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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




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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, 2000
|     
|[   ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE 
	 SECURITIES EXCHANGE ACT OF 1934                                      

Commission File Number



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webMethods, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                             |  |                                                
|---------------------------------------------------------------------------- |  | -----------------------------------------------
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Delaware(State or other jurisdiction of
	incorporation or organization)      |  | 54-1807654(I.R.S. Employer
	Identification No.)
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|3930 Pender Drive, Fairfax, Virginia(Address of principal executive offices) |  | 22030(Zip Code)                                

Registrants telephone number, including area
code:  (703) 460-2500

Securities registered pursuant to Section 12(b) of the Act:



Securities registered pursuant to Section 12(g) of the Act:





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

Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of Regulation S-K is not contained
 herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. 
[   ]

The aggregate market value of Common Stock held by non-affiliates
 of the registrant as of May 31, 2000 based upon the closing
 price of the Common Stock on the Nasdaq National Market for such
 date, was $1,141,909,577.

DOCUMENTS INCORPORATED BY REFERENCE

The registrant intends to file a definitive joint proxy
statement/prospectus for its annual meeting of stockholders
pursuant to Regulation 14A within 120 days of the end of the
fiscal year ended March 31, 2000. Portions of such joint
proxy statement/prospectus are incorporated by reference into
Part III of this Form 10-K.









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TABLE OF CONTENTS



|                                    |                                                                                                |  |  |  |  |  |  | 
|----------------------------------- | ---------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                             
|                                    | Item.1.   Business                                                                            
|                                    | Item2.   Properties                                                                           
|                                    | Item3.   Legal Proceedings                                                                    
|                                    | Item4.   Submission of Matters to a Vote of Security Holders                                  
|PART II                            
|                                    | Item5.   Market for Registrants Common Stock and Related Stockholder Matters                 
|                                    | Item6.   Selected Financial Data                                                              
|                                    | Item7.   Managements Discussion and Analysis of Financial Condition and Results of Operations
|                                    | Item8.   Financial Statements and Supplementary Data                                          
|                                    | Item9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
|PART III                           
|                                    | Item10.   Directors and Executive Officers of the Registrant                                  
|                                    | Item11.   Executive Compensation                                                              
|                                    | Item12.   Security Ownership of Certain Beneficial Owners and Management                      
|                                    | Item13.   Certain Relationships and Related Transactions                                      
|PART IV                            
|                                    | Item14.   Exhibits, Financial Statement Schedules and Reports on Form 8-K                     
|                                    | SIGNATURES                                                                                    
|Consent of Independent Acccountants
|Financial Data Schedule            



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PART I

This report contains forward-looking statements. For this
purpose, any statements contained herein that are not statements
of historical fact may be deemed to be forward-looking
statements. Without limiting the foregoing, the words
believes, anticipates,
plans,, expects, intends and
similar expressions are intended to identify forward-looking
statements. The important factors discussed below under the
caption Factors that May Affect Future Operating
Results, among others, could cause actual results to differ
 materially from those indicated by forward-looking statements
made herein and presented elsewhere by management from time to
time. We do not undertake any obligation to publicly update or
revise any forward-looking statements, whether as a result of new
 information, future events or otherwise.




Item 1.  BUSINESS

The following description of our business contains
forward-looking statements that involve risks and uncertainties.
Our actual results may differ significantly from the results
discussed in the forward-looking statements. Some of the factors
that may cause such results to differ include, but are not
limited to, those discussed in Factors that May Affect
Future Operating Results contained in Item 1 and
Managements Discussion and Analysis of Financial
Condition and Results of Operations contained in
Item 7.

Overview

We are a leading provider of infrastructure software and services
 for achieving business-to-business integration, or B2Bi. B2Bi
software is a new category of software that enables companies to
work more closely with their customers, suppliers and other
business partners through the real-time exchange of information
and transactions. We achieve this integration by connecting our
customers existing enterprise applications over the
Internet. Our customers can use our software, webMethods B2B, to
achieve varying levels of integration, from integration with a
single business partner up to full integration across an entire
trading network. With webMethods B2B, a companys portfolio
of existing enterprise applications can be extended to its
customers, suppliers and other business partners. Our software is
 also incorporated into the operation of a number of major
business-to-business marketplaces.

