          | 23.8 |      |          |      | 29.9 |          |       |      | 24.8      |      |       |          | 22.4 |      |       |      | 23.7 |      |       |      | 20.8 |     
|                 | Maintenance                            |                                             |                       | 34.0 |          |       |      | 31.2      |      |       |          | 29.2 |      |          |      | 34.8 |          |       |      | 26.6      |      |       |          | 27.6 |      |       |      | 29.0 |      |       |      | 29.5 |     
|                 |                                        |                                             |                       |      |          |       |      |           |      |       |          |      |      |          |      |      |          |       |      |           |      |       |          |     
|                 |                                        |                                             | Total revenue         |      |          | 100.0 |      |           |      | 100.0 |          |      |      | 100.0    |      |      |          | 100.0 |      |           |      | 100.0 |          |      |      | 100.0 |      |      |      | 100.0 |      |      |      | 100.0 | 
|                 |                                        |                                             |                       |      |          |       |      |           |      |       |          |      |      |          |      |      |          |       |      |           |      |       |          |     
|Cost of revenue: |                                        |                                             |                       |      |          |       |      |           |      |       |          |      |      |          |      |      |          |       |      |           |      |       |          |      |      |       |      |      |      |       |      |     
|                 | Amortization of intangibles            |                                             |                       | 1.1  |          |       |      | 1.1       |      |       |          | 1.2  |      |          |      | 1.4  |          |       |      | 1.1       |      |       |          | 1.2  |      |       |      |     |      |       |      |     |     
|                 | License                                |                                             |                       | 0.3  |          |       |      | 0.5       |      |       |          | 0.5  |      |          |      | 1.5  |          |       |      | 1.1       |      |       |          | 1.2  |      |       |      | 1.3  |      |       |      | 1.1  |     
|                 | Professional services and maintenance: |                                             |                       |      |          |       |      |           |      |       |          |      |      |          |      |      |          |       |      |           |      |       |          |      |      |       |      |      |      |       |      |      |     
|                 |                                        | Stock based compensation                    |                       |      |         |       |      |           |     |       |          |      |     |          |      |      |         |       |      |           |     |       |          |      |     |       |      |      | 0.1  |       |      |      | 0.1  |      
|                 |                                        | Other professional services and maintenance |                       |      | 27.6     |       |      |           | 25.0 |       |          |      | 28.1 |          |      |      | 34.0     |       |      |           | 29.9 |       |          |      | 27.2 |       |      |      | 28.0 |       |      |      | 27.3 |      
|                 |                                        |                                             |                       |      |          |       |      |           |      |       |          |      |      |          |      |      |          |       |      |           |      |       |          |     
|                 |                                        |                                             | Total cost of revenue |      |          | 29.0  |      |           |      | 26.6  |          |      |      | 29.8     |      |      |          | 36.9  |      |           |      | 32.1  |          |      |      | 29.6  |      |      |      | 29.4  |      |      |      | 28.5  | 
|                 |                                        |                                             |                       |      |          |       |      |           |      |       |          |      |      |          |      |      |          |       |      |           |      |       |          |     
|Gross profit     |                                        |                                             | 71.0                  |      |          |       | 73.4 |           |      |       | 70.2     |      |      |          | 63.1 |      |          |       | 67.9 |           |      |       | 70.4     |      |      |       | 70.6 |      |      |       | 71.5 |     
|                 |                                        |                                             |                       |      |          |       |      |           |      |       |          |      |      |          |      |      |          |       |      |           |      |       |          |     

39



---



##### 



|                                                      |                                            |                                             |                          |     |          |      |      |           |      |      |          |     |      |          |       |    |          |      |       |           |      |      |          |     |      |      |       |    |      |      |       |    |      |      | 
|----------------------------------------------------- | ------------------------------------------ | ------------------------------------------- | ------------------------ | --- | -------- | ---- | ---- | --------- | ---- | ---- | -------- | --- | ---- | -------- | ----- | -- | -------- | ---- | ----- | --------- | ---- | ---- | -------- | --- | ---- | ---- | ----- | -- | ---- | ---- | ----- | -- | ---- | ---- | 
|                                                      |                                            | As a Percentage of Total Revenue            |                         
|                                                      |                                            |                                             |                         
|                                                      |                                            | Mar. 31,                                    |                          |     | Dec. 31, |      |      | Sept. 30, |      |      | June 30, |     |      | Mar. 31, |       |    | Dec. 31, |      |       | Sept. 30, |      |      | June 30, |    
|                                                      |                                            | 2005                                        |                          |     | 2004     |      |      | 2004      |      |      | 2004     |     |      | 2004     |       |    | 2003     |      |       | 2003      |      |      | 2003     |    
|                                                      |                                            |                                             |                          |     |          |      |      |           |      |      |          |     |      |          |       |    |          |      |       |           |      |      |          |    
|                                                      |                                            | (In thousands)                              |                         
|Operating expenses:                                   |                                            |                                             |                          |     |          |      |      |           |      |      |          |     |      |          |       |    |          |      |       |           |      |      |          |     |      |      |       |    |      |      |       |   
|                                                      | Sales and marketing:                       |                                             |                          |     |          |      |      |           |      |      |          |     |      |          |       |    |          |      |       |           |      |      |          |     |      |      |       |    |      |      |       |    |     
|                                                      |                                            | Stock based compensation and warrant charge |                          |     | 1.3      |      |      |           | 1.2  |      |          |     | 1.3  |          |       |    | 1.6      |      |       |           | 1.3  |      |          |     | 1.4  |      |       |    | 1.6  |      |       |    | 1.6  |     
|                                                      |                                            | Other sales and marketing                   |                          |     | 35.0     |      |      |           | 40.2 |      |          |     | 39.3 |          |       |    | 50.3     |      |       |           | 43.8 |      |          |     | 49.2 |      |       |    | 48.7 |      |       |    | 52.7 |     
|                                                      | Research and development:                  |                                             |                          |     |          |      |      |           |      |      |          |     |      |          |       |    |          |      |       |           |      |      |          |     |      |      |       |    |      |      |       |    |     
|                                                      |                                            | Stock based compensation                    |                          |     |         |      |      |           |     |      |          |     |     |          |       |    |         |      |       |           |     |      |          |     |     |      |       |    |     |      |       |    |     |     
|                                                      |                                            | Other research and development              |                          |     | 22.2     |      |      |           | 19.8 |      |          |     | 21.3 |          |       |    | 26.4     |      |       |           | 21.8 |      |          |     | 22.9 |      |       |    | 24.7 |      |       |    | 26.3 |     
|                                                      | General and administrative:                |                                             |                          |     |          |      |      |           |      |      |          |     |      |          |       |    |          |      |       |           |      |      |          |     |      |      |       |    |      |      |       |    |     
|                                                      |                                            | Stock based compensation                    |                          |     |         |      |      |           |     |      |          |     |     |          |       |    |         |      |       |           |     |      |          |     |     |      |       |    |     |      |       |    |     |     
|                                                      |                                            | Other general and administrative            |                          |     | 15.1     |      |      |           | 12.9 |      |          |     | 9.6  |          |       |    | 12.1     |      |       |           | 8.7  |      |          |     | 8.7  |      |       |    | 10.3 |      |       |    | 10.4 |     
|                                                      | Restructuring and related charges          |                                             |                          | 5.9 |          |      |      |          |      |      |          | 5.4 |      |          |       |   |          |      |       | 4.9       |      |      |          | 2.6 |      |      |       |   |      |      |       |   |     
|                                                      | In-process research and development        |                                             |                          |    |          |      |      |          |      |      |          |    |      |          |       |   |          |      |       |          |      |      |          | 8.6 |      |      |       |   |      |      |       |   |     
|                                                      | Settlement of intellectual property matter |                                             |                          |    |          |      |      |          |      |      |          |    |      |          |       |   |          |      |       | 4.3       |      |      |          |    |      |      |       |   |      |      |       |   |     
|                                                      |                                            |                                             |                          |     |          |      |      |           |      |      |          |     |      |          |       |    |          |      |       |           |      |      |          |    
|                                                      |                                            |                                             | Total operating expenses |     |          | 79.5 |      |           |      | 74.1 |          |     |      | 76.9     |       |    |          | 90.4 |       |           |      | 84.8 |          |     |      | 93.4 |       |    |      | 85.3 |       |    |      | 91.0 | 
|                                                      |                                            |                                             |                          |     |          |      |      |           |      |      |          |     |      |          |       |    |          |      |       |           |      |      |          |    
|Operating loss                                        |                                            |                                             | (8.5                     | )   |          |      | (0.7 | )         |      |      | (6.7     | )   |      |          | (27.3 | )  |          |      | (16.9 | )         |      |      | (23.0    | )   |      |      | (14.7 | )  |      |      | (19.5 | ) 
|Interest income                                       |                                            |                                             | 1.5                      |     |          |      | 1.1  |           |      |      | 1.1      |     |      |          | 1.3   |    |          |      | 1.1   |           |      |      | 1.1      |     |      |      | 1.6   |    |      |      | 2.3   |   
|Interest expense                                      |                                            |                                             | (                       | )   |          |      | (0.1 | )         |      |      | (0.1     | )   |      |          | (0.1  | )  |          |      | (0.1  | )         |      |      | (0.1     | )   |      |      |      |    |      |      | (0.2  | ) 
|Other (expense)/income                                |                                            |                                             | (0.2                     | )   |          |      |     |           |      |      | (0.2     | )   |      |          | 0.3   |    |          |      | (0.5  | )         |      |      | (0.4     | )   |      |      |      |    |      |      | 0.1   |   
|Impairment of equity investments in private companies |                                            |                                             |                         |     |          |      |     |           |      |      | (2.1     | )   |      |          |      |    |          |      |      |           |      |      |         |     |      |      |      |    |      |      |      |   
|                                                      |                                            |                                             |                          |     |          |      |      |           |      |      |          |     |      |          |       |    |          |      |       |           |      |      |          |    
|Net (loss)/income before taxes                        |                                            |                                             | (7.2                     | )   |          |      | 0.3  |           |      |      | (8.0     | )   |      |          | (25.8 | )  |          |      | (16.4 | )         |      |      | (22.4    | )   |      |      | (13.1 | )  |      |      | (17.3 | ) 
|Provision for income taxes                            |                                            |                                             | 0.1                      |     |          |      | 0.2  |           |      |      | 0.1      |     |      |          | 0.0   |    |          |      |      |           |      |      |         |     |      |      |      |    |      |      |      |   
|                                                      |                                            |                                             |                          |     |          |      |      |           |      |      |          |     |      |          |       |    |          |      |       |           |      |      |          |    
|Net (loss)/income                                     |                                            |                                             | (7.3                     | )%  |          |      | 0.1  | %         |      |      | (8.1     | )%  |      |          | (25.8 | )% |          |      | (16.4 | )%        |      |      | (22.4    | )%  |      |      | (13.1 | )% |      |      | (17.3 | )%
|                                                      |                                            |                                             |                          |     |          |      |      |           |      |      |          |     |      |          |       |    |          |      |       |           |      |      |          |    




LIQUIDITY AND CAPITAL RESOURCES










40



---



##### 













|                                                 |            |                |        |        |         |   |      |     | 
|------------------------------------------------ | ---------- | -------------- | ------ | ------ | ------- | - | ---- | --- | 
|                                                 |            | Operating      |        |        | Capital |  
|                                                 |            |                |        |        |         |  
|                                                 |            | (In thousands) |       
|Years ending March 31, 2006                      |            | $              | 11,431 |        |         | $ | 502  |    
|                                                 | 2007       |                |        | 10,124 |         |   |      | 143 | 
|                                                 | 2008       |                |        | 6,535  |         |   |      |    | 
|                                                 | 2009       |                |        | 3,043  |         |   |      |    | 
|                                                 | 2010       |                |        | 2,741  |         |   |      |    | 
|                                                 | Thereafter |                |        | 16,372 |         |   |      |    | 
|                                                 |            |                |        |        |         |  
|                                                 |            | $              | 50,246 |        |         | $ | 645  |    
|                                                 |            |                |        |        |         |  
|Less amounts representing interest               |            |                |        |        |         |   | (31  | )  
|                                                 |            |                |        |        |         |  
|                                                 |            |                |        |        |         |   | 614  |    
|Less current portion                             |            |                |        |        |         |   | (475 | )  
|                                                 |            |                |        |        |         |  
|Capital lease obligation, net of current portion |            |                |        |        |         | $ | 139  |    
|                                                 |            |                |        |        |         |  

41



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##### 








RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS















|         |                                                           
|-------- | ----------------------------------------------------------
|Item 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



Interest rate risk.


