##### 









UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-K


(Mark One)




|  |                                                                                                                                        
|- | ---------------------------------------------------------------------------------------------------------------------------------------
|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED
    MARCH 31, 2006  
| 
|o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM
    
    TO

Commission File Number


1-15681





webMethods, Inc.


(Exact name of Registrant as Specified in its Charter)


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

(703) 460-2500











o x


o x


x o


S-K 10-K 10-K. x


12b-2


o x o


12b-2 o x






DOCUMENTS INCORPORATED BY REFERENCE


10-K










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##### 



WEBMETHODS, INC.


ANNUAL REPORT ON
FORM 10-K


FOR THE YEAR ENDED MARCH 31, 2006


TABLE OF CONTENTS


|           |  |                                                                                                                  |  |   
|---------- |  | ---------------------------------------------------------------------------------------------------------------- |  | --
|Part I    
|          
|Item 1.    |  | Business                                                                                                         |  | 1 
|Item 1A.   |  | Risk Factors                                                                                                     |  | 10
|Item 1B.   |  | Unresolved Staff Comments                                                                                        |  | 20
|Item 2.    |  | Properties                                                                                                       |  | 21
|Item 3.    |  | Legal Proceedings                                                                                                |  | 21
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                              |  | 21
|          
|Part II   
|          
|Item 5.    |  | Market for Registrants Common Equity, Related Stockholder
    Matters and Issuer Purchases of Equity Securities |  | 22
|Item 6.    |  | Selected Financial Data                                                                                          |  | 22
|Item 7.    |  | Managements Discussion and Analysis of Financial Condition
    and Results of Operations                        |  | 24
|Item 7A.   |  | Quantitative and Qualitative Disclosures about Market Risk                                                       |  | 40
|Item 8.    |  | Financial Statements and Supplementary Data                                                                      |  | 40
|Item 9.    |  | Changes in and Disagreements with Accountants on Accounting and
    Financial Disclosure                         |  | 40
|Item 9A.   |  | Controls and Procedures                                                                                          |  | 40
|Item 9B.   |  | Other Information                                                                                                |  | 42
|          
|Part III  
|          
|Item 10.   |  | Directors and Executive Officers of the Registrant                                                               |  | 43
|Item 11.   |  | Executive Compensation                                                                                           |  | 43
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management
    and Related Stockholder Matters               |  | 43
|Item 13.   |  | Certain Relationships and Related Transactions                                                                   |  | 43
|Item 14.   |  | Principal Accountant Fees and Services                                                                           |  | 43
|          
|Part IV   
|          
|Item 15.   |  | Exhibits and Financial Statement Schedules                                                                       |  | 43
|Signatures |  | 44                                                                                                              



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##### 



10-K


FORWARD-LOOKING STATEMENTS


10-K




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | projections of revenue, costs or expense, margins, income or
    loss, earnings or loss per share, capital expenditures, cash
    requirements or other financial items, effective tax rate,
    sufficiency of working capital and projections regarding the
    market for our software and services;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | statements of our plans, objectives or expectations, including
    the development or enhancement of software, development and
    continuation of strategic partnerships and alliances,
    contributions to revenue by our business partners,
    implementation and effect of sales and marketing initiatives,
    future financial results, future financial results within
    geographic or specific markets and the allocation of resources
    to those markets, predictions of the timing and type of customer
    or market reaction to sales and marketing initiatives, the
    ability to control expenses, anticipated cost savings or expense
    reduction strategies, future hiring, business strategy and the
    execution on it and actions by customers and competitors;
|
| |  | statements of future economic performance or economic
    conditions, the continuation of patterns identified as trends or
    seasonal occurrences or the impact of recent or anticipated
    changes in accounting standards;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| |  | statements of our plans for remediation of a material weakness,
    or other changes, in our internal controls over financial
    reporting; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|
| |  | assumptions underlying any of the foregoing.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                






PART I







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

OVERVIEW




1



---



##### 







PRODUCTS AND SOLUTIONS


webMethods Fabric


tm




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Proven enterprise application integration (EAI) and
    business-to-business
    (B2B) integration capabilities drawn from our
    product leadership in those markets.                                                                                                                                                                                                                                                                                                                      
|
| |  | A comprehensive set of capabilities for implementing
    Service-Oriented Architecture (SOA), which enables
    customers to extend the value of existing IT assets by
    converting them into reusable components that can be reassembled
    and reconfigured to meet new business needs. These capabilities
    include an integrated Web services registry, Web services
    monitoring, mediation, and management functionality, and
    real-time analytics for managing service levels.
|
| |  | Mature Business Process Management (BPM)
    capabilities that are not only targeted at integrating an
    organizations core, high-volume, mission-critical business
    processes, but which also include rich workflow capabilities
    that allow manual tasks and human decision points to be
    incorporated into an
    end-to-end business
    process.                                                                                                                              
|
| |  | Patent-pending Business Activity Monitoring (BAM)
    capabilities that provide real-time visibility into business
    process performance, as well as the ability to predict
    exceptions by comparing current activity with historical norms.                                                                                                                                                                                                                                              



end-to






| |   |                                                                                                                                                                                                                                                                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | In August 2005, we announced a strategic partnership and
    reseller agreement with NEON Systems, Inc. (now DataDirect
    Technologies, an operating unit of Progress Software
    Corporation), that allows us to offer NEONs Shadow
    RTE®
    mainframe integration technology for companies wanting to
    connect to mainframe systems and data using standard Web
    services technology.
|
| |  | In November 2005, we announced a licensing agreement with Fair
    Isaac Corporation to incorporate Fair Isaacs Blaze
    Advisor, a leading rules management product, as the embedded
    rules engine for future editions of webMethods Fabric. This
    capability provides business users with added versatility                                                                                

2



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##### 



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | and ease-of-use in the
    way in which business rules and policies are created, managed,
    and changed within the webMethods Fabric operating environment.                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | In December 2005, webMethods Fabric was certified for
    conformance to the Common Criteria for IT Security Evaluation
    (ISO Standard 15408). The Common Criteria certification is
    accepted internationally as a definitive standard for
    guaranteeing that the integrity and security architecture of a
    technology have been thoroughly tested and validated by an
    accredited, third-party source. In the USA, various government
    departments and agencies have policies requiring the use of
    Common Criteria certified technology under certain scenarios.



Enterprise Services Platform


tm




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Proven business integration functionalitythat provides
    customers a unified XML-based environment for addressing both
    application-to-application
    and
    business-to-business
    integration scenarios, including the ability to connect reliably
    to a variety of legacy systems and packaged applications,
    communicate securely across firewalls, perform data
    transformations and mappings, and manage a community of trading
    partners.                                                                                                                                                                                                            
|
| |  | An extensive library of adaptersthat provides customers
    a standard mechanism for integrating applications that have
    proprietary programming interfaces, such as those from vendors
    like Oracle Corporation and SAP. Using adapters, developers do
    not have to learn the technical intricacies of each interface;
    instead, they have a graphical interface for configuring the
    operations to be performed against a software application. An
    adapter development kit simplifies the creation of custom
    adapters for software applications that are not supported within
    our broad library of adapters.                                        
|
| |  | Support for a wide range of electronic commerce protocolsthat enable customers to integrate their information systems
    with those of their business partners to automate inter-company
    interactions, such as order management, inventory
    synchronization, logistics management and supply collaboration.
    Supported protocols and
    e-business standards
    include EDI, EDIINT (AS1, AS2, and AS3), RosettaNet, CIDX, PIDX,
    FIX, SWIFT and ebXML.                                                                                                                                                                                                          
|
| |  | High performance messaging middlewarethat serves as the
    communications layer in the webMethods Fabric architecture, and
    which enables the real-time, event-driven interactions needed
    for BAM and other high- volume applications that require
    reliable message delivery and a scalable publish/subscribe
    architecture capable of processing thousands of messages per
    second. A Java Message Service (JMS)-compliant
    interface is also available.                                                                                                                                                                                                 
|
| |  | Web services enablement and management featuresthat
    allow customers to make integration assets created with
    webMethods Fabric and existing application functions available
    as standard Web services, and then to manage the deployment of
    those services and any other Web services in the environment,
    irrespective of where they originate, with enterprise-class
    quality of service. The Web services management capabilities
    integrated into webMethods Fabric include a service registry,
    security, load balancing, fail-over, and unique real-time
    service-level monitoring functionality enabled by our
    patent-pending technology.

3



---



##### 



Business Process Management


easy-to


Business Activity Monitoring




Composite Application Framework


tm


Business Process Productivity Solutions


tm




| |   |                                                                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Personalized user interfaces and reporting dashboards to speed
    and simplify end-user adoption.                                                                                                       
|
| |  | Predefined business templates, rules, processes and key
    performance indicators to enhance the immediate business value
    that these solutions can deliver.                                         
|
| |  | Documented reference architectures, implementation
    methodologies, targeted training programs, and user-based
    business case analysis to help ensure successful implementation
    of the software.

4



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##### 





webMethods for Compliance




webMethods for Financial Services




webMethods for the Demand-Driven Enterprise




order-to




point-of time-to


SERVICES


on-site


5



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10-step




24-hour tm


SALES AND MARKETING






6



---



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end-of


PRODUCT DEVELOPMENT






STRATEGIC RELATIONSHIPS






7



---



##### 





COMPETITION






INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS






8



---



##### 









CORPORATE INFORMATION




AVAILABLE INFORMATION


www.webMethods.com. 10-K, 10-Q, 8-K


EMPLOYEES




9



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|         |             
|-------- | ------------
|Item 1A. | RISK FACTORS



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






| |   |                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | changes in demand for our software products and services;                                                                                                                                                                          
|
| |  | the timing and terms of large transactions with customers;                                                                                                                                                                         
|
| |  | the spending environment for business integration and
    optimization solutions;                                                                                                                                                  
|
| |  | competitive pressures;                                                                                                                                                                                                             
|
| |  | fluctuations in the revenue and license revenue of our
    geographic regions;                                                                                                                                                     
|
| |  | our ability to execute on our business strategy and sales
    strategies within the timeframes we anticipate;                                                                                                                      
|
| |  | the number of our quota-bearing sales representatives, their
    experience with our solutions, software products and sales
    processes and their capability to utilize our solution-selling
    approach;                       
|
| |  | the timing and amount of revenue from acquired technologies or
    businesses;                                                                                                                                                     
|
| |  | the amount and timing of operating expenses and the success of
    attempts to increase expense efficiency and the timing and
    amount of non-recurring or non-cash charges;                                                     
|
| |  | delays in the availability of new products or new releases of
    existing products;                                                                                                                                               
|
| |  | costs of legal compliance, including compliance with the
    Sarbanes-Oxley Act of 2002 and regulatory requirements and
    investigating allegations that may be made or resolving any
    pending or threatened legal claims; and
|
| |  | changes that we may make in our business, operations and
    infrastructure.                                                                                                                                                       



10



---



##### 





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






| |   |                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------
| |  | the overall volatility of the stock market, particularly the
    stock prices of software and technology companies;                           
|
| |  | fluctuation in the levels of total revenue, license revenue and
    operating results of competitors;                                         
|
| |  | changes in securities analysts estimates, recommendations
    or expectations with respect to our business, common stock or
    our industry;
|
| |  | rapid developments, consolidation and technology changes within
    our industry; and                                                         
|
| |  | changes to accounting rules.                                                                                                                  



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








| |   |                                                                                      
| | - | -------------------------------------------------------------------------------------
| |  | large software vendors;                                                              
|
| |  | companies that develop their own integration software or Web
    services technology;
|
| |  | business integration software vendors;                                               
|
| |  | electronic data interchange vendors;                                                 
|
| |  | vendors of proprietary enterprise application
    integration; and                   
|
| |  | application server vendors.                                                          

in-house


11



---



##### 





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




Before the current fiscal year, we had a history of
operating losses, and our failure to sustain profitability could
impact our prospects of achieving our growth targets and have a
material adverse effect on the market price of our common
stock.




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




12



---



##### 





Our international operations expose us to foreign currency
gains and losses.




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






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




13



---



##### 





We may incur significant expenses in hiring new employees
and in reducing our headcount in response to changing market
conditions.




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




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




14



---



##### 



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




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




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




15



---



##### 



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




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








16



---



##### 





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






The use of open source software in our products may expose
us to additional risks.




17



---



##### 





The Sarbanes-Oxley Act of 2002 requires that we undertake
periodic evaluations of our internal control over financial
reporting, and we have identified a material weakness that could
harm our reputation and impact the market price of our common
stock.




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




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




18



---



##### 





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




Our international sales efforts could subject us to greater
or unique uncertainties and additional risk.






| |   |                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------
| |  | the difficulties and costs of staffing and managing foreign
    operations;                          
|
| |  | the difficulty of ensuring adherence to our revenue recognition
    and other policies;              
|
| |  | the difficulty of monitoring and enforcing internal controls and
    disclosure controls;            
|
| |  | unexpected changes in regulatory requirements, business
    practices, taxes, trade laws and tariffs;
|
| |  | differing intellectual property rights; differing labor
    regulations; and                         
|
| |  | changes in a specific countrys or regions political
    or economic conditions.                    



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




19



---



##### 





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







Item 1B.     UNRESOLVED STAFF
COMMENTS




20



---



##### 








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










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










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



21



---



##### 






PART II







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



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

|                           |                                           |      |   |      |     |  |   |      | 
|-------------------------- | ----------------------------------------- | ---- | - | ---- | --- |  | - | ---- | 
|                           |                                           | High |   |      | Low | 
|                           |                                           |      |   |      |     | 
|Year ended March 31, 2006: |                                           |      |   |      |     |  |   |     
|                           | First Quarter (ended June 30, 2005)       |      | $ | 5.73 |     |  | $ | 4.50 | 
|                           | Second Quarter (ended September 30, 2005) |      |   | 7.32 |     |  |   | 5.33 | 
|                           | Third Quarter (ended December 31, 2005)   |      |   | 8.17 |     |  |   | 6.21 | 
|                           | Fourth Quarter (ended March 31, 2006)     |      |   | 8.50 |     |  |   | 7.26 | 










