##### 









UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-K/A


(Amendment No. 2)


(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, 2004
| 
|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.)
|                                                                            
|3930 Pender Drive, 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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##### 



Explanatory Note to Form 10-K Amendment No. 2










| |   |                                                                                                            
| | - | -----------------------------------------------------------------------------------------------------------
| |  | Part II, Item 6. Selected Financial Data.                                                                  
|
| |  | Part II, Item 7. Managements Discussion and
    Analysis of Financial Condition and Results of Operations.
|
| |  | Part II, Item 8. Financial Statements and
    Supplementary Data.                                          
|
| |  | Part II, Item 9A. Controls and Procedures.                                                                 
|
| |  | Part III, Item 15. Exhibits and Financial Statement
    Schedules and Reports on Form 8-K.                 







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##### 



WEBMETHODS, INC.


FORM 10-K/A


TABLE OF CONTENTS


|           |  |                                                                                           |  |   
|---------- |  | ----------------------------------------------------------------------------------------- |  | --
|Part I    
|Item 1.    |  | Business                                                                                  |  | 1 
|           |  | Overview                                                                                  |  | 1 
|           |  | Industry Background                                                                       |  | 3 
|           |  | The webMethods Solution                                                                   |  | 4 
|           |  | webMethods Strategy                                                                      |  | 7 
|           |  | Customers                                                                                 |  | 9 
|           |  | Sales and Marketing                                                                       |  | 9 
|           |  | Partners and Strategic Relationships                                                      |  | 10
|           |  | Global Customer Services                                                                  |  | 11
|           |  | Product Development                                                                       |  | 11
|           |  | Competition                                                                               |  | 12
|           |  | Intellectual Property and Other Proprietary Rights                                        |  | 12
|           |  | Corporate Information                                                                     |  | 14
|           |  | Available Information                                                                     |  | 15
|           |  | Employees                                                                                 |  | 15
|           |  | Executive Officers of webMethods                                                          |  | 15
|           |  | Factors That May Affect Future Operating Results                                          |  | 17
|Item 2.    |  | Properties                                                                                |  | 25
|Item 3.    |  | Legal Proceedings                                                                         |  | 25
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                       |  | 26
|Part II   
|Item 5.    |  | Market for Registrants Common Stock and Related
    Stockholder Matters                  |  | 26
|Item 6.    |  | Selected Financial Data                                                                   |  | 28
|Item 7.    |  | Managements Discussion and Analysis of Financial Condition
    and Results of Operations |  | 29
|           |  | Recent Developments                                                                       |  | 29
|           |  | Overview                                                                                  |  | 30
|           |  | Results of Operations                                                                     |  | 34
|           |  | Liquidity and Capital Resources                                                           |  | 42
|           |  | Recently Issued Accounting Pronouncements                                                 |  | 43
|Item 7A.   |  | Quantitative and Qualitative Disclosures about Market Risk                                |  | 44
|Item 8.    |  | Financial Statements and Supplementary Data                                               |  | 44
|Item 9.    |  | Changes in and Disagreements with Accountants on Accounting and
    Financial Disclosures |  | 45
|Item 9A.   |  | Controls and Procedures                                                                   |  | 45
|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                            |  | 47
|Item 13.   |  | Certain Relationships and Related Transactions                                            |  | 47
|Item 14.   |  | Principal Accountant Fees and Services                                                    |  | 47
|Part IV   
|Item 15.   |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                           |  | 48
|Signatures |  | 50                                                                                       



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##### 



PART I




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



OVERVIEW








| |   |                                                                                                                                                                                                                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Mind Electric. webMethods acquired The Mind Electric,
    Inc., a privately-held provider of Web services and Service
    Oriented Architecture software that enables enterprise Service
    Oriented Architectures. The software products offered by
    webMethods that are derived from this acquisition are webMethods
    Fabrictm
    and webMethods Glue®.
|
| |  | The Dante Group. webMethods acquired The Dante Group,
    Inc., a privately-held provider of Business Activity Monitoring
    software. The software product offered by webMethods that is
    derived from this acquisition is webMethods
    Optimizetm.                                                                                                           

1



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| |   |                                                                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | DataChannel Portal. webMethods acquired certain assets of
    DataChannel (recently marketed as PortalMinder by Netegrity), a
    portal platform for creating secure, identity-driven portals
    within a scalable architecture. The software product offered by
    webMethods that is derived from this acquisition is webMethods
    Portaltm.



tm tm tm








2



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INDUSTRY BACKGROUND














3



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THE WEBMETHODS SOLUTION






4



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webMethods Enterprise Services Platform








| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Proven business integration functionality 
    inherited from our previous flagship offering, the webMethods
    Integration Platform  which allows companies to not
    only integrate existing applications and establish electronic
    communications with trading partners, but to incorporate these
    resources seamlessly into the Enterprise Service Oriented
    Architecture. The webMethods Integration Server, which unites
    enterprise application integration and business-to-business
    functionality under a common architecture, is the basis for this
    capability. As a foundation for business integration and
    Composite Application development, the webMethods Integration
    Server allows the customers information technology
    resources to be published, managed and orchestrated as Web
    services in a Service Oriented Architecture. With so much
    investment tied up in existing information technology systems,
    this is the most expedient and cost-effective path to populating
    a Service Oriented Architecture with the Web services that
    higher-level software tools, portals, and other service-based
    applications can leverage. The move to Web services also
    benefits downstream business integration initiatives through
    reusability and the reduced cost and complexity resulting from
    standardization.
|
| |  | A robust, scalable, high performance event-driven messaging
    capability that allows the webMethods Enterprise Services
    Platform to support real-time, message-oriented interactions in
    addition to the Web services request/reply style of interaction.
    Enabled by the webMethods Broker, event-driven processing
    naturally complements Web services by providing the real-time
    capabilities that are needed for Business Activity Monitoring
    and other applications. The webMethods
    Brokertmoffers
    reliable message delivery and a scalable publish/subscribe
    architecture that is capable of processing thousands of messages
    per second. The webMethods Broker is also the basis of
    webMethods
    JMS+tm,
    a Java Message Service-compliant messaging solution that is
    offered as a standalone product.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| |  | Enables implementation of an enterprise-caliber
    service-oriented infrastructure. Delivered by webMethods
    Fabric, the webMethods Enterprise Services Platform enables
    enterprises to go from small, static, brittle, ad hoc networks
    of unmanaged Web services to larger, dynamic, robust,
    coordinated networks of managed Web services. webMethods Fabric
    can be deployed as an intermediary or in conjunction with either
    the Web service producer or Web service consumer or both.
    webMethods Fabric coordinates the use of Web services in a
    Service Oriented Architecture regardless of what technology was
    used to create those services including, but not limited to,
    webMethods software, J2EE application servers, .NET-based
    applications, other packaged applications or mainframe
    environments. With this flexible deployment architecture,
    customers can reduce network latency and create a more secure
    and robust environment for deploying a Service Oriented
    Architecture. These include capabilities such as Web services
    monitoring and management, service discovery, dynamic binding,
    failover and load-balancing, and intelligent message processing.                                                                                                                                                
|
| |  | An extensive library of adaptersso that the webMethods
    Enterprise Services Platform can integrate the numerous
    proprietary interfaces presented by a broad variety of
    enterprise applications (e.g., supply chain management software
    from i2 Technologies, inter-enterprise software solutions
    from SAP AG, sales, marketing and customer relationship
    management software from Siebel Systems, customer relationship
    management and enterprise management software from PeopleSoft).
    The                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

5



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##### 



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | webMethods Enterprise Services Platform can also be extended by
    customers and partners through the use of webMethods software
    toolkits that allow them to develop interfaces to integrate
    custom applications or other software with the webMethods
    Enterprise Services Platform.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | Support for a wide range of electronic commerce protocolsthat enable our customers to automate and integrate their
    commercial transactions generated by their information
    technology resources with the information systems of their
    customers and business partners. Examples of these types of
    transactions include purchasing and procurement, supply chain
    management, collaborative product design and vendor-managed
    inventory. Our software supports a broad range of capabilities
    to support these and other initiatives of an enterprise to
    integrate its information resources with those of its customers
    and business partners. These protocols include XML, traditional
    and Internet EDI, Commerce Ones xCBL, RosettaNet, Chem
    eStandards and ebXML.
|
| |  | A high-performance Java Web services platformwith
    webMethods Glue. webMethods Glue eliminates the traditional
    complexity of Web services development. Targeted at the Java
    developer, webMethods Glue provides the fastest and easiest way
    to turn ordinary Java objects into Web services with very little
    incremental effort. By using webMethods Glue, developers can
    publish any Java object as a Web service using just a few lines
    of code, while remote Web services can be invoked as if they
    were local Java objects.                                                                                                                                                                                                                                                
|
| |  | Capabilities targeted at J2EE and .NETdevelopers to make
    it easier for users of those technologies to connect their
    application into the Enterprise Service Oriented Architecture.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

Business Process Management (BPM)




Business Activity Monitoring (BAM)




6



---



##### 



Composite Application Framework


tm


WEBMETHODS STRATEGY




Focus on Customer Success.


Expand and Maximize Our Strategic Software Vendor
Partnerships.




Concentrate on Major Systems Integrators.


7



---



##### 







Extend Technology and Product Leadership to Provide the Most
Compelling Integration Solution.


Continue to Demonstrate Leadership in Web Services and
Service Oriented Architecture.


Extend the Value of Integration to the Business Users at Our
Customers and Prospects.




8



---



##### 



CUSTOMERS






SALES AND MARKETING














9



---



##### 





PARTNERS AND STRATEGIC RELATIONSHIPS








tm






10



---



##### 



GLOBAL CUSTOMER SERVICES


tm






PRODUCT DEVELOPMENT








11



---



##### 



COMPETITION






INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS






12



---



##### 















13



---



##### 















CORPORATE INFORMATION




14



---



##### 





AVAILABLE INFORMATION


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


EMPLOYEES




EXECUTIVE OFFICERS OF WEBMETHODS




|                  |  |     |    |  |          |                                                                
|----------------- |  | --- | -- |  | -------- | ---------------------------------------------------------------
|Name              |  | Age |    |  | Position
|                  |  |     |    |  |         
|Phillip Merrick   |  |     | 41 |  |          | Chairman of the Board and Chief Executive Officer              
|David Mitchell    |  |     | 39 |  |          | President and Chief Operating Officer                          
|Richard Chiarello |  |     | 51 |  |          | Executive Vice President, Worldwide Operations                 
|Mary Dridi        |  |     | 43 |  |          | Chief Financial Officer, Executive Vice President and Treasurer
|Douglas W. McNitt |  |     | 39 |  |          | General Counsel, Executive Vice President and Secretary        
|Kristin A. Weller |  |     | 33 |  |          | Executive Vice President, Product Development                  

Phillip Merrick


15



---



##### 





David Mitchell


Richard Chiarello


Mary Dridi


Douglas W. McNitt


Kristin A. Weller


16



---



##### 



FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS




Unanticipated fluctuations in our quarterly revenue or
operating results, or failure to return to and maintain
profitability, could significantly affect the price of
webMethods common stock.






Growth of our sales may slow from time to time, causing
our quarterly operating results to fluctuate and possibly
resulting in significant volatility in the market price of
webMethods common stock.




17



---



##### 







We are a relatively young company and have a relatively
limited operating history with which to evaluate our business
and the prospects of achieving our anticipated growth and our
forecasts of operating results.




Our target markets are highly competitive, and we may not
be able to compete effectively.




18



---



##### 





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




Recent and future acquisitions of companies or
technologies may result in disruptions to our business, dilution
or other adverse effects on future financial results or the
distraction of our management.






19



---



##### 





Treating stock options and employee stock purchase plan
participation as a compensation expense could significantly
impair our ability to return to and maintain
profitability.




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






20



---



##### 





We are trying to increase our sales to the US Government
and to others in the public sector, and we may face difficulties
in our attempts to procure new contracts with them and risks
unique to government contracts that may have a detrimental
impact on our business or operating results.






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




21



---



##### 



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




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




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






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




22



---



##### 





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




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




23



---



##### 





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






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




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




24



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##### 





|        |           
|------- | ----------
|Item 2. | PROPERTIES







|        |                  
|------- | -----------------
|Item 3. | LEGAL PROCEEDINGS







25



---



##### 





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



PART II




|        |                                                                         
|------- | ------------------------------------------------------------------------
|Item 5. | MARKET FOR REGISTRANTS COMMON STOCK AND RELATED
    STOCKHOLDER MATTERS



|                           |                                           |      |   |       |     |  |   |      | 
|-------------------------- | ----------------------------------------- | ---- | - | ----- | --- |  | - | ---- | 
|                           |                                           | High |   |       | Low | 
|                           |                                           |      |   |       |     | 
|Year ended March 31, 2003: |                                           |      |   |       |     |  |   |     
|                           | First Quarter (ended June 30, 2002)       |      | $ | 18.64 |     |  | $ | 7.61 | 
|                           | Second Quarter (ended September 30, 2002) |      |   | 11.83 |     |  |   | 4.71 | 
|                           | Third Quarter (ended December 31, 2002)   |      |   | 10.24 |     |  |   | 4.25 | 
|                           | Fourth Quarter (ended March 31, 2003)     |      |   | 12.82 |     |  |   | 8.07 | 

|                           |                                           |      |  |       |     |  |  |      | 
|-------------------------- | ----------------------------------------- | ---- |  | ----- | --- |  |  | ---- | 
|                           |                                           | 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 | 







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       |  |                      | 16,619,841 | (1) |                      | $ | 15.0218                        | (1)                           |  |  | 2,647,357 | (1)
|Equity compensation plans not approved by securities holders |  |                      | 171,619    | (2) |                      |   | 42.1032                        | (2)                           |  |  |          |    
|                                                             |  |                      |            |     |                      |   |                                |                               | 
|Total                                                        |  |                      | 16,791,460 |     |                      | $ | 15.3001                        |                               |  |  | 2,647,357 |    
|                                                             |  |                      |            |     |                      |   |                                |                               | 

26



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##### 








|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes webMethods Employee Stock Purchase Plan, under
    which, as of March 31, 2004, a total of
    4,500,000 shares of webMethods common stock have been
    reserved for issuance, 1,081,624 shares had been issued at
    an average purchase price of $11.6835 and 3,418,376 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, 2004.                                                                           
|   
|(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. 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.