42



---



##### 





Foreign currency exchange rate risk.









|        |                                            
|------- | -------------------------------------------
|Item 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA








|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
    AND FINANCIAL DISCLOSURES








|         |                        
|-------- | -----------------------
|Item 9A. | CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures.




43



---



##### 





Managements Report on Internal Control Over Financial
Reporting.




| |   |                                                                                                                                                                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | pertain to the maintenance of records that, in reasonable
    detail, accurately and fairly reflect the transactions and
    dispositions of our assets;                                                                                                                                                                                            
|
| |  | provide reasonable assurance that transactions are recorded as
    necessary to permit preparation of financial statements in
    accordance with generally accepted accounting principles, and
    that receipts and expenditures of the company are being made
    only in accordance with authorizations of our management and
    directors; and
|
| |  | provide reasonable assurance regarding prevention or timely
    detection of unauthorized acquisition, use or disposition of our
    assets that could have a material effect on the financial
    statements.                                                                                                                                      



Internal Control  Integrated Framework


Changes in Internal Control Over Financial Reporting.


44



---



##### 







| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We placed the employees of our Japanese subsidiary who were
    principally involved in the improper activities on a special
    status under Japanese labor law under which they had no further
    access to the offices or e-mail system of our Japanese
    subsidiary and were precluded from conducting business on behalf
    of the Company. We terminated the employment of those employees
    principally involved in the improper activities who remained
    employed by our Japanese subsidiary, and we pursued claims for
    restitution as we believed appropriate.                                                                                         
|
| |  | We engaged an experienced financial consulting firm in Japan to
    assist us in providing financial and accounting services on
    behalf of our Japanese subsidiary, and we subsequently replaced
    the Finance Director of our Japanese subsidiary.                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | We recommunicated to employees of our Japanese subsidiary, and
    confirmed their understanding of, our policy requiring
    collection and preservation of appropriate documentation that
    evidences an end-users purchase of a license to our
    software products in the quarter in which the revenue is
    recognized. We reiterated this policy to all of our senior
    management, sales management and finance managers.                                                                                                                                                                                                                                      
|
| |  | We reiterated to all of our senior management, sales management
    and finance managers that borrowing from banks or any third
    party is strictly prohibited unless specifically authorized in
    writing by certain specified executive officers of webMethods
    and by the Board of Directors of the respective borrowing entity
    and sought verification of compliance with this policy in
    certifications collected from members of management of
    webMethods and our subsidiaries each quarter.                                                                                                                                                         
|
| |  | We reiterated to all of our senior management, sales management
    and finance managers that no employee may engage in verbal or
    written side agreements, including without limitation, side
    agreements that modify, cancel or agree to cancel any order or
    agreement for the license of our software products from a
    reseller or end-user or that modify, cancel or agree to modify
    or cancel any associated account receivable without complying
    with applicable procedures. We sought verification of compliance
    with this policy in certifications collected from members of
    management of webMethods and our subsidiaries each quarter.
|
| |  | We recruited and hired a Director, Internal Audit, who will be
    developing and implementing internal audit plans and procedures
    with respect our domestic and international operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | We evaluated and are implementing more comprehensive procedures
    for the timely detection, deterrence, and mitigation of
    wrongdoing and improper activities, as well as procedures to
    test compliance with our revenue recognition policy and our code
    of business conduct.                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | We implemented organizational changes to clarify that persons
    responsible for finance and accounting functions concerning our
    Japanese subsidiary report directly to persons responsible for
    finance and accounting functions in our global management team
    and that persons responsible for the legal function concerning
    our Japanese subsidiary report directly to persons responsible
    for the legal function in our global management team.                                                                                                                                                                                                      
|
| |  | We evaluated our relationships with each of our Japanese
    resellers, including reviewing arrangements with them to ensure
    that they are providing to us those materials required by our
    revenue recognition policy.                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | We implemented new or modified procedures under which the
    appropriate persons within our global management team will have
    greater levels of involvement in, and oversight of,
    international operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                          

45



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##### 








|         |                  
|-------- | -----------------
|Item 9B. | OTHER INFORMATION



46



---



##### 






PART III









|         |                                                   
|-------- | --------------------------------------------------
|Item 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT










|         |                       
|-------- | ----------------------
|Item 11. | EXECUTIVE COMPENSATION








|         |                                                                                                   
|-------- | --------------------------------------------------------------------------------------------------
|Item 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
    MANAGEMENT AND RELATED STOCKHOLDER MATTERS





Equity Compensation Plan Information


|                                                             |  |                      |            |     |                      |   |                                |                               |  |  |           |    
|------------------------------------------------------------ |  | -------------------- | ---------- | --- | -------------------- | - | ------------------------------ | ----------------------------- |  |  | --------- | ---
|                                                             |  | Number of securities |            |     |                      |   | Number of securities remaining |                              
|                                                             |  | to be issued upon    |            |     | Weighted-average     |   |                                | available for future issuance | 
|                                                             |  | exercise of          |            |     | exercise price of    |   |                                | under equity compensation     | 
|                                                             |  | outstanding options, |            |     | outstanding options, |   |                                | plans (excluding securities   | 
|Plan category                                                |  | warrants and rights  |            |     | warrants and rights  |   |                                | reflected in column (a))      | 
|                                                             |  |                      |            |     |                      |   |                                |                               | 
|                                                             |  | (a)                  |            |     | (b)                  |   |                                | (c)                           | 
|Equity compensation plans approved by security holders       |  |                      | 17,515,400 | (1) |                      | $ | 12.4645                        | (1)                           |  |  | 3,925,827 | (1)
|Equity compensation plans not approved by securities holders |  |                      | 141,616    | (2) |                      |   | 45.3825                        | (2)                           |  |  |          |    
|                                                             |  |                      |            |     |                      |   |                                |                               | 
|Total                                                        |  |                      | 17,657,016 |     |                      | $ | 12.7285                        |                               |  |  | 3,925,827 |    
|                                                             |  |                      |            |     |                      |   |                                |                               | 






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes webMethods Employee Stock Purchase Plan, under
    which, as of March 31, 2005, a total of 5,250,000 shares of
    webMethods common stock have been reserved for issuance,
    1,385,586 shares had been issued at an average purchase price of
    $10.5650 and 3,864,414 shares remained available for future
    issuance. Also excludes an additional 2,462,195 shares of
    webMethods common stock that were reserved for issuance under
    the webMethods, Inc. Amended and Restated Stock Option Plan as
    of April 1, 2005.
|   
|(2) | Consists only of shares of webMethods common stock to be issued
    upon the exercise of stock options issued by Active Software
    under its 1999 Stock Option Plan, its 1996 and 1996A Stock
    Option Plans and its 1999 Director Option Plan, and stock
    options assumed by Active Software that had been granted by the
    respective company under the TransLink Software, Inc. Stock
    Option Plan, Alier, Inc.                                                                                                                     

47



---



##### 



| |                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1997 Stock Option Plan and Alier, Inc. 1996 Stock Option Plan,
    all such options having been granted prior to the acquisition of
    Active Software by webMethods, Inc. in August 2000.








|         |                                               
|-------- | ----------------------------------------------
|Item 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS








|         |                                       
|-------- | --------------------------------------
|Item 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES



48



---



##### 






PART IV







|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
    FORM 8-K

Financial Statements:




| |     |                                                        
| | --- | -------------------------------------------------------
| | (1) | Report of Independent Registered Public Accounting Firm

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


|                                                                                                                   |  |      |     | 
|------------------------------------------------------------------------------------------------------------------ |  | ---- | --- | 
|                                                                                                                   |  | Page |    
|                                                                                                                   |  |      |    
|Report of Independent Registered Public Accounting Firm                                                            |  |      | F-1 | 
|Consolidated Balance Sheets at March 31, 2005 and 2004                                                             |  |      | F-3 | 
|Consolidated Statements of Operations and Comprehensive Loss for
    the years ended March 31, 2005, 2004 and 2003 |  |      | F-4 | 
|Consolidated Statements of Changes in Stockholders Equity
    for the years ended March 31, 2005, 2004 and 2003   |  |      | F-5 | 
|Consolidated Statements of Cash Flows for the years ended
    March 31, 2005, 2004 and 2003                        |  |      | F-6 | 
|Notes to Consolidated Financial Statements                                                                         |  |      | F-7 | 



| |     |                                                 
| | --- | ------------------------------------------------
| | (2) | Financial Statement Schedules and Report Thereon

|                                                                                            |  |  |      | 
|------------------------------------------------------------------------------------------- |  |  | ---- | 
|Schedule II  Valuation and Qualifying Accounts                                             |  |  | F-28 | 
|Report of Independent Registered Public Accounting Firm on
    Financial Statement Schedule |  |  | F-29 | 

Exhibits.


|        |         |   |             |                                                                                                                       
|------- | ------- | - | ----------- | ----------------------------------------------------------------------------------------------------------------------
|Exhibit |         |   |            
|Number  |         |   | Description
|        |         |   |            
|        | 3.1(1)  |   |             | Fifth Amended and Restated Certificate of Incorporation of
    webMethods, Inc., as amended                           
|        | 3.2(2)  |   |             | Amended and Restated Bylaws of webMethods, Inc.                                                                       
|        | 4.1(3)  |   |             | Specimen certificate for shares of webMethods, Inc. Common Stock                                                      
|        | 4.2(4)  |   |             | Rights Agreement dated as of October 18, 2001 between
    webMethods, Inc. and American Stock Transfer & Trust Company
|        | 10.2(5) |   |             | webMethods, Inc. Amended and Restated Stock Option Plan, as
    Amended                                               
|        | 10.3(3) |   |             | Employee Stock Purchase Plan                                                                                          
|        | 10.4(3) |   |             | Indemnification Agreement entered into between webMethods, Inc.
    and each of its directors                         
|        | 10.5(6) |   |             | Executive Agreement entered into between webMethods, Inc. and
    certain of its executive officers                   
|        | 10.6(7) |   |             | Form of Stock Option Agreement for stock option grants to
    employees or officers other than California residents   
|        | 10.7(8) |   |             | Form of Stock Option Agreement for stock option grants to
    directors                                               
|        | 10.8(7) |   |             | Form of notice of grant of stock option                                                                               
|        | 10.9*   |   |             | Deferred Compensation Plan for Directors, as amended                                                                  
|        | 10.10(8 | ) |             | Consulting Agreement dated October 3, 2004 between Phillip
    Merrick and webMethods, Inc.                           
|        | 14(9)   |   |             | webMethods, Inc. Code of Ethics                                                                                       
|        | 21.1*   |   |             | Subsidiaries of webMethods, Inc.                                                                                      
|        | 23.1*   |   |             | Consent of PricewaterhouseCoopers LLP                                                                                 
|        | 24      |   |             | Power of Attorney (included on signature page hereof)                                                                 