webMethods B2B permits our customers to rapidly and cost
effectively deploy new real-time business-to-business e-commerce
applications by integrating the customers existing
enterprise systems with those of their business partners. For
example, webMethods B2B can improve supply chain management by
integrating the procurement, order processing, inventory
management, shipping and fulfillment systems and enterprise
resource planning systems of companies doing business together.
As a result of this integration, inventory can be automatically
replenished, orders can be processed faster and more accurately,
components can be shipped sooner and customer queries can be
addressed more rapidly. By using webMethods B2B software, we
believe that our customers can:



| |   |                                                                                                                                                                                              
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Create new revenue opportunities due to improved customer
	retention, improved customer service and the ability to deliver
	additional value-added services and customized product offerings;
|
| |  | Strengthen relationships with their customers, suppliers and
	business partners due to new direct, secure connections across
	multiple computing platforms, applications and protocols;      
|
| |  | Improve supply chain efficiencies through shortened cycle times,
	lower inventories and reduced error rates; and                                                                             
|
| |  | Increase return on investment from existing enterprise software
	systems.                                                                                                                    

We market our software globally through a direct sales force and
a number of resellers and systems integrators. A key element of
our sales and marketing strategy is to leverage relationships
with our customers and business partners. We believe that by
providing solutions to leading buyers, suppliers, portals and
enterprise software and hardware companies pursuing B2B
e-commerce opportunities, our software sales will increase
substantially as our technologies become more widely deployed in
the

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webMethods B2B has been licensed to customers in a variety of
industries including high-technology manufacturing,
telecommunications, financial services, shipping and logistics,
chemicals and insurance. As of March 31, 2000, we had over
160 customers, including SAP AG, Eastman Chemical,
W.W. Grainger, Dell Computer, Hewlett Packard, Compaq
Computer, Federal Express, Dun & Bradstreet, Lucent and
Lexmark. In addition, we have established strategic relationships
 with leading business-to-business e-commerce marketplaces such
as mySAP.com, the Ariba Network, Commerce One, Grainger.com,
VerticalNet, ChemConnect, Staples.com, Buzzsaw, TPN Marketplace,
e-Steel, retail.com and Ventro, many of which have purchased our
software to operate their trading networks. We also have
strategic relationships with enterprise application vendors that
incorporate our technology into their software or resell our
software. We are an SAP AG development partner and have licensed
a version of our software to them for inclusion into their
products.

Industry Background

Growth of the Internet and business-to-business electronic
commerce

The competitive environment for businesses has intensified
dramatically in recent years, causing companies to seek new ways
to generate sustainable competitive advantages. Over the last
decade, companies have invested heavily in enterprise
applications to automate and improve the efficiency of their
internal business processes. As competition has increased and
markets have become more dynamic, companies have begun to
recognize that they must coordinate more closely with their
customers, suppliers and business partners. Traditional
enterprise applications, however, do not readily support business
 processes beyond the borders of an enterprise. As a result,
companies relying only on their enterprise applications have not
been able to easily integrate their business processes with those
 of their customers, suppliers and other business partners to
achieve productivity gains.

In the midst of this environment, the Internet has emerged as a
crucial medium for electronic commerce. The widespread adoption
of the Internet as a business communications platform has created
 a foundation for B2B e-commerce that has already enabled
organizations to tap new revenue streams, streamline cumbersome
processes, lower costs and improve productivity. We believe the
next wave of business innovation will focus on greater
collaboration among businesses and the sharing of business
processes among members of a business community. Businesses are
seeking a B2Bi solution that allows them to utilize their
existing portfolio of enterprise applications to exchange
information and transact business with customers, suppliers and
other business partners over the Internet.

Based on the growth of the Internet and the expectations for
growth in e-commerce, we believe the market opportunity for
B2Bi software and services is substantial. Research has been
 conducted to project the size of the B2Bi market. This research
is based on interviews and surveys of industry associations and
companies and measures only revenue to be received from Internet
commerce sites. According to Forrester Research, revenue
generated from business-to-business e-commerce will exceed
$2.7 trillion by 2003, representing a far larger market
opportunity than business-to-consumer e-commerce. Forrester
Research also estimates that B2B e-commerce will account for more
 than 90% of U.S. e-commerce transactions by 2004. In an
attempt to capitalize on this opportunity, businesses are
spending heavily to develop the infrastructure to communicate and
 transact business effectively over the Internet. International
Data Corporation, or IDC, projects that the worldwide Internet
commerce application market will grow from $444 million in
1998 to over $13 billion in 2003.