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



22



---



##### 



|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |         |         |        |         |         |         |        |         | 
|----------------------------------------------------- | ------------------------------------------ | ---------------------------------------- | ------------------------ | ------ | ------ | ------- | ------- | ------ | ------ | ------- | ------- | ------ | ------ | ------- | ------- | ------- | ------ | ------- | ------- | ------- | ------ | ------- | 
|                                                      |                                            | Year Ended March 31,                     |                         
|                                                      |                                            |                                          |                         
|                                                      |                                            | 2006                                     |                          |        | 2005   |         |         | 2004   |        |         | 2003    |        |        | 2002    |        
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|                                                      |                                            | (In thousands, except per share amounts) |                         
|Consolidated Statements of Operations Data:           |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |         |         |        |         |         |        
|Revenue:                                              |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |         |         |        |         |         |        
|                                                      | License                                    |                                          | $                        | 87,449 |        |         | $       | 86,800 |        |         | $       | 92,740 |        |         | $       | 117,066 |        |         | $       | 121,803 |       
|                                                      | Professional services                      |                                          |                          | 47,183 |        |         |         | 49,218 |        |         |         | 43,634 |        |         |         | 33,378  |        |         |         | 35,800  |       
|                                                      | Maintenance                                |                                          |                          | 74,186 |        |         |         | 64,583 |        |         |         | 53,167 |        |         |         | 46,310  |        |         |         | 38,393  |       
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|                                                      |                                            |                                          | Total revenue            |        |        | 208,818 |         |        |        | 200,601 |         |        |        | 189,541 |         |         |        | 196,754 |         |         |        | 195,996 | 
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|Cost of revenue:                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |         |         |        |         |         |        
|                                                      | Amortization of intangibles                |                                          |                          | 2,397  |        |         |         | 2,397  |        |         |         | 1,199  |        |         |         |        |        |         |         |        |       
|                                                      | License                                    |                                          |                          | 1,002  |        |         |         | 1,252  |        |         |         | 2,211  |        |         |         | 1,937   |        |         |         | 2,335   |       
|                                                      | Professional services                      |                                          |                          | 42,688 |        |         |         | 43,989 |        |         |         | 42,308 |        |         |         | 31,911  |        |         |         | 34,491  |       
|                                                      | Maintenance                                |                                          |                          | 12,774 |        |         |         | 12,965 |        |         |         | 11,205 |        |         |         | 10,277  |        |         |         | 8,069   |       
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|                                                      |                                            |                                          | Total cost of revenue    |        |        | 58,861  |         |        |        | 60,603  |         |        |        | 56,923  |         |         |        | 44,125  |         |         |        | 44,895  | 
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|Gross profit                                          |                                            |                                          | 149,957                  |        |        |         | 139,998 |        |        |         | 132,618 |        |        |         | 152,629 |         |        |         | 151,101 |        
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|Operating expenses:                                   |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |         |         |        |         |         |        
|                                                      | Sales and marketing costs                  |                                          |                          | 74,084 |        |         |         | 84,313 |        |         |         | 94,433 |        |         |         | 96,719  |        |         |         | 109,242 |       
|                                                      | Research and development costs             |                                          |                          | 40,197 |        |         |         | 44,518 |        |         |         | 45,060 |        |         |         | 47,538  |        |         |         | 62,160  |       
|                                                      | General and administrative costs           |                                          |                          | 23,812 |        |         |         | 25,042 |        |         |         | 17,880 |        |         |         | 17,878  |        |         |         | 19,805  |       
|                                                      | Restructuring and related charges          |                                          |                          | 411    |        |         |         | 5,849  |        |         |         | 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 |        |        | 138,504 |         |        |        | 159,722 |         |        |        | 167,827 |         |         |        | 164,290 |         |         |        | 237,147 | 
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|Operating income (loss)                               |                                            |                                          | 11,453                   |        |        |         | (19,724 | )      |        |         | (35,209 | )      |        |         | (11,661 | )       |        |         | (86,046 | )      
|Interest income                                       |                                            |                                          | 4,496                    |        |        |         | 2,487   |        |        |         | 2,851   |        |        |         | 4,732   |         |        |         | 9,116   |        
|Interest expense                                      |                                            |                                          | (82                      | )      |        |         | (98     | )      |        |         | (205    | )      |        |         | (674    | )       |        |         | (553    | )      
|Other income (expense)                                |                                            |                                          | 807                      |        |        |         | (124    | )      |        |         | (461    | )      |        |         | 18      |         |        |         | (26     | )      
|Impairment of equity investments in private companies |                                            |                                          |                         |        |        |         | (1,057  | )      |        |         |        |        |        |         | (1,000  | )       |        |         | (5,200  | )      
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|Net income (loss) before income taxes                 |                                            |                                          | 16,674                   |        |        |         | (18,516 | )      |        |         | (33,024 | )      |        |         | (8,585  | )       |        |         | (82,709 | )      
|Provision for (benefit from) income taxes             |                                            |                                          | (1,348                   | )      |        |         | 235     |        |        |         |        |        |        |         |        |         |        |         |        |        
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|Net income (loss)                                     |                                            |                                          | 18,022                   |        |        |         | (18,751 | )      |        |         | (33,024 | )      |        |         | (8,585  | )       |        |         | (82,709 | )      
|Basic net income (loss) per share                     |                                            | $                                        | 0.34                     |        |        | $       | (0.35   | )      |        | $       | (0.63   | )      |        | $       | (0.17   | )       |        | $       | (1.67   | )      
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|Fully diluted net income (loss) per share             |                                            | $                                        | 0.33                     |        |        | $       | (0.35   | )      |        | $       | (0.63   | )      |        | $       | (0.17   | )       |        | $       | (1.67   | )      
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|Shares used in computing per share amount             |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |         |         |        |         |         |        
|                                                      |                                            | Basic                                    |                          |        | 53,779 |         |         |        | 53,103 |         |         |        | 52,137 |         |         |         | 51,282 |         |         |         | 49,493 |        
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        
|                                                      |                                            | Fully diluted                            |                          |        | 55,045 |         |         |        | 53,103 |         |         |        | 52,137 |         |         |         | 51,282 |         |         |         | 49,493 |        
|                                                      |                                            |                                          |                          |        |        |         |         |        |        |         |         |        |        |         |        

|                                                                                                 |  |                |         |  |      |   |         |      |  |   |         |  |  |      |         |  |  |   |         | 
|------------------------------------------------------------------------------------------------ |  | -------------- | ------- |  | ---- | - | ------- | ---- |  | - | ------- |  |  | ---- | ------- |  |  | - | ------- | 
|                                                                                                 |  | March 31,      |        
|                                                                                                 |  |                |        
|                                                                                                 |  | 2006           |         |  | 2005 |   |         | 2004 |  |   | 2003    |  |  | 2002 |        
|                                                                                                 |  |                |         |  |      |   |         |      |  |   |         |  |  |      |        
|                                                                                                 |  | (In thousands) |        
|Consolidated Balance Sheet Data:                                                                 |  |                |         |  |      |   |         |      |  |   |         |  |  |      |         |  |  |   |         | 
|Cash, cash equivalents and short-term and long-term marketable
    securities available for sale |  | $              | 162,314 |  |      | $ | 150,054 |      |  | $ | 155,947 |  |  | $    | 201,626 |  |  | $ | 211,842 | 
|Working capital                                                                                  |  |                | 143,270 |  |      |   | 108,340 |      |  |   | 93,692  |  |  |      | 149,424 |  |  |   | 178,909 | 
|Total assets                                                                                     |  |                | 302,811 |  |      |   | 275,344 |      |  |   | 283,650 |  |  |      | 304,436 |  |  |   | 324,063 | 
|Long-term liabilities                                                                            |  |                | 5,723   |  |      |   | 9,884   |      |  |   | 7,439   |  |  |      | 7,267   |  |  |   | 21,653  | 
|Total stockholders equity                                                                       |  |                | 206,778 |  |      |   | 184,532 |      |  |   | 197,137 |  |  |      | 218,559 |  |  |   | 215,544 | 

23



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##### 








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

INTRODUCTION


10-K




| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Overview. This section provides a general description of
    our business, the performance indicators that management uses in
    assessing our financial condition and results of operations, and
    anticipated trends that management expects to affect our
    financial condition and results of operations.                                                                                                                                                       
|
| |  | Results of operations. This section provides an analysis
    of our results of operations for the three years ended
    March 31, 2006.                                                                                                                                                                                                                                                                                                                                  
|
| |  | Liquidity and Capital Resources. This section provides an
    analysis of our cash flows for the year ended March 31,
    2006, and a discussion of our capital requirements and the
    resources available to us to meet those requirements.                                                                                                                                                                                                                           
|
| |  | Critical accounting policies. This section discusses
    accounting policies that are considered important to our
    financial condition and results of operations, require
    significant judgment and require estimates on the part of
    management in application. Our significant accounting policies,
    including those considered to be critical accounting policies,
    are summarized in Note 2 to the accompanying consolidated
    financial statements.

OVERVIEW




Fiscal 2006 Review












24



---



##### 













Fiscal 2007 Outlook








| |   |                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The expected increase in adoption of Service-Oriented
    Architecture, or SOA, by our existing and prospective
    customers; and                                                             
|
| |  | The expected, continued increase in demand from these
    organizations for products and solutions that improve operating
    performance by improving the processes that run their businesses.









25



---



##### 



RESULTS OF OPERATIONS




|                         |  |                   |         |   |            |  |       |           |  |  |            |    |  |           |       |    |  |  |         |   
|------------------------ |  | ----------------- | ------- | - | ---------- |  | ----- | --------- |  |  | ---------- | -- |  | --------- | ----- | -- |  |  | ------- | --
|                         |  | Fiscal Year Ended |        
|                         |  |                   |        
|                         |  | March 31,         |         |   | Percentage |  |       | March 31, |  |  | Percentage |    |  | March 31, |      
|                         |  | 2006              |         |   | Change     |  |       | 2005      |  |  | Change     |    |  | 2004      |      
|                         |  |                   |         |   |            |  |       |           |  |  |            |    |  |           |      
|                         |  | ($ in thousands)  |        
|Total revenue            |  |                   | 208,818 |   |            |  | 4.1   | %         |  |  | 200,601    |    |  |           | 5.8   | %  |  |  | 189,541 |   
|Total cost of revenue    |  |                   | 58,861  |   |            |  | (2.9  | )%        |  |  | 60,603     |    |  |           | 6.5   | %  |  |  | 56,923  |   
|% of total revenue       |  |                   | 28.2    | % |            |  |       |           |  |  | 30.2       | %  |  |           |       |    |  |  | 30.0    | % 
|Gross profit             |  |                   | 149,957 |   |            |  | 7.1   | %         |  |  | 139,998    |    |  |           | 5.6   | %  |  |  | 132,618 |   
|% of total revenue       |  |                   | 71.8    | % |            |  |       |           |  |  | 69.8       | %  |  |           |       |    |  |  | 70.0    | % 
|Total operating expenses |  |                   | 138,504 |   |            |  | (13.3 | )%        |  |  | 159,722    |    |  |           | (4.8  | )% |  |  | 167,827 |   
|% of total revenue       |  |                   | 66.3    | % |            |  |       |           |  |  | 79.6       | %  |  |           |       |    |  |  | 88.5    | % 
|Operating income (loss)  |  |                   | 11,453  |   |            |  | N/A   |           |  |  | (19,724    | )  |  |           | (44.0 | )% |  |  | (35,209 | ) 
|% of total revenue       |  |                   | 5.5     | % |            |  |       |           |  |  | (9.8       | )% |  |           |       |    |  |  | (18.6   | )%
|Net income (loss)        |  |                   | 18,022  |   |            |  | N/A   |           |  |  | (18,751    | )  |  |           | (43.2 | )% |  |  | (33,024 | ) 
|% of total revenue       |  |                   | 8.6     | % |            |  |       |           |  |  | (9.3       | )% |  |           |       |    |  |  | (17.4   | )%





Revenue




|                      |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |      |    |  |   |         | 
|--------------------- |  | ----------------- | ------- |  | ---------- |  | ---- | --------- |  | - | ---------- |  |  | --------- | ---- | -- |  | - | ------- | 
|                      |  | Fiscal Year Ended |        
|                      |  |                   |        
|                      |  | March 31,         |         |  | Percentage |  |      | March 31, |  |   | Percentage |  |  | March 31, |     
|                      |  | 2006              |         |  | Change     |  |      | 2005      |  |   | Change     |  |  | 2004      |     
|                      |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |     
|                      |  | ($ in thousands)  |        
|License               |  | $                 | 87,449  |  |            |  | 0.7  | %         |  | $ | 86,800     |  |  |           | (6.4 | )% |  | $ | 92,740  | 
|Professional services |  |                   | 47,183  |  |            |  | (4.1 | )%        |  |   | 49,218     |  |  |           | 12.8 | %  |  |   | 43,634  | 
|Maintenance           |  |                   | 74,186  |  |            |  | 14.9 | %         |  |   | 64,583     |  |  |           | 21.5 | %  |  |   | 53,167  | 
|                      |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |     
|Total revenue         |  | $                 | 208,818 |  |            |  | 4.1  | %         |  | $ | 200,601    |  |  |           | 5.8  | %  |  | $ | 189,541 | 
|                      |  |                   |         |  |            |  |      |           |  |   |            |  |  |           |     

26



---



##### 





|              |  |                   |         |  |            |  |       |           |  |   |            |  |  |           |      |    |  |   |         | 
|------------- |  | ----------------- | ------- |  | ---------- |  | ----- | --------- |  | - | ---------- |  |  | --------- | ---- | -- |  | - | ------- | 
|              |  | Fiscal Year Ended |        
|              |  |                   |        
|              |  | March 31,         |         |  | Percentage |  |       | March 31, |  |   | Percentage |  |  | March 31, |     
|              |  | 2006              |         |  | Change     |  |       | 2005      |  |   | Change     |  |  | 2004      |     
|              |  |                   |         |  |            |  |       |           |  |   |            |  |  |           |     
|              |  | ($ in thousands)  |        
|Americas      |  | $                 | 131,410 |  |            |  | 9.9   | %         |  | $ | 119,610    |  |  |           | 4.5  | %  |  | $ | 114,507 | 
|EMEA          |  |                   | 52,884  |  |            |  | 4.5   | %         |  |   | 50,599     |  |  |           | 12.5 | %  |  |   | 44,965  | 
|Japan         |  |                   | 9,100   |  |            |  | (40.0 | )%        |  |   | 15,157     |  |  |           | (2.0 | )% |  |   | 15,472  | 
|Asia Pacific  |  |                   | 15,424  |  |            |  | 1.2   | %         |  |   | 15,235     |  |  |           | 4.4  | %  |  |   | 14,597  | 
|              |  |                   |         |  |            |  |       |           |  |   |            |  |  |           |     
|Total revenue |  | $                 | 208,818 |  |            |  | 4.1   | %         |  | $ | 200,601    |  |  |           | 5.8  | %  |  | $ | 189,541 | 
|              |  |                   |         |  |            |  |       |           |  |   |            |  |  |           |     



| |              
| | -------------
| | Total Revenue







| |                
| | ---------------
| | License Revenue







| |                              
| | -----------------------------
| | Professional Services Revenue



27



---



##### 







| |                    
| | -------------------
| | Maintenance Revenue





Cost of Revenue




|                                      |  |                   |        |   |           |  |        |           |  |  |        |  
|------------------------------------- |  | ----------------- | ------ | - | --------- |  | ------ | --------- |  |  | ------ | -
|                                      |  | Fiscal Year Ended |       
|                                      |  |                   |       
|                                      |  | March 31,         |        |   | March 31, |  |        | March 31, | 
|                                      |  | 2006              |        |   | 2005      |  |        | 2004      | 
|                                      |  |                   |        |   |           |  |        |           | 
|                                      |  | ($ in thousands)  |       
|Amortization of Intangibles           |  |                   | 2,397  |   |           |  | 2,397  |           |  |  | 1,199  |  
|% of License Revenue                  |  |                   | 2.7    | % |           |  | 2.8    | %         |  |  | 1.3    | %
|Cost of License Revenue               |  |                   | 1,002  |   |           |  | 1,252  |           |  |  | 2,211  |  
|% of License Revenue                  |  |                   | 1.1    | % |           |  | 1.4    | %         |  |  | 2.4    | %
|Cost of Professional Services Revenue |  |                   | 42,688 |   |           |  | 43,989 |           |  |  | 42,308 |  
|% of Professional Services Revenue    |  |                   | 90.5   | % |           |  | 89.4   | %         |  |  | 97.0   | %
|Cost of Maintenance Revenue           |  |                   | 12,774 |   |           |  | 12,965 |           |  |  | 11,205 |  
|% of Maintenance Revenue              |  |                   | 17.2   | % |           |  | 20.1   | %         |  |  | 21.1   | %
|Total cost of revenue                 |  |                   | 58,861 |   |           |  | 60,603 |           |  |  | 56,923 |  
|% of Total revenue                    |  |                   | 28.2   | % |           |  | 30.2   | %         |  |  | 30.0   | %







28



---



##### 









Operating expenses




|                                           |  |                   |         |   |            |  |       |           |  |   |            |   |  |           |        |    |  |   |         |  
|------------------------------------------ |  | ----------------- | ------- | - | ---------- |  | ----- | --------- |  | - | ---------- | - |  | --------- | ------ | -- |  | - | ------- | -
|                                           |  | Fiscal Year Ended |        
|                                           |  |                   |        
|                                           |  | March 31,         |         |   | Percentage |  |       | March 31, |  |   | Percentage |   |  | March 31, |       
|                                           |  | 2006              |         |   | Change     |  |       | 2005      |  |   | Change     |   |  | 2004      |       
|                                           |  |                   |         |   |            |  |       |           |  |   |            |   |  |           |       
|                                           |  | ($ in thousands)  |        
|Operating Expenses:                        |  |                   |         |   |            |  |       |           |  |   |            |   |  |           |        |    |  |   |         |  
|Sales and marketing                        |  | $                 | 74,084  |   |            |  | (12.1 | )%        |  | $ | 84,313     |   |  |           | (10.7  | )% |  | $ | 94,433  |  
|% of total revenue                         |  |                   | 35.5    | % |            |  |       |           |  |   | 42.0       | % |  |           |        |    |  |   | 49.8    | %
|Research and development                   |  |                   | 40,197  |   |            |  | (9.7  | )%        |  |   | 44,518     |   |  |           | (1.2   | )% |  |   | 45,060  |  
|% of total revenue                         |  |                   | 19.2    | % |            |  |       |           |  |   | 22.2       | % |  |           |        |    |  |   | 23.8    | %
|General and administrative                 |  |                   | 23,812  |   |            |  | (4.9  | )%        |  |   | 25,042     |   |  |           | 40.1   | %  |  |   | 17,880  |  
|% of total revenue                         |  |                   | 11.4    | % |            |  |       |           |  |   | 12.5       | % |  |           |        |    |  |   | 9.4     | %
|Restructuring and related charges          |  |                   | 411     |   |            |  | (93.0 | )%        |  |   | 5,849      |   |  |           | 49.2   | %  |  |   | 3,920   |  
|% of total revenue                         |  |                   | 0.2     | % |            |  |       |           |  |   | 2.9        | % |  |           |        |    |  |   | 2.1     | %
|In-process research and development        |  |                   |        |   |            |  |      |           |  |   |           |   |  |           | (100.0 | )% |  |   | 4,284   |  
|% of total revenue                         |  |                   |        |   |            |  |       |           |  |   |           |   |  |           |        |    |  |   | 2.3     | %
|Settlement of intellectual property matter |  |                   |        |   |            |  |      |           |  |   |           |   |  |           | (100.0 | )% |  |   | 2,250   |  
|% of total revenue                         |  |                   |        |   |            |  |       |           |  |   |           |   |  |           |        |    |  |   | 1.2     | %
|Total operating expenses                   |  | $                 | 138,504 |   |            |  | (13.3 | )%        |  | $ | 159,722    |   |  |           | (4.8   | )% |  | $ | 167,827 |  
|% of total revenue                         |  |                   | 66.3    | % |            |  |       |           |  |   | 79.6       | % |  |           |        |    |  |   | 88.5    | %