49



---



##### 



|        |         |  |             |                                                         
|------- | ------- |  | ----------- | --------------------------------------------------------
|Exhibit |         |  |            
|Number  |         |  | Description
|        |         |  |            
|        | 31.1*   |  |             | Rule 13a-14(a) Certification of Chief Executive Officer 
|        | 31.2*   |  |             | Rule 13a-14(a) Certification of Chief Accounting Officer
|        | 31.3*   |  |             | Rule 13a-14(a) Certification of Executive Vice President
|        | 32.1* # |  |             | Section 1350 Certification of Chief Executive Officer   
|        | 32.2* # |  |             | Section 1350 Certification of Chief Accounting Officer  
|        | 32.3* # |  |             | Section 1350 Certification of Executive Vice President  




|    |                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to webMethods Form 10-K for
    the year ended March 31, 2002 (File No. 1-15681).                
|   
|(2) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended December 31, 2004 (File
    No. 1-15681). 
|   
|(3) | Incorporated by reference to webMethods Registration
    Statement on Form S-1, as amended
    (File No. 333-91309).       
|   
|(4) | Incorporated by reference to webMethods Registration
    Statement on Form 8-A (File No. 1-15681).                         
|   
|(5) | Incorporated by reference to webMethods Form 10-K for
    the year ended March 31, 2003 (File No. 1-15681).                
|   
|(6) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended June 30, 2004 (File
    No. 1-15681).     
|   
|(7) | Incorporated by reference to webMethods Form 8-K
    dated October 2, 2004 (File No. 1-15681).                             
|   
|(8) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended September 30, 2004 (File
    No. 1-15681).
|   
|(9) | Incorporated by reference to webMethods definitive proxy
    statement dated July 29, 2003 (File No. 1-15681).             
|   
|*   | Filed herewith.                                                                                                             
|   
|#   | This item is furnished as an exhibit to this report but is not
    filed with the Securities and Exchange Commission.       

Financial Statement Schedule.


| |  |          |    |  |             |                                  
| |  | -------- | -- |  | ----------- | ---------------------------------
| |  | Schedule |    |  | Description
| |  |          |    |  |            
| |  |          | II |  |             | Valuation and Qualifying Accounts



50



---



##### 






SIGNATURES






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



| |     |                   
| | --- | ------------------
| | By: | /s/ David Mitchell

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



|                                                     |  |                                                                                                              |  |              
|---------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------ |  | -------------
|Signature                                            |  | Title                                                                                                        |  | Date         
|                                                     |  |                                                                                                              |  |              
|/s/ David MitchellDavid
    Mitchell                 |  | President, Chief Executive Officer and Director                                                              |  | June 13, 2005
|/s/ Mark L. WabschallMark
    L. Wabschall           |  | Senior Vice President, Finance and Chief Accounting Officer
    (principal accounting and financial officer) |  | June 13, 2005
|/s/ Mary DridiMary
    Dridi                         |  | Executive Vice President and Treasurer                                                                       |  | June 13, 2005
|/s/ James P. GauerJames
    P. Gauer                 |  | Director                                                                                                     |  | June 13, 2005
|/s/ R. James GreenR.
    James Green                 |  | Director                                                                                                     |  | June 13, 2005
|/s/ William A. HalterWilliam
    A. Halter           |  | Director                                                                                                     |  | June 13, 2005
|/s/ Jerry J. JasinowskiJerry
    J. Jasinowski       |  | Director                                                                                                     |  | June 13, 2005
|/s/ Jack L. LewisJack
    L. Lewis                   |  | Director                                                                                                     |  | June 13, 2005
|/s/ Vincent J.
    MullarkeyVincent
    J. Mullarkey |  | Director                                                                                                     |  | June 13, 2005
|/s/ Gene RiechersGene
    Riechers                   |  | Director                                                                                                     |  | June 13, 2005
|/s/ William V. RussellWilliam
    V. Russell         |  | Non-Executive Chairman of the Board and Director                                                             |  | June 13, 2005

51



---



##### 



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM







Consolidated financial statements




Internal control over financial reporting


Internal Control  Integrated Framework Internal Control 
Integrated Framework




F-1



---



##### 







PRICEWATERHOUSECOOPERS
LLP






F-2



---



##### 



WEBMETHODS, INC.


CONSOLIDATED BALANCE SHEETS


|                                         |                                                                                                                           |                                            |        |          |         |  |        |          |         | 
|---------------------------------------- | ------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | ------- |  | ------ | -------- | ------- | 
|                                         |                                                                                                                           | March 31,                                  |       
|                                         |                                                                                                                           |                                            |       
|                                         |                                                                                                                           | 2005                                       |        |          | 2004    | 
|                                         |                                                                                                                           |                                            |        |          |         | 
|                                         |                                                                                                                           | (In thousands, except                      |       
|                                         |                                                                                                                           | share and per share                        |       
|                                         |                                                                                                                           | amounts)                                   |       
|ASSETS                                   |                                                                                                                           |                                            |        |          |         |  |        |         
|Current assets:                          |                                                                                                                           |                                            |        |          |         |  |        |         
|                                         | Cash and cash equivalents                                                                                                 |                                            | $      | 57,209   |         |  | $      | 75,462   |        
|                                         | Marketable securities available for sale                                                                                  |                                            |        | 78,332   |         |  |        | 44,328   |        
|                                         | Accounts receivable, net of allowance of $1,862 and $2,103                                                                |                                            |        | 47,326   |         |  |        | 46,741   |        
|                                         | Prepaid expenses and other current assets                                                                                 |                                            |        | 6,401    |         |  |        | 6,235    |        
|                                         |                                                                                                                           |                                            |        |          |         | 
|                                         |                                                                                                                           | Total current assets                       |        |          | 189,268 |  |        |          | 172,766 | 
|Marketable securities available for sale |                                                                                                                           |                                            | 14,513 |          |         |  | 36,157 |         
|Property and equipment, net              |                                                                                                                           |                                            | 10,342 |          |         |  | 8,106  |         
|Goodwill                                 |                                                                                                                           |                                            | 46,704 |          |         |  | 46,704 |         
|Intangible assets, net                   |                                                                                                                           |                                            | 8,390  |          |         |  | 10,787 |         
|Other assets                             |                                                                                                                           |                                            | 6,127  |          |         |  | 9,130  |         
|                                         |                                                                                                                           |                                            |        |          |         | 
|                                         |                                                                                                                           | Total assets                               |        | $        | 275,344 |  |        | $        | 283,650 | 
|                                         |                                                                                                                           |                                            |        |          |         | 
|LIABILITIES AND STOCKHOLDERS EQUITY     |                                                                                                                           |                                            |        |          |         |  |        |         
|Current liabilities:                     |                                                                                                                           |                                            |        |          |         |  |        |         
|                                         | Accounts payable                                                                                                          |                                            | $      | 8,673    |         |  | $      | 10,919   |        
|                                         | Accrued expenses                                                                                                          |                                            |        | 16,506   |         |  |        | 17,084   |        
|                                         | Accrued salaries and commissions                                                                                          |                                            |        | 12,219   |         |  |        | 11,560   |        
|                                         | Deferred revenue                                                                                                          |                                            |        | 43,055   |         |  |        | 36,018   |        
|                                         | Short-term borrowings                                                                                                     |                                            |        |         |         |  |        | 2,584    |        
|                                         | Current portion of capital lease obligations                                                                              |                                            |        | 475      |         |  |        | 909      |        
|                                         |                                                                                                                           |                                            |        |          |         | 
|                                         |                                                                                                                           | Total current liabilities                  |        |          | 80,928  |  |        |          | 79,074  | 
|                                         | Capital lease obligations, net of current portion                                                                         |                                            |        | 139      |         |  |        | 373      |        
|                                         | Other long term liabilities                                                                                               |                                            |        | 3,374    |         |  |        | 1,000    |        
|                                         | Long term deferred revenue                                                                                                |                                            |        | 6,371    |         |  |        | 6,066    |        
|                                         |                                                                                                                           |                                            |        |          |         | 
|                                         |                                                                                                                           | Total liabilities                          |        |          | 90,812  |  |        |          | 86,513  | 
|                                         |                                                                                                                           |                                            |        |          |         | 
|Commitments and contingencies            |                                                                                                                           |                                            |        |          |         |  |        |         
|Stockholders equity:                    |                                                                                                                           |                                            |        |          |         |  |        |         
|                                         | Common stock, $0.01 par value; 500,000,000 shares authorized;
    53,346,623 and 52,746,722 shares issued and outstanding |                                            |        | 533      |         |  |        | 527      |        
|                                         | Additional paid-in capital                                                                                                |                                            |        | 524,487  |         |  |        | 521,455  |        
|                                         | Deferred stock compensation and warrant charge                                                                            |                                            |        | (2,480   | )       |  |        | (5,625   | )      
|                                         | Accumulated deficit                                                                                                       |                                            |        | (340,224 | )       |  |        | (321,473 | )      
|                                         | Accumulated other comprehensive income                                                                                    |                                            |        | 2,216    |         |  |        | 2,253    |        
|                                         |                                                                                                                           |                                            |        |          |         | 
|                                         |                                                                                                                           | Total stockholders equity                 |        |          | 184,532 |  |        |          | 197,137 | 
|                                         |                                                                                                                           |                                            |        |          |         | 
|                                         |                                                                                                                           | Total liabilities and stockholders equity |        | $        | 275,344 |  |        | $        | 283,650 | 
|                                         |                                                                                                                           |                                            |        |          |         | 