Current approaches to business-to-business integration are
inadequate

The variety of computing environments and the inability to share
information across those environments have been a major
impediment to B2Bi. For example, the co-existence of
mainframe-based legacy systems and enterprise applications within
 a single business often makes it difficult to share information
internally. More importantly, many organizations
applications, particularly their enterprise

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Current B2Bi approaches are costly, problematic and ineffective.
For example, traditional electronic data interchange, or EDI, is
inflexible because it is based on pre-defined, fixed data formats
 that are not easily adjusted. EDI usually requires the use of
expensive and proprietary communications networks and software
and often requires difficult and time-consuming point-to-point
integration. In addition, EDI is not readily scalable for large
numbers of business partners, and because it is batch processed,
it lacks real-time data exchange capability. It has taken years
and millions of dollars to implement EDI trading networks among
large communities of business partners.

Enterprise application integration, or EAI, software and other
middleware technologies also fail to fully deliver B2Bi. These
packages integrate systems within a single company, but typically
 cannot provide the open and scalable inter-company integration
that is critical for B2Bi. EAI relies on proprietary, custom
architectures and software, which must be implemented by all
parties to enable any inter-company usage. It is difficult to
convince multiple parties in a trading network to implement the
same products or technologies. In addition, EAI solutions
experience operating difficulties because many corporate security
 firewalls do not readily recognize the communications protocols
these solutions employ.

First generation e-business Web sites based on Hypertext Markup
Language, or HTML, also do not address the requirements of B2Bi.
HTML is designed chiefly for the presentation of data, and does
not directly support data exchange between the enterprise
applications of participating companies. Since these Web sites
were designed primarily for human-to-system communication, they
are difficult to incorporate into shared multi-company business
processes that require system-to-system communication. Achieving
this integration usually requires significant re-keying of data
from at least one, if not both, parties to a transaction,
increasing costs and rates of error. For example, many large
companies that procure goods from their suppliers Web sites
 must first enter orders into an internal enterprise application
and then completely re-key them into vendors Web sites
through their Web browsers.

While recently developed Internet procurement and order
management applications often reduce the overall cost of
procurement, they do not provide comprehensive B2Bi. These
applications generally focus on ordering goods, such as office
supplies, that do not become part of a finished product, rather
than the procurement of goods that become part of a
companys own products. The automation of procurement over
the Internet of goods used to manufacture a product requires
inter-company, system-to-system integration of ERP and
manufacturing applications.

A comprehensive B2Bi solution must provide companies with
integrated direct links to their major customers and suppliers,
while also facilitating participation in B2B marketplaces to
leverage their networks of buyers and suppliers. It should also
allow companies to offer their business partners the ability to
exchange information and conduct transactions across the Internet
 securely, reliably and in real time, regardless of installed
technology infrastructure. To meet the challenges raised by the
changing competitive environment, organizations are searching for
 a solution that provides comprehensive B2Bi. The existing
approaches have proven inadequate due to their high cost,
inflexibility and inability to easily adapt to large numbers of
business partners. In addition, existing approaches have
typically encountered difficulties working across many corporate
security infrastructures.

The webMethods solution

Our solution provides the foundation for a new class of B2Bi
applications that can be delivered with shorter, more
cost-effective implementation cycles and the ability to scale to
large numbers of business partners. webMethods B2B provides
companies with integrated direct links to buyers and suppliers,
connects them to major B2B marketplaces and enables
real-time, interactive communication through the Internet
regardless of existing technology infrastructure. The webMethods
B2B software provides support for a broad range of current
and emerging B2B communication standards, including eXtensible
Markup Language, or XML, traditional EDI, Open Buying on the
Internet, or OBI, and XML-based e-commerce frameworks, such as
RosettaNet, cXML, Commerce Ones xCBL and Microsoft BizTalk.
 With

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New Revenue Opportunities.Our solution enables companies
to increase market share by allowing them to bring products to
market more quickly, and to provide value-added services to their
 customers. For example, a manufacturer can use our software to
make it easier for customers to purchase products by linking its
customers internal procurement application directly to the
manufacturers ordering system. Value-added services may
also include the provision of data concerning purchased goods for
 direct incorporation into a customers asset management
system. In the financial services industry, the ability of
webMethods B2B to manage and exchange many XML document formats
can be used to create and configure new financial products and
services. This capability allows companies to rapidly offer new
and more targeted products and services to customers.