27



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##### 





|        |                        
|------- | -----------------------
|Item 6. | SELECTED FINANCIAL DATA



|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        | 
|------------------------------------------------------------------------------------- | ------------------------------------------ | ------------------------------------------- | ------------------------ | ------ | ------ | ------- | ------- | ------- | ------ | ------- | ------- | ------- | ------- | ------- | -------- | ------- | ------- | ------- | ------- | ------ | ------ | ------ | 
|                                                                                      |                                            | Year Ended March 31,                        |                         
|                                                                                      |                                            |                                             |                         
|(In thousands, except per share amounts)                                              |                                            | 2004                                        |                          |        | 2003   |         |         | 2002    |        |         | 2001    |         |         | 2000    |         
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|                                                                                      |                                            | *As restated                                |                          |        |        |         |         |         |        |         |        
|Consolidated Statements of Operations Data:                                           |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |          |         |         |         |         |       
|Revenue:                                                                              |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |          |         |         |         |         |       
|                                                                                      | License                                    |                                             | $                        | 92,740 |        |         | $       | 117,066 |        |         | $       | 121,803 |         |         | $        | 143,514 |         |         | $       | 42,822 |       
|                                                                                      | Professional services                      |                                             |                          | 43,634 |        |         |         | 33,378  |        |         |         | 35,800  |         |         |          | 34,945  |         |         |         | 11,699 |       
|                                                                                      | Maintenance                                |                                             |                          | 53,167 |        |         |         | 46,310  |        |         |         | 38,393  |         |         |          | 23,498  |         |         |         | 5,624  |       
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|                                                                                      |                                            |                                             | Total revenue            |        |        | 189,541 |         |         |        | 196,754 |         |         |         | 195,996 |          |         |         | 201,957 |         |        |        | 60,145 | 
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|Cost of revenue:                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |          |         |         |         |         |       
|                                                                                      | Amortization of intangibles                |                                             |                          | 1,199  |        |         |         |        |        |         |         |        |         |         |          |        |         |         |         |       |       
|                                                                                      | License                                    |                                             |                          | 2,211  |        |         |         | 1,937   |        |         |         | 2,335   |         |         |          | 5,189   |         |         |         | 2,612  |       
|                                                                                      | Professional services and maintenance:     |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |          |         |         |         |         |        |       
|                                                                                      |                                            | Stock based compensation                    |                          |        | 56     |         |         |         | 251    |         |         |         | 436     |         |          |         | 1,188   |         |         |        | 560    |       
|                                                                                      |                                            | Other professional services and maintenance |                          |        | 53,457 |         |         |         | 41,937 |         |         |         | 42,124  |         |          |         | 46,304  |         |         |        | 16,102 |       
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|                                                                                      |                                            |                                             | Total cost of revenue    |        |        | 56,923  |         |         |        | 44,125  |         |         |         | 44,895  |          |         |         | 52,681  |         |        |        | 19,274 | 
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|Gross profit                                                                          |                                            |                                             | 132,618                  |        |        |         | 152,629 |         |        |         | 151,101 |         |         |         | 149,276  |         |         |         | 40,871  |       
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|Operating expenses:                                                                   |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |          |         |         |         |         |       
|                                                                                      | Sales and marketing:                       |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |          |         |         |         |         |        |       
|                                                                                      |                                            | Stock based compensation and warrant charge |                          |        | 2,769  |         |         |         | 3,761  |         |         |         | 2,865   |         |          |         | 4,813   |         |         |        | 1,471  |       
|                                                                                      |                                            | Other sales and marketing costs             |                          |        | 91,664 |         |         |         | 92,958 |         |         |         | 106,377 |         |          |         | 100,154 |         |         |        | 44,033 |       
|                                                                                      | Research and development:                  |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |          |         |         |         |         |        |       
|                                                                                      |                                            | Stock based compensation                    |                          |        | 15     |         |         |         | 97     |         |         |         | 12,526  |         |          |         | 12,447  |         |         |        | 1,250  |       
|                                                                                      |                                            | Other research and development costs        |                          |        | 45,045 |         |         |         | 47,441 |         |         |         | 49,634  |         |          |         | 45,158  |         |         |        | 14,780 |       
|                                                                                      | General and administrative:                |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |          |         |         |         |         |        |       
|                                                                                      |                                            | Stock based compensation                    |                          |        | 7      |         |         |         | 47     |         |         |         | 433     |         |          |         | 1,640   |         |         |        | 307    |       
|                                                                                      |                                            | Other general and administrative costs      |                          |        | 17,873 |         |         |         | 17,831 |         |         |         | 19,372  |         |          |         | 20,837  |         |         |        | 9,753  |       
|                                                                                      | Restructuring and related charges          |                                             |                          | 3,920  |        |         |         | 2,155   |        |         |         | 7,243   |         |         |          |        |         |         |         |       |       
|                                                                                      | Acquisition related expenses               |                                             |                          |       |        |         |         |        |        |         |         |        |         |         |          | 34,039  |         |         |         |       |       
|                                                                                      | Amortization of goodwill and intangibles   |                                             |                          |       |        |         |         |        |        |         |         | 38,697  |         |         |          | 41,395  |         |         |         | 1,305  |       
|                                                                                      | In-process research and development        |                                             |                          | 4,284  |        |         |         |        |        |         |         |        |         |         |          | 34,910  |         |         |         | 2,737  |       
|                                                                                      | Settlement of intellectual property matter |                                             |                          | 2,250  |        |         |         |        |        |         |         |        |         |         |          |        |         |         |         |       |       
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|                                                                                      |                                            |                                             | Total operating expenses |        |        | 167,827 |         |         |        | 164,290 |         |         |         | 237,147 |          |         |         | 295,393 |         |        |        | 75,636 | 
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|Operating loss                                                                        |                                            |                                             | (35,209                  | )      |        |         | (11,661 | )       |        |         | (86,046 | )       |         |         | (146,117 | )       |         |         | (34,765 | )     
|Interest income                                                                       |                                            |                                             | 2,851                    |        |        |         | 4,732   |         |        |         | 9,116   |         |         |         | 14,894   |         |         |         | 3,507   |       
|Interest expense                                                                      |                                            |                                             | (205                     | )      |        |         | (674    | )       |        |         | (553    | )       |         |         | (503     | )       |         |         | (145    | )     
|Other income (expense)                                                                |                                            |                                             | (461                     | )      |        |         | 18      |         |        |         | (26     | )       |         |         | 112      |         |         |         | (47     | )     
|Impairment of equity investments in private companies                                 |                                            |                                             |                         |        |        |         | (1,000  | )       |        |         | (5,200  | )       |         |         |         |         |         |         |        |       
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|Loss before income taxes                                                              |                                            |                                             | (33,024                  | )      |        |         | (8,585  | )       |        |         | (82,709 | )       |         |         | (131,614 | )       |         |         | (31,450 | )     
|Provision for income taxes                                                            |                                            |                                             |                         |        |        |         |        |         |        |         |        |         |         |         |         |         |         |         |        |       
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|Net loss                                                                              |                                            |                                             | (33,024                  | )      |        |         | (8,585  | )       |        |         | (82,709 | )       |         |         | (131,614 | )       |         |         | (31,450 | )     
|Accretion and accrued dividends related to mandatorily
    redeemable preferred stock |                                            |                                             |                         |        |        |         |        |         |        |         |        |         |         |         |         |         |         |         | (10,223 | )     
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|Net loss                                                                              |                                            | $                                           | (33,024                  | )      |        | $       | (8,585  | )       |        | $       | (82,709 | )       |         | $       | (131,614 | )       |         | $       | (41,673 | )     
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|Basic and diluted net loss per share                                                  |                                            | $                                           | (0.63                    | )      |        | $       | (0.17   | )       |        | $       | (1.67   | )       |         | $       | (2.81    | )       |         | $       | (2.23   | )     
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         
|Shares used in computing basic and diluted net loss per common
    share              |                                            |                                             | 52,137                   |        |        |         | 51,282  |         |        |         | 49,493  |         |         |         | 46,860   |         |         |         | 18,717  |       
|                                                                                      |                                            |                                             |                          |        |        |         |         |         |        |         |         |         |         |         |         






|  |                                                                      
|- | ---------------------------------------------------------------------
|* | See note 2 to the accompanying consolidated financial
    statements.

28



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##### 



|                                                                                                 |  |              |         |  |      |   |         |      |  |   |         |  |  |      |         |  |  |   |         | 
|------------------------------------------------------------------------------------------------ |  | ------------ | ------- |  | ---- | - | ------- | ---- |  | - | ------- |  |  | ---- | ------- |  |  | - | ------- | 
|                                                                                                 |  | March 31,    |        
|                                                                                                 |  |              |        
|(In thousands)                                                                                   |  | 2004         |         |  | 2003 |   |         | 2002 |  |   | 2001    |  |  | 2000 |        
|                                                                                                 |  |              |         |  |      |   |         |      |  |   |         |  |  |      |        
|                                                                                                 |  | *As restated |         |  |      |   |         |      |  |   |        
|Consolidated Balance Sheet Data:                                                                 |  |              |         |  |      |   |         |      |  |   |         |  |  |      |         |  |  |   |         | 
|Cash, cash equivalents and short-term and long-term marketable
    securities available for sale |  | $            | 155,947 |  |      | $ | 201,626 |      |  | $ | 211,842 |  |  | $    | 206,389 |  |  | $ | 196,972 | 
|Working capital                                                                                  |  |              | 93,692  |  |      |   | 149,424 |      |  |   | 178,909 |  |  |      | 190,722 |  |  |   | 181,355 | 
|Total assets                                                                                     |  |              | 283,650 |  |      |   | 304,436 |      |  |   | 324,063 |  |  |      | 375,288 |  |  |   | 299,187 | 
|Long-term liabilities                                                                            |  |              | 7,439   |  |      |   | 7,267   |      |  |   | 21,653  |  |  |      | 25,409  |  |  |   | 6,208   | 
|Total stockholders equity                                                                       |  |              | 197,137 |  |      |   | 218,559 |      |  |   | 215,544 |  |  |      | 265,609 |  |  |   | 252,169 | 






|  |                                                                      
|- | ---------------------------------------------------------------------
|* | See note 2 to the accompanying consolidated financial
    statements.



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



RECENT DEVELOPMENTS


Restatements








29



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##### 











OVERVIEW


Background








30



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##### 









Critical Accounting Policies and Estimates






Revenue Recognition




31



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##### 







Allowance for Doubtful Accounts




Business Combinations








Goodwill and Intangible Assets




32



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##### 





Acquired In-process Research and Development




Foreign Currency Effects




Accounting for Income Taxes




Restructuring and Related Charges




Litigation and Contingencies




33



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##### 





RESULTS OF OPERATIONS




|                         |  |                  |         |    |            |  |       |           |  |  |            |    |  |           |       |    |  |  |         |   
|------------------------ |  | ---------------- | ------- | -- | ---------- |  | ----- | --------- |  |  | ---------- | -- |  | --------- | ----- | -- |  |  | ------- | --
|                         |  | March 31,        |         |    | Percentage |  |       | March 31, |  |  | Percentage |    |  | March 31, |      
|                         |  | 2004             |         |    | Change     |  |       | 2003      |  |  | Change     |    |  | 2002      |      
|                         |  |                  |         |    |            |  |       |           |  |  |            |    |  |           |      
|                         |  | As restated      |         |    |            |  |       |           |  |  |           
|                         |  | ($ in thousands) |        
|Total revenue            |  |                  | 189,541 |    |            |  | (3.7  | )%        |  |  | 196,754    |    |  |           | 0.4   | %  |  |  | 195,996 |   
|Gross profit             |  |                  | 132,618 |    |            |  | (13.1 | )%        |  |  | 152,629    |    |  |           | 1.0   | %  |  |  | 151,101 |   
|% of total revenue       |  |                  | 70.0    | %  |            |  |       |           |  |  | 77.6       | %  |  |           |       |    |  |  | 77.1    | % 
|Total operating expenses |  |                  | 167,827 |    |            |  | 2.2   | %         |  |  | 164,290    |    |  |           | (30.7 | )% |  |  | 237,147 |   
|% of total revenue       |  |                  | 88.5    | %  |            |  |       |           |  |  | 83.5       | %  |  |           |       |    |  |  | 121.0   | % 
|Operating loss           |  |                  | (35,209 | )  |            |  | 202.0 | %         |  |  | (11,661    | )  |  |           | (86.4 | )% |  |  | (86,046 | ) 
|% of total revenue       |  |                  | (18.6   | )% |            |  |       |           |  |  | (5.9       | )% |  |           |       |    |  |  | (43.9   | )%
|Net loss                 |  |                  | (33,024 | )  |            |  | 284.7 | %         |  |  | (8,585     | )  |  |           | (89.6 | )% |  |  | (82,709 | ) 
|% of total revenue       |  |                  | (17.4   | )% |            |  |       |           |  |  | (4.4       | )% |  |           |       |    |  |  | (42.2   | )%





Revenue




|                      |  |                  |         |  |            |  |       |           |  |   |            |  |  |           |      |    |  |   |         | 
|--------------------- |  | ---------------- | ------- |  | ---------- |  | ----- | --------- |  | - | ---------- |  |  | --------- | ---- | -- |  | - | ------- | 
|                      |  | March 31,        |         |  | Percentage |  |       | March 31, |  |   | Percentage |  |  | March 31, |     
|                      |  | 2004             |         |  | Change     |  |       | 2003      |  |   | Change     |  |  | 2002      |     
|                      |  |                  |         |  |            |  |       |           |  |   |            |  |  |           |     
|                      |  | As restated      |         |  |            |  |       |           |  |   |           
|                      |  | ($ in thousands) |        
|License               |  | $                | 92,740  |  |            |  | (20.8 | )%        |  | $ | 117,066    |  |  |           | (3.9 | )% |  | $ | 121,803 | 
|Professional services |  |                  | 43,634  |  |            |  | 30.7  | %         |  |   | 33,378     |  |  |           | (6.8 | )% |  |   | 35,800  | 
|Maintenance           |  |                  | 53,167  |  |            |  | 14.8  | %         |  |   | 46,310     |  |  |           | 20.6 | %  |  |   | 38,393  | 
|                      |  |                  |         |  |            |  |       |           |  |   |            |  |  |           |     
|Total revenue         |  | $                | 189,541 |  |            |  | (3.7  | )%        |  | $ | 196,754    |  |  |           | 0.4  | %  |  | $ | 195,996 | 
|                      |  |                  |         |  |            |  |       |           |  |   |            |  |  |           |     

34



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##### 





|              |  |                  |         |  |            |  |       |           |  |   |            |  |  |           |       |    |  |   |         | 
|------------- |  | ---------------- | ------- |  | ---------- |  | ----- | --------- |  | - | ---------- |  |  | --------- | ----- | -- |  | - | ------- | 
|              |  | March 31,        |         |  | Percentage |  |       | March 31, |  |   | Percentage |  |  | March 31, |      
|              |  | 2004             |         |  | Change     |  |       | 2003      |  |   | Change     |  |  | 2002      |      
|              |  |                  |         |  |            |  |       |           |  |   |            |  |  |           |      
|              |  | As restated      |         |  |            |  |       |           |  |   |           
|              |  | ($ in thousands) |        
|Americas      |  | $                | 114,507 |  |            |  | (14.4 | )%        |  | $ | 133,756    |  |  |           | (6.5  | )% |  | $ | 143,003 | 
|Europe        |  |                  | 44,965  |  |            |  | 23.7  | %         |  |   | 36,351     |  |  |           | 1.9   | %  |  |   | 35,666  | 
|Japan         |  |                  | 15,472  |  |            |  | 1.3   | %         |  |   | 15,274     |  |  |           | 130.3 | %  |  |   | 6,632   | 
|Asia Pacific  |  |                  | 14,597  |  |            |  | 28.3  | %         |  |   | 11,373     |  |  |           | 6.3   | %  |  |   | 10,695  | 
|              |  |                  |         |  |            |  |       |           |  |   |            |  |  |           |      
|Total revenue |  | $                | 189,541 |  |            |  | (3.7  | )%        |  | $ | 196,754    |  |  |           | 0.4   | %  |  | $ | 195,996 | 
|              |  |                  |         |  |            |  |       |           |  |   |            |  |  |           |      