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


F-3



---



##### 



WEBMETHODS, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
LOSS


|                                                                         |                                            |                                                    |                          |         |        |         |            |         |        |         |            |         |        |         |  
|------------------------------------------------------------------------ | ------------------------------------------ | -------------------------------------------------- | ------------------------ | ------- | ------ | ------- | ---------- | ------- | ------ | ------- | ---------- | ------- | ------ | ------- | -
|                                                                         |                                            | Year Ended March 31,                               |                         
|                                                                         |                                            |                                                    |                         
|                                                                         |                                            | 2005                                               |                          |         | 2004   |         |            | 2003    |       
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|                                                                         |                                            | (In thousands, except per share amounts)           |                         
|Revenue:                                                                 |                                            |                                                    |                          |         |        |         |            |         |        |         |            |        
|                                                                         | License                                    |                                                    | $                        | 86,800  |        |         | $          | 92,740  |        |         | $          | 117,066 |       
|                                                                         | Professional services                      |                                                    |                          | 49,218  |        |         |            | 43,634  |        |         |            | 33,378  |       
|                                                                         | Maintenance                                |                                                    |                          | 64,583  |        |         |            | 53,167  |        |         |            | 46,310  |       
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|                                                                         |                                            |                                                    | Total revenue            |         |        | 200,601 |            |         |        | 189,541 |            |         |        | 196,754 |  
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|Cost of revenue:                                                         |                                            |                                                    |                          |         |        |         |            |         |        |         |            |        
|                                                                         | Amortization of intangibles                |                                                    |                          | 2,397   |        |         |            | 1,199   |        |         |            |        |       
|                                                                         | License                                    |                                                    |                          | 1,252   |        |         |            | 2,211   |        |         |            | 1,937   |       
|                                                                         | Professional services and maintenance:     |                                                    |                          |         |        |         |            |         |        |         |            |         |       
|                                                                         |                                            | Stock based compensation                           |                          |         |       |         |            |         | 56     |         |            |         | 251    |        
|                                                                         |                                            | Other professional services and maintenance        |                          |         | 56,954 |         |            |         | 53,457 |         |            |         | 41,937 |        
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|                                                                         |                                            |                                                    | Total cost of revenue    |         |        | 60,603  |            |         |        | 56,923  |            |         |        | 44,125  |  
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|Gross profit                                                             |                                            |                                                    | 139,998                  |         |        |         | 132,618    |         |        |         | 152,629    |        
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|Operating expenses:                                                      |                                            |                                                    |                          |         |        |         |            |         |        |         |            |        
|                                                                         | Sales and marketing:                       |                                                    |                          |         |        |         |            |         |        |         |            |         |       
|                                                                         |                                            | Stock based compensation and warrant charge        |                          |         | 2,645  |         |            |         | 2,769  |         |            |         | 3,761  |        
|                                                                         |                                            | Other sales and marketing costs                    |                          |         | 81,668 |         |            |         | 91,664 |         |            |         | 92,958 |        
|                                                                         | Research and development:                  |                                                    |                          |         |        |         |            |         |        |         |            |         |       
|                                                                         |                                            | Stock based compensation                           |                          |         |       |         |            |         | 15     |         |            |         | 97     |        
|                                                                         |                                            | Other research and development costs               |                          |         | 44,518 |         |            |         | 45,045 |         |            |         | 47,441 |        
|                                                                         | General and administrative:                |                                                    |                          |         |        |         |            |         |        |         |            |         |       
|                                                                         |                                            | Stock based compensation                           |                          |         |       |         |            |         | 7      |         |            |         | 47     |        
|                                                                         |                                            | Other general and administrative costs             |                          |         | 25,042 |         |            |         | 17,873 |         |            |         | 17,831 |        
|                                                                         | Restructuring and other related charges    |                                                    |                          | 5,849   |        |         |            | 3,920   |        |         |            | 2,155   |       
|                                                                         | In-process research and development        |                                                    |                          |        |        |         |            | 4,284   |        |         |            |        |       
|                                                                         | Settlement of intellectual property matter |                                                    |                          |        |        |         |            | 2,250   |        |         |            |        |       
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|                                                                         |                                            |                                                    | Total operating expenses |         |        | 159,722 |            |         |        | 167,827 |            |         |        | 164,290 |  
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|Operating loss                                                           |                                            |                                                    | (19,724                  | )       |        |         | (35,209    | )       |        |         | (11,661    | )      
|Interest income                                                          |                                            |                                                    | 2,487                    |         |        |         | 2,851      |         |        |         | 4,732      |        
|Interest expense                                                         |                                            |                                                    | (98                      | )       |        |         | (205       | )       |        |         | (674       | )      
|Other (expense) income                                                   |                                            |                                                    | (124                     | )       |        |         | (461       | )       |        |         | 18         |        
|Impairment of equity investment in private companies                     |                                            |                                                    | (1,057                   | )       |        |         |           |         |        |         | (1,000     | )      
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|Net loss before taxes                                                    |                                            | $                                                  | (18,516                  | )       |        | $       | (33,024    | )       |        | $       | (8,585     | )      
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|Provision for income taxes                                               |                                            |                                                    | 235                      |         |        |         |           |         |        |         |           |        
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|Net loss                                                                 |                                            | $                                                  | (18,751                  | )       |        | $       | (33,024    | )       |        | $       | (8,585     | )      
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|Basic and diluted net loss per share                                     |                                            | $                                                  | (0.35                    | )       |        | $       | (0.63      | )       |        | $       | (0.17      | )      
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|Shares used in computing basic and diluted net loss per common
    share |                                            |                                                    | 53,102,934               |         |        |         | 52,136,919 |         |        |         | 51,281,729 |        
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|Comprehensive loss:                                                      |                                            |                                                    |                          |         |        |         |            |         |        |         |            |        
|                                                                         | Net loss                                   |                                                    | $                        | (18,751 | )      |         | $          | (33,024 | )      |         | $          | (8,585  | )     
|                                                                         | Other comprehensive income (loss):         |                                                    |                          |         |        |         |            |         |        |         |            |         |       
|                                                                         |                                            | Unrealized loss on securities available for sale   |                          |         | (496   | )       |            |         | (165   | )       |            |         | (135   | )      
|                                                                         |                                            | Foreign currency cumulative translation adjustment |                          |         | 459    |         |            |         | 2,306  |         |            |         | 750    |        
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       
|                                                                         |                                            |                                                    | Total comprehensive loss |         | $      | (18,788 | )          |         | $      | (30,883 | )          |         | $      | (7,970  | )
|                                                                         |                                            |                                                    |                          |         |        |         |            |         |       

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


F-4



---



##### 



WEBMETHODS, INC.


CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
EQUITY


for the years ended March 31, 2003, 2004 and 2005


|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       |  |   |       |   |  |   |         |  
|------------------------------------------------------------------------------------------------- |  | ------------ | ------ |  | ---------- | ----- | --- | ------------ |  | - | ----------- | - | ------------- | ------- | ------- | - | ------ | - | -------- | ----- |  | - | ----- | - |  | - | ------- | -
|                                                                                                  |  |              |        |  |            |       |     | Deferred     |  |   |             |   | Accumulated   |         |         |  
|                                                                                                  |  |              |        |  |            | Stock |     |              |  |   | Other       |   |               |        
|                                                                                                  |  | Common Stock |        |  | Additional |       |     | Compensation |  |   |             |   | Comprehensive |         |         |  
|                                                                                                  |  |              |        |  | Paid-in    |       |     | and Warrant  |  |   | Accumulated |   |               | Income  |         |   |       
|                                                                                                  |  | Shares       |        |  | Amount     |       |     | Capital      |  |   | Charge      |   |               | Deficit |         |   | (Loss) |   |          | Total | 
|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       | 
|Balance, March 31, 2002                                                                           |  |              | 50,477 |  |            | $     | 505 |              |  | $ | 510,281     |   |               | $       | (14,875 | ) |        | $ | (279,864 | )     |  | $ | (503  | ) |  | $ | 215,544 |  
|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       | 
|Stock options exercised, net                                                                      |  |              | 907    |  |            |       | 9   |              |  |   | 2,608       |   |               |         |        |   |        |   |         |       |  |   |      |   |  |   | 2,617   |  
|ESPP common stock issuances                                                                       |  |              | 383    |  |            |       | 4   |              |  |   | 2,957       |   |               |         |        |   |        |   |         |       |  |   |      |   |  |   | 2,961   |  
|Adjustment of deferred compensation related to forfeitures                                        |  |              |       |  |            |       |    |              |  |   | (303        | ) |               |         | 303     |   |        |   |         |       |  |   |      |   |  |   |        |  
|Amortization of deferred warrant charge                                                           |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 3,402   |   |        |   |         |       |  |   |      |   |  |   | 3,402   |  
|Amortization of deferred stock compensation related to
    restricted stock                       |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 470     |   |        |   |         |       |  |   |      |   |  |   | 470     |  
|Compensation charge related to stock option grants to
    non-employees                           |  |              |       |  |            |       |    |              |  |   | 285         |   |               |         |        |   |        |   |         |       |  |   |      |   |  |   | 285     |  
|Proceeds from OEM fees applied to deferred warrant charge                                         |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 1,250   |   |        |   |         |       |  |   |      |   |  |   | 1,250   |  
|Other comprehensive income                                                                        |  |              |       |  |            |       |    |              |  |   |            |   |               |         |        |   |        |   |         |       |  |   | 615   |   |  |   | 615     |  
|Net loss                                                                                          |  |              |       |  |            |       |    |              |  |   |            |   |               |         |        |   |        |   | (8,585   | )     |  |   |      |   |  |   | (8,585  | )
|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       | 
|Balance, March 31, 2003                                                                           |  |              | 51,767 |  |            | $     | 518 |              |  | $ | 515,828     |   |               | $       | (9,450  | ) |        | $ | (288,449 | )     |  | $ | 112   |   |  | $ | 218,559 |  
|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       | 
|Stock options exercised, net                                                                      |  |              | 620    |  |            |       | 6   |              |  |   | 3,033       |   |               |         |        |   |        |   |         |       |  |   |      |   |  |   | 3,039   |  
|ESPP common stock issuances                                                                       |  |              | 360    |  |            |       | 3   |              |  |   | 2,478       |   |               |         |        |   |        |   |         |       |  |   |      |   |  |   | 2,481   |  
|Adjustment of deferred compensation related to forfeitures                                        |  |              |       |  |            |       |    |              |  |   | (48         | ) |               |         | 48      |   |        |   |         |       |  |   |      |   |  |   |        |  
|Amortization of deferred warrant charge                                                           |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 2,645   |   |        |   |         |       |  |   |      |   |  |   | 2,645   |  
|Amortization of deferred stock compensation related to
    restricted stock                       |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 132     |   |        |   |         |       |  |   |      |   |  |   | 132     |  
|Compensation charge related to stock option grants to
    non-employees                           |  |              |       |  |            |       |    |              |  |   | 70          |   |               |         |        |   |        |   |         |       |  |   |      |   |  |   | 70      |  
|Compensation charge related to accelerated vesting of stock
    option grants issued to employees |  |              |       |  |            |       |    |              |  |   | 94          |   |               |         |        |   |        |   |         |       |  |   |      |   |  |   | 94      |  
|Proceeds from OEM fees applied to deferred warrant charge                                         |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 1,000   |   |        |   |         |       |  |   |      |   |  |   | 1,000   |  
|Other comprehensive income                                                                        |  |              |       |  |            |       |    |              |  |   |            |   |               |         |        |   |        |   |         |       |  |   | 2,141 |   |  |   | 2,141   |  
|Net loss                                                                                          |  |              |       |  |            |       |    |              |  |   |            |   |               |         |        |   |        |   | (33,024  | )     |  |   |      |   |  |   | (33,024 | )
|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       | 
|Balance, March 31, 2004                                                                           |  |              | 52,747 |  |            | $     | 527 |              |  | $ | 521,455     |   |               | $       | (5,625  | ) |        | $ | (321,473 | )     |  | $ | 2,253 |   |  | $ | 197,137 |  
|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       | 
|Stock options exercised, net                                                                      |  |              | 296    |  |            |       | 3   |              |  |   | 982         |   |               |         |        |   |        |   |         |       |  |   |      |   |  |   | 985     |  
|ESPP common stock issuances                                                                       |  |              | 304    |  |            |       | 3   |              |  |   | 1,998       |   |               |         |        |   |        |   |         |       |  |   |      |   |  |   | 2,001   |  
|Amortization of deferred warrant charge                                                           |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 2,645   |   |        |   |         |       |  |   |      |   |  |   | 2,645   |  
|Compensation charge payable in common stock under deferred
    compensation plan for directors    |  |              |       |  |            |       |    |              |  |   | 52          |   |               |         |        |   |        |   |         |       |  |   |      |   |  |   | 52      |  
|Proceeds from OEM fees applied to deferred warrant charge                                         |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 500     |   |        |   |         |       |  |   |      |   |  |   | 500     |  
|Other comprehensive income                                                                        |  |              |       |  |            |       |    |              |  |   |            |   |               |         |        |   |        |   |         |       |  |   | (37   | ) |  |   | (37     | )
|Net loss                                                                                          |  |              |       |  |            |       |    |              |  |   |            |   |               |         |        |   |        |   | (18,751  | )     |  |   |      |   |  |   | (18,751 | )
|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       | 
|Balance, March 31, 2005                                                                           |  |              | 53,347 |  |            | $     | 533 |              |  | $ | 524,487     |   |               | $       | (2,480  | ) |        | $ | (340,224 | )     |  | $ | 2,216 |   |  | $ | 184,532 |  
|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       | 