29



---



##### 













30



---



##### 







Interest income




Interest expense




Other income (expense), net




Impairment of equity investment in private companies




Income taxes




31



---



##### 









Quarterly results of operations




|                    |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |        |        |  |        |        |        |  |         |        |        | 
|------------------- | --------------------------------- | ------------------------ | ------ | ------ | -------- |  | ------ | --------- | ------ |  | -------- | ------ | ------ | -------- | ------ | ------ | -------- |  | ------ | --------- | ------ |  | -------- | ------ | ------ |  | ------ | ------ | ------ |  | ------- | ------ | ------ | 
|                    |                                   | Three Months Ended       |       
|                    |                                   |                          |       
|                    |                                   | Mar. 31,                 |        |        | Dec. 31, |  |        | Sept. 30, |        |  | June 30, |        |        | Mar. 31, |        |        | Dec. 31, |  |        | Sept. 30, |        |  | June 30, |       
|                    |                                   | 2006                     |        |        | 2005     |  |        | 2005      |        |  | 2005     |        |        | 2005     |        |        | 2004     |  |        | 2004      |        |  | 2004     |       
|                    |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |       
|                    |                                   | (In thousands)           |       
|Revenue:            |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |        |        |  |        |        |        |  |         |       
|                    | License                           |                          | $      | 27,628 |          |  | $      | 21,964    |        |  | $        | 19,390 |        |          | $      | 18,467 |          |  | $      | 22,190    |        |  | $        | 25,953 |        |  | $      | 23,851 |        |  | $       | 14,806 |       
|                    | Professional services             |                          |        | 12,547 |          |  |        | 11,627    |        |  |          | 11,326 |        |          |        | 11,683 |          |  |        | 12,763    |        |  |          | 11,854 |        |  |        | 12,077 |        |  |         | 12,524 |       
|                    | Maintenance                       |                          |        | 19,241 |          |  |        | 18,908    |        |  |          | 18,452 |        |          |        | 17,585 |          |  |        | 17,982    |        |  |          | 17,156 |        |  |        | 14,838 |        |  |         | 14,607 |       
|                    |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |       
|                    |                                   | Total revenue            |        |        | 59,416   |  |        |           | 52,499 |  |          |        | 49,168 |          |        |        | 47,735   |  |        |           | 52,935 |  |          |        | 54,963 |  |        |        | 50,766 |  |         |        | 41,937 | 
|                    |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |       
|Cost of revenue:    |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |        |        |  |        |        |        |  |         |       
|                    | Amortization of intangibles       |                          |        | 600    |          |  |        | 599       |        |  |          | 599    |        |          |        | 599    |          |  |        | 600       |        |  |          | 599    |        |  |        | 599    |        |  |         | 599    |       
|                    | License                           |                          |        | 299    |          |  |        | 218       |        |  |          | 271    |        |          |        | 214    |          |  |        | 135       |        |  |          | 252    |        |  |        | 245    |        |  |         | 620    |       
|                    | Professional services             |                          |        | 12,013 |          |  |        | 10,368    |        |  |          | 10,008 |        |          |        | 10,299 |          |  |        | 11,293    |        |  |          | 10,402 |        |  |        | 11,070 |        |  |         | 11,224 |       
|                    | Maintenance                       |                          |        | 3,182  |          |  |        | 2,864     |        |  |          | 3,473  |        |          |        | 3,255  |          |  |        | 3,344     |        |  |          | 3,362  |        |  |        | 3,210  |        |  |         | 3,049  |       
|                    |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |       
|                    |                                   | Total cost of revenue    |        |        | 16,094   |  |        |           | 14,049 |  |          |        | 14,351 |          |        |        | 14,367   |  |        |           | 15,372 |  |          |        | 14,615 |  |        |        | 15,124 |  |         |        | 15,492 | 
|                    |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |       
|Gross profit        |                                   |                          | 43,322 |        |          |  | 38,450 |           |        |  | 34,817   |        |        |          | 33,368 |        |          |  | 37,563 |           |        |  | 40,348   |        |        |  | 35,642 |        |        |  | 26,445  |       
|                    |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |       
|Operating expenses: |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |        |        |  |        |        |        |  |         |       
|                    | Sales and marketing               |                          |        | 20,209 |          |  |        | 19,549    |        |  |          | 17,051 |        |          |        | 17,275 |          |  |        | 19,187    |        |  |          | 22,764 |        |  |        | 20,587 |        |  |         | 21,775 |       
|                    | Research and development          |                          |        | 9,973  |          |  |        | 8,980     |        |  |          | 10,126 |        |          |        | 11,118 |          |  |        | 11,771    |        |  |          | 10,877 |        |  |        | 10,820 |        |  |         | 11,050 |       
|                    | General and administrative        |                          |        | 6,270  |          |  |        | 5,927     |        |  |          | 5,401  |        |          |        | 6,214  |          |  |        | 8,008     |        |  |          | 7,093  |        |  |        | 4,868  |        |  |         | 5,073  |       
|                    | Restructuring and related charges |                          |        | (191   | )        |  |        | (117      | )      |  |          | 431    |        |          |        | 288    |          |  |        | 3,093     |        |  |          |       |        |  |        | 2,756  |        |  |         |       |       
|                    |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |       
|                    |                                   | Total operating expenses |        |        | 36,261   |  |        |           | 34,339 |  |          |        | 33,009 |          |        |        | 34,895   |  |        |           | 42,059 |  |          |        | 40,734 |  |        |        | 39,031 |  |         |        | 37,898 | 
|                    |                                   |                          |        |        |          |  |        |           |        |  |          |        |        |          |        |        |          |  |        |           |        |  |          |       
|Operating loss      |                                   |                          | 7,061  |        |          |  | 4,111  |           |        |  | 1,808    |        |        |          | (1,527 | )      |          |  | (4,496 | )         |        |  | (386     | )      |        |  | (3,389 | )      |        |  | (11,453 | )     

32



---



##### 



|                                                             |                                           |                    |        |        |          |   |        |           |  |   |          |     |  |          |        |     |          |   |        |           |  |   |          |     |  |   |        |    |  |   |         |   | 
|------------------------------------------------------------ | ----------------------------------------- | ------------------ | ------ | ------ | -------- | - | ------ | --------- |  | - | -------- | --- |  | -------- | ------ | --- | -------- | - | ------ | --------- |  | - | -------- | --- |  | - | ------ | -- |  | - | ------- | - | 
|                                                             |                                           | Three Months Ended |       
|                                                             |                                           |                    |       
|                                                             |                                           | Mar. 31,           |        |        | Dec. 31, |   |        | Sept. 30, |  |   | June 30, |     |  | Mar. 31, |        |     | Dec. 31, |   |        | Sept. 30, |  |   | June 30, |    
|                                                             |                                           | 2006               |        |        | 2005     |   |        | 2005      |  |   | 2005     |     |  | 2005     |        |     | 2004     |   |        | 2004      |  |   | 2004     |    
|                                                             |                                           |                    |        |        |          |   |        |           |  |   |          |     |  |          |        |     |          |   |        |           |  |   |          |    
|                                                             |                                           | (In thousands)     |       
|Interest income                                              |                                           |                    | 1,374  |        |          |   | 1,137  |           |  |   | 1,019    |     |  |          | 966    |     |          |   | 787    |           |  |   | 615      |     |  |   | 532    |    |  |   | 553     |  
|Interest expense                                             |                                           |                    | (5     | )      |          |   | (14    | )         |  |   | (46      | )   |  |          | (17    | )   |          |   | (15    | )         |  |   | (28      | )   |  |   | (29    | )  |  |   | (27     | )
|Other (expense)/income                                       |                                           |                    | 235    |        |          |   | 346    |           |  |   | 20       |     |  |          | 206    |     |          |   | (92    | )         |  |   | (27      | )   |  |   | (116   | )  |  |   | 112     |  
|Impairment of equity investments in private companies        |                                           |                    |       |        |          |   |       |           |  |   |         |     |  |          |       |     |          |   |       |           |  |   |         |     |  |   | (1,057 | )  |  |   |        |  
|                                                             |                                           |                    |        |        |          |   |        |           |  |   |          |     |  |          |        |     |          |   |        |           |  |   |          |    
|Net (loss)/income before taxes                               |                                           |                    | 8,665  |        |          |   | 5,580  |           |  |   | 2,801    |     |  |          | (372   | )   |          |   | (3,816 | )         |  |   | 174      |     |  |   | (4,059 | )  |  |   | (10,815 | )
|                                                             |                                           |                    |        |        |          |   |        |           |  |   |          |     |  |          |        |     |          |   |        |           |  |   |          |    
|                                                             | Provision for (benefit from) income taxes |                    |        | (1,803 | )        |   |        | 70        |  |   |          | 243 |  |          |        | 142 |          |   |        | 40        |  |   |          | 126 |  |   |        | 65 |  |   |         | 4 | 
|                                                             |                                           |                    |        |        |          |   |        |           |  |   |          |     |  |          |        |     |          |   |        |           |  |   |          |    
|Net (loss)/income                                            |                                           | $                  | 10,468 |        |          | $ | 5,510  |           |  | $ | 2,558    |     |  | $        | (514   | )   |          | $ | (3,856 | )         |  | $ | 48       |     |  | $ | (4,124 | )  |  | $ | (10,819 | )
|                                                             |                                           |                    |        |        |          |   |        |           |  |   |          |     |  |          |        |     |          |   |        |           |  |   |          |    
|Basic net income (loss) per share                            |                                           |                    | 0.19   |        |          |   | 0.10   |           |  |   | 0.05     |     |  |          | (0.01  | )   |          |   | (0.07  | )         |  |   | 0.00     |     |  |   | (0.08  | )  |  |   | (0.20   | )
|Shares used in computing basic net income (loss) per share   |                                           |                    | 54,367 |        |          |   | 53,773 |           |  |   | 53,610   |     |  |          | 53,375 |     |          |   | 53,332 |           |  |   | 53,156   |     |  |   | 53,089 |    |  |   | 52,827  |  
|Diluted net income (loss) per share                          |                                           |                    | 0.19   |        |          |   | 0.10   |           |  |   | 0.05     |     |  |          | (0.01  | )   |          |   | (0.07  | )         |  |   | 0.00     |     |  |   | (0.08  | )  |  |   | (0.20   | )
|Shares used in computing diluted net income (loss) per share |                                           |                    | 56,550 |        |          |   | 55,778 |           |  |   | 54,305   |     |  |          | 53,375 |     |          |   | 53,332 |           |  |   | 54,144   |     |  |   | 53,089 |    |  |   | 52,827  |  

|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |      |       |  |      |      |       |  |       |      |       | 
|----------------------------------------------------- | --------------------------------- | -------------------------------- | ---- | ---- | -------- |  | ---- | --------- | ----- |  | -------- | ---- | ----- | -------- | ---- | ---- | -------- |  | ---- | --------- | ----- |  | -------- | ---- | ----- |  | ---- | ---- | ----- |  | ----- | ---- | ----- | 
|                                                      |                                   | As a Percentage of Total Revenue |     
|                                                      |                                   |                                  |     
|                                                      |                                   | Mar. 31,                         |      |      | Dec. 31, |  |      | Sept. 30, |       |  | June 30, |      |       | Mar. 31, |      |      | Dec. 31, |  |      | Sept. 30, |       |  | June 30, |     
|                                                      |                                   | 2006                             |      |      | 2005     |  |      | 2005      |       |  | 2005     |      |       | 2005     |      |      | 2004     |  |      | 2004      |       |  | 2004     |     
|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |     
|                                                      |                                   | (In thousands)                   |     
|Revenue:                                              |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |      |       |  |      |      |       |  |       |     
|                                                      | License                           |                                  |      | 46.5 | %        |  |      | 41.8      | %     |  |          | 39.5 | %     |          |      | 38.7 | %        |  |      | 41.9      | %     |  |          | 47.2 | %     |  |      | 47.0 | %     |  |       | 35.3 | %    
|                                                      | Professional services             |                                  |      | 21.1 |          |  |      | 22.2      |       |  |          | 23.0 |       |          |      | 24.5 |          |  |      | 24.1      |       |  |          | 21.6 |       |  |      | 23.8 |       |  |       | 29.9 |      
|                                                      | Maintenance                       |                                  |      | 32.4 |          |  |      | 36.0      |       |  |          | 37.5 |       |          |      | 36.8 |          |  |      | 34.0      |       |  |          | 31.2 |       |  |      | 29.2 |       |  |       | 34.8 |      
|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |     
|                                                      |                                   | Total revenue                    |      |      | 100.0    |  |      |           | 100.0 |  |          |      | 100.0 |          |      |      | 100.0    |  |      |           | 100.0 |  |          |      | 100.0 |  |      |      | 100.0 |  |       |      | 100.0 | 
|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |     
|Cost of revenue:                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |      |       |  |      |      |       |  |       |     
|                                                      | Amortization of intangibles       |                                  |      | 1.0  |          |  |      | 1.1       |       |  |          | 1.2  |       |          |      | 1.3  |          |  |      | 1.1       |       |  |          | 1.1  |       |  |      | 1.2  |       |  |       | 1.4  |      
|                                                      | License                           |                                  |      | 0.5  |          |  |      | 0.4       |       |  |          | 0.6  |       |          |      | 0.4  |          |  |      | 0.3       |       |  |          | 0.5  |       |  |      | 0.5  |       |  |       | 1.5  |      
|                                                      | Professional services             |                                  |      | 20.2 |          |  |      | 19.8      |       |  |          | 20.4 |       |          |      | 21.6 |          |  |      | 21.3      |       |  |          | 18.9 |       |  |      | 21.8 |       |  |       | 26.8 |      
|                                                      | Maintenance                       |                                  |      | 5.4  |          |  |      | 5.5       |       |  |          | 7.1  |       |          |      | 6.8  |          |  |      | 6.3       |       |  |          | 6.1  |       |  |      | 6.3  |       |  |       | 7.2  |      
|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |     
|                                                      |                                   | Total cost of revenue            |      |      | 27.1     |  |      |           | 26.8  |  |          |      | 29.3  |          |      |      | 30.1     |  |      |           | 29.0  |  |          |      | 26.6  |  |      |      | 29.8  |  |       |      | 36.9  | 
|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |     
|Gross profit                                          |                                   |                                  | 72.9 |      |          |  | 73.2 |           |       |  | 70.7     |      |       |          | 69.9 |      |          |  | 71.0 |           |       |  | 73.4     |      |       |  | 70.2 |      |       |  | 63.1  |     
|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |     
|Operating expenses:                                   |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |      |       |  |      |      |       |  |       |     
|                                                      | Sales and marketing               |                                  |      | 34.0 |          |  |      | 37.2      |       |  |          | 34.7 |       |          |      | 36.2 |          |  |      | 36.2      |       |  |          | 41.4 |       |  |      | 40.6 |       |  |       | 51.9 |      
|                                                      | Research and development          |                                  |      | 16.8 |          |  |      | 17.1      |       |  |          | 20.6 |       |          |      | 23.3 |          |  |      | 22.2      |       |  |          | 19.8 |       |  |      | 21.3 |       |  |       | 26.3 |      
|                                                      | General and administrative        |                                  |      | 10.6 |          |  |      | 11.3      |       |  |          | 11.0 |       |          |      | 13.0 |          |  |      | 15.1      |       |  |          | 12.9 |       |  |      | 9.6  |       |  |       | 12.1 |      
|                                                      | Restructuring and related charges |                                  |      | (0.3 | )        |  |      | (0.2      | )     |  |          | 0.9  |       |          |      | 0.6  |          |  |      | 5.8       |       |  |          |     |       |  |      | 5.4  |       |  |       |     |      
|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |     
|                                                      |                                   | Total operating expenses         |      |      | 61.1     |  |      |           | 65.4  |  |          |      | 67.2  |          |      |      | 73.1     |  |      |           | 79.5  |  |          |      | 74.1  |  |      |      | 76.9  |  |       |      | 90.4  | 
|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |     
|Operating income (loss)                               |                                   |                                  | 11.9 |      |          |  | 7.8  |           |       |  | 3.7      |      |       |          | (3.2 | )    |          |  | (8.5 | )         |       |  | (0.7     | )    |       |  | (6.7 | )    |       |  | (27.3 | )   
|Interest income                                       |                                   |                                  | 2.3  |      |          |  | 2.2  |           |       |  | 2.1      |      |       |          | 2.0  |      |          |  | 1.5  |           |       |  | 1.1      |      |       |  | 1.1  |      |       |  | 1.3   |     
|Interest expense                                      |                                   |                                  |     |      |          |  |     |           |       |  | (0.1     | )    |       |          |     |      |          |  |     |           |       |  | (0.1     | )    |       |  | (0.1 | )    |       |  | (0.1  | )   
|Other (expense)/income                                |                                   |                                  | 0.4  |      |          |  | 0.7  |           |       |  |         |      |       |          | 0.4  |      |          |  | (0.2 | )         |       |  |         |      |       |  | (0.2 | )    |       |  | 0.3   |     
|Impairment of equity investments in private companies |                                   |                                  |     |      |          |  |     |           |       |  |         |      |       |          |     |      |          |  |     |           |       |  |         |      |       |  | (2.1 | )    |       |  |      |     
|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |     
|Net (loss)/income before taxes                        |                                   |                                  | 14.6 |      |          |  | 10.7 |           |       |  | 5.7      |      |       |          | (0.8 | )    |          |  | (7.2 | )         |       |  | 0.3      |      |       |  | (8.0 | )    |       |  | (25.8 | )   
|Provision for (benefit from) income taxes             |                                   |                                  | (3.0 | )    |          |  | 0.1  |           |       |  | 0.5      |      |       |          | 0.3  |      |          |  | 0.1  |           |       |  | 0.2      |      |       |  | 0.1  |      |       |  | 0.0   |     
|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |     
|Net (loss)/income                                     |                                   |                                  | 17.6 | %    |          |  | 10.5 | %         |       |  | 5.2      | %    |       |          | (1.1 | )%   |          |  | (7.3 | )%        |       |  | 0.1      | %    |       |  | (8.1 | )%   |       |  | (25.8 | )%  
|                                                      |                                   |                                  |      |      |          |  |      |           |       |  |          |      |       |          |      |      |          |  |      |           |       |  |          |     