Strengthened Relationships with Customers, Suppliers and
Trading Partners. The webMethods B2B solution gives companies
 the ability to interact directly and securely with a variety of
customers, suppliers and other business partners, resulting in
improved coordination and decreasing the time it takes to respond
 to increasingly rapid changes in their markets. For example, to
further improve their relationships with their customers,
companies may directly link their customer relationship
management, or CRM, systems through the webMethods B2B solution.
This CRM system integration allows customers to use their own
uniform problem reporting systems to enter and track product or
service problem reports, which are communicated to their vendors
and facilitates the coordination required to resolve open issues.
 Furthermore, because the webMethods B2B solution requires
limited customization and does not require all the parties in a
trading network to install identical software, trading partners
are able to rapidly develop trading networks in a cost effective
manner.

Improved Supply Chain Efficiencies.Achieving a close
degree of collaboration with suppliers allows many companies to
realize cost efficiencies by outsourcing a significant share of
their manufacturing. With or without an outsourcing strategy,
companies can use our software to achieve significant cost
savings and productivity enhancements by reducing cycle times,
lowering inventories and reducing error rates through the
real-time exchange of information. Closer integration with their
suppliers and buyers helps our customers improve their planning
and forecasting capabilities. Additionally, our customers can use
 webMethods B2B to gain the competitive advantage of providing
their customers with real-time pricing and availability
information for key products and services. For example,
webMethods B2B can enable a company to automatically check the
availability of a requested item in its suppliers inventory
 and relate pricing, availability and shipping information
directly to its customer. An order for the requested item could
then be automatically entered directly into the suppliers
order processing system. For suppliers, direct receipt of orders
in this way means the order can reach the suppliers
manufacturing operation in minutes, compared to the hours or days
 taken when the order is received by fax or EDI.

Increased Return on Technology Investments and Rapid
Implementation.Over the years, companies have invested
significant amounts in ERP and other enterprise applications. Our
 solution maximizes the returns on these investments by extending
 the benefits provided by those applications to a companys
customers, suppliers and other business partners. We believe our
solution entails lower deployment costs than competing products,
in part because limited customization is required. Implementation
 time for our software averages about six weeks, which allows our
 customers to begin deriving benefits quickly. Our solution is
also easily scalable to accommodate the growth of a
customers trading network. As our customers trading
networks and the number of transactions grow, they can continue
to use our software for their e-business requirements without
having to acquire new software products.

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The webMethods growth strategy

Our objective is to enhance our position as a leading global
provider of B2Bi infrastructure software and services that enable
 companies to easily and effectively link their existing business
 applications and share data in real-time over the Internet. To
achieve this goal, we are pursuing the following strategies:

Leverage Customers and Partners as Distribution Channels.
We believe that because we provide solutions to some of the
leading e-commerce buyers, suppliers, portals and enterprise
software and hardware companies, our product sales benefit from a
 multiplier effect as our customers expose more of their business
 partners to our solution. As of March 31, 2000, we had over
 160 customers including SAP AG, Eastman Chemical,
W.W. Grainger, Dell Computer, Hewlett Packard, Compaq
Computer, Federal Express, Dun & Bradstreet, Lucent and
Lexmark. In addition, we have established strategic relationships
 with leading business-to-business e-commerce marketplaces such
as mySAP.com, the Ariba Network, Commerce One, Grainger.com,
VerticalNet, ChemConnect, Staples.com, Buzzsaw,
TPN Marketplace, e-Steel, retail.com and Ventro, many of
which have purchased our software to operate their trading
networks. We also have relationships with leading enterprise
application software providers including SAP AG and Baan. We
believe that we can leverage our base of customers and business
relationships into additional direct sales. For example, our
relationship with SAP AG gives us access to
SAP AGs customer base of over 12,000 leading companies
 worldwide. SAP AG is offering its customers the SAP Business
Connector, an OEM version of webMethods B2B that can only be used
 to integrate SAP applications. This provides us with
significant opportunities to sell to these customers the full
webMethods B2B product, which supports integration of
non-SAP applications.

Extend Technology and Product Leadership.webMethods
believes that it has developed the broadest and most
comprehensive B2Bi software currently available, supporting
more B2B protocols and data format standards than any
competing product. webMethods has been a pioneer in the
application of XML and Java technologies for B2B integration
 and e-commerce. webMethods intends to continue investing in
research and development and to remain actively involved with
industry standards bodies to ensure that its products incorporate
 developing technology and industry standards. webMethods also
intends to increase the performance, functionality and ease of
use of its software by integrating new technologies and
supporting a wider range of enterprise applications. In the
future, webMethods may acquire technology or businesses that
enhance or complement its technology.