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


F-5



---



##### 



WEBMETHODS, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


|                                                         |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |        |   |         |        |         |  
|-------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------- | ------- | ------ | - | ------- | ------- | ------ | - | ------- | ------ | ------- | -
|                                                         |                                                                                                                  | Year Ended March 31,                                                                                                                                          |        
|                                                         |                                                                                                                  |                                                                                                                                                               |        
|                                                         |                                                                                                                  | 2005                                                                                                                                                          |         |         | 2004   |   |         | 2003    |       
|                                                         |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |       
|                                                         |                                                                                                                  | (In thousands)                                                                                                                                                |        
|Cash flows from operating activities:                    |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |        |   |         |       
|                                                         | Net loss                                                                                                         |                                                                                                                                                               | $       | (18,751 | )      |   | $       | (33,024 | )      |   | $       | (8,585 | )      
|                                                         | Adjustments to reconcile net loss to net cash used in operating
    activities:                                  |                                                                                                                                                               |         |         |        |   |         |         |        |   |         |        |        
|                                                         |                                                                                                                  | Depreciation and amortization                                                                                                                                 |         |         | 6,343  |   |         |         | 8,428  |   |         |        | 10,044  |  
|                                                         |                                                                                                                  | Provision for doubtful accounts                                                                                                                               |         |         | 244    |   |         |         | 19     |   |         |        | 384     |  
|                                                         |                                                                                                                  | Impairment of equity investments                                                                                                                              |         |         | 1,057  |   |         |         |       |   |         |        | 1,000   |  
|                                                         |                                                                                                                  | Amortization of deferred stock compensation and compensation for
    accelerated vesting related to employee stock options and
    non-employee stock warrant |         |         | 2,645  |   |         |         | 2,846  |   |         |        | 4,156   |  
|                                                         |                                                                                                                  | Amortization of acquired intangibles                                                                                                                          |         |         | 2,397  |   |         |         | 1,199  |   |         |        |        |  
|                                                         |                                                                                                                  | Write off of in-process research and development                                                                                                              |         |         |       |   |         |         | 4,284  |   |         |        |        |  
|                                                         |                                                                                                                  | Conversion of interest income to equity in private company
    investments                                                                                    |         |         |       |   |         |         | (257   | ) |         |        |        |  
|                                                         |                                                                                                                  | Non cash restructuring and related costs, and other                                                                                                           |         |         |       |   |         |         | 473    |   |         |        |        |  
|                                                         |                                                                                                                  | Amortization of deferred rent                                                                                                                                 |         |         | (200   | ) |         |         |       |   |         |        |        |  
|                                                         | Increase (decrease) in cash resulting from changes in
    assets and liabilities, net of effect of acquisitions: |                                                                                                                                                               |         |         |        |   |         |         |        |   |         |        |        
|                                                         |                                                                                                                  | Accounts receivable                                                                                                                                           |         |         | (252   | ) |         |         | (534   | ) |         |        | 4,477   |  
|                                                         |                                                                                                                  | Prepaid expenses and other current assets                                                                                                                     |         |         | (212   | ) |         |         | 1,608  |   |         |        | 181     |  
|                                                         |                                                                                                                  | Other non-current assets                                                                                                                                      |         |         | 1,956  |   |         |         | 91     |   |         |        | 551     |  
|                                                         |                                                                                                                  | Accounts payable                                                                                                                                              |         |         | (2,386 | ) |         |         | 406    |   |         |        | (6,065  | )
|                                                         |                                                                                                                  | Accrued expenses                                                                                                                                              |         |         | (1,064 | ) |         |         | 1,752  |   |         |        | (1,698  | )
|                                                         |                                                                                                                  | Deferred rent                                                                                                                                                 |         |         | 3,105  |   |         |         |       |   |         |        |        |  
|                                                         |                                                                                                                  | Accrued salaries and commissions                                                                                                                              |         |         | 529    |   |         |         | (649   | ) |         |        | (4,689  | )
|                                                         |                                                                                                                  | Deferred revenue                                                                                                                                              |         |         | 6,989  |   |         |         | (6,650 | ) |         |        | (12,562 | )
|                                                         |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |       
|Net cash provided by/(used in) operating activities      |                                                                                                                  |                                                                                                                                                               | 2,400   |         |        |   | (20,008 | )       |        |   | (12,806 | )     
|                                                         |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |       
|Cash flows from investing activities:                    |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |        |   |         |       
|                                                         | Acquisition of businesses and technology, net of cash acquired                                                   |                                                                                                                                                               |         |        |        |   |         | (32,384 | )      |   |         |       |        
|                                                         | Purchases of property and equipment                                                                              |                                                                                                                                                               |         | (8,380  | )      |   |         | (2,744  | )      |   |         | (2,967 | )      
|                                                         | Net maturities (purchases) of marketable securities
    available for sale                                       |                                                                                                                                                               |         | (12,857 | )      |   |         | 41,274  |        |   |         | (8,717 | )      
|                                                         | Repayments of investments in private companies                                                                   |                                                                                                                                                               |         |        |        |   |         | 1,000   |        |   |         |       |        
|                                                         |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |       
|Net cash provided by (used in) investing activities      |                                                                                                                  |                                                                                                                                                               | (21,237 | )       |        |   | 7,146   |         |        |   | (11,684 | )     
|                                                         |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |       
|Cash flows from financing activities:                    |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |        |   |         |       
|                                                         | Short-term borrowings                                                                                            |                                                                                                                                                               |         | 3,533   |        |   |         | 5,882   |        |   |         |       |        
|                                                         | Payments on short-term borrowings                                                                                |                                                                                                                                                               |         | (6,080  | )      |   |         | (3,561  | )      |   |         |       |        
|                                                         | Borrowings under capital leases                                                                                  |                                                                                                                                                               |         |        |        |   |         |        |        |   |         | 2,500  |        
|                                                         | Payments on capital leases                                                                                       |                                                                                                                                                               |         | (937    | )      |   |         | (3,255  | )      |   |         | (4,932 | )      
|                                                         | Proceeds from exercise of stock options                                                                          |                                                                                                                                                               |         | 1,037   |        |   |         | 3,039   |        |   |         | 2,617  |        
|                                                         | Proceeds from ESPP common stock issuances                                                                        |                                                                                                                                                               |         | 2,002   |        |   |         | 2,481   |        |   |         | 2,961  |        
|                                                         | Proceeds from OEM fees applied to deferred warrant charge                                                        |                                                                                                                                                               |         | 500     |        |   |         | 1,000   |        |   |         | 1,250  |        
|                                                         |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |       
|Net cash provided by financing activities                |                                                                                                                  |                                                                                                                                                               | 55      |         |        |   | 5,586   |         |        |   | 4,396   |       
|                                                         |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |       
|Effect of the exchange rate on cash and cash equivalents |                                                                                                                  |                                                                                                                                                               | 529     |         |        |   | 3,036   |         |        |   | 1,299   |       
|                                                         |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |       
|Net decrease in cash and cash equivalents                |                                                                                                                  |                                                                                                                                                               | (18,253 | )       |        |   | (4,240  | )       |        |   | (18,795 | )     
|Cash and cash equivalents at beginning of period         |                                                                                                                  |                                                                                                                                                               | 75,462  |         |        |   | 79,702  |         |        |   | 98,497  |       
|                                                         |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |       
|Cash and cash equivalents at end of period               |                                                                                                                  | $                                                                                                                                                             | 57,209  |         |        | $ | 75,462  |         |        | $ | 79,702  |       
|                                                         |                                                                                                                  |                                                                                                                                                               |         |         |        |   |         |         |       

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


F-6



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.     Organization






2.     Summary of significant
accounting policies




| |                            
| | ---------------------------
| | Principles of consolidation





| |                 
| | ----------------
| | Use of estimates





| |                       
| | ----------------------
| | Fair value information





| |                          
| | -------------------------
| | Cash and cash equivalents





| |                                
| | -------------------------------
| | Allowance for doubtful accounts



F-7



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)






| |                      
| | ---------------------
| | Marketable securities





| |                       
| | ----------------------
| | Property and equipment







| |                                 
| | --------------------------------
| | Investments in private companies





| |                           
| | --------------------------
| | Software development costs



F-8



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)






| |                                        
| | ---------------------------------------
| | Goodwill and acquired intangible assets



Impairment of
long-lived assets




| |                                
| | -------------------------------
| | Impairment of long-lived assets





| |             
| | ------------
| | Income taxes





| |                              
| | -----------------------------
| | Foreign currency translations



F-9



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)






| |                    
| | -------------------
| | Revenue recognition













F-10



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)






| |                         
| | ------------------------
| | Stock-based compensation





|                                                                                  |  |                      |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------- |  | -------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                  |  | Year Ended March 31, |        
|                                                                                  |  |                      |        
|                                                                                  |  | 2005                 |         |   | 2004 |   |         | 2003 | 
|                                                                                  |  |                      |         |   |      |   |         |      | 
|Net loss, as reported                                                             |  | $                    | (18,751 | ) |      | $ | (33,024 | )    |  | $ | (8,585  | )
|Add: Stock-based compensation expense determined under intrinsic
    value method |  |                      |        |   |      |   | 202     |      |  |   | 755     |  
|Less: Stock-based compensation expense determined under fair
    value method     |  |                      | (31,233 | ) |      |   | (51,084 | )    |  |   | (56,466 | )
|                                                                                  |  |                      |         |   |      |   |         |      | 
|Net loss, pro forma                                                               |  | $                    | (49,984 | ) |      | $ | (83,906 | )    |  | $ | (64,296 | )
|                                                                                  |  |                      |         |   |      |   |         |      | 
|Basic and diluted net loss per common share, as reported                          |  | $                    | (0.35   | ) |      | $ | (0.63   | )    |  | $ | (0.17   | )
|Basic and diluted net loss per common share, pro forma                            |  | $                    | (0.94   | ) |      | $ | (1.61   | )    |  | $ | (1.25   | )



|                        |  |                |     |   |                |  |     |      |  |  |      |   |  |      |     |   |      |  |     |   |  |  |     |  
|----------------------- |  | -------------- | --- | - | -------------- |  | --- | ---- |  |  | ---- | - |  | ---- | --- | - | ---- |  | --- | - |  |  | --- | -
|                        |  | Employee Stock |     |   | Employee Stock | 
|                        |  | Option Plans   |     |   | Purchase Plan  | 
|                        |  | March 31,      |     |   | March 31,      | 
|                        |  |                |     |   |                | 
|                        |  | 2005           |     |   | 2004           |  |     | 2003 |  |  | 2005 |   |  | 2004 |     |   | 2003 | 
|                        |  |                |     |   |                |  |     |      |  |  |      |   |  |      |     |   |      | 
|Expected volatility     |  |                | 85  | % |                |  | 95  | %    |  |  | 97   | % |  |      | 62  | % |      |  | 68  | % |  |  | 87  | %
|Risk-free interest rate |  |                | 3.8 | % |                |  | 2.9 | %    |  |  | 2.9  | % |  |      | 3.1 | % |      |  | 2.9 | % |  |  | 3.0 | %
|Expected life (years)   |  |                | 4   |   |                |  | 4   |      |  |  | 4    |   |  |      | 1.3 |   |      |  | 1   |   |  |  | 0.5 |  
|Expected dividend yield |  |                | 0   | % |                |  | 0   | %    |  |  | 0    | % |  |      | 0   | % |      |  | 0   | % |  |  | 0   | %





| |                                                                 
| | ----------------------------------------------------------------
| | Stock-based compensation to non-employees and warrant
    charge



F-11



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)






| |                   
| | ------------------
| | Net loss per share





| |                  
| | -----------------
| | Segment reporting





| |                               
| | ------------------------------
| | Guarantees and indemnification





| |                                 
| | --------------------------------
| | Recent accounting pronouncements





F-12



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)










|   |                           
|-- | --------------------------
|3. | Related-party transactions





|   |                               
|-- | ------------------------------
|4. | Investments in private company