35



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##### 



Gross margin




|                                      |  |                   |    |   |           |  |    |           |  |  |    |  
|------------------------------------- |  | ----------------- | -- | - | --------- |  | -- | --------- |  |  | -- | -
|                                      |  | Fiscal Year Ended |   
|                                      |  |                   |   
|                                      |  | March 31,         |    |   | March 31, |  |    | March 31, | 
|                                      |  | 2004              |    |   | 2003      |  |    | 2002      | 
|                                      |  |                   |    |   |           |  |    |           | 
|                                      |  | As restated       |    |   |           |  |   
|License                               |  |                   | 96 | % |           |  | 98 | %         |  |  | 98 | %
|Professional services and maintenance |  |                   | 45 | % |           |  | 47 | %         |  |  | 43 | %
|Total revenue                         |  |                   | 70 | % |           |  | 78 | %         |  |  | 77 | %







36



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##### 



Operating expenses




|                                              |  |                   |         |   |            |  |       |           |  |   |            |   |  |           |        |    |  |   |         |  
|--------------------------------------------- |  | ----------------- | ------- | - | ---------- |  | ----- | --------- |  | - | ---------- | - |  | --------- | ------ | -- |  | - | ------- | -
|                                              |  | Fiscal Year Ended |        
|                                              |  |                   |        
|                                              |  | March 31,         |         |   | Percentage |  |       | March 31, |  |   | Percentage |   |  | March 31, |       
|                                              |  | 2004              |         |   | Change     |  |       | 2003      |  |   | Change     |   |  | 2002      |       
|                                              |  |                   |         |   |            |  |       |           |  |   |            |   |  |           |       
|                                              |  | As restated       |         |   |            |  |       |           |  |   |           
|                                              |  | ($ in thousands)  |        
|Operating Expenses:                           |  |                   |         |   |            |  |       |           |  |   |            |   |  |           |        |    |  |   |         |  
|Sales and marketing*                          |  | $                 | 91,664  |   |            |  | (1.4  | )%        |  | $ | 92,958     |   |  |           | (12.6  | )% |  | $ | 106,377 |  
|% of total revenue                            |  |                   | 48.4    | % |            |  |       |           |  |   | 47.2       | % |  |           |        |    |  |   | 54.3    | %
|Research and development*                     |  |                   | 45,045  |   |            |  | (5.1  | )%        |  |   | 47,441     |   |  |           | (4.4   | )% |  |   | 49,634  |  
|% of total revenue                            |  |                   | 23.8    | % |            |  |       |           |  |   | 24.1       | % |  |           |        |    |  |   | 25.3    | %
|General and administrative*                   |  |                   | 17,873  |   |            |  | 0.2   | %         |  |   | 17,831     |   |  |           | (8.0   | )% |  |   | 19,372  |  
|% of total revenue                            |  |                   | 9.4     | % |            |  |       |           |  |   | 9.1        | % |  |           |        |    |  |   | 9.9     | %
|Stock based compensation and warrant charge** |  |                   | 2,791   |   |            |  | (28.5 | )%        |  |   | 3,905      |   |  |           | (75.3  | )% |  |   | 15,824  |  
|% of total revenue                            |  |                   | 1.5     | % |            |  |       |           |  |   | 2.0        | % |  |           |        |    |  |   | 8.1     | %
|Restructuring and related charges             |  |                   | 3,920   |   |            |  | 81.9  | %         |  |   | 2,155      |   |  |           | (70.2  | )% |  |   | 7,243   |  
|% of total revenue                            |  |                   | 2.1     | % |            |  |       |           |  |   | 1.1        | % |  |           |        |    |  |   | 3.7     | %
|Amortization of goodwill and intangibles      |  |                   |        |   |            |  | 0.0   | %         |  |   |           |   |  |           | (100.0 | )% |  |   | 38,697  |  
|% of total revenue                            |  |                   | 0.0     | % |            |  |       |           |  |   | 0.0        | % |  |           |        |    |  |   | 19.7    | %
|In-process research and development           |  |                   | 4,284   |   |            |  | 100.0 | %         |  |   |           |   |  |           | 0.0    | %  |  |   |        |  
|% of total revenue                            |  |                   | 2.3     | % |            |  |       |           |  |   | 0.0        | % |  |           |        |    |  |   | 0.0     | %
|Settlement of intellectual property matter    |  |                   | 2,250   |   |            |  | 100.0 | %         |  |   |           |   |  |           | 0.0    | %  |  |   |        |  
|% of total revenue                            |  |                   | 1.2     | % |            |  |       |           |  |   | 0.0        | % |  |           |        |    |  |   | 0.0     | %
|Operating expense                             |  | $                 | 167,827 |   |            |  | 2.2   | %         |  | $ | 164,290    |   |  |           | (30.7  | )% |  | $ | 237,147 |  
|% of total revenue                            |  |                   | 88.5    | % |            |  |       |           |  |   | 83.5       | % |  |           |        |    |  |   | 121.0   | %






|   |                                                                                                                                                                                                                                       
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*  | 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.







37



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##### 















| |                                                                                                                                                                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (i) In connection with the grant of stock options to
    employees and non-employee directors during the fiscal years
    ended March 31, 2000 and 1999, we recorded aggregate
    unearned compensation of $15.5 million, representing the
    difference between the deemed fair value of our common stock at
    the date of grant and the exercise price of such options.
|
| | (ii) As a result of the acquisitions of TransLink Software,
    Inc., Premier Software Technology, Inc. and Alier, Inc. we
    recorded a deferred stock compensation charge of
    $27.9 million related to restricted stock issued to
    stockholders of the acquired companies.                                                                                          
|
| | (iii) In connection with the acquisition of Active
    Software, in August 2000, 50% of Active Softwares
    remaining options vested upon consummation of the merger which
    resulted in an acceleration of amortization of deferred stock
    compensation.                                                                                                             

38



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##### 





| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (iv) In March 2001 we entered into an OEM/Reseller
    agreement with i2 Technologies (i2) and issued a warrant
    which, as amended, permits i2 to
    purchase 710,000 shares of our common stock at an
    exercise price of $28.70 per share. The fair value of the
    warrant was based on the Black-Scholes valuation model was
    $23.6 million on the date of issuance which has been
    recorded as a deferred warrant charge. As part of the agreement,
    i2 will pay us Original Equipment Manufacturer (OEM) fees
    of $10.0 million over the term of the OEM/ Reseller
    agreement which will be recorded as a reduction to the deferred
    warrant charge and will not be recorded as revenue. In March
    2004, we amended our OEM/ Reseller agreement with i2. We
    extended the term of the agreement by one year to March 2006 and
    also reduced the number of required webMethods on-site resources
    from 10 to 1 which resulted in a corresponding reduction of
    $1.3 million in OEM fees due under the agreement. Due to
    this change in the agreement, the amortization of the remaining
    unamortized deferred warrant charge has been changed from
    4 years to 5 years to coincide with the new payment
    schedule, resulting in a decrease in the annual amortization of
    $757,000 from $3,402,000 to $2,645,000. Additionally, we made
    changes relating to the sharing of revenue related to
    maintenance.











39



---



##### 





Interest income




Interest expense




Other income (expense), net




Impairment of equity investment in private companies




Income taxes






40



---



##### 



Quarterly results of operations




|                                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |        |        |        | 
|----------------------------------------------------- | ------------------------------------------ | ------------------------------------------- | ------------------------ | ------ | ----------- | ------ | ------- | ----------- | ------ | ------ | ----------- | ------ | ------ | -------- | ------ | ------ | -------- | ------ | ------ | --------- | ------ | ------ | -------- | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | ------ | 
|                                                      |                                            | Three Months Ended                          |                         
|                                                      |                                            |                                             |                         
|                                                      |                                            | Mar. 31,                                    |                          |        | Dec. 31,    |        |         | Sept. 30,   |        |        | June 30,    |        |        | Mar. 31, |        |        | Dec. 31, |        |        | Sept. 30, |        |        | June 30, |       
|                                                      |                                            | 2004                                        |                          |        | 2003        |        |         | 2003        |        |        | 2003        |        |        | 2003     |        |        | 2002     |        |        | 2002      |        |        | 2002     |       
|                                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |       
|                                                      |                                            | As restated                                 |                          |        | As restated |        |         | As restated |        |        | As restated |        |        |          |        |        |          |        |        |          
|                                                      |                                            | (In thousands)                              |                         
|Revenue:                                              |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |       
|                                                      | License                                    |                                             | $                        | 25,679 |             |        | $       | 25,037      |        |        | $           | 20,850 |        |          | $      | 21,174 |          |        | $      | 27,982    |        |        | $        | 33,940 |        |        | $      | 26,475 |        |        | $      | 28,669 |       
|                                                      | Professional services                      |                                             |                          | 13,091 |             |        |         | 11,210      |        |        |             | 10,460 |        |          |        | 8,873  |          |        |        | 8,641     |        |        |          | 7,951  |        |        |        | 8,584  |        |        |        | 8,202  |       
|                                                      | Maintenance                                |                                             |                          | 14,066 |             |        |         | 13,785      |        |        |             | 12,766 |        |          |        | 12,550 |          |        |        | 12,478    |        |        |          | 11,919 |        |        |        | 11,103 |        |        |        | 10,810 |       
|                                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |       
|                                                      |                                            |                                             | Total revenue            |        |             | 52,836 |         |             |        | 50,032 |             |        |        | 44,076   |        |        |          | 42,597 |        |           |        | 49,101 |          |        |        | 53,810 |        |        |        | 46,162 |        |        |        | 47,681 | 
|                                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |       
|Cost of revenue:                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |       
|                                                      | Amortization of intangibles                |                                             |                          | 600    |             |        |         | 599         |        |        |             |       |        |          |        |       |          |        |        |          |        |        |          |       |        |        |        |       |        |        |        |       |       
|                                                      | License                                    |                                             |                          | 588    |             |        |         | 601         |        |        |             | 555    |        |          |        | 467    |          |        |        | 512       |        |        |          | 765    |        |        |        | 525    |        |        |        | 135    |       
|                                                      | Professional services and maintenance:     |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |        |       
|                                                      |                                            | Stock based compensation                    |                          |        |            |        |         |             | 12     |        |             |        | 22     |          |        |        | 22       |        |        |           | 34     |        |          |        | 65     |        |        |        | 76     |        |        |        | 76     |       
|                                                      |                                            | Other professional services and maintenance |                          |        | 15,781      |        |         |             | 13,614 |        |             |        | 12,403 |          |        |        | 11,659   |        |        |           | 10,593 |        |          |        | 10,409 |        |        |        | 10,668 |        |        |        | 10,267 |       
|                                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |       
|                                                      |                                            |                                             | Total cost of revenue    |        |             | 16,969 |         |             |        | 14,826 |             |        |        | 12,980   |        |        |          | 12,148 |        |           |        | 11,139 |          |        |        | 11,239 |        |        |        | 11,269 |        |        |        | 10,478 | 
|                                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |       
|Gross profit                                          |                                            |                                             | 35,867                   |        |             |        | 35,206  |             |        |        | 31,096      |        |        |          | 30,449 |        |          |        | 37,962 |           |        |        | 42,571   |        |        |        | 34,893 |        |        |        | 37,203 |       
|                                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |       
|Operating expenses:                                   |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |       
|                                                      | Sales and marketing:                       |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |        |       
|                                                      |                                            | Stock based compensation and warrant charge |                          |        | 663         |        |         |             | 689    |        |             |        | 721    |          |        |        | 696      |        |        |           | 912    |        |          |        | 896    |        |        |        | 983    |        |        |        | 970    |       
|                                                      |                                            | Other sales and marketing                   |                          |        | 23,130      |        |         |             | 24,617 |        |             |        | 21,467 |          |        |        | 22,450   |        |        |           | 21,747 |        |          |        | 24,309 |        |        |        | 22,592 |        |        |        | 24,310 |       
|                                                      | Research and development:                  |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |        |       
|                                                      |                                            | Stock based compensation                    |                          |        |            |        |         |             | 5      |        |             |        | 10     |          |        |        |         |        |        |           | 12     |        |          |        | 26     |        |        |        | 40     |        |        |        | 19     |       
|                                                      |                                            | Other research and development              |                          |        | 11,542      |        |         |             | 11,446 |        |             |        | 10,857 |          |        |        | 11,200   |        |        |           | 11,282 |        |          |        | 12,059 |        |        |        | 11,821 |        |        |        | 12,279 |       
|                                                      | General and administrative:                |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |        |        |        |        |        |        |        |        |        |       
|                                                      |                                            | Stock based compensation                    |                          |        |            |        |         |             | 1      |        |             |        | 3      |          |        |        | 3        |        |        |           | 3      |        |          |        |       |        |        |        | 23     |        |        |        | 21     |       
|                                                      |                                            | Other general and administrative            |                          |        | 4,593       |        |         |             | 4,333  |        |             |        | 4,524  |          |        |        | 4,423    |        |        |           | 4,780  |        |          |        | 4,758  |        |        |        | 4,228  |        |        |        | 4,065  |       
|                                                      | Restructuring and related charges          |                                             |                          | 2,605  |             |        |         | 1,315       |        |        |             |       |        |          |        |       |          |        |        | (82       | )      |        |          | 2,237  |        |        |        |       |        |        |        |       |       
|                                                      | In-process research and development        |                                             |                          |       |             |        |         | 4,284       |        |        |             |       |        |          |        |       |          |        |        |          |        |        |          |       |        |        |        |       |        |        |        |       |       
|                                                      | Settlement of intellectual property matter |                                             |                          | 2,250  |             |        |         |            |        |        |             |       |        |          |        |       |          |        |        |          |        |        |          |       |        |        |        |       |        |        |        |       |       
|                                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |       
|                                                      |                                            |                                             | Total operating expenses |        |             | 44,783 |         |             |        | 46,690 |             |        |        | 37,582   |        |        |          | 38,772 |        |           |        | 38,654 |          |        |        | 44,285 |        |        |        | 39,687 |        |        |        | 41,664 | 
|                                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |       
|Operating loss                                        |                                            |                                             | (8,916                   | )      |             |        | (11,484 | )           |        |        | (6,486      | )      |        |          | (8,323 | )      |          |        | (692   | )         |        |        | (1,714   | )      |        |        | (4,794 | )      |        |        | (4,461 | )     
|Interest income                                       |                                            |                                             | 575                      |        |             |        | 549     |             |        |        | 721         |        |        |          | 1,007  |        |          |        | 921    |           |        |        | 1,105    |        |        |        | 1,244  |        |        |        | 1,462  |       
|Interest expense                                      |                                            |                                             | (42                      | )      |             |        | (56     | )           |        |        | (17         | )      |        |          | (89    | )      |          |        | (129   | )         |        |        | (193     | )      |        |        | (245   | )      |        |        | (107   | )     
|Other (expense)/income                                |                                            |                                             | (290                     | )      |             |        | (196    | )           |        |        | (5          | )      |        |          | 28     |        |          |        | 57     |           |        |        | 63       |        |        |        | (86    | )      |        |        | (16    | )     
|Impairment of equity investments in private companies |                                            |                                             |                         |        |             |        |        |             |        |        |            |        |        |          |       |        |          |        |       |           |        |        |         |        |        |        | (1,000 | )      |        |        |       |       
|                                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |       
|Net (loss)/income                                     |                                            | $                                           | (8,673                   | )      |             | $      | (11,187 | )           |        | $      | (5,787      | )      |        | $        | (7,377 | )      |          | $      | 157    |           |        | $      | (739     | )      |        | $      | (4,881 | )      |        | $      | (3,122 | )     
|                                                      |                                            |                                             |                          |        |             |        |         |             |        |        |             |        |        |          |        |        |          |        |        |           |        |        |          |       