33



---



##### 



LIQUIDITY AND CAPITAL RESOURCES


Cash Flows










Liquidity Requirements


Debt Financing








34



---



##### 



Contractual Obligations




|                                                 |            |                |        |        |         |   |      |    | 
|------------------------------------------------ | ---------- | -------------- | ------ | ------ | ------- | - | ---- | -- | 
|                                                 |            | Operating      |        |        | Capital |  
|                                                 |            |                |        |        |         |  
|                                                 |            | (In thousands) |       
|Years ending March 31, 2007                      |            | $              | 11,562 |        |         | $ | 264  |   
|                                                 | 2008       |                |        | 7,926  |         |   |      | 10 | 
|                                                 | 2009       |                |        | 4,612  |         |   |      |   | 
|                                                 | 2010       |                |        | 4,279  |         |   |      |   | 
|                                                 | 2011       |                |        | 4,338  |         |   |      |   | 
|                                                 | Thereafter |                |        | 18,131 |         |   |      |   | 
|                                                 |            |                |        |        |         |  
|                                                 |            | $              | 50,848 |        |         | $ | 274  |   
|                                                 |            |                |        |        |         |  
|Less amounts representing interest               |            |                |        |        |         |   | (5   | ) 
|                                                 |            |                |        |        |         |  
|                                                 |            |                |        |        |         |   | 269  |   
|Less current portion                             |            |                |        |        |         |   | (259 | ) 
|                                                 |            |                |        |        |         |  
|Capital lease obligation, net of current portion |            |                |        |        |         | $ | 10   |   
|                                                 |            |                |        |        |         |  

Liquidity Outlook








Off Balance Sheet
Arrangements




CRITICAL ACCOUNTING POLICIES AND ESTIMATES






35



---



##### 



Revenue Recognition


97-2, 97-2






Allowance for Doubtful Accounts




36



---



##### 



Business Combinations








Goodwill and Intangible Assets




Acquired In-process Research and Development




Foreign Currency Effects






37



---



##### 





Accounting for Income Taxes






Stock-Based Compensation






out-of


38



---



##### 





Restructuring and Related Charges




Litigation and Contingencies




Recently Issued Accounting Pronouncements




FAS115-1 FAS124-1, 115-1), 115-1 115-1


39



---



##### 








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



Interest rate risk.


Foreign currency exchange rate risk.









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








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








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

Evaluation of Disclosure Controls and Procedures. 13a-15(e)


40



---



##### 







13a-15 10-K.


10-K 10-K


Managements Report on Internal Control Over Financial
Reporting. 13a-15(f)




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



Internal Control  Integrated Framework






41



---



##### 







10-K.


Material Weakness Remediation Plans.




| |   |                                                                                                                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Implement formal procedures to evaluate the continued
    profitability of each of our subsidiaries on a quarterly basis
    in order to determine the income tax benefit of reducing the
    valuation allowances on net operating loss carryforwards and
    other deferred tax assets.
|
| |  | Implement formal procedures to monitor net deferred tax assets
    relating to goodwill and intangible assets of companies that we
    acquire.                                                                                                                                          
|
| |  | Evaluate the implementation of a new tax accounting and
    reporting system and improve our procedures with respect to
    communicating, documenting, and reconciling the detailed
    components of income tax assets and liabilities of each of our
    subsidiaries.                
|
| |  | Expand staffing and resources, including the continued use of
    external consultants, and provide training on income tax
    accounting and reporting.                                                                                                                                 

Changes in Internal Control Over Financial Reporting.







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



42



---



##### 






PART III







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








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








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








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








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






PART IV







|         |                                           
|-------- | ------------------------------------------
|Item 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

Financial Statements:




INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


|                                                                                                                            |  |      |     | 
|--------------------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                            |  | Page |    
|                                                                                                                            |  |      |    
|Report of Independent Registered Public Accounting Firm                                                                     |  |      | F-1 | 
|Consolidated Balance Sheets at March 31, 2006 and 2005                                                                      |  |      | F-3 | 
|Consolidated Statements of Operations and Comprehensive Income
    (Loss) for the years ended March 31, 2006, 2005 and 2004 |  |      | F-4 | 
|Consolidated Statements of Changes in Stockholders Equity
    for the years ended March 31, 2006, 2005 and 2004            |  |      | F-5 | 
|Consolidated Statements of Cash Flows for the years ended
    March 31, 2006, 2005 and 2004                                 |  |      | F-6 | 
|Notes to Consolidated Financial Statements                                                                                  |  |      | F-7 | 





43



---



##### 






SIGNATURES






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



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

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

attorney-in attorney-in attorney-in


|                                                 |  |                                                                                            |  |               |  | 
|------------------------------------------------ |  | ------------------------------------------------------------------------------------------ |  | ------------- |  | 
|Signature                                        |  | Title                                                                                      |  | Date         
|                                                 |  |                                                                                            |  |              
|                                                
|/s/ David MitchellDavid Mitchell                 |  | President, Chief Executive Officer and Director                                            |  | June 22, 2006
|                                                
|/s/ Mark L. WabschallMark L. Wabschall           |  | Chief Financial Officer, Chief Accounting Officer, Executive
    Vice President, Treasurer |  | June 22, 2006
|                                                
|/s/ James P. GauerJames P. Gauer                 |  | Director                                                                                   |  | June 22, 2006
|                                                
|/s/ R. James GreenR. James Green                 |  | Director                                                                                   |  | June 22, 2006
|                                                
|/s/ Peter GyenesPeter Gyenes                     |  | Director                                                                                   |  | June 22, 2006
|                                                
|/s/ William A. HalterWilliam A. Halter           |  | Director                                                                                   |  | June 22, 2006
|                                                
|/s/ Jerry J. JasinowskiJerry J. Jasinowski       |  | Director                                                                                   |  | June 22, 2006
|                                                
|/s/ Jack L. LewisJack L. Lewis                   |  | Director                                                                                   |  | June 22, 2006
|                                                
|/s/ Vincent J.
    MullarkeyVincent J. Mullarkey |  | Director                                                                                   |  | June 22, 2006
|                                                
|/s/ Gene RiechersGene Riechers                   |  | Director                                                                                   |  | June 22, 2006
|                                                
|/s/ William V. RussellWilliam V. Russell         |  | Non-Executive Chairman of the Board and Director                                           |  | June 22, 2006

44



---



##### 






REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM






Consolidated financial statements




Internal control over financial reporting


Internal
Control  Integrated Framework






F-1



---



##### 









Internal
Control  Integrated Framework Internal Control  Integrated Framework .








F-2



---



##### 



WEBMETHODS, INC.





CONSOLIDATED BALANCE SHEETS


|                                          |                                                                                                               |                                            |        |          |         |  |        |          |         | 
|----------------------------------------- | ------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | ------- |  | ------ | -------- | ------- | 
|                                          |                                                                                                               | March 31,                                  |       
|                                          |                                                                                                               |                                            |       
|                                          |                                                                                                               | 2006                                       |        |          | 2005    | 
|                                          |                                                                                                               |                                            |        |          |         | 
|                                          |                                                                                                               | (In thousands)                             |       
|ASSETS                                    |                                                                                                               |                                            |        |          |         |  |        |         
|Current assets:                           |                                                                                                               |                                            |        |          |         |  |        |         
|                                          | Cash and cash equivalents                                                                                     |                                            | $      | 82,371   |         |  | $      | 57,209   |        
|                                          | Marketable securities available for sale                                                                      |                                            |        | 79,943   |         |  |        | 78,332   |        
|                                          | Accounts receivable, net of allowance of $652 and $1,862                                                      |                                            |        | 64,298   |         |  |        | 47,326   |        
|                                          | Deferred income tax assets, net                                                                               |                                            |        | 138      |         |  |        |         |        
|                                          | Prepaid expenses and other current assets                                                                     |                                            |        | 6,830    |         |  |        | 6,401    |        
|                                          |                                                                                                               |                                            |        |          |         | 
|                                          |                                                                                                               | Total current assets                       |        |          | 233,580 |  |        |          | 189,268 | 
|Marketable securities available for sale  |                                                                                                               |                                            |       |          |         |  | 14,513 |         
|Property and equipment, net               |                                                                                                               |                                            | 10,274 |          |         |  | 10,342 |         
|Goodwill                                  |                                                                                                               |                                            | 46,704 |          |         |  | 46,704 |         
|Intangible assets, net                    |                                                                                                               |                                            | 5,993  |          |         |  | 8,390  |         
|Long-term deferred income tax assets, net |                                                                                                               |                                            | 1,961  |          |         |  |       |         
|Other assets                              |                                                                                                               |                                            | 4,299  |          |         |  | 6,127  |         
|                                          |                                                                                                               |                                            |        |          |         | 
|                                          |                                                                                                               | Total assets                               |        | $        | 302,811 |  |        | $        | 275,344 | 
|                                          |                                                                                                               |                                            |        |          |         | 
|LIABILITIES AND STOCKHOLDERS EQUITY      |                                                                                                               |                                            |        |          |         |  |        |         
|Current liabilities:                      |                                                                                                               |                                            |        |          |         |  |        |         
|                                          | Accounts payable                                                                                              |                                            | $      | 7,323    |         |  | $      | 8,673    |        
|                                          | Accrued expenses                                                                                              |                                            |        | 10,866   |         |  |        | 16,506   |        
|                                          | Accrued salaries and commissions                                                                              |                                            |        | 12,694   |         |  |        | 12,219   |        
|                                          | Deferred revenue                                                                                              |                                            |        | 59,168   |         |  |        | 43,055   |        
|                                          | Current portion of capital lease obligations                                                                  |                                            |        | 259      |         |  |        | 475      |        
|                                          |                                                                                                               |                                            |        |          |         | 
|                                          |                                                                                                               | Total current liabilities                  |        |          | 90,310  |  |        |          | 80,928  | 
|                                          | Capital lease obligations, net of current portion                                                             |                                            |        | 10       |         |  |        | 139      |        
|                                          | Other long-term liabilities                                                                                   |                                            |        | 3,941    |         |  |        | 3,374    |        
|                                          | Long-term deferred revenue                                                                                    |                                            |        | 1,772    |         |  |        | 6,371    |        
|                                          |                                                                                                               |                                            |        |          |         | 
|                                          |                                                                                                               | Total liabilities                          |        |          | 96,033  |  |        |          | 90,812  | 
|                                          |                                                                                                               |                                            |        |          |         | 
|Commitments and contingencies             |                                                                                                               |                                            |        |          |         |  |        |         
|                                         
|Stockholders equity:                     |                                                                                                               |                                            |        |          |         |  |        |         
|                                          | Common stock, $0.01 par value; 500,000 shares
    authorized; 54,479 and 53,347 shares issued and outstanding |                                            |        | 545      |         |  |        | 533      |        
|                                          | Additional paid-in capital                                                                                    |                                            |        | 529,972  |         |  |        | 524,487  |        
|                                          | Deferred stock compensation and warrant charge                                                                |                                            |        | (357     | )       |  |        | (2,480   | )      
|                                          | Accumulated deficit                                                                                           |                                            |        | (322,202 | )       |  |        | (340,224 | )      
|                                          | Accumulated other comprehensive income (loss)                                                                 |                                            |        | (1,180   | )       |  |        | 2,216    |        
|                                          |                                                                                                               |                                            |        |          |         | 
|                                          |                                                                                                               | Total stockholders equity                 |        |          | 206,778 |  |        |          | 184,532 | 
|                                          |                                                                                                               |                                            |        |          |         | 
|                                          |                                                                                                               | Total liabilities and stockholders equity |        | $        | 302,811 |  |        | $        | 275,344 | 
|                                          |                                                                                                               |                                            |        |          |         | 

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


F-3



---



##### 



WEBMETHODS, INC.





CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
INCOME (LOSS)


|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |      |         |         |         |       |         |  
|----------------------------------------------------------------------- | ------------------------------------------ | ------------------------------------------------------- | --------------------------------- | ------ | ------ | ------- | ------- | ------- | ---- | ------- | ------- | ------- | ----- | ------- | -
|                                                                        |                                            | Year Ended March 31,                                    |                                  
|                                                                        |                                            |                                                         |                                  
|                                                                        |                                            | 2006                                                    |                                   |        | 2005   |         |         | 2004    |     
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|                                                                        |                                            | (In thousands, except per share amounts)                |                                  
|Revenue:                                                                |                                            |                                                         |                                   |        |        |         |         |         |      |         |         |        
|                                                                        | License                                    |                                                         | $                                 | 87,449 |        |         | $       | 86,800  |      |         | $       | 92,740  |      
|                                                                        | Professional services                      |                                                         |                                   | 47,183 |        |         |         | 49,218  |      |         |         | 43,634  |      
|                                                                        | Maintenance                                |                                                         |                                   | 74,186 |        |         |         | 64,583  |      |         |         | 53,167  |      
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|                                                                        |                                            |                                                         | Total revenue                     |        |        | 208,818 |         |         |      | 200,601 |         |         |       | 189,541 |  
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Cost of revenue:                                                        |                                            |                                                         |                                   |        |        |         |         |         |      |         |         |        
|                                                                        | Amortization of intangibles                |                                                         |                                   | 2,397  |        |         |         | 2,397   |      |         |         | 1,199   |      
|                                                                        | License                                    |                                                         |                                   | 1,002  |        |         |         | 1,252   |      |         |         | 2,211   |      
|                                                                        | Professional services                      |                                                         |                                   | 42,688 |        |         |         | 43,989  |      |         |         | 42,308  |      
|                                                                        | Maintenance                                |                                                         |                                   | 12,774 |        |         |         | 12,965  |      |         |         | 11,205  |      
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|                                                                        |                                            |                                                         | Total cost of revenue             |        |        | 58,861  |         |         |      | 60,603  |         |         |       | 56,923  |  
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Gross profit                                                            |                                            |                                                         | 149,957                           |        |        |         | 139,998 |         |      |         | 132,618 |        
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Operating expenses:                                                     |                                            |                                                         |                                   |        |        |         |         |         |      |         |         |        
|                                                                        | Sales and marketing                        |                                                         |                                   | 74,084 |        |         |         | 84,313  |      |         |         | 94,433  |      
|                                                                        | Research and development                   |                                                         |                                   | 40,197 |        |         |         | 44,518  |      |         |         | 45,060  |      
|                                                                        | General and administrative                 |                                                         |                                   | 23,812 |        |         |         | 25,042  |      |         |         | 17,880  |      
|                                                                        | Restructuring and other related charges    |                                                         |                                   | 411    |        |         |         | 5,849   |      |         |         | 3,920   |      
|                                                                        | In-process research and development        |                                                         |                                   |       |        |         |         |        |      |         |         | 4,284   |      
|                                                                        | Settlement of intellectual property matter |                                                         |                                   |       |        |         |         |        |      |         |         | 2,250   |      
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|                                                                        |                                            |                                                         | Total operating expenses          |        |        | 138,504 |         |         |      | 159,722 |         |         |       | 167,827 |  
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Operating income (loss)                                                 |                                            |                                                         | 11,453                            |        |        |         | (19,724 | )       |      |         | (35,209 | )      
|Interest income                                                         |                                            |                                                         | 4,496                             |        |        |         | 2,487   |         |      |         | 2,851   |        
|Interest expense                                                        |                                            |                                                         | (82                               | )      |        |         | (99     | )       |      |         | (205    | )      
|Other income (expense)                                                  |                                            |                                                         | 807                               |        |        |         | (123    | )       |      |         | (461    | )      
|Impairment of equity investment in private company                      |                                            |                                                         |                                  |        |        |         | (1,057  | )       |      |         |        |        
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Net income (loss) before taxes                                          |                                            | $                                                       | 16,674                            |        |        | $       | (18,516 | )       |      | $       | (33,024 | )      
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Provision for (benefit from) income taxes                               |                                            |                                                         | (1,348                            | )      |        |         | 235     |         |      |         |        |        
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Net income (loss)                                                       |                                            | $                                                       | 18,022                            |        |        | $       | (18,751 | )       |      | $       | (33,024 | )      
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Basic net income (loss) per share                                       |                                            | $                                                       | 0.34                              |        |        | $       | (0.35   | )       |      | $       | (0.63   | )      
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Diluted net income (loss) per share                                     |                                            | $                                                       | 0.33                              |        |        | $       | (0.35   | )       |      | $       | (0.63   | )      
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Shares used in computing basic net income (loss) per common share       |                                            |                                                         | 53,779                            |        |        |         | 53,103  |         |      |         | 52,137  |        
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Shares used in computing diluted net income (loss) per common
    share |                                            |                                                         | 55,045                            |        |        |         | 53,103  |         |      |         | 52,137  |        
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|Comprehensive income (loss):                                            |                                            |                                                         |                                   |        |        |         |         |         |      |         |         |        
|                                                                        | Net income (loss)                          |                                                         | $                                 | 18,022 |        |         | $       | (18,751 | )    |         | $       | (33,024 | )    
|                                                                        | Other comprehensive income (loss):         |                                                         |                                   |        |        |         |         |         |      |         |         |         |      
|                                                                        |                                            | Unrealized gain (loss) on securities available for sale |                                   |        | 199    |         |         |         | (496 | )       |         |         | (165  | )      
|                                                                        |                                            | Foreign currency cumulative translation adjustment      |                                   |        | (3,595 | )       |         |         | 459  |         |         |         | 2,306 |        
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     
|                                                                        |                                            |                                                         | Total comprehensive income (loss) |        | $      | 14,626  |         |         | $    | (18,788 | )       |         | $     | (30,883 | )
|                                                                        |                                            |                                                         |                                   |        |        |         |         |         |     

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


F-4



---



##### 



WEBMETHODS, INC.





CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
EQUITY


for the years ended March 31, 2004, 2005 and 2006


|                                                                                                  |  |                |        |  |            |       |     |              |  |   |             |   |               |         |        |   |        |   |          |       |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------------------------- |  | -------------- | ------ |  | ---------- | ----- | --- | ------------ |  | - | ----------- | - | ------------- | ------- | ------ | - | ------ | - | -------- | ----- |  | - | ------ | - |  | - | ------- | -
|                                                                                                  |  |                |        |  |            |       |     | Deferred     |  |   |             |   | Accumulated   |         |        |  
|                                                                                                  |  |                |        |  |            | Stock |     |              |  |   | Other       |   |               |        
|                                                                                                  |  | Common Stock   |        |  | Additional |       |     | Compensation |  |   |             |   | Comprehensive |         |        |  
|                                                                                                  |  |                |        |  | Paid-In    |       |     | and Warrant  |  |   | Accumulated |   |               | Income  |        |   |       
|                                                                                                  |  | Shares         |        |  | Amount     |       |     | Capital      |  |   | Charge      |   |               | Deficit |        |   | (Loss) |   |          | Total | 
|                                                                                                  |  |                |        |  |            |       |     |              |  |   |             |   |               |         |        |   |        |   |          |       | 
|                                                                                                  |  | (In thousands) |       
|Balance, March 31, 2003                                                                           |  |                | 51,767 |  |            | $     | 518 |              |  | $ | 515,828     |   |               | $       | (9,450 | ) |        | $ | (288,449 | )     |  | $ | 112    |   |  | $ | 218,559 |  
|                                                                                                  |  |                |        |  |            |       |     |              |  |   |             |   |               |         |        |   |        |   |          |       | 
|Stock options exercised, net                                                                      |  |                | 620    |  |            |       | 6   |              |  |   | 3,033       |   |               |         |       |   |        |   |         |       |  |   |       |   |  |   | 3,039   |  
|ESPP common stock issuances                                                                       |  |                | 360    |  |            |       | 3   |              |  |   | 2,478       |   |               |         |       |   |        |   |         |       |  |   |       |   |  |   | 2,481   |  
|Adjustment of deferred compensation related to forfeitures                                        |  |                |       |  |            |       |    |              |  |   | (48         | ) |               |         | 48     |   |        |   |         |       |  |   |       |   |  |   |        |  
|Amortization of deferred warrant charge                                                           |  |                |       |  |            |       |    |              |  |   |            |   |               |         | 2,645  |   |        |   |         |       |  |   |       |   |  |   | 2,645   |  
|Amortization of deferred stock compensation related to
    restricted stock                       |  |                |       |  |            |       |    |              |  |   |            |   |               |         | 132    |   |        |   |         |       |  |   |       |   |  |   | 132     |  
|Compensation charge related to stock option grants to
    non-employees                           |  |                |       |  |            |       |    |              |  |   | 70          |   |               |         |       |   |        |   |         |       |  |   |       |   |  |   | 70      |  
|Compensation charge related to accelerated vesting of stock
    option grants issued to employees |  |                |       |  |            |       |    |              |  |   | 94          |   |               |         |       |   |        |   |         |       |  |   |       |   |  |   | 94      |  
|Proceeds from OEM fees applied to deferred warrant charge                                         |  |                |       |  |            |       |    |              |  |   |            |   |               |         | 1,000  |   |        |   |         |       |  |   |       |   |  |   | 1,000   |  
|Other comprehensive income                                                                        |  |                |       |  |            |       |    |              |  |   |            |   |               |         |       |   |        |   |         |       |  |   | 2,141  |   |  |   | 2,141   |  
|Net loss                                                                                          |  |                |       |  |            |       |    |              |  |   |            |   |               |         |       |   |        |   | (33,024  | )     |  |   |       |   |  |   | (33,024 | )
|                                                                                                  |  |                |        |  |            |       |     |              |  |   |             |   |               |         |        |   |        |   |          |       | 
|Balance, March 31, 2004                                                                           |  |                | 52,747 |  |            | $     | 527 |              |  | $ | 521,455     |   |               | $       | (5,625 | ) |        | $ | (321,473 | )     |  | $ | 2,253  |   |  | $ | 197,137 |  
|                                                                                                  |  |                |        |  |            |       |     |              |  |   |             |   |               |         |        |   |        |   |          |       | 
|Stock options exercised, net                                                                      |  |                | 296    |  |            |       | 3   |              |  |   | 982         |   |               |         |       |   |        |   |         |       |  |   |       |   |  |   | 985     |  
|ESPP common stock issuances                                                                       |  |                | 304    |  |            |       | 3   |              |  |   | 1,998       |   |               |         |       |   |        |   |         |       |  |   |       |   |  |   | 2,001   |  
|Amortization of deferred warrant charge                                                           |  |                |       |  |            |       |    |              |  |   |            |   |               |         | 2,645  |   |        |   |         |       |  |   |       |   |  |   | 2,645   |  
|Compensation charge payable in common stock under deferred
    compensation plan for directors    |  |                |       |  |            |       |    |              |  |   | 52          |   |               |         |       |   |        |   |         |       |  |   |       |   |  |   | 52      |  
|Proceeds from OEM fees applied to deferred warrant charge                                         |  |                |       |  |            |       |    |              |  |   |            |   |               |         | 500    |   |        |   |         |       |  |   |       |   |  |   | 500     |  
|Other comprehensive income                                                                        |  |                |       |  |            |       |    |              |  |   |            |   |               |         |       |   |        |   |         |       |  |   | (37    | ) |  |   | (37     | )
|Net loss                                                                                          |  |                |       |  |            |       |    |              |  |   |            |   |               |         |       |   |        |   | (18,751  | )     |  |   |       |   |  |   | (18,751 | )
|                                                                                                  |  |                |        |  |            |       |     |              |  |   |             |   |               |         |        |   |        |   |          |       | 
|Balance, March 31, 2005                                                                           |  |                | 53,347 |  |            | $     | 533 |              |  | $ | 524,487     |   |               | $       | (2,480 | ) |        | $ | (340,224 | )     |  | $ | 2,216  |   |  | $ | 184,532 |  
|                                                                                                  |  |                |        |  |            |       |     |              |  |   |             |   |               |         |        |   |        |   |          |       | 
|Stock options exercised, net                                                                      |  |                | 854    |  |            |       | 9   |              |  |   | 3,584       |   |               |         |       |   |        |   |         |       |  |   |       |   |  |   | 3,593   |  
|ESPP common stock issuances                                                                       |  |                | 278    |  |            |       | 3   |              |  |   | 1,335       |   |               |         |       |   |        |   |         |       |  |   |       |   |  |   | 1,338   |  
|Amortization of deferred warrant charge                                                           |  |                |       |  |            |       |    |              |  |   |            |   |               |         | 2,480  |   |        |   |         |       |  |   |       |   |  |   | 2,480   |  
|Compensation charge payable in common stock under deferred
    compensation plan for directors    |  |                |       |  |            |       |    |              |  |   | 96          |   |               |         |       |   |        |   |         |       |  |   |       |   |  |   | 96      |  
|Deferred compensation charge related to stock option grants to
    employees                      |  |                |       |  |            |       |    |              |  |   | 529         |   |               |         | (529   | ) |        |   |         |       |  |   |       |   |  |   |        |  
|Amortization of deferred stock compensation related to stock
    options                          |  |                |       |  |            |       |    |              |  |   |            |   |               |         | 113    |   |        |   |         |       |  |   |       |   |  |   | 113     |  
|Adjustment of deferred compensation related to forfeitures                                        |  |                |       |  |            |       |    |              |  |   | (59         | ) |               |         | 59     |   |        |   |         |       |  |   |       |   |  |   |        |  
|Other comprehensive income                                                                        |  |                |       |  |            |       |    |              |  |   |            |   |               |         |       |   |        |   |         |       |  |   | (3,396 | ) |  |   | (3,396  | )
|Net income                                                                                        |  |                |       |  |            |       |    |              |  |   |            |   |               |         |       |   |        |   | 18,022   |       |  |   |       |   |  |   | 18,022  |  
|                                                                                                  |  |                |        |  |            |       |     |              |  |   |             |   |               |         |        |   |        |   |          |       | 
|Balance, March 31, 2006                                                                           |  |                | 54,479 |  |            | $     | 545 |              |  | $ | 529,972     |   |               | $       | (357   | ) |        | $ | (322,202 | )     |  | $ | (1,180 | ) |  | $ | 206,778 |  
|                                                                                                  |  |                |        |  |            |       |     |              |  |   |             |   |               |         |        |   |        |   |          |       | 