F-13



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




4.     Investments in private
companies  (Continued)








|   |                              
|-- | -----------------------------
|5. | Concentrations of credit risk





|   |                      
|-- | ---------------------
|6. | Marketable securities



|                                     |  |                |        |  |                |   |        |      |  |   |            |  |  |   |        | 
|------------------------------------ |  | -------------- | ------ |  | -------------- | - | ------ | ---- |  | - | ---------- |  |  | - | ------ | 
|                                     |  | March 31, 2005 |        |  | March 31, 2004 |  
|                                     |  |                |        |  |                |  
|                                     |  | Cost           |        |  | Fair Value     |   |        | Cost |  |   | Fair Value | 
|                                     |  |                |        |  |                |   |        |      |  |   |            | 
|                                     |  | (In thousands) |        |  | (In thousands) |  
|Due in one year or less              |  | $              | 78,560 |  |                | $ | 78,332 |      |  | $ | 44,313     |  |  | $ | 44,328 | 
|Due after one year through two years |  |                | 14,647 |  |                |   | 14,513 |      |  |   | 36,037     |  |  |   | 36,157 | 
|                                     |  |                |        |  |                |   |        |      |  |   |            | 
|                                     |  | $              | 93,207 |  |                | $ | 92,845 |      |  | $ | 80,350     |  |  | $ | 80,485 | 
|                                     |  |                |        |  |                |   |        |      |  |   |            | 





|   |                       
|-- | ----------------------
|7. | Property and equipment



|                                          |  |                |         |   |      |   |         |  
|----------------------------------------- |  | -------------- | ------- | - | ---- | - | ------- | -
|                                          |  | March 31,      |        
|                                          |  |                |        
|                                          |  | 2005           |         |   | 2004 |  
|                                          |  |                |         |   |      |  
|                                          |  | (In thousands) |        
|Equipment                                 |  | $              | 16,593  |   |      | $ | 18,852  |  
|Software                                  |  |                | 8,824   |   |      |   | 6,049   |  
|Furniture                                 |  |                | 4,146   |   |      |   | 3,475   |  
|Leasehold improvements                    |  |                | 5,450   |   |      |   | 3,104   |  
|                                          |  |                |         |   |      |  
|                                          |  |                | 35,013  |   |      |   | 31,480  |  
|Accumulated depreciation and amortization |  |                | (24,671 | ) |      |   | (23,374 | )
|                                          |  |                |         |   |      |  
|                                          |  | $              | 10,342  |   |      | $ | 8,106   |  
|                                          |  |                |         |   |      |  



F-14



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




7.     Property and
equipment  (Continued)






|   |             
|-- | ------------
|8. | Income taxes







|         |  |                |         |   |      |   |         |      |  |   |         |  
|-------- |  | -------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|         |  | 2005           |         |   | 2004 |   |         | 2003 | 
|         |  |                |         |   |      |   |         |      | 
|         |  | (In thousands) |        
|Domestic |  | $              | (22,214 | ) |      | $ | (26,435 | )    |  | $ | 4,740   |  
|Foreign  |  |                | (1,032  | ) |      |   | (6,589  | )    |  |   | (13,325 | )
|         |  |                |         |   |      |   |         |      | 
|Total    |  | $              | (23,246 | ) |      | $ | (33,024 | )    |  | $ | (8,585  | )
|         |  |                |         |   |      |   |         |      | 



|                                      |  |                |          |   |      |   |          |  
|------------------------------------- |  | -------------- | -------- | - | ---- | - | -------- | -
|                                      |  | March 31,      |          |   |     
|                                      |  | 2005           |          |   | 2004 |  
|                                      |  |                |          |   |      |  
|                                      |  | (In thousands) |         
|Net operating loss carryforwards      |  | $              | 98,618   |   |      | $ | 103,419  |  
|Accrued expenses                      |  |                | 1,592    |   |      |   | 589      |  
|Deferred revenue                      |  |                | 1,363    |   |      |   | 3,459    |  
|Accounts receivable                   |  |                | 416      |   |      |   | 960      |  
|Impairment loss in equity investments |  |                | 2,751    |   |      |   | 2,350    |  
|Property and equipment                |  |                | 589      |   |      |   | (334     | )
|Stock option compensation             |  |                | 8,475    |   |      |   | 7,473    |  
|Acquired intangibles                  |  |                | 8,099    |   |      |   | (1,559   | )
|Research and development credit       |  |                | 9,783    |   |      |   | 8,034    |  
|Other                                 |  |                | (581     | ) |      |   | 384      |  
|Valuation allowance                   |  |                | (131,105 | ) |      |   | (124,775 | )
|                                      |  |                |          |   |      |  
|Net deferred tax assets               |  | $              |         |   |      | $ |         |  
|                                      |  |                |          |   |      |  



F-15



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




8.     Income taxes 
(Continued)






|                                                         |                    |           |       |     |      |  |       |      |   |  |       |    |  
|-------------------------------------------------------- | ------------------ | --------- | ----- | --- | ---- |  | ----- | ---- | - |  | ----- | -- | -
|                                                         |                    | March 31, |      
|                                                         |                    |           |      
|                                                         |                    | 2005      |       |     | 2004 |  |       | 2003 |  
|                                                         |                    |           |       |     |      |  |       |      |  
|U.S. Federal statutory rate                              |                    |           | (34.0 | )%  |      |  | (34.0 | )%   |   |  | (34.0 | )%
|State and local taxes, net of Federal income tax benefit |                    |           | (3.7  | )   |      |  | (3.1  | )    |   |  | 2.5   |   
|Non-deductible items                                     |                    |           | 2.2   |     |      |  | 1.1   |      |   |  | 2.1   |   
|Change in valuation allowance                            |                    |           | 44.0  |     |      |  | 44.5  |      |   |  | 34.0  |   
|Amortization of nondeductible goodwill                   |                    |           |      |     |      |  |      |      |   |  |      |   
|Change in general business credit                        |                    |           | (7.5  | )   |      |  | (5.3  | )    |   |  | (21.1 | ) 
|Foreign rate differential                                |                    |           |      |     |      |  | (3.2  | )    |   |  | 16.5  |   
|Other                                                    |                    |           |      |     |      |  |      |      |   |  |      |   
|                                                         |                    |           |       |     |      |  |       |      |  
|                                                         | Effective tax rate |           |       | 1.0 | %    |  |       |     | % |  |       |   | %
|                                                         |                    |           |       |     |      |  |       |      |  



|   |           
|-- | ----------
|9. | Borrowings









|    |                  
|--- | -----------------
|10. | Lease commitments



F-16



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




10.     Lease
commitments  (Continued)








|                                                 |            |                |        |        |         |   |      |     | 
|------------------------------------------------ | ---------- | -------------- | ------ | ------ | ------- | - | ---- | --- | 
|                                                 |            | Operating      |        |        | Capital |  
|                                                 |            |                |        |        |         |  
|                                                 |            | (In thousands) |       
|Years ending March 31, 2006                      |            | $              | 11,431 |        |         | $ | 502  |    
|                                                 | 2007       |                |        | 10,124 |         |   |      | 143 | 
|                                                 | 2008       |                |        | 6,535  |         |   |      |    | 
|                                                 | 2009       |                |        | 3,043  |         |   |      |    | 
|                                                 | 2010       |                |        | 2,741  |         |   |      |    | 
|                                                 | Thereafter |                |        | 16,372 |         |   |      |    | 
|                                                 |            |                |        |        |         |  
|                                                 |            | $              | 50,246 |        |         | $ | 645  |    
|                                                 |            |                |        |        |         |  
|Less amounts representing interest               |            |                |        |        |         |   | (31  | )  
|                                                 |            |                |        |        |         |  
|                                                 |            |                |        |        |         |   | 614  |    
|Less current portion                             |            |                |        |        |         |   | (475 | )  
|                                                 |            |                |        |        |         |  
|Capital lease obligation, net of current portion |            |                |        |        |         | $ | 139  |    
|                                                 |            |                |        |        |         |  



|    |                     
|--- | --------------------
|11. | Stockholders equity

Preferred stock




Warrant




F-17



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




11.     Stockholders
equity  (Continued)






12.     Business combinations




| |                      
| | ---------------------
| | Business acquisitions









F-18



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




12.     Business
acquisitions  (Continued)




|                                       |  |                 |        |   |     |   |       |       |  |   |        |  
|-------------------------------------- |  | --------------- | ------ | - | --- | - | ----- | ----- |  | - | ------ | -
|                                       |  | The Dante Group |        |   | TME |   |       | Total | 
|                                       |  |                 |        |   |     |   |       |       | 
|Cash and cash equivalents              |  | $               | 90     |   |     | $ | 3     |       |  | $ | 93     |  
|Accounts receivable                    |  |                 | 69     |   |     |   | 116   |       |  |   | 185    |  
|Property and equipment                 |  |                 | 146    |   |     |   | 31    |       |  |   | 177    |  
|Other assets                           |  |                 | 93     |   |     |   | 7     |       |  |   | 100    |  
|Accounts payable                       |  |                 | (32    | ) |     |   | (580  | )     |  |   | (612   | )
|Accrued expenses and other liabilities |  |                 | (231   | ) |     |   | (230  | )     |  |   | (461   | )
|Deferred revenue                       |  |                 | (138   | ) |     |   | (38   | )     |  |   | (176   | )
|In-process research and development    |  |                 | 3,138  |   |     |   | 1,146 |       |  |   | 4,284  |  
|Existing technology                    |  |                 | 3,530  |   |     |   | 2,379 |       |  |   | 5,909  |  
|Customer relationships                 |  |                 | 392    |   |     |   | 441   |       |  |   | 833    |  
|Goodwill                               |  |                 | 12,152 |   |     |   | 4,715 |       |  |   | 16,867 |  
|                                       |  |                 |        |   |     |   |       |       | 
|Total cash purchase price              |  | $               | 19,209 |   |     | $ | 7,990 |       |  | $ | 27,199 |  
|                                       |  |                 |        |   |     |   |       |       | 







|                                               |  |                      |         |   |      |   |         |  
|---------------------------------------------- |  | -------------------- | ------- | - | ---- | - | ------- | -
|                                               |  | Year Ended March 31, |        
|                                               |  |                      |        
|                                               |  | 2004                 |         |   | 2003 |  
|                                               |  |                      |         |   |      |  
|                                               |  | (Unaudited)          |        
|Pro forma net revenue                          |  | $                    | 190,083 |   |      | $ | 198,348 |  
|Pro forma net loss                             |  |                      | (35,355 | ) |      |   | (12,842 | )
|Pro forma net loss per basic and diluted share |  | $                    | (0.68   | ) |      | $ | (0.25   | )