41



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##### 



|                                                      |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |      |      |       |       |      |      |       |      |      |      |       | 
|----------------------------------------------------- | ------------------------------------------ | ------------------------------------------- | ------------------------ | ---- | ----------- | ----- | ----- | ----------- | ---- | ----- | ----------- | ---- | ---- | -------- | ------ | ---- | -------- | ----- | ---- | --------- | ---- | ----- | -------- | ---- | ---- | ----- | ----- | ---- | ---- | ----- | ---- | ---- | ---- | ----- | 
|                                                      |                                            | As a Percentage of Total Revenue            |                         
|                                                      |                                            |                                             |                         
|                                                      |                                            | Mar. 31,                                    |                          |      | Dec. 31,    |       |       | Sept. 30,   |      |       | June 30,    |      |      | Mar. 31, |        |      | Dec. 31, |       |      | Sept. 30, |      |       | June 30, |     
|                                                      |                                            | 2004                                        |                          |      | 2003        |       |       | 2003        |      |       | 2003        |      |      | 2003     |        |      | 2002     |       |      | 2002      |      |       | 2002     |     
|                                                      |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |     
|                                                      |                                            | As restated                                 |                          |      | As restated |       |       | As restated |      |       | As restated |      |      |          |        |      |          |       |      |          
|                                                      |                                            | (In thousands)                              |                         
|Revenue:                                              |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |      |      |       |       |      |      |       |      |     
|                                                      | License                                    |                                             |                          | 48.6 | %           |       |       | 50.0        | %    |       |             | 47.3 | %    |          |        | 49.7 | %        |       |      | 57.0      | %    |       |          | 63.1 | %    |       |       | 57.4 | %    |       |      | 60.1 | %   
|                                                      | Professional services                      |                                             |                          | 24.8 |             |       |       | 22.4        |      |       |             | 23.7 |      |          |        | 20.8 |          |       |      | 17.6      |      |       |          | 14.8 |      |       |       | 18.6 |      |       |      | 17.2 |     
|                                                      | Maintenance                                |                                             |                          | 26.6 |             |       |       | 27.6        |      |       |             | 29.0 |      |          |        | 29.5 |          |       |      | 25.4      |      |       |          | 22.1 |      |       |       | 24.0 |      |       |      | 22.7 |     
|                                                      |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |     
|                                                      |                                            |                                             | 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  |             |       |       | 1.2         |      |       |             |     |      |          |        |     |          |       |      |          |      |       |          |     |      |       |       |     |      |       |      |     |     
|                                                      | License                                    |                                             |                          | 1.1  |             |       |       | 1.2         |      |       |             | 1.3  |      |          |        | 1.1  |          |       |      | 1.0       |      |       |          | 1.4  |      |       |       | 1.1  |      |       |      | 0.3  |     
|                                                      | Professional services and maintenance:     |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |      |      |       |       |      |      |       |      |      |     
|                                                      |                                            | Stock based compensation                    |                          |      |            |       |       |             |     |       |             |      | 0.1  |          |        |      | 0.1      |       |      |           | 0.1  |       |          |      | 0.1  |       |       |      | 0.2  |       |      |      | 0.2  |      
|                                                      |                                            | Other professional services and maintenance |                          |      | 29.9        |       |       |             | 27.2 |       |             |      | 28.1 |          |        |      | 27.4     |       |      |           | 21.6 |       |          |      | 19.4 |       |       |      | 23.1 |       |      |      | 21.5 |      
|                                                      |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |     
|                                                      |                                            |                                             | Total cost of revenue    |      |             | 32.1  |       |             |      | 29.6  |             |      |      | 29.4     |        |      |          | 28.5  |      |           |      | 22.7  |          |      |      | 20.9  |       |      |      | 24.4  |      |      |      | 22.0  | 
|                                                      |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |     
|Gross profit                                          |                                            |                                             | 67.9                     |      |             |       | 70.4  |             |      |       | 70.6        |      |      |          | 71.5   |      |          |       | 77.3 |           |      |       | 79.1     |      |      |       | 75.6  |      |      |       | 78.0 |     
|                                                      |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |     
|Operating expenses:                                   |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |      |      |       |       |      |      |       |      |     
|                                                      | Sales and marketing:                       |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |      |      |       |       |      |      |       |      |      |     
|                                                      |                                            | Stock based compensation and warrant charge |                          |      | 1.3         |       |       |             | 1.4  |       |             |      | 1.6  |          |        |      | 1.6      |       |      |           | 1.9  |       |          |      | 1.7  |       |       |      | 2.1  |       |      |      | 2.0  |      
|                                                      |                                            | Other sales and marketing                   |                          |      | 43.8        |       |       |             | 49.1 |       |             |      | 48.7 |          |        |      | 52.7     |       |      |           | 44.3 |       |          |      | 45.2 |       |       |      | 48.9 |       |      |      | 51.0 |      
|                                                      | Research and development:                  |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |      |      |       |       |      |      |       |      |      |     
|                                                      |                                            | Stock based compensation                    |                          |      |            |       |       |             |     |       |             |      |     |          |        |      |         |       |      |           |     |       |          |      |     |       |       |      | 0.1  |       |      |      |     |      
|                                                      |                                            | Other research and development              |                          |      | 21.8        |       |       |             | 22.9 |       |             |      | 24.6 |          |        |      | 26.3     |       |      |           | 23.0 |       |          |      | 22.4 |       |       |      | 25.6 |       |      |      | 25.8 |      
|                                                      | General and administrative:                |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |      |      |       |       |      |      |       |      |      |     
|                                                      |                                            | Stock based compensation                    |                          |      |            |       |       |             |     |       |             |      |     |          |        |      |         |       |      |           |     |       |          |      |     |       |       |      |     |       |      |      |     |      
|                                                      |                                            | Other general and administrative            |                          |      | 8.7         |       |       |             | 8.7  |       |             |      | 10.3 |          |        |      | 10.4     |       |      |           | 9.7  |       |          |      | 8.8  |       |       |      | 9.3  |       |      |      | 8.6  |      
|                                                      | Restructuring and related charges          |                                             |                          | 4.9  |             |       |       | 2.6         |      |       |             |     |      |          |        |     |          |       |      | (0.2      | )    |       |          | 4.2  |      |       |       |     |      |       |      |     |     
|                                                      | In-process research and development        |                                             |                          |     |             |       |       | 8.6         |      |       |             |     |      |          |        |     |          |       |      |          |      |       |          |     |      |       |       |     |      |       |      |     |     
|                                                      | Settlement of intellectual property matter |                                             |                          | 4.3  |             |       |       |            |      |       |             |     |      |          |        |     |          |       |      |          |      |       |          |     |      |       |       |     |      |       |      |     |     
|                                                      |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |     
|                                                      |                                            |                                             | Total operating expenses |      |             | 84.8  |       |             |      | 93.3  |             |      |      | 85.2     |        |      |          | 91.0  |      |           |      | 78.7  |          |      |      | 82.3  |       |      |      | 86.0  |      |      |      | 87.4  | 
|                                                      |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |     
|Operating loss                                        |                                            |                                             | (16.9                    | )    |             |       | (22.9 | )           |      |       | (14.6       | )    |      |          | ( 19.5 | )    |          |       | (1.4 | )         |      |       | (3.2     | )    |      |       | (10.4 | )    |      |       | (9.4 | )   
|Interest income                                       |                                            |                                             | 1.1                      |      |             |       | 1.1   |             |      |       | 1.6         |      |      |          | 2.4    |      |          |       | 1.9  |           |      |       | 2.1      |      |      |       | 2.7   |      |      |       | 3.1  |     
|Interest expense                                      |                                            |                                             | (0.1                     | )    |             |       | (0.1  | )           |      |       |            |      |      |          | (0.2   | )    |          |       | (0.3 | )         |      |       | (0.4     | )    |      |       | (0.5  | )    |      |       | (0.2 | )   
|Other (expense)/income                                |                                            |                                             | (0.5                     | )    |             |       | (0.4  | )           |      |       |            |      |      |          | (0.1   | )    |          |       | 0.1  |           |      |       | 0.1      |      |      |       | (0.2  | )    |      |       |     |     
|Impairment of equity investments in private companies |                                            |                                             |                         |      |             |       |      |             |      |       |            |      |      |          |       |      |          |       |     |           |      |       |         |      |      |       | (2.2  | )    |      |       |     |     
|                                                      |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |     
|Net (loss)/income                                     |                                            |                                             | (16.4                    | )%   |             |       | (22.4 | )%          |      |       | (13.0       | )%   |      |          | (17.3  | )%   |          |       | 0.3  | %         |      |       | (1.4     | )%   |      |       | (10.6 | )%   |      |       | (6.6 | )%  
|                                                      |                                            |                                             |                          |      |             |       |       |             |      |       |             |      |      |          |        |      |          |       |      |           |      |       |          |     

LIQUIDITY AND CAPITAL RESOURCES




42



---



##### 













RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS






43



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##### 









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



Interest rate risk.


Foreign currency exchange rate risk.






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



44



---



##### 





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



Item 9A.     CONTROLS AND
PROCEDURES


Disclosure Controls and Procedures










Internal Controls Over Financial Reporting




45



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##### 









| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We have 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 have no further
    access to the offices or e-mail system of our Japanese
    subsidiary and are precluded from conducting business on behalf
    of the Company. We are pursuing disciplinary actions, which may
    include termination and restitution, concerning each employee
    implicated in wrongdoing in accordance with Japanese labor law
    and the work rules of the Companys Japanese subsidiary.                                                                                                                              
|
| |  | We have engaged an experienced financial consulting firm in
    Japan to assist the Company in providing financial and
    accounting services on behalf of our Japanese subsidiary.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | We have recommunicated to employees of our Japanese subsidiary,
    and have confirmed their understanding of, our policy requiring
    collection and preservation of appropriate documentation that
    evidences an end-users purchase of a license to the
    Companys products in the quarter in which the revenue is
    recognized. We have reiterated this policy to all of our senior
    management, sales management and finance managers.                                                                                                                                                                                                                                                                                  
|
| |  | We have 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
    the Company and by the Board of Directors of the respective
    borrowing entity. Verification of compliance with this policy
    has been added to certifications collected from members of
    management of the Company and our subsidiaries each quarter.                                                                                                                                                                                                         
|
| |  | We have reiterated to all of our senior management, sales
    management and finance managers that no employee of the Company
    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 the applicable Company procedures.
    Clarification and verification of compliance with this policy
    has been added to certifications collected from members of
    management of the Company and our subsidiaries each quarter.
|
| |  | We have recruited and hired a Director, Internal Audit, who will
    be developing and implementing internal audit plans and
    procedures with respect to the Companys domestic and
    international operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | We are evaluating 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 are implementing organizational changes to clarify that
    persons responsible for finance, accounting and legal functions
    concerning the Companys Japanese subsidiary report
    directly to persons responsible for the appropriate function in
    the global management team.                                                                                                                                                                                                                                                                                                                                                                                                                                               
|
| |  | We are evaluating our relationships with each of our Japanese
    resellers, including reviewing arrangements with them to ensure
    that they are providing to the Company those materials required
    by the Companys revenue recognition policy.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | We are studying new or modified procedures under which the
    appropriate persons within the Companys global management
    team will have greater levels of involvement in, and oversight
    of, international operations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

46



---



##### 





47



---



##### 



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





|         |                                               
|-------- | ----------------------------------------------
|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





| |     |                                                        
| | --- | -------------------------------------------------------
| | (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, 2004 and 2003                                                             |  |      | F-2 | 
|Consolidated Statements of Operations and Comprehensive Loss for
    the years ended March 31, 2004, 2003 and 2002 |  |      | F-3 | 
|Consolidated Statements of Changes in Stockholders Equity
    for the years ended March 31, 2004, 2003 and 2002   |  |      | F-4 | 
|Consolidated Statements of Cash Flows for the years ended
    March 31, 2004, 2003 and 2002                        |  |      | F-5 | 
|Notes to Consolidated Financial Statements                                                                         |  |      | F-6 | 



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

|                                                                                            |  |  |      | 
|------------------------------------------------------------------------------------------- |  |  | ---- | 
|Schedule II  Valuation and Qualifying Accounts                                             |  |  | F-29 | 
|Report of Independent Registered Public Accounting Firm on
    Financial Statement Schedule |  |  | F-30 | 



| |     |         
| | --- | --------
| | (3) | Exhibits

|        |        |   |             |                                                                                                                                               
|------- | ------ | - | ----------- | ----------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |        |   |            
|Number  |        |   | Description
|        |        |   |            
|        | 2.1(1  | ) |             | Agreement and Plan of Merger dated as of May 20, 2000, by
    and among webMethods, Inc., Wolf Acquisition, Inc. and Active
    Software, Inc.
|        | 3.1(2  | ) |             | Fifth Amended and Restated Certificate of Incorporation of
    webMethods, Inc., as amended                                                   
|        | 3.2(3  | ) |             | Amended and Restated Bylaws of webMethods, Inc.                                                                                               
|        | 4.1(3  | ) |             | Specimen certificate for shares of webMethods, Inc. Common Stock                                                                              
|        | 4.2(4  | ) |             | Rights Agreement dated as of October 18, 2001 between
    webMethods, Inc. and American Stock Transfer &
    Trust Company                    
|        | 10.1(3 | ) |             | Second Amended and Restated Investor Rights Agreement                                                                                         
|        | 10.2(5 | ) |             | webMethods, Inc. Amended and Restated Stock Option Plan, as
    Amended                                                                       
|        | 10.3(3 | ) |             | Employee Stock Purchase Plan                                                                                                                  
|        | 10.4(3 | ) |             | Indemnification Agreement entered into between webMethods, Inc.
    and each of its directors                                                 
|        | 21.1(6 | ) |             | Subsidiaries of webMethods, Inc.                                                                                                              
|        | 23.1*  |   |             | Consent of PricewaterhouseCoopers LLP                                                                                                         
|        | 24(6)  |   |             | Power of Attorney (included on signature page of
    webMethods Form 10-K for the year ended
    March 31, 2004 filed on June 14, 2004)      
|        | 31.1*  |   |             | Rule 13a-14(a) Certification of Chief Executive Officer                                                                                       
|        | 31.2*  |   |             | Rule 13a-14(a) Certification of Chief Financial Officer                                                                                       
|        | 32.1*  | # |             | Section 1350 Certification of Chief Executive Officer                                                                                         
|        | 32.2*  | # |             | Section 1350 Certification of Chief Financial Officer                                                                                         

49



---



##### 






|    |                                                                                                                                                                                        
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to webMethods Registration
    Statement on Form S-4, as amended (File No. 333-39572).                                                                      
|   
|(2) | Incorporated by reference to webMethods Form 10-K for
    the year ended March 31, 2002 (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-K for
    the year ended March 31, 2004 filed with the Securities and
    Exchange Commission on June 14, 2004 (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.                                                                  

Reports on Form 8-K.


|                 |  |          |      |  |               |  |                                       | 
|---------------- |  | -------- | ---- |  | ------------- |  | ------------------------------------- | 
|Date of Report   |  | Item No. |      |  | Item Reported | 
|                 |  |          |      |  |               | 
|January 21, 2004 |  |          | 7,12 |  |               |  | Press release dated January 21, 2004. | 

Exhibits.