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


F-5



---



##### 



WEBMETHODS, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


|                                                         |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |        |   |         |         |        |  
|-------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------- | ------ | ------- | ------- | - | ------- | ------- | ------ | - | ------- | ------- | ------ | -
|                                                         |                                                                                                                  | Year Ended March 31,                                                                                             |       
|                                                         |                                                                                                                  |                                                                                                                  |       
|                                                         |                                                                                                                  | 2006                                                                                                             |        |         | 2005    |   |         | 2004    |       
|                                                         |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |       
|                                                         |                                                                                                                  | (In thousands)                                                                                                   |       
|Cash flows from operating activities:                    |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |        |   |         |        
|                                                         | Net income (loss)                                                                                                |                                                                                                                  | $      | 18,022  |         |   | $       | (18,751 | )      |   | $       | (33,024 | )     
|                                                         | Adjustments to reconcile net income (loss) to net cash used in
    operating activities:                         |                                                                                                                  |        |         |         |   |         |         |        |   |         |         |       
|                                                         |                                                                                                                  | Depreciation and amortization                                                                                    |        |         | 5,317   |   |         |         | 6,343  |   |         |         | 8,428  |  
|                                                         |                                                                                                                  | Provision for (recovery of) doubtful accounts                                                                    |        |         | (477    | ) |         |         | 244    |   |         |         | 19     |  
|                                                         |                                                                                                                  | Impairment of equity investments                                                                                 |        |         |        |   |         |         | 1,057  |   |         |         |       |  
|                                                         |                                                                                                                  | Amortization of deferred stock compensation related to employee
    stock options and non-employee stock warrant |        |         | 2,593   |   |         |         | 2,645  |   |         |         | 2,846  |  
|                                                         |                                                                                                                  | Amortization of acquired intangibles                                                                             |        |         | 2,397   |   |         |         | 2,397  |   |         |         | 1,199  |  
|                                                         |                                                                                                                  | Release of deferred tax valuation allowance                                                                      |        |         | (2,171  | ) |         |         |       |   |         |         |       |  
|                                                         |                                                                                                                  | Write off of in-process research and development                                                                 |        |         |        |   |         |         |       |   |         |         | 4,284  |  
|                                                         |                                                                                                                  | Conversion of interest income to equity in private company
    investments                                       |        |         |        |   |         |         |       |   |         |         | (257   | )
|                                                         |                                                                                                                  | Non cash restructuring and related costs, and other                                                              |        |         |        |   |         |         |       |   |         |         | 473    |  
|                                                         |                                                                                                                  | Amortization of deferred rent                                                                                    |        |         | (457    | ) |         |         | (200   | ) |         |         |       |  
|                                                         |                                                                                                                  | Stock-based compensation                                                                                         |        |         | 122     |   |         |         |       |   |         |         |       |  
|                                                         | Increase (decrease) in cash resulting from changes in assets and
    liabilities, net of effect of acquisitions: |                                                                                                                  |        |         |         |   |         |         |        |   |         |         |       
|                                                         |                                                                                                                  | Accounts receivable                                                                                              |        |         | (17,561 | ) |         |         | (252   | ) |         |         | (534   | )
|                                                         |                                                                                                                  | Prepaid expenses and other current assets                                                                        |        |         | 137     |   |         |         | (212   | ) |         |         | 1,608  |  
|                                                         |                                                                                                                  | Other non-current assets                                                                                         |        |         | 1,895   |   |         |         | 1,956  |   |         |         | 91     |  
|                                                         |                                                                                                                  | Accounts payable                                                                                                 |        |         | (1,015  | ) |         |         | (2,386 | ) |         |         | 406    |  
|                                                         |                                                                                                                  | Accrued expenses and other liabilities                                                                           |        |         | (4,403  | ) |         |         | (1,064 | ) |         |         | 1,752  |  
|                                                         |                                                                                                                  | Deferred rent                                                                                                    |        |         |        |   |         |         | 3,105  |   |         |         |       |  
|                                                         |                                                                                                                  | Accrued salaries and commissions                                                                                 |        |         | 707     |   |         |         | 529    |   |         |         | (649   | )
|                                                         |                                                                                                                  | Deferred revenue                                                                                                 |        |         | 12,936  |   |         |         | 6,989  |   |         |         | (6,650 | )
|                                                         |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |       
|Net cash provided by(used in) operating activities       |                                                                                                                  |                                                                                                                  | 18,042 |         |         |   | 2,400   |         |        |   | (20,008 | )      
|                                                         |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |       
|Cash flows from investing activities:                    |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |        |   |         |        
|                                                         | Acquisition of businesses and technology, net of cash acquired                                                   |                                                                                                                  |        |        |         |   |         |        |        |   |         | (32,384 | )     
|                                                         | Purchases of property and equipment                                                                              |                                                                                                                  |        | (5,138  | )       |   |         | (8,380  | )      |   |         | (2,744  | )     
|                                                         | Proceeds from maturities of marketable securities available for
    sale                                         |                                                                                                                  |        | 90,119  |         |   |         | 85,258  |        |   |         | 111,737 |       
|                                                         | Purchases of marketable securities available for sale                                                            |                                                                                                                  |        | (77,018 | )       |   |         | (98,115 | )      |   |         | (70,463 | )     
|                                                         | Restricted cash                                                                                                  |                                                                                                                  |        | (899    | )       |   |         |        |        |   |         |        |       
|                                                         | Repayments of investments in private companies                                                                   |                                                                                                                  |        |        |         |   |         |        |        |   |         | 1,000   |       
|                                                         |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |       
|Net cash provided by (used in) investing activities      |                                                                                                                  |                                                                                                                  | 7,064  |         |         |   | (21,237 | )       |        |   | 7,146   |        
|                                                         |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |       
|Cash flows from financing activities:                    |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |        |   |         |        
|                                                         | Short-term borrowings                                                                                            |                                                                                                                  |        |        |         |   |         | 3,533   |        |   |         | 5,882   |       
|                                                         | Payments on short-term borrowings                                                                                |                                                                                                                  |        |        |         |   |         | (6,080  | )      |   |         | (3,561  | )     
|                                                         | Payments on capital leases                                                                                       |                                                                                                                  |        | (585    | )       |   |         | (937    | )      |   |         | (3,255  | )     
|                                                         | Proceeds from exercise of stock options                                                                          |                                                                                                                  |        | 3,562   |         |   |         | 1,037   |        |   |         | 3,039   |       
|                                                         | Proceeds from ESPP common stock issuances                                                                        |                                                                                                                  |        | 1,338   |         |   |         | 2,002   |        |   |         | 2,481   |       
|                                                         | Proceeds from OEM fees applied to deferred warrant charge                                                        |                                                                                                                  |        |        |         |   |         | 500     |        |   |         | 1,000   |       
|                                                         |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |       
|Net cash provided by financing activities                |                                                                                                                  |                                                                                                                  | 4,315  |         |         |   | 55      |         |        |   | 5,586   |        
|                                                         |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |       
|Effect of the exchange rate on cash and cash equivalents |                                                                                                                  |                                                                                                                  | (4,259 | )       |         |   | 529     |         |        |   | 3,036   |        
|                                                         |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |       
|Net increase (decrease) in cash and cash equivalents     |                                                                                                                  |                                                                                                                  | 25,162 |         |         |   | (18,253 | )       |        |   | (4,240  | )      
|Cash and cash equivalents at beginning of period         |                                                                                                                  |                                                                                                                  | 57,209 |         |         |   | 75,462  |         |        |   | 79,702  |        
|                                                         |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |       
|Cash and cash equivalents at end of period               |                                                                                                                  | $                                                                                                                | 82,371 |         |         | $ | 57,209  |         |        | $ | 75,462  |        
|                                                         |                                                                                                                  |                                                                                                                  |        |         |         |   |         |         |       

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


F-6



---



##### 



WEBMETHODS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.     Organization






|   |                                           
|-- | ------------------------------------------
|2. | Summary of significant accounting policies



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





| |                  
| | -----------------
| | Reclassifications





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





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





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





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





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



F-7



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)






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



98-1,




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





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



F-8



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)




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



Impairment of
long-lived assets




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





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





| |                            
| | ---------------------------
| | Comprehensive Income (Loss)



F-9



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)




|                             |  |                    |      |   |                  |   |        |               |  |   |        |  
|---------------------------- |  | ------------------ | ---- | - | ---------------- | - | ------ | ------------- |  | - | ------ | -
|                             |  | Unrealized Gain    |      |   | Foreign Currency |   |        | Accumulated   | 
|                             |  | (Loss) on          |      |   | Cumulative       |   |        | Other         | 
|                             |  | Securities         |      |   | Translation      |   |        | Comprehensive | 
|                             |  | Available for Sale |      |   | Adjustment       |   |        | Income (Loss) | 
|                             |  |                    |      |   |                  |   |        |               | 
|Balance as of March 31, 2003 |  | $                  | (155 | ) |                  | $ | 267    |               |  | $ | 112    |  
|Change during year           |  |                    | (165 | ) |                  |   | 2,306  |               |  |   | 2,141  |  
|                             |  |                    |      |   |                  |   |        |               | 
|Balance as of March 31, 2004 |  |                    | (320 | ) |                  |   | 2,573  |               |  |   | 2,253  |  
|Change during year           |  |                    | (496 | ) |                  |   | 459    |               |  |   | (37    | )
|                             |  |                    |      |   |                  |   |        |               | 
|Balance as of March 31, 2005 |  |                    | (816 | ) |                  |   | 3,032  |               |  |   | 2,216  |  
|Change during year           |  |                    | 199  |   |                  |   | (3,595 | )             |  |   | (3,396 | )
|                             |  |                    |      |   |                  |   |        |               | 
|Balance as of March 31, 2006 |  | $                  | (617 | ) |                  | $ | (563   | )             |  | $ | (1,180 | )
|                             |  |                    |      |   |                  |   |        |               | 



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





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

97-2, 98-9, 97-2, 98-9 97-2




F-10



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)










percentage-of






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



F-11



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)




|                                                                                  |  |                      |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------------- |  | -------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                  |  | Year Ended March 31, |        
|                                                                                  |  |                      |        
|                                                                                  |  | 2006                 |         |   | 2005 |   |         | 2004 | 
|                                                                                  |  |                      |         |   |      |   |         |      | 
|Net income (loss), as reported                                                    |  | $                    | 18,022  |   |      | $ | (18,751 | )    |  | $ | (33,024 | )
|Add: Stock-based compensation expense determined under intrinsic
    value method |  |                      | 113     |   |      |   |        |      |  |   | 202     |  
|Less: Stock-based compensation expense determined under fair
    value method     |  |                      | (28,592 | ) |      |   | (31,233 | )    |  |   | (51,084 | )
|                                                                                  |  |                      |         |   |      |   |         |      | 
|Net income (loss), pro forma                                                      |  | $                    | (10,457 | ) |      | $ | (49,984 | )    |  | $ | (83,906 | )
|                                                                                  |  |                      |         |   |      |   |         |      | 
|Basic net income (loss) per common share, as reported                             |  | $                    | .34     |   |      | $ | (0.35   | )    |  | $ | (0.63   | )
|Basic net income (loss) per common share, pro forma                               |  | $                    | (.19    | ) |      | $ | (0.94   | )    |  | $ | (1.61   | )
|Diluted net income (loss) per common share, as reported                           |  | $                    | .33     |   |      | $ | (0.35   | )    |  | $ | (0.63   | )
|Diluted net income (loss) per common share, pro forma                             |  | $                    | (.19    | ) |      | $ | (0.94   | )    |  | $ | (1.61   | )



|                        |  |                |     |   |                |  |     |      |  |  |      |   |  |      |     |   |      |  |     |   |  |  |     |  
|----------------------- |  | -------------- | --- | - | -------------- |  | --- | ---- |  |  | ---- | - |  | ---- | --- | - | ---- |  | --- | - |  |  | --- | -
|                        |  | Employee Stock |     |   | Employee Stock | 
|                        |  | Option Plans   |     |   | Purchase Plan  | 
|                        |  | March 31,      |     |   | March 31,      | 
|                        |  |                |     |   |                | 
|                        |  | 2006           |     |   | 2005           |  |     | 2004 |  |  | 2006 |   |  | 2005 |     |   | 2004 | 
|                        |  |                |     |   |                |  |     |      |  |  |      |   |  |      |     |   |      | 
|Expected volatility     |  |                | 73  | % |                |  | 85  | %    |  |  | 95   | % |  |      | 54  | % |      |  | 62  | % |  |  | 68  | %
|Risk-free interest rate |  |                | 4.1 | % |                |  | 3.8 | %    |  |  | 2.9  | % |  |      | 4.1 | % |      |  | 3.1 | % |  |  | 2.9 | %
|Expected life (years)   |  |                | 4   |   |                |  | 4   |      |  |  | 4    |   |  |      | 1.2 |   |      |  | 1.3 |   |  |  | 1   |  
|Expected dividend yield |  |                | 0   | % |                |  | 0   | %    |  |  | 0    | % |  |      | 0   | % |      |  | 0   | % |  |  | 0   | %



out-of


F-12



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)






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





| |                            
| | ---------------------------
| | Net income (loss) per share





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





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



F-13



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




2.     Summary of significant
accounting policies  (Continued)






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



FAS115-1 FAS124-1, 115-1), 115-1 115-1




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





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



F-14



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




4.     Investments in private
companies  (Continued)






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





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



|                                          |  |                |         |  |            |   |      |           |  |   |             |  |  |             |        |  |             |   |        |  |  |   |   | 
|----------------------------------------- |  | -------------- | ------- |  | ---------- | - | ---- | --------- |  | - | ----------- |  |  | ----------- | ------ |  | ----------- | - | ------ |  |  | - | - | 
|                                          |  | Purchase/      |         |  | Gross      |   |      | Aggregate |  |   | Cash and    |  |  | Short-      |        |  |            
|                                          |  | Amortized      |         |  | Unrealized |   |      | Fair      |  |   | Cash        |  |  | Term        |        |  | Long-Term  
|                                          |  | Cost           |         |  | Losses     |   |      | Value     |  |   | Equivalents |  |  | Investments |        |  | Investments
|                                          |  |                |         |  |            |   |      |           |  |   |             |  |  |             |        |  |            
|                                          |  | (In thousands)
|As of March 31, 2006                      |  |                |         |  |            |   |      |           |  |   |             |  |  |             |        |  |             |   |        |  |  |   |   | 
|Taxable municipal auction rate securities |  | $              | 9,850   |  |            | $ |     |           |  | $ | 9,850       |  |  | $           |       |  |             | $ | 9,850  |  |  | $ |  | 
|Corporate bonds                           |  |                | 82,217  |  |            |   | (163 | )         |  |   | 82,054      |  |  |             | 11,961 |  |             |   | 70,093 |  |  |   |  | 
|Money market funds                        |  |                | 30,137  |  |            |   |     |           |  |   | 30,137      |  |  |             | 30,137 |  |             |   |       |  |  |   |  | 
|                                          |  |                |         |  |            |   |      |           |  |   |             |  |  |             |        |  |             |  
|Total                                     |  | $              | 122,204 |  |            | $ | (163 | )         |  | $ | 122,041     |  |  | $           | 42,098 |  |             | $ | 79,943 |  |  | $ |  | 
|                                          |  |                |         |  |            |   |      |           |  |   |             |  |  |             |        |  |             |  

|                                                                             |  |                |        |  |            |   |      |           |  |   |             |  |  |             |       |  |             |   |        |  |  |   |        | 
|---------------------------------------------------------------------------- |  | -------------- | ------ |  | ---------- | - | ---- | --------- |  | - | ----------- |  |  | ----------- | ----- |  | ----------- | - | ------ |  |  | - | ------ | 
|                                                                             |  | Purchase/      |        |  | Gross      |   |      | Aggregate |  |   | Cash and    |  |  | Short-      |       |  |            
|                                                                             |  | Amortized      |        |  | Unrealized |   |      | Fair      |  |   | Cash        |  |  | Term        |       |  | Long-Term   |  
|                                                                             |  | Cost           |        |  | Losses     |   |      | Value     |  |   | Equivalents |  |  | Investments |       |  | Investments |  
|                                                                             |  |                |        |  |            |   |      |           |  |   |             |  |  |             |       |  |             |  
|                                                                             |  | (In thousands) |       
|As of March 31, 2005                                                         |  |                |        |  |            |   |      |           |  |   |             |  |  |             |       |  |             |   |        |  |  |   |        | 
|Taxable municipal auction rate securities                                    |  | $              | 9,600  |  |            | $ |     |           |  | $ | 9,600       |  |  | $           |      |  |             | $ | 9,600  |  |  | $ |       | 
|US Treasury obligations and direct obligations of
    US government agencies |  |                | 1,008  |  |            |   | (2   | )         |  |   | 1,006       |  |  |             |      |  |             |   | 1,006  |  |  |   |       | 
|Corporate bonds                                                              |  |                | 87,850 |  |            |   | (360 | )         |  |   | 87,490      |  |  |             | 5,251 |  |             |   | 67,726 |  |  |   | 14,513 | 
|Money market funds                                                           |  |                | 22     |  |            |   |     |           |  |   | 22          |  |  |             | 22    |  |             |   |       |  |  |   |       | 
|                                                                             |  |                |        |  |            |   |      |           |  |   |             |  |  |             |       |  |             |  
|Total                                                                        |  | $              | 98,480 |  |            | $ | (362 | )         |  | $ | 98,118      |  |  | $           | 5,273 |  |             | $ | 78,332 |  |  | $ | 14,513 | 
|                                                                             |  |                |        |  |            |   |      |           |  |   |             |  |  |             |       |  |             |  



F-15



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




6.     Marketable
securities  (Continued)




In accordance with FASB Staff Position Nos.


|                |  |                     |        |            |                        |   |      |            |            |   |        |  |  |            |     |   |        |   |        |  |  |   |      |  
|--------------- |  | ------------------- | ------ | ---------- | ---------------------- | - | ---- | ---------- | ---------- | - | ------ |  |  | ---------- | --- | - | ------ | - | ------ |  |  | - | ---- | -
|                |  | Less than 12 Months |        |            | Greater than 12 Months |   |      | Total      |           
|                |  |                     |        |            |                        |   |      |            |           
|                |  |                     |        | Gross      |                        |   |      |            | Gross      |   |        |  |  | Gross      |    
|                |  |                     |        | Unrealized |                        |   |      |            | Unrealized |   |        |  |  | Unrealized |    
|                |  | Fair Value          |        |            | Losses                 |   |      | Fair Value |            |   | Losses |  |  | Fair Value |     |   | Losses |  
|                |  |                     |        |            |                        |   |      |            |            |   |        |  |  |            |     |   |        |  
|                |  | (In thousands)      |       
|Corporate bonds |  | $                   | 55,848 |            |                        | $ | (138 | )          |            | $ | 14,245 |  |  | $          | (25 | ) |        | $ | 70,093 |  |  | $ | (163 | )







|   |                                                                         
|-- | ------------------------------------------------------------------------
|7. | Accounts receivable and allowances for doubtful accounts and
    returns



|                                                   |  |                |        |   |      |   |        |  
|-------------------------------------------------- |  | -------------- | ------ | - | ---- | - | ------ | -
|                                                   |  | March 31,      |       
|                                                   |  |                |       
|                                                   |  | 2006           |        |   | 2005 |  
|                                                   |  |                |        |   |      |  
|                                                   |  | (In thousands) |       
|Accounts receivable                                |  | $              | 62,926 |   |      | $ | 47,781 |  
|Unbilled services                                  |  |                | 2,024  |   |      |   | 1,407  |  
|Less: Allowances for doubtful accounts and returns |  |                | (652   | ) |      |   | (1,862 | )
|                                                   |  |                |        |   |      |  
|Net accounts receivable                            |  | $              | 64,298 |   |      | $ | 47,326 |  
|                                                   |  |                |        |   |      |  