F-19



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




12.     Business
acquisitions  (Continued)


Acquisition of technology






13.     Goodwill and intangible
assets








|                               |  |          |        | 
|------------------------------ |  | -------- | ------ | 
|                               |  | Goodwill |       
|                               |  |          |       
|Balance at March 31, 2003      |  | $        | 29,838 | 
|Acquisition of The Dante Group |  |          | 12,152 | 
|Acquisition of TME             |  |          | 4,715  | 
|                               |  |          |       
|Balance at March 31, 2004      |  | $        | 46,705 | 
|Balance at March 31, 2005      |  | $        | 46,705 | 
|                               |  |          |       



|                       |  |                      |        |  |                      |   |       |              |  |   |          |     |  |              |        |  |          |   |       |  |  |   |        | 
|---------------------- |  | -------------------- | ------ |  | -------------------- | - | ----- | ------------ |  | - | -------- | --- |  | ------------ | ------ |  | -------- | - | ----- |  |  | - | ------ | 
|                       |  | As of March 31, 2005 |        |  | As of March 31, 2004 |  
|                       |  |                      |        |  |                      |  
|                       |  | Gross                |        |  |                      |   | Gross |              |  |   |          | Net | 
|                       |  | Carrying             |        |  | Accumulated          |   |       | Net Carrying |  |   | Carrying |     |  | Accumulated  |        |  | Carrying |  
|                       |  | Amount               |        |  | Amortization         |   |       | Amount       |  |   | Amount   |     |  | Amortization |        |  | Amount   |  
|                       |  |                      |        |  |                      |   |       |              |  |   |          |     |  |              |        |  |          |  
|Existing technology    |  | $                    | 11,152 |  |                      | $ | 3,342 |              |  | $ | 7,810    |     |  | $            | 11,152 |  |          | $ | 1,112 |  |  | $ | 10,040 | 
|Customer relationships |  |                      | 833    |  |                      |   | 253   |              |  |   | 580      |     |  |              | 833    |  |          |   | 87    |  |  |   | 746    | 
|Total                  |  | $                    | 11,985 |  |                      | $ | 3,595 |              |  | $ | 8,390    |     |  | $            | 11,985 |  |          | $ | 1,199 |  |  | $ | 10,786 | 
|                       |  |                      |        |  |                      |   |       |              |  |   |          |     |  |              |        |  |          |  

F-20



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




13.     Goodwill and intangible
assets  (Continued)




|     |  |   |       | 
|---- |  | - | ----- | 
|2006 |  |   | 2,396 | 
|2007 |  |   | 2,396 | 
|2008 |  |   | 2,396 | 
|2009 |  |   | 1,202 | 
|     |  |   |      
|     |  | $ | 8,390 | 
|     |  |   |      

14.     Stock based compensation


Stock incentive plan








F-21



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




14.     Stock based
compensation  (Continued)




|                            |           |         |            |            |                |   |        |                  |  |   |        |        |  |   |       |       | 
|--------------------------- | --------- | ------- | ---------- | ---------- | -------------- | - | ------ | ---------------- |  | - | ------ | ------ |  | - | ----- | ----- | 
|                            |           | Stock   |            |            | Range of       |   |        | Weighted Average | 
|                            |           | Options |            |            | Exercise Price |   |        | Exercise Price   | 
|                            |           |         |            |            |                |   |        |                  | 
|Outstanding, March 31, 2002 |           |         | 15,578,211 |            |                | $ | 0.11  |                  |  | $ | 161.29 |        |  | $ | 19.77 |      
|                            | Granted   |         |            | 3,606,974  |                |   |        | 4.32            |  |   |        | 17.82  |  |   |       | 8.93  | 
|                            | Exercised |         |            | (906,603   | )              |   |        | 0.11            |  |   |        | 14.36  |  |   |       | 3.20  | 
|                            | Cancelled |         |            | (2,448,580 | )              |   |        | 0.11            |  |   |        | 151.09 |  |   |       | 17.70 | 
|                            |           |         |            |            |                |   |        |                 
|Outstanding, March 31, 2003 |           |         | 15,830,002 |            |                | $ | 0.11  |                  |  | $ | 161.29 |        |  | $ | 18.49 |      
|                            | Granted   |         |            | 5,598,215  |                |   |        | 7.54            |  |   |        | 11.70  |  |   |       | 9.00  | 
|                            | Exercised |         |            | (620,216   | )              |   |        | 0.11            |  |   |        | 9.08   |  |   |       | 4.90  | 
|                            | Cancelled |         |            | (4,016,541 | )              |   |        | 2.88            |  |   |        | 161.29 |  |   |       | 20.44 | 
|                            |           |         |            |            |                |   |        |                 
|Outstanding, March 31, 2004 |           |         | 16,791,460 |            |                | $ | 0.11  |                  |  | $ | 161.29 |        |  | $ | 15.30 |      
|                            | Granted   |         |            | 6,704,952  |                |   |        | 3.99            |  |   |        | 10.55  |  |   |       | 7.65  | 
|                            | Exercised |         |            | (295,939   | )              |   |        | 0.11            |  |   |        | 8.79   |  |   |       | 3.33  | 
|                            | Cancelled |         |            | (5,543,457 | )              |   |        | 3.99            |  |   |        | 161.29 |  |   |       | 14.88 | 
|                            |           |         |            |            |                |   |        |                 
|Outstanding, March 31, 2005 |           |         | 17,657,016 |            |                | $ | 0.11  |                  |  | $ | 115.75 |        |  | $ | 12.73 |      
|                            |           |         |            |            |                |   |        |                 



|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                |  |  |      |  |  |   |       |  |  |  |            |  |  |   |       | 
|--------------- | ----- | --------- |  | ---------------- | ---------------- | - | ------ | ---------------- |  |  | ------------------- |  | ---------- | -------------- |  |  | ---- |  |  | - | ----- |  |  |  | ---------- |  |  | - | ----- | 
|                |       |           |  |                  |                  |   |        | Outstanding      |  |  | Options Exercisable | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     | 
|                |       |           |  | Weighted Average |                  |   |        |                  | 
|Range of        |       | Number of |  |                  | Remaining        |   |        | Weighted Average |  |  | Number of           |  |            |               
|Exercise Prices |       | Shares    |  |                  | Contractual Life |   |        | Exercise Price   |  |  | Shares              |  |            | Exercise Price | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                | 
|$               | 0.11  |           |  |                 |                  | $ | 7.03   |                  |  |  |                     |  | 3,762,259  |                |  |  | 8.32 |  |  | $ | 4.88  |  |  |  | 1,373,906  |  |  | $ | 3.83  | 
|                | 7.05  |           |  |                 |                  |   | 8.87   |                  |  |  |                     |  | 4,295,436  |                |  |  | 7.95 |  |  |   | 8.34  |  |  |  | 2,254,750  |  |  |   | 8.31  | 
|                | 8.89  |           |  |                 |                  |   | 10.35  |                  |  |  |                     |  | 3,654,932  |                |  |  | 8.77 |  |  |   | 9.77  |  |  |  | 1,004,315  |  |  |   | 9.73  | 
|                | 10.37 |           |  |                 |                  |   | 13.99  |                  |  |  |                     |  | 757,258    |                |  |  | 6.54 |  |  |   | 11.65 |  |  |  | 536,881    |  |  |   | 11.96 | 
|                | 14.27 |           |  |                 |                  |   | 115.75 |                  |  |  |                     |  | 5,187,131  |                |  |  | 6.37 |  |  |   | 24.30 |  |  |  | 5,069,650  |  |  |   | 24.44 | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                |  |  |      |  |  |   |       |  | 
|$               | 0.11  |           |  |                 |                  | $ | 115.75 |                  |  |  |                     |  | 17,657,016 |                |  |  | 7.67 |  |  | $ | 12.73 |  |  |  | 10,239,502 |  |  | $ | 16.03 | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                |  |  |      |  |  |   |       |  | 



Employee Stock Purchase
Plan




F-22



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




14.     Stock based
compensation  (Continued)








|                             |  |  |       |  
|---------------------------- |  |  | ----- | -
|Balance at March 31, 2003.   |  |  | 3,028 |  
|                             |  |  |      
|Additional authorized shares |  |  | 750   |  
|Purchases                    |  |  | (360  | )
|                             |  |  |      
|Balance at March 31, 2004.   |  |  | 3,418 |  
|                             |  |  |      
|Additional authorized shares |  |  | 750   |  
|Purchases                    |  |  | (304  | )
|                             |  |  |      
|Balance at March 31, 2005.   |  |  | 3,864 |  
|                             |  |  |      

Shareholder Rights
Plan




15.     Employee benefit plan




F-23



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)


16.     Supplemental disclosures of
cash flow information:


|                                             |                                                                |                      |    |     |      |   |      |        |   |   |     |       |  | 
|-------------------------------------------- | -------------------------------------------------------------- | -------------------- | -- | --- | ---- | - | ---- | ------ | - | - | --- | ----- |  | 
|                                             |                                                                | Year Ended March 31, |   
|                                             |                                                                |                      |   
|                                             |                                                                | 2005                 |    |     | 2004 |   |      | 2003   |  
|                                             |                                                                |                      |    |     |      |   |      |        |  
|                                             |                                                                | (In thousands)       |   
|Cash paid during the period for interest     |                                                                | $                    | 98 |     |      | $ | 202  |        |   | $ | 673 |      
|                                             |                                                                |                      |    |     |      |   |      |        |  
|Non-cash investing and financing activities: |                                                                |                      |    |     |      |   |      |        |   |   |     |      
|                                             | Equipment purchased under capital lease                        |                      | $  | 313 |      |   | $    | 1,457  |   |   | $   | 1,665 | 
|                                             | Conversion of interest income into equity in private company   |                      |    |    |      |   |      | 257    |   |   |     |      | 
|                                             | Change in net unrealized gain or loss on marketable securities |                      |    | 496 |      |   |      | 165    |   |   |     | 135   | 
|Dante Acquisition:                           |                                                                |                      |    |     |      |   |      |        |   |   |     |      
|                                             | Fair value of assets acquired, net of cash acquired            |                      |    |    |      |   |      | 308    |   |   |     |      | 
|                                             |                                                                | Less:                |    |     |      |   |      |        |   |   |     |       |  | 
|                                             | Liabilities assumed                                            |                      |    |    |      |   |      | (401   | ) |   |     |      | 
|                                             |                                                                |                      |    |     |      |   |      |        |  
|                                             |                                                                |                      |   |     |      |   | (93  | )      |   |   |    |      
|                                             | In-process research and development                            |                      |    |    |      |   |      | 3,138  |   |   |     |      | 
|                                             | Existing technology                                            |                      |    |    |      |   |      | 3,530  |   |   |     |      | 
|                                             | Customer relationships                                         |                      |    |    |      |   |      | 392    |   |   |     |      | 
|                                             | Goodwill                                                       |                      |    |    |      |   |      | 12,152 |   |   |     |      | 
|                                             |                                                                |                      |    |     |      |   |      |        |  
|                                             | Cash paid for acquisition, net of cash acquired                |                      | $  |    |      |   | $    | 19,119 |   |   | $   |      | 
|                                             |                                                                |                      |    |     |      |   |      |        |  
|TME Acquisition:                             |                                                                |                      |    |     |      |   |      |        |   |   |     |      
|                                             | Fair value of assets acquired, net of cash acquired            |                      | $  |    |      |   | $    | 154    |   |   | $   |      | 
|                                             |                                                                | Less:                |    |     |      |   |      |        |   |   |     |       |  | 
|Liabilities assumed                          |                                                                |                      |   |     |      |   | (848 | )      |   |   |    |      
|                                             |                                                                |                      |    |     |      |   |      |        |  
|                                             |                                                                |                      |   |     |      |   | (694 | )      |   |   |    |      
|                                             | In-process research and development                            |                      |    |    |      |   |      | 1,146  |   |   |     |      | 
|                                             | Existing technology                                            |                      |    |    |      |   |      | 2,379  |   |   |     |      | 
|                                             | Customer relationships                                         |                      |    |    |      |   |      | 441    |   |   |     |      | 
|                                             | Goodwill                                                       |                      |    |    |      |   |      | 4,715  |   |   |     |      | 
|                                             |                                                                |                      |    |     |      |   |      |        |  
|                                             | Cash paid for acquisition, net of cash acquired                |                      | $  |    |      |   | $    | 7,987  |   |   | $   |      | 
|                                             |                                                                |                      |    |     |      |   |      |        |  
|DataChannel Assets Acquired from Netegrity:  |                                                                |                      |    |     |      |   |      |        |   |   |     |      
|                                             | Fair value of assets acquired, net of cash acquired            |                      | $  |    |      |   | $    | 101    |   |   | $   |      | 
|                                             |                                                                | Less:                |    |     |      |   |      |        |   |   |     |       |  | 
|                                             | Liabilities assumed                                            |                      |    |    |      |   |      | (66    | ) |   |     |      | 
|                                             |                                                                |                      |    |     |      |   |      |        |  
|                                             |                                                                |                      |   |     |      |   | 35   |        |   |   |    |      
|                                             | Existing technology                                            |                      |    |    |      |   |      | 5,243  |   |   |     |      | 
|                                             |                                                                |                      |    |     |      |   |      |        |  
|                                             | Cash paid for acquisition, net of cash acquired                |                      | $  |    |      |   | $    | 5,278  |   |   | $   |      | 
|                                             |                                                                |                      |    |     |      |   |      |        |  