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 and Chief Executive Officer                                  |  | February 14, 2005
|                                    
|/s/ Mary DridiMary
    Dridi         |  | Officer and Treasurer Executive Vice President and Chief
    Financial |  | February 14, 2005
|                                    
|*Gary
    J. Fernandes               |  | Director                                                               |  | February 14, 2005
|                                    
|*James
    P. Gauer                  |  | Director                                                               |  | February 14, 2005
|                                    
|*R.
    James Green                  |  | Director                                                               |  | February 14, 2005
|                                    
|*William
    A. Halter               |  | Director                                                               |  | February 14, 2005
|                                    
|*Jerry
    Jasinowski                |  | Director                                                               |  | February 14, 2005
|                                    
|*Jack
    L. Lewis                   |  | Director                                                               |  | February 14, 2005
|                                    
|*Gene
    Riechers                   |  | Director                                                               |  | February 14, 2005
|                                    
|*William
    V. Russell              |  | Non-Executive Chairman of the Board and Director                       |  | February 14, 2005
|                                    
|By:                                  |  | /s/ Mary DridiMary
    Dridi, Attorney-in-Fact                         |  |                   |  | 

51



---



##### 



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM










PRICEWATERHOUSECOOPERS
LLP







F-1



---



##### 



WEBMETHODS, INC.


CONSOLIDATED BALANCE SHEETS


|                                                        |                                                                                                                               |                                            |        |          |         |  |        |          |         | 
|------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | ------- |  | ------ | -------- | ------- | 
|                                                        |                                                                                                                               | March 31,                                  |       
|                                                        |                                                                                                                               |                                            |       
|                                                        |                                                                                                                               | 2004                                       |        |          | 2003    | 
|                                                        |                                                                                                                               |                                            |        |          |         | 
|                                                        |                                                                                                                               | As restated                                |        |          |        
|                                                        |                                                                                                                               | (In thousands, except                      |       
|                                                        |                                                                                                                               | share and per share amounts)               |       
|ASSETS                                                  |                                                                                                                               |                                            |        |          |         |  |        |         
|Current assets:                                         |                                                                                                                               |                                            |        |          |         |  |        |         
|                                                        | Cash and cash equivalents                                                                                                     |                                            | $      | 75,462   |         |  | $      | 79,702   |        
|                                                        | Marketable securities available for sale                                                                                      |                                            |        | 44,328   |         |  |        | 97,079   |        
|                                                        | Accounts receivable, net of allowance of $2,103 and $2,850                                                                    |                                            |        | 46,741   |         |  |        | 43,691   |        
|                                                        | Prepaid expenses and other current assets                                                                                     |                                            |        | 6,235    |         |  |        | 7,562    |        
|                                                        |                                                                                                                               |                                            |        |          |         | 
|                                                        |                                                                                                                               | Total current assets                       |        |          | 172,766 |  |        |          | 228,034 | 
|Marketable securities available for sale                |                                                                                                                               |                                            | 36,157 |          |         |  | 24,845 |         
|Property and equipment, net                             |                                                                                                                               |                                            | 8,106  |          |         |  | 12,068 |         
|Goodwill                                                |                                                                                                                               |                                            | 46,704 |          |         |  | 29,838 |         
|Intangibles assets, net                                 |                                                                                                                               |                                            | 10,787 |          |         |  |       |         
|Other assets                                            |                                                                                                                               |                                            | 9,130  |          |         |  | 9,651  |         
|                                                        |                                                                                                                               |                                            |        |          |         | 
|                                                        |                                                                                                                               | Total assets                               |        | $        | 283,650 |  |        | $        | 304,436 | 
|                                                        |                                                                                                                               |                                            |        |          |         | 
|                                                       
|LIABILITIES AND STOCKHOLDERS EQUITY                    |                                                                                                                               |                                            |        |          |         |  |        |         
|Current liabilities:                                    |                                                                                                                               |                                            |        |          |         |  |        |         
|                                                        | Accounts payable                                                                                                              |                                            | $      | 10,919   |         |  | $      | 9,768    |        
|                                                        | Accrued expenses                                                                                                              |                                            |        | 17,084   |         |  |        | 14,802   |        
|                                                        | Accrued salaries and commissions                                                                                              |                                            |        | 11,560   |         |  |        | 11,648   |        
|                                                        | Deferred revenue                                                                                                              |                                            |        | 36,018   |         |  |        | 39,649   |        
|                                                        | Short-term borrowings                                                                                                         |                                            |        | 2,584    |         |  |        |         |        
|                                                        | Current portion of capital lease obligations                                                                                  |                                            |        | 909      |         |  |        | 2,743    |        
|                                                        |                                                                                                                               |                                            |        |          |         | 
|                                                        |                                                                                                                               | Total current liabilities                  |        |          | 79,074  |  |        |          | 78,610  | 
|                                                        | Capital lease obligations, net of current portion and other                                                                   |                                            |        | 373      |         |  |        | 567      |        
|                                                        | Other long term liabilities                                                                                                   |                                            |        | 1,000    |         |  |        |         |        
|                                                        | Long term deferred revenue                                                                                                    |                                            |        | 6,066    |         |  |        | 6,700    |        
|                                                        |                                                                                                                               |                                            |        |          |         | 
|                                                        |                                                                                                                               | Total liabilities                          |        |          | 86,513  |  |        |          | 85,877  | 
|                                                        |                                                                                                                               |                                            |        |          |         | 
|Commitments and contingencies
    Stockholders equity: |                                                                                                                               |                                            |        |          |         |  |        |         
|                                                        | Common stock, $0.01 par value; 500,000,000 shares
    authorized; 52,746,722 and 51,766,572 shares issued and
    outstanding |                                            |        | 527      |         |  |        | 518      |        
|                                                        | Additional paid-in capital                                                                                                    |                                            |        | 521,455  |         |  |        | 515,828  |        
|                                                        | Deferred stock compensation and warrant charge                                                                                |                                            |        | (5,625   | )       |  |        | (9,450   | )      
|                                                        | Accumulated deficit                                                                                                           |                                            |        | (321,473 | )       |  |        | (288,449 | )      
|                                                        | Accumulated other comprehensive income                                                                                        |                                            |        | 2,253    |         |  |        | 112      |        
|                                                        |                                                                                                                               |                                            |        |          |         | 
|                                                        |                                                                                                                               | Total stockholders equity                 |        |          | 197,137 |  |        |          | 218,559 | 
|                                                        |                                                                                                                               |                                            |        |          |         | 
|                                                        |                                                                                                                               | Total liabilities and stockholders equity |        | $        | 283,650 |  |        | $        | 304,436 | 
|                                                        |                                                                                                                               |                                            |        |          |         | 

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


F-2



---



##### 



WEBMETHODS, INC.


CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
LOSS


|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |        |         |            |         |         |         |         |  
|------------------------------------------------------------------------ | ------------------------------------------ | -------------------------------------------------- | ------------------------ | ------------------------ | ------ | ------- | ---------- | ------- | ------ | ------- | ---------- | ------- | ------- | ------- | ------- | -
|                                                                         |                                            | Year Ended March 31,                               |                         
|                                                                         |                                            |                                                    |                         
|                                                                         |                                            | 2004                                               |                          |                          | 2003   |         |            | 2002    |       
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|                                                                         |                                            | As restated                                        |                          |                          |        |         |           
|                                                                         |                                            | (In thousands, except per share amounts)           |                         
|Revenue:                                                                 |                                            |                                                    |                          |                          |        |         |            |         |        |         |            |        
|                                                                         | License                                    |                                                    | $                        | 92,740                   |        |         | $          | 117,066 |        |         | $          | 121,803 |        
|                                                                         | Professional services                      |                                                    |                          | 43,634                   |        |         |            | 33,378  |        |         |            | 35,800  |        
|                                                                         | Maintenance                                |                                                    |                          | 53,167                   |        |         |            | 46,310  |        |         |            | 38,393  |        
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|                                                                         |                                            |                                                    |                          | Total revenue            |        |         | 189,541    |         |        |         | 196,754    |         |         |         | 195,996 |  
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|Cost of revenue:                                                         |                                            |                                                    |                          |                          |        |         |            |         |        |         |            |        
|                                                                         | Amortization of intangibles                |                                                    |                          | 1,199                    |        |         |            |        |        |         |            |        |        
|                                                                         | License                                    |                                                    |                          | 2,211                    |        |         |            | 1,937   |        |         |            | 2,335   |        
|                                                                         | Professional services and maintenance:     |                                                    |                          |                          |        |         |            |         |        |         |            |         |        
|                                                                         |                                            | Stock based compensation                           |                          |                          | 56     |         |            |         | 251    |         |            |         | 436     |        
|                                                                         |                                            | Other professional services and maintenance        |                          |                          | 53,457 |         |            |         | 41,937 |         |            |         | 42,124  |        
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|                                                                         |                                            |                                                    |                          | Total cost of revenue    |        |         | 56,923     |         |        |         | 44,125     |         |         |         | 44,895  |  
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|Gross profit                                                             |                                            |                                                    | 132,618                  |                          |        |         | 152,629    |         |        |         | 151,101    |        
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|Operating expenses:                                                      |                                            |                                                    |                          |                          |        |         |            |         |        |         |            |        
|                                                                         | Sales and marketing:                       |                                                    |                          |                          |        |         |            |         |        |         |            |         |        
|                                                                         |                                            | Stock based compensation and warrant charge        |                          |                          | 2,769  |         |            |         | 3,761  |         |            |         | 2,865   |        
|                                                                         |                                            | Other sales and marketing costs                    |                          |                          | 91,664 |         |            |         | 92,958 |         |            |         | 106,377 |        
|                                                                         | Research and development:                  |                                                    |                          |                          |        |         |            |         |        |         |            |         |        
|                                                                         |                                            | Stock based compensation                           |                          |                          | 15     |         |            |         | 97     |         |            |         | 12,526  |        
|                                                                         |                                            | Other research and development costs               |                          |                          | 45,045 |         |            |         | 47,441 |         |            |         | 49,634  |        
|                                                                         | General and administrative:                |                                                    |                          |                          |        |         |            |         |        |         |            |         |        
|                                                                         |                                            | Stock based compensation                           |                          |                          | 7      |         |            |         | 47     |         |            |         | 433     |        
|                                                                         |                                            | Other general and administrative costs             |                          |                          | 17,873 |         |            |         | 17,831 |         |            |         | 19,372  |        
|                                                                         | Restructuring and related charges          |                                                    |                          | 3,920                    |        |         |            | 2,155   |        |         |            | 7,243   |        
|                                                                         | Amortization of goodwill and intangibles   |                                                    |                          |                         |        |         |            |        |        |         |            | 38,697  |        
|                                                                         | In-process research and development        |                                                    |                          | 4,284                    |        |         |            |        |        |         |            |        |        
|                                                                         | Settlement of intellectual property matter |                                                    |                          | 2,250                    |        |         |            |        |        |         |            |        |        
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|                                                                         |                                            |                                                    | Total operating expenses |                          |        | 167,827 |            |         |        | 164,290 |            |         |         | 237,147 |        
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|Operating loss                                                           |                                            |                                                    | (35,209                  | )                        |        |         | (11,661    | )       |        |         | (86,046    | )      
|Interest income                                                          |                                            |                                                    | 2,851                    |                          |        |         | 4,732      |         |        |         | 9,116      |        
|Interest expense                                                         |                                            |                                                    | (205                     | )                        |        |         | (674       | )       |        |         | (553       | )      
|Other (expense) income                                                   |                                            |                                                    | (461                     | )                        |        |         | 18         |         |        |         | (26        | )      
|Impairment of equity investment in private companies                     |                                            |                                                    |                         |                          |        |         | (1,000     | )       |        |         | (5,200     | )      
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|Net loss                                                                 |                                            | $                                                  | (33,024                  | )                        |        | $       | (8,585     | )       |        | $       | (82,709    | )      
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|Basic and diluted net loss per share                                     |                                            | $                                                  | (0.63                    | )                        |        | $       | (0.17      | )       |        | $       | (1.67      | )      
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|Shares used in computing basic and diluted net loss per common
    share |                                            |                                                    | 52,136,919               |                          |        |         | 51,281,729 |         |        |         | 49,492,654 |        
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|Comprehensive loss:                                                      |                                            |                                                    |                          |                          |        |         |            |         |        |         |            |        
|                                                                         | Net loss                                   |                                                    | $                        | (33,024                  | )      |         | $          | (8,585  | )      |         | $          | (82,709 | )      
|                                                                         | Other comprehensive income (loss):         |                                                    |                          |                          |        |         |            |         |        |         |            |         |        
|                                                                         |                                            | Unrealized loss on securities available for sale   |                          |                          | (165   | )       |            |         | (135   | )       |            |         | (692    | )      
|                                                                         |                                            | Foreign currency cumulative translation adjustment |                          |                          | 2,306  |         |            |         | 750    |         |            |         | (417    | )      
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       
|                                                                         |                                            |                                                    |                          | Total comprehensive loss |        | $       | (30,883    | )       |        | $       | (7,970     | )       |         | $       | (83,818 | )
|                                                                         |                                            |                                                    |                          |                          |        |         |            |         |       

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


F-3



---



##### 



WEBMETHODS, INC.


CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
EQUITY


for the years ended March 31, 2002, 2003 and 2004


|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------------------------- |  | ------------ | ------ |  | ---------- | ----- | --- | ------------ |  | - | ----------- | - | ------------- | ------- | ------- | - | ------ | - | -------- | ----- |  | - | ------ | - |  | - | ------- | -
|                                                                                                  |  |              |        |  |            |       |     | 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, 2001                                                                           |  |              | 48,733 |  |            | $     | 487 |              |  | $ | 499,825     |   |               | $       | (38,154 | ) |        | $ | (197,155 | )     |  | $ | 606    |   |  | $ | 265,609 |  
|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       | 
|Stock options exercised, net                                                                      |  |              | 1,442  |  |            |       | 15  |              |  |   | 10,497      |   |               |         |        |   |        |   |         |       |  |   |       |   |  |   | 10,512  |  
|ESPP common stock issuances                                                                       |  |              | 302    |  |            |       | 3   |              |  |   | 4,978       |   |               |         |        |   |        |   |         |       |  |   |       |   |  |   | 4,981   |  
|Amortization of deferred stock compensation related to options                                    |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 954     |   |        |   |         |       |  |   |       |   |  |   | 954     |  
|Compensation charge related to accelerated vesting                                                |  |              |       |  |            |       |    |              |  |   | 264         |   |               |         |        |   |        |   |         |       |  |   |       |   |  |   | 264     |  
|Adjustment of deferred compensation related to forfeitures                                        |  |              |       |  |            |       |    |              |  |   | (5,283      | ) |               |         | 5,283   |   |        |   |         |       |  |   |       |   |  |   |        |  
|Amortization of deferred warrant charge                                                           |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 3,402   |   |        |   |         |       |  |   |       |   |  |   | 3,402   |  
|Amortization of deferred stock compensation related to
    restricted stock                       |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 11,640  |   |        |   |         |       |  |   |       |   |  |   | 11,640  |  
|Proceeds from OEM fees applied to deferred warrant charge                                         |  |              |       |  |            |       |    |              |  |   |            |   |               |         | 2,000   |   |        |   |         |       |  |   |       |   |  |   | 2,000   |  
|Other comprehensive loss                                                                          |  |              |       |  |            |       |    |              |  |   |            |   |               |         |        |   |        |   |         |       |  |   | (1,109 | ) |  |   | (1,109  | )
|Net loss                                                                                          |  |              |       |  |            |       |    |              |  |   |            |   |               |         |        |   |        |   | (82,709  | )     |  |   |       |   |  |   | (82,709 | )
|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       | 
|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, as restated                                                              |  |              | 52,747 |  |            | $     | 527 |              |  | $ | 521,455     |   |               | $       | (5,625  | ) |        | $ | (321,473 | )     |  | $ | 2,253  |   |  | $ | 197,137 |  
|                                                                                                  |  |              |        |  |            |       |     |              |  |   |             |   |               |         |         |   |        |   |          |       | 

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


F-4



---



##### 



WEBMETHODS, INC.


CONSOLIDATED STATEMENTS OF CASH FLOWS


|                                                         |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |         |   |         |         |         |  
|-------------------------------------------------------- | --------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------- | ------- | ------ | - | ------- | ------ | ------- | - | ------- | ------- | ------- | -
|                                                         |                                                                                   | Year Ended March 31,                                                                                                                                          |        
|                                                         |                                                                                   |                                                                                                                                                               |        
|                                                         |                                                                                   | 2004                                                                                                                                                          |         |         | 2003   |   |         | 2002   |        
|                                                         |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |        
|                                                         |                                                                                   | As restated                                                                                                                                                   |         |         |        |   |        
|                                                         |                                                                                   | (In thousands)                                                                                                                                                |        
|Cash flows from operating activities:                    |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |         |   |         |        
|                                                        
|                                                         | Net loss                                                                          |                                                                                                                                                               | $       | (33,024 | )      |   | $       | (8,585 | )       |   | $       | (82,709 | )      
|                                                         | Adjustments to reconcile net loss to net cash used in operating
    activities:   |                                                                                                                                                               |         |         |        |   |         |        |         |   |         |         |        
|                                                         |                                                                                   | Depreciation and amortization                                                                                                                                 |         |         | 8,428  |   |         |        | 10,044  |   |         |         | 8,453   |  
|                                                         |                                                                                   | Provision for doubtful accounts                                                                                                                               |         |         | 19     |   |         |        | 384     |   |         |         | 2,840   |  
|                                                         |                                                                                   | Impairment of equity investments                                                                                                                              |         |         |       |   |         |        | 1,000   |   |         |         | 5,200   |  
|                                                         |                                                                                   | Loss on disposal of equipment                                                                                                                                 |         |         |       |   |         |        |        |   |         |         | 574     |  
|                                                         |                                                                                   | Amortization of deferred stock compensation and compensation for
    accelerated vesting related to employee stock options and
    non-employee stock warrant |         |         | 2,846  |   |         |        | 4,156   |   |         |         | 16,260  |  
|                                                         |                                                                                   | Amortization of goodwill                                                                                                                                      |         |         |       |   |         |        |        |   |         |         | 35,590  |  
|                                                         |                                                                                   | Amortization of acquired intangibles                                                                                                                          |         |         | 1,199  |   |         |        |        |   |         |         | 3,107   |  
|                                                         |                                                                                   | 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    |   |         |        |        |   |         |         |        |  
|                                                         | Increase (decrease) in cash resulting from changes in assets and
    liabilities: |                                                                                                                                                               |         |         |        |   |         |        |         |   |         |         |        
|                                                         |                                                                                   | Accounts receivable                                                                                                                                           |         |         | (534   | ) |         |        | 4,477   |   |         |         | 9,373   |  
|                                                         |                                                                                   | Prepaid expenses and other current assets                                                                                                                     |         |         | 1,608  |   |         |        | 181     |   |         |         | 2,720   |  
|                                                         |                                                                                   | Other non-current assets                                                                                                                                      |         |         | 91     |   |         |        | 551     |   |         |         | (4,569  | )
|                                                         |                                                                                   | Accounts payable                                                                                                                                              |         |         | 406    |   |         |        | (6,065  | ) |         |         | 6,596   |  
|                                                         |                                                                                   | Accrued expenses                                                                                                                                              |         |         | 1,752  |   |         |        | (1,698  | ) |         |         | 3,386   |  
|                                                         |                                                                                   | Accrued salaries and commissions                                                                                                                              |         |         | (649   | ) |         |        | (4,689  | ) |         |         | 176     |  
|                                                         |                                                                                   | Deferred revenue                                                                                                                                              |         |         | (6,650 | ) |         |        | (12,562 | ) |         |         | (11,124 | )
|                                                         |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |        
|Net cash used in operating activities                    |                                                                                   |                                                                                                                                                               | (20,008 | )       |        |   | (12,806 | )      |         |   | (4,127  | )      
|                                                         |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |        
|Cash flows from investing activities:                    |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |         |   |         |        
|                                                         | Acquisition of businesses and technology, net of cash acquired                    |                                                                                                                                                               |         | (32,384 | )      |   |         |       |         |   |         |        |        
|                                                         | Purchases of property and equipment                                               |                                                                                                                                                               |         | (2,744  | )      |   |         | (2,967 | )       |   |         | (5,859  | )      
|                                                         | Net maturities (purchases) of marketable securities
    available for sale        |                                                                                                                                                               |         | 41,274  |        |   |         | (8,717 | )       |   |         | (17,360 | )      
|                                                         | Repayments of investments in private companies                                    |                                                                                                                                                               |         | 1,000   |        |   |         |       |         |   |         | 2,000   |        
|                                                         |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |        
|Net cash provided by (used in) investing activities      |                                                                                   |                                                                                                                                                               | 7,146   |         |        |   | (11,684 | )      |         |   | (21,219 | )      
|                                                         |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |        
|Cash flows from financing activities:                    |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |         |   |         |        
|                                                         | Short-term borrowings                                                             |                                                                                                                                                               |         | 5,882   |        |   |         |       |         |   |         |        |        
|                                                         | Payments on short-term borrowings                                                 |                                                                                                                                                               |         | (3,561  | )      |   |         |       |         |   |         |        |        
|                                                         | Borrowings under capital leases                                                   |                                                                                                                                                               |         |        |        |   |         | 2,500  |         |   |         |        |        
|                                                         | Payments on capital leases                                                        |                                                                                                                                                               |         | (3,255  | )      |   |         | (4,932 | )       |   |         | (3,135  | )      
|                                                         | Proceeds from exercise of stock options                                           |                                                                                                                                                               |         | 3,039   |        |   |         | 2,617  |         |   |         | 10,512  |        
|                                                         | Proceeds from ESPP common stock issuances                                         |                                                                                                                                                               |         | 2,481   |        |   |         | 2,961  |         |   |         | 4,981   |        
|                                                         | Proceeds from OEM fees applied to deferred warrant charge                         |                                                                                                                                                               |         | 1,000   |        |   |         | 1,250  |         |   |         | 2,000   |        
|                                                         |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |        
|Net cash provided by financing activities                |                                                                                   |                                                                                                                                                               | 5,586   |         |        |   | 4,396   |        |         |   | 14,358  |        
|                                                         |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |        
|Effect of the exchange rate on cash and cash equivalents |                                                                                   |                                                                                                                                                               | 3,036   |         |        |   | 1,299   |        |         |   | (228    | )      
|                                                         |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |        
|Net decrease in cash and cash equivalents                |                                                                                   |                                                                                                                                                               | (4,240  | )       |        |   | (18,795 | )      |         |   | (11,216 | )      
|Cash and cash equivalents at beginning of period         |                                                                                   |                                                                                                                                                               | 79,702  |         |        |   | 98,497  |        |         |   | 109,713 |        
|                                                         |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |        
|Cash and cash equivalents at end of period               |                                                                                   | $                                                                                                                                                             | 75,462  |         |        | $ | 79,702  |        |         | $ | 98,497  |        
|                                                         |                                                                                   |                                                                                                                                                               |         |         |        |   |         |        |        

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


F-5



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




|   |             
|-- | ------------
|1. | Organization







|   |             
|-- | ------------
|2. | Restatements









F-6



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




2.     Restatements 
(Continued)




Summary of the Significant
Effects of the Restatement on the Consolidated Statement of
Operations


|                                     |                                |                                         |         |        |             |   |        |             |        |   |         |        |         | 
|------------------------------------ | ------------------------------ | --------------------------------------- | ------- | ------ | ----------- | - | ------ | ----------- | ------ | - | ------- | ------ | ------- | 
|                                     |                                | Year Ended March 31, 2004               |        
|                                     |                                |                                         |        
|                                     |                                | As previously                           |         |        |            
|                                     |                                | reported                                |         |        | Adjustments |   |        | As restated |       
|                                     |                                |                                         |         |        |             |   |        |             |       
|                                     |                                | (In thousands except per share amounts) |        
|Revenue:                             |                                |                                         |         |        |             |   |        |             |        |   |         |       
|                                     | License                        |                                         | $       | 97,282 |             |   | $      | (4,542      | )      |   | $       | 92,740 |        
|                                     | Professional services          |                                         |         | 43,923 |             |   |        | (289        | )      |   |         | 43,634 |        
|                                     | Maintenance                    |                                         |         | 53,320 |             |   |        | (153        | )      |   |         | 53,167 |        
|                                     |                                |                                         |         |        |             |   |        |             |       
|                                     |                                | Total revenue                           |         |        | 194,525     |   |        |             | (4,984 | ) |         |        | 189,541 | 
|                                     |                                |                                         |         |        |             |   |        |             |       
|Cost of revenue                      |                                |                                         | 56,798  |        |             |   | 125    |             |        |   | 56,923  |       
|                                     |                                |                                         |         |        |             |   |        |             |       
|Gross profit                         |                                |                                         | 137,727 |        |             |   | (5,109 | )           |        |   | 132,618 |       
|                                     |                                |                                         |         |        |             |   |        |             |       
|Operating expenses                   |                                |                                         | 167,488 |        |             |   | 339    |             |        |   | 167,827 |       
|                                     |                                |                                         |         |        |             |   |        |             |       
|Operating loss                       |                                |                                         | (29,761 | )      |             |   | (5,448 | )           |        |   | (35,209 | )     
|                                     | Interest and other income, net |                                         |         | 2,173  |             |   |        | 12          |        |   |         | 2,185  |        
|                                     |                                |                                         |         |        |             |   |        |             |       
|Loss before income taxes             |                                |                                         | (27,588 | )      |             |   | (5,436 | )           |        |   | (33,024 | )     
|                                     | Provision for income taxes     |                                         |         | 323    |             |   |        | (323        | )      |   |         |       |        
|                                     |                                |                                         |         |        |             |   |        |             |       
|Net loss                             |                                | $                                       | (27,911 | )      |             | $ | (5,113 | )           |        | $ | (33,024 | )     
|                                     |                                |                                         |         |        |             |   |        |             |       
|Basic and diluted net loss per share |                                | $                                       | (0.54   | )      |             | $ | (0.09  | )           |        | $ | (0.63   | )     

Summary of the Significant
Effects of the Restatement on the Consolidated Balance Sheet


|                                          |  |                |          |   |             |   |        |             |  |   |          |  
|----------------------------------------- |  | -------------- | -------- | - | ----------- | - | ------ | ----------- |  | - | -------- | -
|                                          |  | March 31, 2004 |         
|                                          |  |                |         
|                                          |  | As previously  |          |   |            
|                                          |  | reported       |          |   | Adjustments |   |        | As restated | 
|                                          |  |                |          |   |             |   |        |             | 
|                                          |  | (In thousands) |         
|Accounts receivable, net                  |  | $              | 47,050   |   |             | $ | (309   | )           |  | $ | 46,741   |  
|Prepaid expenses and other current assets |  |                | 6,398    |   |             |   | (163   | )           |  |   | 6,235    |  
|Total current assets                      |  |                | 173,238  |   |             |   | (472   | )           |  |   | 172,766  |  
|Total assets                              |  |                | 284,122  |   |             |   | (472   | )           |  |   | 283,650  |  
|Short-term borrowings                     |  |                |         |   |             |   | 2,584  |             |  |   | 2,584    |  
|Accounts payable                          |  |                | 11,055   |   |             |   | (136   | )           |  |   | 10,919   |  
|Deferred revenue                          |  |                | 36,785   |   |             |   | (767   | )           |  |   | 36,018   |  
|Long term deferred revenue                |  |                | 2,802    |   |             |   | 3,264  |             |  |   | 6,066    |  
|Total liabilities                         |  |                | 81,568   |   |             |   | 4,945  |             |  |   | 86,513   |  
|Accumulated deficit                       |  |                | (316,360 | ) |             |   | (5,113 | )           |  |   | (321,473 | )
|Accumulated other comprehensive income    |  |                | 2,557    |   |             |   | (304   | )           |  |   | 2,253    |  