F-16



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




7.     Accounts receivable and
allowances for doubtful accounts and returns 
(Continued)




|                                                          |  |                |       |  |                |   |      |            |            |        |        |  |  |   |       | 
|--------------------------------------------------------- |  | -------------- | ----- |  | -------------- | - | ---- | ---------- | ---------- | ------ | ------ |  |  | - | ----- | 
|                                                          |  | Balance at     |       |  |                |   |      |            | Balance at |       
|                                                          |  | Beginning of   |       |  | (Recovery of)  |   |      |            |            | End of |       
|                                                          |  | Period         |       |  | Provisions for |   |      | Deductions |            |        | Period | 
|                                                          |  |                |       |  |                |   |      |            |            |        |        | 
|                                                          |  | (In thousands) |      
|Year ended March 31, 2004 allowance for doubtful accounts |  | $              | 2,850 |  |                | $ | 19   |            |            | $      | 766    |  |  | $ | 2,103 | 
|Year ended March 31, 2005 allowance for doubtful accounts |  |                | 2,103 |  |                |   | 233  |            |            |        | 474    |  |  |   | 1,862 | 
|Year ended March 31, 2006 allowance for doubtful accounts |  |                | 1,862 |  |                |   | (475 | )          |            |        | 735    |  |  |   | 652   | 



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



|                                          |  |                |         |   |      |   |         |  
|----------------------------------------- |  | -------------- | ------- | - | ---- | - | ------- | -
|                                          |  | March 31,      |        
|                                          |  |                |        
|                                          |  | 2006           |         |   | 2005 |  
|                                          |  |                |         |   |      |  
|                                          |  | (In thousands) |        
|Equipment                                 |  | $              | 16,916  |   |      | $ | 16,593  |  
|Software                                  |  |                | 10,840  |   |      |   | 8,824   |  
|Furniture                                 |  |                | 3,677   |   |      |   | 4,146   |  
|Leasehold improvements                    |  |                | 5,346   |   |      |   | 5,450   |  
|                                          |  |                |         |   |      |  
|                                          |  |                | 36,779  |   |      |   | 35,013  |  
|Accumulated depreciation and amortization |  |                | (26,505 | ) |      |   | (24,671 | )
|                                          |  |                |         |   |      |  
|                                          |  | $              | 10,274  |   |      | $ | 10,342  |  
|                                          |  |                |         |   |      |  





F-17



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




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



|                                 |         |                |        |        |      |   |     |      |  |   |   |   | 
|-------------------------------- | ------- | -------------- | ------ | ------ | ---- | - | --- | ---- |  | - | - | - | 
|                                 |         | 2006           |        |        | 2005 |   |     | 2004
|                                 |         |                |        |        |      |   |     |     
|                                 |         | (In thousands)
|Current tax provision:           |         |                |        |        |      |   |     |      |  |   |   |  
|                                 | Federal |                | $      | 36     |      |   | $   |     |  |   | $ |  | 
|                                 | State   |                |        | 2      |      |   |     |     |  |   |   |  | 
|                                 | Foreign |                |        | 757    |      |   |     | 235  |  |   |   |  | 
|                                 |         |                |        |        |      |   |     |      | 
|Total current                    |         |                | 795    |        |      |   | 235 |      |  |   |  |  
|                                 |         |                |        |        |      |   |     |      | 
|Deferred tax provision:          |         |                |        |        |      |   |     |      |  |   |   |  
|                                 | Federal |                | $      |       |      |   | $   |     |  |   | $ |  | 
|                                 | State   |                |        |       |      |   |     |     |  |   |   |  | 
|                                 | Foreign |                |        | (2,143 | )    |   |     |     |  |   |   |  | 
|                                 |         |                |        |        |      |   |     |      | 
|Total deferred                   |         |                | (2,143 | )      |      |   |    |      |  |   |  |  
|                                 |         |                |        |        |      |   |     |      | 
|Total provision for income taxes |         | $              | (1,348 | )      |      | $ | 235 |      |  | $ |  |  
|                                 |         |                |        |        |      |   |     |      | 



|              |  |                |        |  |      |   |         |      |  |   |         |  
|------------- |  | -------------- | ------ |  | ---- | - | ------- | ---- |  | - | ------- | -
|              |  | 2006           |        |  | 2005 |   |         | 2004 | 
|              |  |                |        |  |      |   |         |      | 
|              |  | (In thousands) |       
|United States |  | $              | 14,881 |  |      | $ | (20,877 | )    |  | $ | (24,946 | )
|International |  |                | 1,793  |  |      |   | 2,361   |      |  |   | (8,078  | )
|              |  |                |        |  |      |   |         |      | 
|Total         |  |                | 16,674 |  |      |   | (18,516 | )    |  |   | (33,024 | )
|              |  |                |        |  |      |   |         |      | 





F-18



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




9.     Income taxes 
(Continued)




|                               |                                                |                      |          |        |   |   |          |        |  
|------------------------------ | ---------------------------------------------- | -------------------- | -------- | ------ | - | - | -------- | ------ | -
|                               |                                                | Year Ended March 31,
|                               |                                                |                     
|                               |                                                | 2006                 |          | 2005  
|                               |                                                |                      |          |       
|                               |                                                | (In thousands)      
|Deferred tax assets:           |                                                |                      |          |        |   |   |          |       
|                               | Net operating loss carryforwards               |                      | $        | 72,734 |   |   | $        | 98,618 |  
|                               | Amortization of research and development costs |                      |          | 20,856 |   |   |          |       |  
|                               | Research and development credit                |                      |          | 11,024 |   |   |          | 9,783  |  
|                               | Stock option compensation                      |                      |          | 9,364  |   |   |          | 8,475  |  
|                               | Amortizable intangibles                        |                      |          | 8,408  |   |   |          | 10,981 |  
|                               | Deferred revenue                               |                      |          | 1,719  |   |   |          | 1,363  |  
|                               | Accrued expenses                               |                      |          | 1,334  |   |   |          | 1,592  |  
|                               | Accounts receivable                            |                      |          | 1,352  |   |   |          | 416    |  
|                               | Deferred rent                                  |                      |          | 1,249  |   |   |          |       |  
|                               | Property and equipment                         |                      |          | 1,042  |   |   |          | 589    |  
|                               | Impairment loss in equity investments          |                      |          |       |   |   |          | 2,751  |  
|                               | Other                                          |                      |          | 496    |   |   |          |       |  
|                               |                                                |                      |          |        |   |   |          |       
|Total deferred tax assets      |                                                |                      | 129,578  |        |   |   | 134,568  |       
|                               |                                                |                      |          |        |   |   |          |       
|Deferred tax liabilities:      |                                                |                      |          |        |   |   |          |       
|                               | Purchased intangibles                          |                      |          | (2,310 | ) |   |          | (2,882 | )
|                               | Other                                          |                      |          |       |   |   |          | (581   | )
|                               |                                                |                      |          |        |   |   |          |       
|Total deferred tax liabilities |                                                |                      | (2,310   | )      |   |   | (3,463   | )     
|                               |                                                |                      |          |        |   |   |          |       
|Net deferred tax assets        |                                                |                      | 127,268  |        |   |   | 131,105  |       
|Valuation allowance            |                                                |                      | (125,169 | )      |   |   | (131,105 | )     
|                               |                                                |                      |          |        |   |   |          |       
|Net deferred tax assets        |                                                | $                    | 2,099    |        |   | $ |         |       
|                               |                                                |                      |          |        |   |   |          |       



F-19



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




9.     Income taxes 
(Continued)






|                                                         |                      |                      |       |      |      |  |       |      |   |  |       |    |  
|-------------------------------------------------------- | -------------------- | -------------------- | ----- | ---- | ---- |  | ----- | ---- | - |  | ----- | -- | -
|                                                         |                      | Year Ended March 31, |      
|                                                         |                      |                      |      
|                                                         |                      | 2006                 |       |      | 2005 |  |       | 2004 |  
|                                                         |                      |                      |       |      |      |  |       |      |  
|U.S. Federal statutory tax rate                          |                      |                      | 34.0  | %    |      |  | (34.0 | )%   |   |  | (34.0 | )%
|State and local taxes, net of Federal income tax benefit |                      |                      | 3.2   |      |      |  | (3.7  | )    |   |  | (3.1  | ) 
|Non-deductible items                                     |                      |                      | 5.7   |      |      |  | 2.2   |      |   |  | 1.1   |   
|Withholding and other foreign tax expense                |                      |                      | 2.6   |      |      |  |      |      |   |  |      |   
|Change in valuation allowance                            |                      |                      | (48.1 | )    |      |  | 44.0  |      |   |  | 44.5  |   
|Foreign rate differential                                |                      |                      | (2.0  | )    |      |  |      |      |   |  | (3.2  | ) 
|Change in general business credit                        |                      |                      | (8.1  | )    |      |  | (7.5  | )    |   |  | (5.3  | ) 
|Change in state income tax rates                         |                      |                      | 4.6   |      |      |  |      |      |   |  |      |   
|                                                         |                      |                      |       |      |      |  |       |      |  
|                                                         | Income tax provision |                      |       | (8.1 | )%   |  |       | 1.0  | % |  |       |   | %
|                                                         |                      |                      |       |      |      |  |       |      |  



|    |                            
|--- | ---------------------------
|10. | Net Income (Loss) Per Share





|                                                                                               |  |                      |        |  |      |   |         |      |  |   |         |  
|---------------------------------------------------------------------------------------------- |  | -------------------- | ------ |  | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                               |  | Year Ended March 31, |       
|                                                                                               |  |                      |       
|                                                                                               |  | 2006                 |        |  | 2005 |   |         | 2004 | 
|                                                                                               |  |                      |        |  |      |   |         |      | 
|                                                                                               |  | (In thousands)       |       
|Net income (loss)                                                                              |  | $                    | 18,022 |  |      | $ | (18,751 | )    |  | $ | (33,024 | )
|                                                                                               |  |                      |        |  |      |   |         |      | 
|Weighted-average common stock shares used to compute basic net
    income (loss) per share     |  |                      | 53,779 |  |      |   | 53,103  |      |  |   | 52,137  |  
|Effect of dilutive common stock equivalents                                                    |  |                      | 1,266  |  |      |   |        |      |  |   |        |  
|                                                                                               |  |                      |        |  |      |   |         |      | 
|Weighted-average common stock shares used in computing diluted
    net income per common share |  |                      | 55,045 |  |      |   | 53,103  |      |  |   | 52,137  |  
|                                                                                               |  |                      |        |  |      |   |         |      | 
|Basic net income (loss) per share                                                              |  | $                    | 0.34   |  |      | $ | (0.35   | )    |  | $ | (0.63   | )
|                                                                                               |  |                      |        |  |      |   |         |      | 
|Diluted net income (loss) per share                                                            |  | $                    | 0.33   |  |      | $ | (0.35   | )    |  | $ | (0.63   | )
|                                                                                               |  |                      |        |  |      |   |         |      | 

F-20



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




10.     Net Income (Loss) Per
Share  (Continued)




|                                                   |  |                      |        |  |      |  |        |      |  |  |        | 
|-------------------------------------------------- |  | -------------------- | ------ |  | ---- |  | ------ | ---- |  |  | ------ | 
|                                                   |  | Year Ended March 31, |       
|                                                   |  |                      |       
|                                                   |  | 2006                 |        |  | 2005 |  |        | 2004 | 
|                                                   |  |                      |        |  |      |  |        |      | 
|                                                   |  | (In thousands)       |       
|Anti-dilutive weighted-average common stock shares |  |                      | 12,892 |  |      |  | 19,010 |      |  |  | 18,039 | 
|                                                   |  |                      |        |  |      |  |        |      | 



|    |           
|--- | ----------
|11. | Borrowings









|    |                  
|--- | -----------------
|12. | Lease commitments

36-month


F-21



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




12.     Lease
commitments  (Continued)






|                                                 |            |                |        |        |         |   |      |    | 
|------------------------------------------------ | ---------- | -------------- | ------ | ------ | ------- | - | ---- | -- | 
|                                                 |            | Operating      |        |        | Capital |  
|                                                 |            |                |        |        |         |  
|                                                 |            | (In thousands) |       
|Years ending March 31, 2007                      |            | $              | 11,562 |        |         | $ | 264  |   
|                                                 | 2008       |                |        | 7,926  |         |   |      | 10 | 
|                                                 | 2009       |                |        | 4,612  |         |   |      |   | 
|                                                 | 2010       |                |        | 4,279  |         |   |      |   | 
|                                                 | 2011       |                |        | 4,338  |         |   |      |   | 
|                                                 | Thereafter |                |        | 18,131 |         |   |      |   | 
|                                                 |            |                |        |        |         |  
|                                                 |            | $              | 50,848 |        |         | $ | 274  |   
|                                                 |            |                |        |        |         |  
|Less amounts representing interest               |            |                |        |        |         |   | (5   | ) 
|                                                 |            |                |        |        |         |  
|                                                 |            |                |        |        |         |   | 269  |   
|Less current portion                             |            |                |        |        |         |   | (259 | ) 
|                                                 |            |                |        |        |         |  
|Capital lease obligation, net of current portion |            |                |        |        |         | $ | 10   |   
|                                                 |            |                |        |        |         |  



|    |                     
|--- | --------------------
|13. | Stockholders equity



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





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





F-22



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




13.     Stockholders
equity  (Continued)








|    |                      
|--- | ---------------------
|14. | Business combinations



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









F-23



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




14.     Business
combinations  (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 |  
|                                       |  |           |        |   |     |   |       |       | 







F-24



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




14.     Business
combinations  (Continued)




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



| |                          
| | -------------------------
| | Acquisition of technology







|    |                               
|--- | ------------------------------
|15. | Goodwill and intangible assets







|                       |  |                      |        |  |                      |   |       |              |  |   |          |     |  |              |        |  |          |   |       |  |  |   |       | 
|---------------------- |  | -------------------- | ------ |  | -------------------- | - | ----- | ------------ |  | - | -------- | --- |  | ------------ | ------ |  | -------- | - | ----- |  |  | - | ----- | 
|                       |  | As of March 31, 2006 |        |  | As of March 31, 2005 |  
|                       |  |                      |        |  |                      |  
|                       |  | Gross                |        |  |                      |   | Gross |              |  |   |          | Net | 
|                       |  | Carrying             |        |  | Accumulated          |   |       | Net Carrying |  |   | Carrying |     |  | Accumulated  |        |  | Carrying |  
|                       |  | Amount               |        |  | Amortization         |   |       | Amount       |  |   | Amount   |     |  | Amortization |        |  | Amount   |  
|                       |  |                      |        |  |                      |   |       |              |  |   |          |     |  |              |        |  |          |  
|Existing technology    |  | $                    | 11,152 |  |                      | $ | 5,572 |              |  | $ | 5,580    |     |  | $            | 11,152 |  |          | $ | 3,342 |  |  | $ | 7,810 | 
|Customer relationships |  |                      | 833    |  |                      |   | 420   |              |  |   | 413      |     |  |              | 833    |  |          |   | 253   |  |  |   | 580   | 
|                       |  |                      |        |  |                      |   |       |              |  |   |          |     |  |              |        |  |          |  
|Total                  |  | $                    | 11,985 |  |                      | $ | 5,992 |              |  | $ | 5,993    |     |  | $            | 11,985 |  |          | $ | 3,595 |  |  | $ | 8,390 | 
|                       |  |                      |        |  |                      |   |       |              |  |   |          |     |  |              |        |  |          |  

F-25



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




15.     Goodwill and intangible
assets  (Continued)




|     |  |   |       | 
|---- |  | - | ----- | 
|2007 |  | $ | 2,397 | 
|2008 |  |   | 2,397 | 
|2009 |  |   | 1,199 | 
|     |  |   |      
|     |  | $ | 5,993 | 
|     |  |   |      



|    |                         
|--- | ------------------------
|16. | Stock based compensation