Leverage Professional Services Capabilities.We have
established strong relationships with our customers by designing
and developing successful B2Bi solutions for them. In order to
continue this, we plan to expand our direct professional services
 capabilities by increasing the number of professional services
consultants and adding additional service locations throughout
the United States and Europe. In addition, we intend to offer
quality professional services through third-party alliances. We
are currently developing additional relationships with major
system integrators and KPMG, Deloitte Consulting and EDS have all
 created business practices around our solutions. We believe that
 developing these relationships will provide us with the ability
to manage multiple concurrent, large-scale projects while
maintaining its commitment to quality service. We intend to
commit significant resources, both financial and personnel, to
providing professional services support to selected customers
that are creating major B2B marketplaces and trading networks. We
 believe that devoting significant resources to these key
relationships will lead to increased opportunities to license
additional software to these customers and their business
partners. Creating a strong base of successful and high profile
customers is essential to the continued growth of our business.

Expand Global Sales Efforts.We are aggressively pursuing
a global, multi-channel distribution strategy that leverages both
 our direct sales force and our relationships with resellers,
systems integrators and international distributors. We currently
have eleven offices around the world including eight offices in
North America and sales and support offices in the U.K., Germany,
 and the Netherlands. We plan to expand our international
presence by establishing additional overseas offices in Europe
and expanding its indirect sales channels in Europe and Asia. In
addition, we plan to increase our customer and partner base
through aggressive sales and marketing campaigns and by
conducting joint marketing efforts with some of

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Further Develop Model for Predictable, Recurring Revenue.
We believe our revenue model is designed to provide substantial
and predictable recurring revenue. We have developed a multi-
faceted revenue model that provides revenue from a number of
sources, including new license sales, license renewals,
maintenance fees, professional services and OEM licenses. We
expect that our market leadership position and our network of
strategic relationships will drive new license sales. Although
most software providers offer perpetual licenses with a single
payment received at the time of the license grant, we typically
offer two-year renewable software licenses. At the end of two
years, customers can either renew for another two-year period,
with a new license fee due, or terminate their license. We
believe that, because of the critical nature of the services
performed by webMethods B2B, renewal rates will be high, which
should provide a source of predictable revenue over time. In
addition, as part of its comprehensive solution, we provide
professional services to insure the successful implementation and
 deployment of our software. We have also entered into long-term
OEM and other licenses that provide an additional source of
revenue.

Products and services

We began commercial shipments of our webMethods B2B software in
June 1998. Since then, we have continued to enhance the
functionality and performance of webMethods B2B. The most recent
version, webMethods B2B 3.1, was first shipped in
April 2000. We also recently introduced webMethods B2B for
RosettaNet, which allows our high technology manufacturing
customers to use RosettaNet for supply chain integration.

webMethods B2B contains features that help integrate business
partners, marketplaces, buyers and suppliers into online trading
networks. Our software helps companies directly integrate with
their business partners while also participating in B2B
marketplaces and portals. The software supports a broad range of
current and emerging standards for B2B communications, including
XML, traditional EDI, OBI and XML-based e-commerce frameworks
such as Commerce XML, xCBL and FpML. In addition, webMethods B2B
provides support for and interoperability with EDI applications,
such as Sterling Commerces GENTRAN. Our product offerings
are summarized below:

|               |  |                                                                                                                                                                                                                                             |  |                                                                                                                        
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------
|Offering       |  | Description                                                                                                                                                                                                                                 |  | Shipment Date                                                                                                          
|               |  |                                                                                                                                                                                                                                             |  |                                                                                                                        
|webMethods B2B |  | Enables enterprises to leverage existing applications to achieve
	B2B integration by facilitating secure, real-time exchange of
	data over the Internet.
	Provides support for a broad range of B2B standards, protocols
	and data formats. |  | Version 1.0  6/98
	Version 2.0  10/98
	Version 2.1  3/99
	Version 2.5  7/99
	Version 3.0  9/99
	Version 3.1  4/00

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|                                         |  |                                                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                           
|---------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Offering                                 |  | Description                                                                                                                                                                                                                                  |  | Shipment Date                                                                                                                                                                                                                                             
|                                         |  |                                                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                           
|Integration Modules for ERP Applications |  | Permits companies to integrate with key business partners using
	popular ERP or middleware systems by providing a secure, reliable
	 method for exchanging data through application interfaces in XML
	 and other formats over the Internet. |  | SAP R/3  10/98
	Baan  9/99
	Sterling Commerce
	GENTRAN  9/99
	Oracle  4/00
	PeopleSoft  4/00
	J. D. Edwards  under
	development
	IBM MQ Series  3/00
	Active Software
	ActiveWorks  4/00
	MSMQ  under development
	Siebel 99  under
	development
|webMethods B2B for Partners              |  | Restricted version of webMethods B2B designed to link one
	individual enterprise to a single portal or to another enterprise
	 running webMethods B2B.                                                                                       |  | 9/99                                                                                                                                                                                                                                                      
|webMethods B2B for RosettaNet            |  | Provides support for the RosettaNet framework and all released
	RosettaNet partner interchange processes                                                                                                                                     |  | 4/00                                                                                                                                                                                                                                                      