F-7



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


2.     Restatements 
(Continued)






|                                              |                                                                                   |                                         |         |         |             |   |         |             |   |   |         |         |  
|--------------------------------------------- | --------------------------------------------------------------------------------- | --------------------------------------- | ------- | ------- | ----------- | - | ------- | ----------- | - | - | ------- | ------- | -
|                                              |                                                                                   | Year Ended March 31, 2004               |        
|                                              |                                                                                   |                                         |        
|                                              |                                                                                   | As previously                           |         |         |            
|                                              |                                                                                   | reported                                |         |         | Adjustments |   |         | As restated |  
|                                              |                                                                                   |                                         |         |         |             |   |         |             |  
|                                              |                                                                                   | (In thousands except per share amounts) |        
|Net loss, as reported                         |                                                                                   | $                                       | (27,911 | )       |             | $ | (5,113  | )           |   | $ | (33,024 | )      
|                                              | Add: Stock-based compensation expense determined under the
    intrinsic method   |                                         |         | 202     |             |   |         |            |   |   |         | 202     |  
|                                              | Less: Stock-based compensation expense determined under the fair
    value method |                                         |         | (26,508 | )           |   |         | (24,576     | ) |   |         | (51,084 | )
|                                              |                                                                                   |                                         |         |         |             |   |         |             |  
|Net loss, pro forma                           |                                                                                   | $                                       | (54,217 | )       |             | $ | (29,689 | )           |   | $ | (83,906 | )      
|                                              |                                                                                   |                                         |         |         |             |   |         |             |  
|Basic and diluted loss per share, as reported |                                                                                   | $                                       | (0.54   | )       |             | $ | (0.09   | )           |   | $ | (0.63   | )      
|Basic and diluted loss per share, pro forma   |                                                                                   | $                                       | (1.04   | )       |             | $ | (0.57   | )           |   | $ | (1.61   | )      





|   |                                           
|-- | ------------------------------------------
|3. | Summary of significant accounting policies



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





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



F-8



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




3.     Summary of significant
accounting policies  (Continued)




| |                 
| | ----------------
| | Reclassification





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





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





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



Marketable securities




Property and
equipment






F-9



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




3.     Summary of significant
accounting policies  (Continued)


Investments in private
companies




Software development
costs




Goodwill and acquired
intangible assets






F-10



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




3.     Summary of significant
accounting policies  (Continued)




|                                          |  |                      |            |   |      |   |            |      |  |   |            |  
|----------------------------------------- |  | -------------------- | ---------- | - | ---- | - | ---------- | ---- |  | - | ---------- | -
|                                          |  | Year Ended March 31, |           
|                                          |  |                      |           
|                                          |  | 2004                 |            |   | 2003 |   |            | 2002 | 
|                                          |  |                      |            |   |      |   |            |      | 
|                                          |  | As restated          |            |   |      |   |           
|Net loss                                  |  | $                    | (33,024    | ) |      | $ | (8,585     | )    |  | $ | (82,709    | )
|Adjustments:                              |  |                      |            |   |      |   |            |      |  |   |            |  
|Amortization of goodwill                  |  |                      |           |   |      |   |           |      |  |   | 35,590     |  
|                                          |  |                      |            |   |      |   |            |      | 
|Adjusted net loss                         |  | $                    | (33,024    | ) |      | $ | (8,585     | )    |  | $ | (47,119    | )
|Weighted average shares-basic and diluted |  |                      | 52,136,919 |   |      |   | 51,281,729 |      |  |   | 49,492,654 |  
|                                          |  |                      |            |   |      |   |            |      | 
|Adjusted basic and diluted EPS            |  | $                    | (0.63      | ) |      | $ | (0.17      | )    |  | $ | (0.95      | )
|Reported basic and diluted EPS            |  | $                    | (0.63      | ) |      | $ | (0.17      | )    |  | $ | (1.67      | )

Impairment of
long-lived assets


Impairment of long-lived
assets




Income taxes




Foreign currency
translations




F-11



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




3.     Summary of significant
accounting policies  (Continued)


Revenue recognition
















F-12



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


3.     Summary of significant
accounting policies  (Continued)




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





|                                                                                  |  |                      |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------- |  | -------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                  |  | Year Ended March 31, |        
|                                                                                  |  |                      |        
|                                                                                  |  | 2004                 |         |   | 2003 |   |         | 2002 | 
|                                                                                  |  |                      |         |   |      |   |         |      | 
|                                                                                  |  | As restated          |         |   |      |   |        
|Net loss, as reported                                                             |  | $                    | (33,024 | ) |      | $ | (8,585  | )    |  | $ | (82,709 | )
|Add: Stock-based compensation expense determined under intrinsic
    value method |  |                      | 202     |   |      |   | 755     |      |  |   | 12,858  |  
|Less: Stock-based compensation expense determined under fair
    value method     |  |                      | (51,084 | ) |      |   | (56,466 | )    |  |   | (18,368 | )
|                                                                                  |  |                      |         |   |      |   |         |      | 
|Net loss, pro forma                                                               |  | $                    | (83,906 | ) |      | $ | (64,296 | )    |  | $ | (88,219 | )
|                                                                                  |  |                      |         |   |      |   |         |      | 
|Basic and diluted net loss per common share, as reported                          |  | $                    | (0.63   | ) |      | $ | (0.17   | )    |  | $ | (1.67   | )
|Basic and diluted net loss per common share, pro forma                            |  | $                    | (1.61   | ) |      | $ | (1.25   | )    |  | $ | (1.78   | )



|                        |  |                |      |   |                |  |      |      |  |  |      |   |  |      |      |   |      |  |      |   |  |  |      |  
|----------------------- |  | -------------- | ---- | - | -------------- |  | ---- | ---- |  |  | ---- | - |  | ---- | ---- | - | ---- |  | ---- | - |  |  | ---- | -
|                        |  | Employee Stock |      |   | Employee Stock | 
|                        |  | Option Plans   |      |   | Purchase Plan  | 
|                        |  | March 31,      |      |   | March 31,      | 
|                        |  |                |      |   |                | 
|                        |  | 2004           |      |   | 2003           |  |      | 2002 |  |  | 2004 |   |  | 2003 |      |   | 2002 | 
|                        |  |                |      |   |                |  |      |      |  |  |      |   |  |      |      |   |      | 
|Expected volatility     |  |                | 95   | % |                |  | 97   | %    |  |  | 125  | % |  |      | 68   | % |      |  | 87   | % |  |  | 138  | %
|Risk-free interest rate |  |                | 2.90 | % |                |  | 2.93 | %    |  |  | 4.40 | % |  |      | 2.88 | % |      |  | 3.04 | % |  |  | 4.87 | %
|Expected life (years)   |  |                | 4    |   |                |  | 4    |      |  |  | 4    |   |  |      | 1    |   |      |  | 0.5  |   |  |  | 1    |  
|Expected dividend yield |  |                | 0    | % |                |  | 0    | %    |  |  | 0    | % |  |      | 0    | % |      |  | 0    | % |  |  | 0    | %





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



F-13



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




3.     Summary of significant
accounting policies  (Continued)




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





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





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





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







F-14



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




3.     Summary of significant
accounting policies  (Continued)






|   |                           
|-- | --------------------------
|4. | Related-party transactions





|   |                               
|-- | ------------------------------
|5. | Investments in private company







|   |                              
|-- | -----------------------------
|6. | Concentrations of credit risk





|   |                      
|-- | ---------------------
|7. | Marketable securities



|                                     |  |                |        |  |                |   |        |      |  |   |            |  |  |   |         | 
|------------------------------------ |  | -------------- | ------ |  | -------------- | - | ------ | ---- |  | - | ---------- |  |  | - | ------- | 
|                                     |  | March 31, 2004 |        |  | March 31, 2003 |  
|                                     |  |                |        |  |                |  
|                                     |  | Cost           |        |  | Fair Value     |   |        | Cost |  |   | Fair Value | 
|                                     |  |                |        |  |                |   |        |      |  |   |            | 
|                                     |  | (In thousands) |        |  | (In thousands) |  
|Due in one year or less              |  | $              | 44,313 |  |                | $ | 44,328 |      |  | $ | 96,799     |  |  | $ | 97,079  | 
|Due after one year through two years |  |                | 36,037 |  |                |   | 36,157 |      |  |   | 24,825     |  |  |   | 24,845  | 
|                                     |  |                |        |  |                |   |        |      |  |   |            | 
|                                     |  | $              | 80,350 |  |                | $ | 80,485 |      |  | $ | 121,624    |  |  | $ | 121,924 | 
|                                     |  |                |        |  |                |   |        |      |  |   |            | 

F-15



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




7.     Marketable
securities  (Continued)






|   |                       
|-- | ----------------------
|8. | Property and equipment



|                                          |  |                |         |   |      |   |         |  
|----------------------------------------- |  | -------------- | ------- | - | ---- | - | ------- | -
|                                          |  | March 31,      |        
|                                          |  |                |        
|                                          |  | 2004           |         |   | 2003 |  
|                                          |  |                |         |   |      |  
|                                          |  | (In thousands) |        
|Equipment                                 |  | $              | 18,852  |   |      | $ | 22,226  |  
|Software                                  |  |                | 6,049   |   |      |   | 7,694   |  
|Furniture                                 |  |                | 3,475   |   |      |   | 4,033   |  
|Leasehold improvements                    |  |                | 3,104   |   |      |   | 2,912   |  
|                                          |  |                |         |   |      |  
|                                          |  |                | 31,480  |   |      |   | 36,865  |  
|Accumulated depreciation and amortization |  |                | (23,374 | ) |      |   | (24,797 | )
|                                          |  |                |         |   |      |  
|                                          |  | $              | 8,106   |   |      | $ | 12,068  |  
|                                          |  |                |         |   |      |  







|   |             
|-- | ------------
|9. | Income taxes





|         |  |                |         |   |      |   |         |      |  |   |         |  
|-------- |  | -------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|         |  | 2004           |         |   | 2003 |   |         | 2002 | 
|         |  |                |         |   |      |   |         |      | 
|         |  | As restated    |         |   |      |   |        
|         |  | (In thousands) |        
|Domestic |  | $              | (26,435 | ) |      | $ | 4,740   |      |  | $ | (70,755 | )
|Foreign  |  |                | (6,589  | ) |      |   | (13,325 | )    |  |   | (11,954 | )
|         |  |                |         |   |      |   |         |      | 
|Total    |  | $              | (33,024 | ) |      | $ | (8,585  | )    |  | $ | (82,709 | )
|         |  |                |         |   |      |   |         |      | 

F-16



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|   |                           
|-- | --------------------------
|9. | Income taxes  (Continued)



|                                      |  |                |          |   |      |   |         |  
|------------------------------------- |  | -------------- | -------- | - | ---- | - | ------- | -
|                                      |  | March 31,      |         
|                                      |  |                |         
|                                      |  | 2004           |          |   | 2003 |  
|                                      |  |                |          |   |      |  
|                                      |  | As restated    |          |   |     
|                                      |  | (In thousands) |         
|Net operating loss carryforwards      |  | $              | 103,419  |   |      | $ | 86,740  |  
|Accrued expenses                      |  |                | 589      |   |      |   | 46      |  
|Deferred revenue                      |  |                | 3,459    |   |      |   | 1,856   |  
|Accounts receivable                   |  |                | 960      |   |      |   | 751     |  
|Impairment loss in equity investments |  |                | 2,350    |   |      |   | 2,350   |  
|Property and equipment                |  |                | (334     | ) |      |   | 568     |  
|Stock option compensation             |  |                | 7,473    |   |      |   | 6,394   |  
|Acquired intangibles                  |  |                | (1,559   | ) |      |   | (9,050  | )
|Research and development credit       |  |                | 8,034    |   |      |   | 6,287   |  
|Other                                 |  |                | 384      |   |      |   | 291     |  
|Valuation allowance                   |  |                | (124,775 | ) |      |   | (96,233 | )
|                                      |  |                |          |   |      |  
|Net deferred tax assets               |  | $              |         |   |      | $ |        |  
|                                      |  |                |          |   |      |  





|                                                         |                    |             |       |    |      |  |       |      |   |  |       |    |  
|-------------------------------------------------------- | ------------------ | ----------- | ----- | -- | ---- |  | ----- | ---- | - |  | ----- | -- | -
|                                                         |                    | March 31,   |      
|                                                         |                    |             |      
|                                                         |                    | 2004        |       |    | 2003 |  |       | 2002 |  
|                                                         |                    |             |       |    |      |  |       |      |  
|                                                         |                    | As restated |       |    |      |  |      
|U.S. Federal statutory rate                              |                    |             | (34.0 | )% |      |  | (34.0 | )%   |   |  | (34.0 | )%
|State and local taxes, net of Federal income tax benefit |                    |             | (3.1  | )  |      |  | 2.5   |      |   |  | (1.4  | ) 
|Non-deductible items                                     |                    |             | 1.1   |    |      |  | 2.1   |      |   |  | 18.8  |   
|Change in valuation allowance                            |                    |             | 44.5  |    |      |  | 34.0  |      |   |  | 6.6   |   
|Amortization of nondeductible goodwill                   |                    |             |      |    |      |  |      |      |   |  | 14.6  |   
|Change in general business credit                        |                    |             | (5.3  | )  |      |  | (21.1 | )    |   |  | (5.3  | ) 
|Foreign rate differential                                |                    |             | (3.2  | )  |      |  | 16.5  |      |   |  | 0.3   |   
|Other                                                    |                    |             |      |    |      |  |      |      |   |  | 0.4   |   
|                                                         |                    |             |       |    |      |  |       |      |  
|                                                         | Effective tax rate |             |       |   | %    |  |       |     | % |  |       |   | %
|                                                         |                    |             |       |    |      |  |       |      |  



|    |           
|--- | ----------
|10. | Borrowings



F-17



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                         
|--- | ------------------------
|10. | Borrowings  (Continued)













|    |                  
|--- | -----------------
|11. | Lease commitments





F-18



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                                
|--- | -------------------------------
|11. | Lease commitments  (Continued)



|                                                 |            |                |        |       |         |   |       |     | 
|------------------------------------------------ | ---------- | -------------- | ------ | ----- | ------- | - | ----- | --- | 
|                                                 |            | Operating      |        |       | Capital |  
|                                                 |            |                |        |       |         |  
|                                                 |            | (In thousands) |       
|Years ending March 31,
    2005                  |            | $              | 12,800 |       |         | $ | 968   |    
|                                                 | 2006       |                |        | 8,417 |         |   |       | 358 | 
|                                                 | 2007       |                |        | 8,198 |         |   |       | 29  | 
|                                                 | 2008       |                |        | 2,714 |         |   |       |    | 
|                                                 | 2009       |                |        | 783   |         |   |       |    | 
|                                                 | Thereafter |                |        | 426   |         |   |       |    | 
|                                                 |            |                |        |       |         |  
|                                                 |            | $              | 33,338 |       |         |   | 1,355 |    
|                                                 |            |                |        |       |         |  
|Less amounts representing interest               |            |                |        |       |         |   | (73   | )  
|                                                 |            |                |        |       |         |  
|                                                 |            |                |        |       |         |   | 1,282 |    
|Less current portion                             |            |                |        |       |         |   | (909  | )  
|                                                 |            |                |        |       |         |  
|Capital lease obligation, net of current portion |            |                |        |       |         | $ | 373   |    
|                                                 |            |                |        |       |         |  



|    |                     
|--- | --------------------
|12. | Stockholders equity



| |                
| | ---------------
| | Preferred stock





| |        
| | -------
| | Warrant





F-19



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                                   
|--- | ----------------------------------
|12. | Stockholders equity  (Continued)





|    |                      
|--- | ---------------------
|13. | Business acquisitions