F-24



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)


17.     Restructuring and related
charges










F-25



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)


17.     Restructuring and related
charges  (Continued)




|                                                                            |  |                 |        |   |              |   |       |             |  |   |             |   |  |            |        |   |       |   |      |   |  |   |        |  
|--------------------------------------------------------------------------- |  | --------------- | ------ | - | ------------ | - | ----- | ----------- |  | - | ----------- | - |  | ---------- | ------ | - | ----- | - | ---- | - |  | - | ------ | -
|                                                                            |  | Excess          |        |   |              |   |       |             |  |   |             |   | 
|                                                                            |  | Facilities      |        |   | Excess       |   |       | Excess      |  |   | Severance   |   |  | Impairment |        |   |      
|                                                                            |  | Santa Clara, CA |        |   | Facilities   |   |       | Facilities  |  |   | And Related |   |  | of Fixed   |        |   |      
|                                                                            |  | and Fairfax, VA |        |   | Berkeley, CA |   |       | Fairfax, VA |  |   | Benefits    |   |  | Assets     |        |   | Total |  
|                                                                            |  |                 |        |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|                                                                            |  | (In thousands)  |       
|Balance at March 31, 2002                                                   |  | $               | 2,995  |   |              | $ |      |             |  | $ |            |   |  | $          |       |   |       | $ |     |   |  | $ | 2,995  |  
|Fiscal 2003 charges                                                         |  |                 |       |   |              |   |      |             |  |   |            |   |  |            | 2,155  |   |       |   |     |   |  |   | 2,155  |  
|Cash payments made in fiscal 2003                                           |  |                 | (1,296 | ) |              |   |      |             |  |   |            |   |  |            | (2,101 | ) |       |   |     |   |  |   | (3,397 | )
|                                                                            |  |                 |        |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|Balance at March 31, 2003                                                   |  | $               | 1,699  |   |              | $ |      |             |  | $ |            |   |  | $          | 54     |   |       | $ |     |   |  | $ | 1,753  |  
|                                                                            |  |                 |        |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|Fiscal 2004 charges                                                         |  |                 |       |   |              |   | 1,508 |             |  | $ |            |   |  |            | 2,165  |   |       |   | 247  |   |  |   | 3,920  |  
|Non-cash write-down of fixed assets                                         |  |                 |       |   |              |   |      |             |  |   |            |   |  |            |       |   |       |   | (247 | ) |  |   | (247   | )
|Cash payments made in fiscal 2004                                           |  |                 | (782   | ) |              |   | (65   | )           |  |   |            |   |  |            | (1,470 | ) |       |   |     |   |  |   | (2,317 | )
|                                                                            |  |                 |        |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|Balance at March 31, 2004                                                   |  | $               | 917    |   |              | $ | 1,443 |             |  | $ |            |   |  | $          | 749    |   |       | $ |     |   |  | $ | 3,109  |  
|                                                                            |  |                 |        |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|Fiscal 2005 charges                                                         |  |                 |       |   |              |   |      |             |  |   | 3,093       |   |  |            | 3,012  |   |       |   |     |   |  |   | 6,105  |  
|Adjustments due to revision in estimated severance and related
    benefits |  |                 |       |   |              |   |      |             |  |   |            |   |  |            | (256   | ) |       |   |     |   |  |   | (256   | )
|Cash payments made in fiscal 2005                                           |  |                 | (383   | ) |              |   | (436  | )           |  |   | (193        | ) |  |            | (3,505 | ) |       |   |     |   |  |   | (4,517 | )
|                                                                            |  |                 |        |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|Balance at March 31, 2005                                                   |  | $               | 534    |   |              | $ | 1,007 |             |  | $ | 2,900       |   |  | $          |       |   |       | $ |     |   |  | $ | 4,441  |  
|                                                                            |  |                 |        |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  



F-26



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)


18.     Segment information




|                  |       |                       |         |         |      |   |         |         |  |   |         |         | 
|----------------- | ----- | --------------------- | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- | 
|                  |       | Years Ended March 31, |        
|                  |       |                       |        
|                  |       | 2005                  |         |         | 2004 |   |         | 2003    | 
|                  |       |                       |         |         |      |   |         |         | 
|                  |       | (In thousands)        |        
|Revenue           |       |                       |         |         |      |   |         |         |  |   |         |        
|Americas          |       | $                     | 119,610 |         |      | $ | 114,507 |         |  | $ | 133,756 |        
|EMEA              |       |                       | 50,599  |         |      |   | 44,965  |         |  |   | 36,351  |        
|Japan             |       |                       | 15,157  |         |      |   | 15,472  |         |  |   | 15,274  |        
|Asia Pacific      |       |                       | 15,235  |         |      |   | 14,597  |         |  |   | 11,373  |        
|                  |       |                       |         |         |      |   |         |         | 
|                  | Total |                       | $       | 200,601 |      |   | $       | 189,541 |  |   | $       | 196,754 | 
|                  |       |                       |         |         |      |   |         |         | 
|Long Lived Assets |       |                       |         |         |      |   |         |         |  |   |         |        
|Americas          |       | $                     | 67,572  |         |      | $ | 70,497  |         |  | $ | 47,853  |        
|EMEA              |       |                       | 1,852   |         |      |   | 2,189   |         |  |   | 2,228   |        
|Japan             |       |                       | 1,509   |         |      |   | 1,681   |         |  |   | 935     |        
|Asia Pacific      |       |                       | 630     |         |      |   | 360     |         |  |   | 541     |        
|                  |       |                       |         |         |      |   |         |         | 
|                  | Total |                       | $       | 71,563  |      |   | $       | 74,727  |  |   | $       | 51,557  | 
|                  |       |                       |         |         |      |   |         |         | 

F-27



---



##### 



SCHEDULE II  VALUATION AND QUALIFYING
ACCOUNTS




|                                                          |  |                |       |  |            |   |     |            |            |   |        |  |  |   |       | 
|--------------------------------------------------------- |  | -------------- | ----- |  | ---------- | - | --- | ---------- | ---------- | - | ------ |  |  | - | ----- | 
|                                                          |  | Balance at     |       |  |            |   |     |            | Balance at |  
|                                                          |  | Beginning of   |       |  |            |   |     |            | End of     |  
|                                                          |  | Period         |       |  | Provisions |   |     | Deductions |            |   | Period | 
|                                                          |  |                |       |  |            |   |     |            |            |   |        | 
|                                                          |  | (In thousands) |      
|Year ended March 31, 2003 allowance for doubtful accounts |  | $              | 3,685 |  |            | $ | 280 |            |            | $ | 1,115  |  |  | $ | 2,850 | 
|Year ended March 31, 2004 allowance for doubtful accounts |  |                | 2,850 |  |            |   | 19  |            |            |   | 766    |  |  |   | 2,103 | 
|Year ended March 31, 2005 allowance for doubtful accounts |  |                | 2,103 |  |            |   | 233 |            |            |   | 474    |  |  |   | 1,862 | 

F-28



---



##### 



Report of Independent Registered Public Accounting Firm on


Financial Statement Schedule







PRICEWATERHOUSECOOPERS LLP


F-29



---



##### 



EXHIBIT INDEX


|        |         |   |             |                                                                                                                           
|------- | ------- | - | ----------- | --------------------------------------------------------------------------------------------------------------------------
|Exhibit |         |   |            
|Number  |         |   | Description
|        |         |   |            
|        | 3.1(1)  |   |             | Fifth Amended and Restated Certificate of Incorporation of
    webMethods, Inc., as amended                               
|        | 3.2 (2  | ) |             | Amended and Restated Bylaws of webMethods, Inc.                                                                           
|        | 4.1(3)  |   |             | Specimen certificate for shares of webMethods, Inc. Common Stock                                                          
|        | 4.2(4)  |   |             | Rights Agreement dated as of October 18, 2001 between
    webMethods, Inc. and American Stock Transfer & Trust
    Company
|        | 10.2(5) |   |             | webMethods, Inc. Amended and Restated Stock Option Plan, as
    amended                                                   
|        | 10.3(3) |   |             | Employee Stock Purchase Plan                                                                                              
|        | 10.4(3) |   |             | Indemnification Agreement entered into between webMethods, Inc.
    and each of its directors                             
|        | 10.5(6) |   |             | Executive Agreement entered into between webMethods, Inc. and
    certain of its executive officers                       
|        | 10.6(7) |   |             | Form of Stock Option Agreement for stock option grants to
    employees or officers other than California residents       
|        | 10.7(8) |   |             | Form of Stock Option Agreement for stock option grants to
    directors                                                   
|        | 10.8(7) |   |             | Form of notice of grant of stock option                                                                                   
|        | 10.9 *  |   |             | Deferred Compensation Plan for Directors, as amended                                                                      
|        | 10.10(8 | ) |             | Consulting Agreement dated October 3, 2004 between Phillip
    Merrick and webMethods, Inc.                               
|        | 14(9)   |   |             | webMethods, Inc. Code of Ethics                                                                                           
|        | 21.1*   |   |             | Subsidiaries of webMethods, Inc.                                                                                          
|        | 23.1*   |   |             | Consent of PricewaterhouseCoopers LLP                                                                                     
|        | 24      |   |             | Power of Attorney (included on signature page hereof)                                                                     
|        | 31.1*   |   |             | Rule 13a-14(a) Certification of Chief Executive Officer                                                                   
|        | 31.2*   |   |             | Rule 13a-14(a) Certification of Chief Accounting Officer                                                                  
|        | 31.3*   |   |             | Rule 13a-14(a) Certification by Executive Vice President                                                                  
|        | 32.1* # |   |             | Section 1350 Certification of Chief Executive Officer                                                                     
|        | 32.2* # |   |             | Section 1350 Certification of Chief Accounting Officer                                                                    
|        | 32.3* # |   |             | Section 1350 Certification of Executive Vice President                                                                    




|    |                                                                                                                             
|--- | ----------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to webMethods Form 10-K for
    the year ended March 31, 2002 (File No. 1-15681).                
|   
|(2) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended December 31, 2004 (File
    No. 1-15681). 
|   
|(3) | Incorporated by reference to webMethods Registration
    Statement on Form S-1, as amended (File No. 333-91309).           
|   
|(4) | Incorporated by reference to webMethods Registration
    Statement on Form 8-A (File No. 1-15681).                         
|   
|(5) | Incorporated by reference to webMethods Form 10-K for
    the year ended March 31, 2003 (File No. 1-15681).                
|   
|(6) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended June 30, 2004 (File
    No. 1-15681).     
|   
|(7) | Incorporated by reference to webMethods Form 8-K
    dated October 2, 2004 (File No. 1-15681).                             
|   
|(8) | Incorporated by reference to webMethods Form 10-Q for
    the three months ended September 30, 2004 (File
    No. 1-15681).



---



##### 





|    |                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------
|(9) | Incorporated by reference to webMethods definitive proxy
    statement dated July 29, 2003 (File No. 1-15681).      
|   
|*   | Filed herewith.                                                                                                      
|   
|#   | This item is furnished as an exhibit to this report but is not
    filed with the Securities and Exchange Commission.