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







F-26



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




16.     Stock based
compensation  (Continued)




|                            |           |         |            |            |                |   |        |                  |  |   |        |        |  |   |       |       | 
|--------------------------- | --------- | ------- | ---------- | ---------- | -------------- | - | ------ | ---------------- |  | - | ------ | ------ |  | - | ----- | ----- | 
|                            |           | Stock   |            |            | Range of       |   |        | Weighted Average | 
|                            |           | Options |            |            | Exercise Price |   |        | Exercise Price   | 
|                            |           |         |            |            |                |   |        |                  | 
|Outstanding, March 31, 2003 |           |         | 15,830,002 |            |                | $ | 0.11  |                  |  | $ | 161.29 |        |  | $ | 18.49 |      
|                            | Granted   |         |            | 5,598,215  |                |   |        | 7.54            |  |   |        | 11.70  |  |   |       | 9.00  | 
|                            | Exercised |         |            | (620,216   | )              |   |        | 0.11            |  |   |        | 9.08   |  |   |       | 4.90  | 
|                            | Cancelled |         |            | (4,016,541 | )              |   |        | 2.88            |  |   |        | 161.29 |  |   |       | 20.44 | 
|                            |           |         |            |            |                |   |        |                 
|Outstanding, March 31, 2004 |           |         | 16,791,460 |            |                | $ | 0.11  |                  |  | $ | 161.29 |        |  | $ | 15.30 |      
|                            | Granted   |         |            | 6,704,952  |                |   |        | 3.99            |  |   |        | 10.55  |  |   |       | 7.65  | 
|                            | Exercised |         |            | (295,939   | )              |   |        | 0.11            |  |   |        | 8.79   |  |   |       | 3.33  | 
|                            | Cancelled |         |            | (5,543,457 | )              |   |        | 3.99            |  |   |        | 161.29 |  |   |       | 14.88 | 
|                            |           |         |            |            |                |   |        |                 
|Outstanding, March 31, 2005 |           |         | 17,657,016 |            |                | $ | 0.11  |                  |  | $ | 115.75 |        |  | $ | 12.73 |      
|                            | Granted   |         |            | 6,863,079  |                |   | $      | 4.60            |  |   |        | 8.25   |  |   |       | 6.25  | 
|                            | Exercised |         |            | (849,965   | )              |   | $      | 0.11            |  |   |        | 7.81   |  |   |       | 4.19  | 
|                            | Cancelled |         |            | (5,471,644 | )              |   | $      | 3.99            |  |   |        | 114.56 |  |   |       | 13.13 | 
|                            |           |         |            |            |                |   |        |                 
|Outstanding, March 31, 2006 |           |         | 18,198,486 |            |                | $ | 0.11  |                  |  | $ | 115.75 |        |  | $ | 10.56 |      
|                            |           |         |            |            |                |   |        |                  |  |   |        |       



|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                  |  |  |                  |  |  |   |       |  |  |  |            |  |  |  |      |  |  |   |       | 
|--------------- | ----- | --------- |  | ---------------- | ---------------- | - | ------ | ---------------- |  |  | ------------------- |  | ---------- | ---------------- |  |  | ---------------- |  |  | - | ----- |  |  |  | ---------- |  |  |  | ---- |  |  | - | ----- | 
|                |       |           |  |                  |                  |   |        | Outstanding      |  |  | Options Exercisable | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     | 
|                |       |           |  | Weighted Average |                  |   |        |                  |  |  | Weighted Average    |  |            |                 
|Range of        |       | Number of |  |                  | Remaining        |   |        | Weighted Average |  |  | Number of           |  |            | Remaining        |  |  | Weighted Average | 
|Exercise Prices |       | Shares    |  |                  | Contractual Life |   |        | Exercise Price   |  |  | Shares              |  |            | Contractual Life |  |  | Exercise Price   | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                  |  |  |                  | 
|$               | 0.11  |           |  |                 |                  | $ | 5.89   |                  |  |  |                     |  | 5,743,240  |                  |  |  | 8.78             |  |  | $ | 5.33  |  |  |  | 1,597,724  |  |  |  | 8.74 |  |  | $ | 4.69  | 
|                | 5.93  |           |  |                 |                  |   | 8.07   |                  |  |  |                     |  | 3,791,916  |                  |  |  | 8.20             |  |  |   | 7.12  |  |  |  | 1,429,914  |  |  |  | 7.55 |  |  |   | 7.11  | 
|                | 8.11  |           |  |                 |                  |   | 10.06  |                  |  |  |                     |  | 3,888,619  |                  |  |  | 7.65             |  |  |   | 9.15  |  |  |  | 3,639,644  |  |  |  | 7.55 |  |  |   | 9.22  | 
|                | 10.14 |           |  |                 |                  |   | 14.36  |                  |  |  |                     |  | 3,820,022  |                  |  |  | 6.08             |  |  |   | 13.15 |  |  |  | 3,820,022  |  |  |  | 6.08 |  |  |   | 13.15 | 
|                | 14.70 |           |  |                 |                  |   | 115.75 |                  |  |  |                     |  | 954,689    |                  |  |  | 4.83             |  |  |   | 51.05 |  |  |  | 954,689    |  |  |  | 4.83 |  |  |   | 51.05 | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                  |  |  |                  |  |  |   |       |  |  |  |            | 
|$               | 0.11  |           |  |                 |                  | $ | 115.75 |                  |  |  |                     |  | 18,198,486 |                  |  |  | 7.64             |  |  | $ | 10.56 |  |  |  | 11,441,993 |  |  |  | 7.41 |  |  | $ | 13.13 | 
|                |       |           |  |                  |                  |   |        |                  |  |  |                     |  |            |                  |  |  |                  |  |  |   |       |  |  |  |            | 





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



F-27



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




16.     Stock based
compensation  (Continued)










|                             |  |  |       |  
|---------------------------- |  |  | ----- | -
|Balance at March 31, 2004    |  |  | 3,418 |  
|                             |  |  |      
|Additional authorized shares |  |  | 750   |  
|Purchases                    |  |  | (304  | )
|                             |  |  |      
|Balance at March 31, 2005    |  |  | 3,864 |  
|                             |  |  |      
|Additional authorized shares |  |  | 750   |  
|Purchases                    |  |  | (278  | )
|                             |  |  |      
|Balance at March 31, 2006    |  |  | 4,336 |  
|                             |  |  |      



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





|    |                      
|--- | ---------------------
|17. | Employee benefit plan



F-28



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|    |                                                   
|--- | --------------------------------------------------
|18. | Supplemental disclosures of cash flow information:

|                                             |                                                                |                      |    |      |      |   |    |      |  |   |      |        |   | 
|-------------------------------------------- | -------------------------------------------------------------- | -------------------- | -- | ---- | ---- | - | -- | ---- |  | - | ---- | ------ | - | 
|                                             |                                                                | Year Ended March 31, |   
|                                             |                                                                |                      |   
|                                             |                                                                | 2006                 |    |      | 2005 |   |    | 2004 | 
|                                             |                                                                |                      |    |      |      |   |    |      | 
|                                             |                                                                | (In thousands)       |   
|Cash paid during the period for interest     |                                                                | $                    | 82 |      |      | $ | 98 |      |  | $ | 202  |       
|                                             |                                                                |                      |    |      |      |   |    |      | 
|Non-cash investing and financing activities: |                                                                |                      |    |      |      |   |    |      |  |   |      |       
|                                             | Equipment purchased under capital lease                        |                      | $  | 270  |      |   | $  | 313  |  |   | $    | 1,457  |  
|                                             | Conversion of interest income into equity in private company   |                      |    |     |      |   |    |     |  |   |      | 257    |  
|                                             | Change in net unrealized gain or loss on marketable securities |                      |    | (199 | )    |   |    | 496  |  |   |      | 165    |  
|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-29



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




|    |                                  
|--- | ---------------------------------
|19. | Restructuring and related charges



11-year








F-30



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




19.     Restructuring and related
charges  (Continued)




|                                                                            |  |                 |       |   |              |   |       |             |  |   |             |   |  |            |        |   |       |   |      |   |  |   |        |  
|--------------------------------------------------------------------------- |  | --------------- | ----- | - | ------------ | - | ----- | ----------- |  | - | ----------- | - |  | ---------- | ------ | - | ----- | - | ---- | - |  | - | ------ | -
|                                                                            |  | Excess          |       |   |              |   |       |             |  |   |             |   | 
|                                                                            |  | Facilities      |       |   | Excess       |   |       | Excess      |  |   | Severance   |   |  | Impairment |        |   |      
|                                                                            |  | Santa Clara, CA |       |   | Facilities   |   |       | Facilities  |  |   | And Related |   |  | of Fixed   |        |   |      
|                                                                            |  | and Fairfax, VA |       |   | Berkeley, CA |   |       | Fairfax, VA |  |   | Benefits    |   |  | Assets     |        |   | Total |  
|                                                                            |  |                 |       |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|                                                                            |  | (In thousands)  |      
|Balance at March 31, 2003                                                   |  | $               | 1,699 |   |              | $ |      |             |  | $ |            |   |  | $          | 54     |   |       | $ |     |   |  | $ | 1,753  |  
|Fiscal 2004 charges                                                         |  |                 |      |   |              |   | 1,508 |             |  | $ |            |   |  |            | 2,165  |   |       |   | 247  |   |  |   | 3,920  |  
|Non-cash write-down of fixed assets                                         |  |                 |      |   |              |   |      |             |  |   |            |   |  |            |       |   |       |   | (247 | ) |  |   | (247   | )
|Cash payments made in fiscal 2004                                           |  |                 | (782  | ) |              |   | (65   | )           |  |   |            |   |  |            | (1,470 | ) |       |   |     |   |  |   | (2,317 | )
|                                                                            |  |                 |       |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|Balance at March 31, 2004                                                   |  | $               | 917   |   |              | $ | 1,443 |             |  | $ |            |   |  | $          | 749    |   |       | $ |     |   |  | $ | 3,109  |  
|                                                                            |  |                 |       |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|Fiscal 2005 charges                                                         |  |                 |      |   |              |   |      |             |  |   | 3,093       |   |  |            | 3,012  |   |       |   |     |   |  |   | 6,105  |  
|Adjustments due to revision in estimated severance and related
    benefits |  |                 |      |   |              |   |      |             |  |   |            |   |  |            | (256   | ) |       |   |     |   |  |   | (256   | )
|Cash payments made in fiscal 2005                                           |  |                 | (383  | ) |              |   | (436  | )           |  |   | (193        | ) |  |            | (3,505 | ) |       |   |     |   |  |   | (4,517 | )
|                                                                            |  |                 |       |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|Balance at March 31, 2005                                                   |  | $               | 534   |   |              | $ | 1,007 |             |  | $ | 2,900       |   |  | $          |       |   |       | $ |     |   |  | $ | 4,441  |  
|                                                                            |  |                 |       |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|Fiscal 2006 charges                                                         |  |                 |      |   |              |   |      |             |  |   |            |   |  |            | 719    |   |       |   |     |   |  |   | 719    |  
|Adjustments due to revision in estimated sublease income                    |  |                 | (153  | ) |              |   | 77    |             |  |   | (232        | ) |  |            |       |   |       |   |     |   |  |   | (308   | )
|Cash payments made in fiscal 2006                                           |  |                 | (215  | ) |              |   | (337  | )           |  |   | (1,418      | ) |  |            | (719   | ) |       |   |     |   |  |   | (2,689 | )
|                                                                            |  |                 |       |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  
|Balance at March 31, 2006                                                   |  | $               | 166   |   |              | $ | 747   |             |  | $ | 1,250       |   |  | $          |       |   |       | $ |     |   |  | $ | 2,163  |  
|                                                                            |  |                 |       |   |              |   |       |             |  |   |             |   |  |            |        |   |       |  



|    |                    
|--- | -------------------
|20. | Segment information





F-31



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)




20.     Segment
information  (Continued)




|                  |       |                       |         |         |      |   |         |         |  |   |         |         | 
|----------------- | ----- | --------------------- | ------- | ------- | ---- | - | ------- | ------- |  | - | ------- | ------- | 
|                  |       | Years Ended March 31, |        
|                  |       |                       |        
|                  |       | 2006                  |         |         | 2005 |   |         | 2004    | 
|                  |       |                       |         |         |      |   |         |         | 
|                  |       | (In thousands)        |        
|Revenue           |       |                       |         |         |      |   |         |         |  |   |         |        
|Americas          |       | $                     | 131,410 |         |      | $ | 119,610 |         |  | $ | 114,507 |        
|EMEA              |       |                       | 52,884  |         |      |   | 50,599  |         |  |   | 44,965  |        
|Japan             |       |                       | 9,100   |         |      |   | 15,157  |         |  |   | 15,472  |        
|Asia Pacific      |       |                       | 15,424  |         |      |   | 15,235  |         |  |   | 14,597  |        
|                  |       |                       |         |         |      |   |         |         | 
|                  | Total |                       | $       | 208,818 |      |   | $       | 200,601 |  |   | $       | 189,541 | 
|                  |       |                       |         |         |      |   |         |         | 
|Long Lived Assets |       |                       |         |         |      |   |         |         |  |   |         |        
|Americas          |       | $                     | 10,981  |         |      | $ | 12,478  |         |  | $ | 13,006  |        
|EMEA              |       |                       | 1,393   |         |      |   | 1,852   |         |  |   | 2,189   |        
|Japan             |       |                       | 1,132   |         |      |   | 1,509   |         |  |   | 1,681   |        
|Asia Pacific      |       |                       | 843     |         |      |   | 630     |         |  |   | 360     |        
|                  |       |                       |         |         |      |   |         |         | 
|                  | Total |                       | $       | 14,349  |      |   | $       | 16,469  |  |   | $       | 17,236  | 
|                  |       |                       |         |         |      |   |         |         | 



|    |                              
|--- | -----------------------------
|21. | Commitments and Contingencies





F-32



---



##### 



EXHIBIT INDEX


|        |         |  |             |                                                                                                                           
|------- | ------- |  | ----------- | --------------------------------------------------------------------------------------------------------------------------
|Exhibit |         |  |            
|Number  |         |  | Description
|        |         |  |            
|        | 3.1(1)  |  |             | Fifth Amended and Restated Certificate of Incorporation of
    webMethods, Inc., as amended                               
|        | 3.2(2)  |  |             | Second 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(5) |  |             | webMethods, Inc. Amended and Restated Stock Option Plan, as
    Amended                                                   
|        | 10.2(3) |  |             | Employee Stock Purchase Plan                                                                                              
|        | 10.3(3) |  |             | Indemnification Agreement entered into between webMethods, Inc.
    and each of its directors and executive officers      
|        | 10.4(6) |  |             | Executive Agreement entered into between webMethods, Inc. and
    certain of its executive officers                       
|        | 10.5(7) |  |             | Form of Stock Option Agreement for stock option grants to
    employees or officers other than California residents       
|        | 10.6(8) |  |             | Form of Stock Option Agreement for stock option grants to
    directors                                                   
|        | 10.7(7) |  |             | Form of notice of grant of stock option                                                                                   
|        | 10.8(9) |  |             | Deferred Compensation Plan for Directors, as amended                                                                      
|        | 10.9*   |  |             | Description of salary and bonus arrangements for certain
    executive officers                                           
|        | 21.1*   |  |             | Subsidiaries of webMethods, Inc.                                                                                          
|        | 23.1*   |  |             | Consent of PricewaterhouseCoopers LLP                                                                                     
|        | 24      |  |             | Power of Attorney (included on signature page hereof)                                                                     
|        | 31.1*   |  |             | Rule 13a-14(a) Certification of Chief Executive Officer                                                                   
|        | 31.2*   |  |             | Rule 13a-14(a) Certification of Chief 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
    Form 10-K for the
    year ended March 31, 2001 (File
    No. 1-15681).            
|   
|(2) | Incorporated by reference to webMethods
    Form 10-Q for the
    three months ended December 31, 2004 (File
    No. 1-15681). 
|   
|(3) | Incorporated by reference to webMethods Registration
    Statement on
    Form S-1, as
    amended (File
    No. 333-91309).   
|   
|(4) | Incorporated by reference to webMethods Registration
    Statement on
    Form 8-A (File
    No. 000-33329).                   
|   
|(5) | Incorporated by reference to webMethods
    Form 10-K for the
    year ended March 31, 2002 (File
    No. 1-15681).            
|   
|(6) | Incorporated by reference to webMethods
    Form 10-Q for the
    three months ended June 30, 2004 (File
    No. 1-15681).     
|   
|(7) | Incorporated by reference to webMethods
    Form 8-K dated
    October 2, 2004 (File
    No. 1-15681).                         
|   
|(8) | Incorporated by reference to webMethods
    Form 10-Q for the
    three months ended September 30, 2004 (File
    No. 1-15681).



---



##### 





|    |                                                                                                                                 
|--- | --------------------------------------------------------------------------------------------------------------------------------
|(9) | Incorporated by reference to webMethods
    Form 10-Q for the
    three months ended September 30, 2005 (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.