F-20



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                                    
|--- | -----------------------------------
|13. | 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 |  
|                                       |  |                 |        |   |     |   |       |       | 







|                                               |  |                       |         |   |      |   |         |  
|---------------------------------------------- |  | --------------------- | ------- | - | ---- | - | ------- | -
|                                               |  | Years Ended March 31, |        
|                                               |  |                       |        
|                                               |  | 2004                  |         |   | 2003 |  
|                                               |  |                       |         |   |      |  
|                                               |  | As restated           |         |   |     
|                                               |  | (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-21



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                          
|--- | -------------------------
|14. | Acquisition of technology







|     |  |   |        | 
|---- |  | - | ------ | 
|2005 |  | $ | 2,396  | 
|2006 |  |   | 2,396  | 
|2007 |  |   | 2,396  | 
|2008 |  |   | 2,396  | 
|2009 |  |   | 1,203  | 
|     |  |   |       
|     |  | $ | 10,787 | 
|     |  |   |       



|    |                         
|--- | ------------------------
|15. | Stock based compensation



| |                     
| | --------------------
| | Stock incentive plan







F-22



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                                       
|--- | --------------------------------------
|15. | Stock based compensation  (Continued)



|                            |           |               |            |             |                |   |                  |                |  |   |        |        |  |   |       |       | 
|--------------------------- | --------- | ------------- | ---------- | ----------- | -------------- | - | ---------------- | -------------- |  | - | ------ | ------ |  | - | ----- | ----- | 
|                            |           |               |            | Range of    |                |   | Weighted Average |               
|                            |           | Stock Options |            |             | Exercise Price |   |                  | Exercise Price | 
|                            |           |               |            |             |                |   |                  |                | 
|Outstanding, March 31, 2001 |           |               | 15,743,245 |             |                | $ | 0.11            |                |  | $ | 254.27 |        |  | $ | 58.18 |      
|                            | Granted   |               |            | 11,294,307  |                |   |                  | 6.32          |  |   |        | 34.17  |  |   |       | 15.65 | 
|                            | Exercised |               |            | (1,451,256  | )              |   |                  | 0.11          |  |   |        | 29.00  |  |   |       | 7.26  | 
|                            | Cancelled |               |            | (10,008,085 | )              |   |                  | 0.11          |  |   |        | 254.27 |  |   |       | 76.97 | 
|                            |           |               |            |             |                |   |                  |               
|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 |      
|                            |           |               |            |             |                |   |                  |               



|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                  |  |  |      |  |  |   |       |  |  |  |           |  |  |   |       | 
|--------------- | ----- | --------- |  | ---------------- | ---------------- | - | ------ | ---------------- |  |  | ------------------- |  | ---------- | ---------------- |  |  | ---- |  |  | - | ----- |  |  |  | --------- |  |  | - | ----- | 
|                |       |           |  |                  |                  |   |        | Outstanding      |  |  | Options Exercisable | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     | 
|                |       |           |  | Weighted Average |                  |   |        |                  | 
|Range of        |       | Number of |  |                  | Remaining        |   |        | Weighted Average |  |  | Number of           |  |            | Weighted Average | 
|Exercise Prices |       | Shares    |  |                  | Contractual Life |   |        | Exercise Price   |  |  | Shares              |  |            | Exercise Price   | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                  | 
|$               | 0.11  |           |  |                 |                  | $ | 8.57   |                  |  |  |                     |  | 3,720,563  |                  |  |  | 7.55 |  |  | $ | 6.45  |  |  |  | 1,958,585 |  |  | $ | 5.19  | 
|                | 8.58  |           |  |                 |                  |   | 9.58   |                  |  |  |                     |  | 3,584,981  |                  |  |  | 9.11 |  |  |   | 8.87  |  |  |  | 713,288   |  |  |   | 8.86  | 
|                | 9.60  |           |  |                 |                  |   | 12.00  |                  |  |  |                     |  | 1,702,280  |                  |  |  | 8.67 |  |  |   | 10.55 |  |  |  | 534,474   |  |  |   | 11.28 | 
|                | 12.01 |           |  |                 |                  |   | 14.36  |                  |  |  |                     |  | 5,294,402  |                  |  |  | 7.59 |  |  |   | 14.29 |  |  |  | 4,371,987 |  |  |   | 14.28 | 
|                | 14.70 |           |  |                 |                  |   | 161.29 |                  |  |  |                     |  | 2,489,234  |                  |  |  | 6.91 |  |  |   | 43.18 |  |  |  | 1,933,185 |  |  |   | 46.20 | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                  |  |  |      |  |  |   |       |  | 
|$               | 0.11  |           |  |                 |                  | $ | 161.29 |                  |  |  |                     |  | 16,791,460 |                  |  |  | 7.91 |  |  | $ | 15.30 |  |  |  | 9,511,519 |  |  | $ | 18.32 | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                  |  |  |      |  |  |   |       |  | 





F-23



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                                       
|--- | --------------------------------------
|15. | Stock based compensation  (Continued)



| |                             
| | ----------------------------
| | Employee Stock Purchase Plan











|                             |  |  |       |  
|---------------------------- |  |  | ----- | -
|Balance at March 31, 2002    |  |  | 2,661 |  
|                             |  |  |      
|Additional authorized shares |  |  | 750   |  
|Purchases                    |  |  | (383  | )
|                             |  |  |      
|Balance at March 31, 2003    |  |  | 3,028 |  
|                             |  |  |      
|Additional authorized shares |  |  | 750   |  
|Purchases                    |  |  | (360  | )
|                             |  |  |      
|Balance at March 31, 2004    |  |  | 3,418 |  
|                             |  |  |      



| |                        
| | -----------------------
| | Shareholder Rights Plan



F-24



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                                       
|--- | --------------------------------------
|15. | Stock based compensation  (Continued)





|    |                      
|--- | ---------------------
|16. | Employee benefit plan



F-25



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                                                   
|--- | --------------------------------------------------
|17. | Supplemental disclosures of cash flow information:

|                                             |                                                                |                      |      |        |      |   |     |       |  |   |     |       |  | 
|-------------------------------------------- | -------------------------------------------------------------- | -------------------- | ---- | ------ | ---- | - | --- | ----- |  | - | --- | ----- |  | 
|                                             |                                                                | Year Ended March 31, |     
|                                             |                                                                |                      |     
|                                             |                                                                | 2004                 |      |        | 2003 |   |     | 2002  | 
|                                             |                                                                |                      |      |        |      |   |     |       | 
|                                             |                                                                | (In thousands)       |     
|Cash paid during the period for interest     |                                                                | $                    | 202  |        |      | $ | 673 |       |  | $ | 511 |      
|                                             |                                                                |                      |      |        |      |   |     |       | 
|Non-cash investing and financing activities: |                                                                |                      |      |        |      |   |     |       |  |   |     |      
|                                             | Equipment purchased under capital lease                        |                      | $    | 1,457  |      |   | $   | 1,665 |  |   | $   | 3,061 | 
|                                             | Conversion of interest income into equity in private company   |                      | $    | 257    |      |   | $   |      |  |   | $   |      | 
|                                             | Change in net unrealized gain or loss on marketable securities |                      | $    | 165    |      |   | $   | 135   |  |   | $   | 692   | 
|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-26



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                                  
|--- | ---------------------------------
|18. | Restructuring and related charges









|                                    |  |                |        |           |             |   |            |          |  |   |       |   |  |   |        |  
|----------------------------------- |  | -------------- | ------ | --------- | ----------- | - | ---------- | -------- |  | - | ----- | - |  | - | ------ | -
|                                    |  |                |        | Severance |             |   | Impairment |          |  |  
|                                    |  | Excess         |        |           | And Related |   |            | of Fixed |  |   |      
|                                    |  | Facilities     |        |           | Benefits    |   |            | Assets   |  |   | Total |  
|                                    |  |                |        |           |             |   |            |          |  |   |       |  
|                                    |  | (In thousands) |       
|Balance at March 31, 2001           |  | $              |       |           |             | $ |           |          |  | $ |      |   |  | $ |       |  
|Fiscal 2002 charges                 |  |                | 3,610  |           |             |   | 3,489      |          |  |   | 144   |   |  |   | 7,243  |  
|Non-cash write-down of fixed assets |  |                |       |           |             |   |           |          |  |   | (144  | ) |  |   | (144   | )
|Cash payments made in fiscal 2002   |  |                | (615   | )         |             |   | (3,489     | )        |  |   |      |   |  |   | (4,104 | )
|                                    |  |                |        |           |             |   |            |          |  |   |       |  
|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   |  |                | (847   | )         |             |   | (1,470     | )        |  |   |      |   |  |   | (2,317 | )
|                                    |  |                |        |           |             |   |            |          |  |   |       |  
|Balance at March 31, 2004           |  | $              | 2,360  |           |             | $ | 749        |          |  | $ |      |   |  | $ | 3,109  |  
|                                    |  |                |        |           |             |   |            |          |  |   |       |  



|    |                    
|--- | -------------------
|19. | Segment information



F-27



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




19.     Segment
information  (Continued)




|                  |       |                       |         |         |      |   |         |         |  |   |         |         | 
|----------------- | ----- | --------------------- | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- | 
|                  |       | Years Ended March 31, |        
|                  |       |                       |        
|                  |       | 2004                  |         |         | 2003 |   |         | 2002    | 
|                  |       |                       |         |         |      |   |         |         | 
|                  |       | As restated           |         |         |      |   |        
|                  |       | (In thousands)        |        
|Revenue           |       |                       |         |         |      |   |         |         |  |   |         |        
|Americas          |       | $                     | 114,507 |         |      | $ | 133,756 |         |  | $ | 143,003 |        
|Europe            |       |                       | 44,965  |         |      |   | 36,351  |         |  |   | 35,666  |        
|Japan             |       |                       | 15,472  |         |      |   | 15,274  |         |  |   | 6,632   |        
|Asia Pacific      |       |                       | 14,597  |         |      |   | 11,373  |         |  |   | 10,695  |        
|                  |       |                       |         |         |      |   |         |         | 
|                  | Total |                       | $       | 189,541 |      |   | $       | 196,754 |  |   | $       | 195,996 | 
|                  |       |                       |         |         |      |   |         |         | 
|Long Lived Assets |       |                       |         |         |      |   |         |         |  |   |         |        
|Americas          |       | $                     | 70,497  |         |      | $ | 47,853  |         |  | $ | 55,360  |        
|Europe            |       |                       | 2,189   |         |      |   | 2,228   |         |  |   | 1,555   |        
|Japan             |       |                       | 1,681   |         |      |   | 935     |         |  |   | 697     |        
|Asia Pacific      |       |                       | 360     |         |      |   | 541     |         |  |   | 676     |        
|                  |       |                       |         |         |      |   |         |         | 
|                  | Total |                       | $       | 74,727  |      |   | $       | 51,557  |  |   | $       | 58,288  | 
|                  |       |                       |         |         |      |   |         |         | 

F-28



---



##### 



SCHEDULE II  VALUATION AND QUALIFYING ACCOUNTS




|                                                          |  |                |       |  |            |   |       |            |            |   |        |  |  |   |       | 
|--------------------------------------------------------- |  | -------------- | ----- |  | ---------- | - | ----- | ---------- | ---------- | - | ------ |  |  | - | ----- | 
|                                                          |  | Balance at     |       |  |            |   |       |            | Balance at |  
|                                                          |  | Beginning of   |       |  |            |   |       |            | End of     |  
|                                                          |  | Period         |       |  | Provisions |   |       | Deductions |            |   | Period | 
|                                                          |  |                |       |  |            |   |       |            |            |   |        | 
|                                                          |  | (In thousands) |      
|Year ended March 31, 2002 allowance for doubtful accounts |  | $              | 4,342 |  |            | $ | 2,840 |            |            | $ | 3,497  |  |  | $ | 3,685 | 
|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 | 

F-29



---



##### 



Report of Independent Registered Public Accounting Firm on


Financial Statement Schedule







PRICEWATERHOUSECOOPERS
LLP


F-30



---



##### 



EXHIBIT INDEX


|        |    |             |  |                                                                                                                                               
|------- | -- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 2  | .1(1)       |  | Agreement and Plan of Merger dated as of May 20, 2000, by
    and among webMethods, Inc., Wolf Acquisition, Inc. and Active
    Software, Inc.
|        | 3  | .1(2)       |  | Fifth Amended and Restated Certificate of Incorporation of
    webMethods, Inc., as amended                                                   
|        | 3  | .2(3)       |  | Amended and Restated Bylaws of webMethods, Inc.                                                                                               
|        | 4  | .1(3)       |  | Specimen certificate for shares of webMethods, Inc. Common Stock                                                                              
|        | 4  | .2(4)       |  | Rights Agreement dated as of October 18, 2001 between
    webMethods, Inc. and American Stock Transfer &
    Trust Company                    
|        | 10 | .1(3)       |  | Second Amended and Restated Investor Rights Agreement                                                                                         
|        | 10 | .2(5)       |  | webMethods, Inc. Amended and Restated Stock Option Plan, as
    Amended                                                                       
|        | 10 | .3(3)       |  | Employee Stock Purchase Plan                                                                                                                  
|        | 10 | .4(3)       |  | Indemnification Agreement entered into between webMethods, Inc.
    and each of its directors                                                 
|        | 21 | .1(6)       |  | Subsidiaries of webMethods, Inc.                                                                                                              
|        | 23 | .1*         |  | Consent of PricewaterhouseCoopers LLP                                                                                                         
|        | 24 | (6)         |  | Power of Attorney (included on signature page of
    webMethods Form 10-K for the year ended
    March 31, 2004 filed on June 14, 2004)      
|        | 31 | .1*         |  | Rule 13a-14(a) Certification of Chief Executive Officer                                                                                       
|        | 31 | .2*         |  | Rule 13a-14(a) Certification of Chief Financial Officer                                                                                       
|        | 32 | .1* #       |  | Section 1350 Certification of Chief Executive Officer                                                                                         
|        | 32 | .2* #       |  | Section 1350 Certification of Chief Financial Officer                                                                                         






|    |                                                                                                                                                                                             
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to webMethods Registration
    Statement on Form S-4, as amended (File No. 333-39572).                                                                           
|   
|(2) | Incorporated by reference to webMethods Form 10-K for
    the year ended March 31, 2002 (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) | Previously filed as an exhibit to webMethods
    Form 10-K for the year ended March 31, 2004 filed with
    the Securities and Exchange Commission on June 14, 2004
    (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.