Product Architecture and Technology

webMethods B2B has been designed to allow our customers to
achieve B2Bi with business partners in less time, at lower cost
and with fewer alterations to their existing applications than
current alternatives.

Product Components

The webMethods B2B Integration Server, the webMethods B2B
Developer and the set of webMethods B2B Integration Modules
comprise the principal components of webMethods B2B. These
components work together to create and execute intercompany
applications and data exchanges that link enterprise and legacy
applications, databases, EDI software and Web sites between
companies participating in online trading networks.

The webMethods B2B Integration Server automates the
exchange of data across the Internet by securely and reliably
transporting, mapping and transforming business documents and
data messages of different types among a diverse array of
applications and databases. An integration server is a software
product that processes requests for sending and receiving data
across the Internet. The requests are submitted by existing
enterprise applications. Using an integration server,
applications may directly access Web data across the Internet in
real-time without the need for costly application redevelopment.
The webMethods B2B Integration Server can be used to integrate
with applications developed in a variety of languages and
technologies. Because the webMethods B2B Integration Server
provides open application interfaces and supports a wide array of
 current and emerging B2B data standards, our software can
successfully integrate otherwise incompatible enterprise
applications, EDI and EAI deployments and XML and HTML-based Web
sites.

Unlike proprietary EAI applications, the webMethods B2B
Integration Server can perform all communications using standard
Hypertext Transport Protocol, or HTTP, as the data transport
protocol. For this reason, communications sent through the
webMethods B2B Integration Server are not rejected by

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The webMethods B2B Developer is a development, testing and
 management environment used by application developers and system
 integrators to define data flow definitions and transformations
between inbound and outbound business documents and messages, and
 the enterprise applications or Web sites that will create and
receive them. These data flow definitions and transformations are
 displayed and manipulated using familiar visually oriented tools
 and metaphors. The webMethods B2B Developer is also able to
define conversions between XML documents of different types. For
instance, it can be used to define a conversion from a purchase
order in Commerce XML format into the equivalent Open
Applications Group data format. The webMethods B2B Developer
provides the capability to upload the data flow definitions and
transformations to the webMethods B2B Integration Server, which
executes them on actual business documents and messages.

webMethods B2B Integration Modules provide functionality
specific to a particular enterprise application, such as Baan or
SAP R/3, that permits its application programming interfaces
 to be accessed securely and reliably by business partners across
 the Internet. This differentiates them from the adaptor modules
employed by proprietary EAI products for purely internal
integration. We also provide documentation and software tools
that allow our customers to build their own custom integration
modules.

WebMethods B2B for RosettaNet provides support for
RosettaNet framework and all released RosettaNet partner
interchange processes. In addition to providing complete support
for this leading supply chain integration standard, webMethods
B2B for RosettaNet processes transactional data and offers
scalable trading partner profiles and business rule management.

XML

Our software suite makes extensive use of eXtensible Markup
Language, or XML, a relatively recent standard that defines a
universal method for structuring data. We believe that XML will
be a key enabler of both B2B e-commerce and the open integration
of applications across enterprises in general. XML was formally
recommended by the World Wide Web Consortium as a standard in
February 1998. Since then, a number of industry leaders,
including Microsoft, SAP AG, IBM, Sun and Oracle, have announced
support for XML.

Unlike HTML, the standard currently used in most Web
applications, XML permits data to be coded for content rather
than solely for presentation. This coding difference allows
applications to examine and manipulate data contained in a
document. Descriptive tags are attached to each piece of data so
applications can understand the meaning of the data and process
it accordingly. This feature eliminates the need for re-keying
data transmitted across the Internet.

XML is a standard, not a technology, and therefore, existing
applications must be adapted to learn to communicate using XML
and integration servers are required to process, route and
translate data. Furthermore, to properly utilize XML, a method
must be found to translate between the various XML document types
 that proliferate among organizations. A solution must offer
services to ensure acceptable performance and maintain security.
webMethods B2B Integration Server and webMethods B2B Developer
provide the infrastructure required to manage the integration
process, securely and reliably route requests and translate
messages that conform to different document types.

Cross-platform support and compatibility

webMethods B2B has been developed exclusively in the Java
programming language, which means webMethods B2B can be readily
deployed on almost all commonly available computing hardware and
operating systems. This makes it easy to deploy the webMethods
B2B solution across a large trading network running different
hardware and operating systems. We currently support major server
 platforms, such as Microsoft Windows NT and Windows 2000, Sun
Microsystems Solaris, Linux, Hewlett Packard

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Scalability, performance and reliability

webMethods B2B has been designed to handle thousands of
simultaneous business partner connections and service a high
volume of transactions among partners. Using a clustered
multi-server, multi-threaded architecture, the softwares
performance is optimized for multi-processor systems, and
supports high-volume server-side processing of business
documents. Business partners that are both running webMethods B2B
 can take advantage of guaranteed delivery features that ensure
that critical messages or business documents get delivered from
one partner to another.

Reusable B2B services architecture

webMethods B2B is built around a reusable architecture for B2B
services, which models business processes and operations such as
purchase order submission and order tracking. The webMethods B2B
Developer includes graphical development tools permitting B2B
services to be reused and combined across multiple trading
partner relationships.

Support for large numbers of trading partners

webMethods B2B includes features that allow companies to readily
manage deployments across a large number of trading partners. For
 instance, a package replication feature allows an administrator
to bundle a set of B2B service definitions, code and data
transformations that provide a certain B2B capability, such as
order receipt, into a package that can be automatically
replicated across an entire network of business partners.

Security

webMethods B2B contains a comprehensive set of security features
that enable enterprises to utilize the Internet to transmit
proprietary information with confidence. These features can
provide security even if the webMethods B2B Integration Server is
 used by only one party to a transaction. The software includes
X.509 digital certificates, RSA public key encryption and SSL
encryption, which are ways to encode information transmitted over
 the Internet to make it unintelligible to all but intended
recipients, and access control lists to ensure authentication,
authorization and data privacy. In addition, because all
communications sent through the webMethods B2B Integration Server
 can be sent using HTTP, which passes through corporate
firewalls, the business partners of our customers are not
required to modify their applications security features.

Ladder of integration

We offer our customers and their business partners the option to
choose the level of integration they desire. Our Ladder of
Integration allows flexibility by providing integration
solutions that do not depend on business partners having the same
 technologies or levels of integration. Business partners may
advance to higher levels of integration as their needs change.
New partners can be added to existing networks with minimal
effort because existing applications do not require extensive
changes as partners applications and data formats develop
over time.

Business partners may choose from the following integration
levels:



| |   |                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The minimal level of integration connects a customers
	webMethods B2B Integration Server to its business partners
	HTML or XML-based Web site. This option requires no adjustments
	to the business partners system.                                                  
|
| |  | A more advanced level of integration connects a customers
	webMethods B2B Integration Server to its business partners
	XML or other B2B integration server using common Internet B2B
	protocols or message formats such xCBL, EDI and RosettaNet.
	Although this option

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | requires that the customer and its business partners agree upon
	the protocol or message format to be used for business documents,
	 no changes to the business partners system are necessary.                                                                                                                                                                                                                                                  
|
| |  | Full integration involves both a customer and its business
	partner using webMethods B2B. The customer and its business
	partners may fully integrate ERP systems and/ or legacy
	applications for real-time interactive data exchange. Because
	webMethods B2B is managing communications on both sides of a
	transaction, customers can take advantage of value-added services
	 such as guaranteed delivery of business documents or messages.

Professional services and customer care

As part of a complete solution, we offer comprehensive
professional services that complement our software, including
strategic planning, project management and systems integration,
as well as consulting services and training relating to our
software products. As of March 31, 2000, our professional
services and customer care group consisted of 63 employees.

Professional Services. A majority of our customers make
use of our professional services to help them design and develop
a successful business solution. Experienced consultants work with
 customers to design a solution based on the customers
existing applications and required functionality and then ensure
that the selected solution is successfully implemented, from
installation to ongoing maintenance. Our consultants have
participated in or led a number of important B2B integration
projects for our customers and partners, including the
development of my SAP.com marketplace for SAP AG, development of
the Ariba Network and the Commerce XML specification for Ariba,
and the Grainger.com portal for W.W. Grainger.

To supplement our internal professional services capabilities, we
 have established strategic relationships with several consulting
 firms, including KPMG, Deloitte Consulting, EDS, Sera Nova,
Collaborex and Lante. These system integrators provide webMethods
 with a substantial body of expertise relating to enterprise
applications and the creation of B2B e-commerce networks, as well
 as the flexibility to handle both large and small projects and
deliver complete solutions. These systems integrators also give
us feedback on our software and its implementation that we can
incorporate into product enhancements. We believe these
relationships benefit our business by exposing our software to
the substantial customer base of each of these systems
integrators.

Services are provided by either our professional services group
or third-party systems integrators and include the following:



| |   |                                                                  
| | - | -----------------------------------------------------------------
| |  | architecture and application design services;                    
|
| |  | application development;                                         
|
| |  | installation services;                                           
|
| |  | testing and implementation services and maintenance services; and
|
| |  | on-site support and coaching.                                    

We charge for these services on a time and materials basis and
provide them through our professional services groups based in
our Fairfax, Virginia; New York, New York; Chicago, Illinois; San
 Francisco, California; Hilversum, Netherlands; and Reading,
United Kingdom facilities. We plan to increase the number of our
professional services consultants and add additional service
locations throughout the United States and Europe.

Customer Care. We believe that offering a superior level
of customer service is essential for our long-term success.
Because customer service is a standard feature of our licenses,
almost all of our customers utilize our customer support. We
offer our customers a choice of several levels of customer
support, all of which provide dependable and timely resolution of
 customer technical inquiries. The most comprehensive option
offers support 24 hours, seven days a week. We are committed
 to resolving customer

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We also provide our customers with education and training. We
regularly offer training courses for the software professionals
responsible for implementing our software. These training courses
 provide practical instruction on topics such as the potential
uses of our software, creation of XML schemas for different types
 of business documents, integration of data from multiple
internal and external sources, automation of data-sharing by
business partners using the Web, bundling and redeployment of
usable business logic and administration and maintenance of
webMethods B2B. We also provide customized classes at customer
locations and offer a certification program for customers and
systems integration partners that requires completion of
designated courses, field experience and a certification
examination.

Customers

As of March 31, 2000, we had licensed our software to over
160 customers. In the fiscal year ended March 31, 2000, one
customer, SAP AG, accounted for approximately 22% of
webMethods total revenues. In the fiscal year ended March
31, 1999, two customers, Telstra and Object Design accounted for
approximately 13% and 10%, respectively, of total revenues. Many
of our customers are Global 2000 companies and the companies
 that serve them and represent a broad spectrum of enterprises
within diverse industry sectors, including high-technology
manufacturing, telecommunications, financial services, shipping
and logistics, chemicals, insurance, and business-to-business
marketplaces. The following is a partial list of customers that
have licensed our software and that we believe are representative
 of our overall customer base:

Chemical Industry















Federal





Financial Services















Insurance







Shipping and Logistics











Utilities





eProcurement and B2B Marketplaces











































Enterprise Application Vendors











Retail







High-Technology Manufacturing

































Telecom











Industrial/ Distribution











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Strategic relationships

To increase our leadership in the market, we have formed
strategic alliances with B2B e-commerce portals and marketplaces,
 enterprise application vendors, B2B e-commerce technology
leaders and system integrators. These relationships enable us to
capitalize on the growing market for e-commerce solutions by
embedding and integrating our software into the products and
services provided by its strategic partners. In addition, many of
 these relationships expose our software to the customer base of
these companies. Our strategic relationships include the
following:

|                                             |  |                               |  |                            
|-------------------------------------------- |  | ----------------------------- |  | ---------------------------
|Parties                                      |  | Relationship                  |  | Examples                   
|                                             |  |                               |  |                            
|Portals and Marketplaces                     |  | webMethods B2B serves as the  |  | mySAP.com, MRO.com, Clarus 
|                                             |  | infrastructure and            |  | Supplier Universe          
|                                             |  | transaction engine that links |  |                            
|                                             |  | existing applications of      |  |                            
|                                             |  | buyers and sellers to B2B     |  |                            
|                                             |  | portals and marketplaces.     |  |                            
|                                            
|                                            
|                                            
|                                            
|Enterprise Application Vendors and Resellers |  | Resell webMethods B2B as part |  | Sterling Commerce, SAP AG, 
|                                             |  | of their offerings or include |  | PSDI, SpaceWorks           
|                                             |  | webMethods B2B in their own   |  |                            
|                                             |  | products.                     |  |                            
|                                            
|                                            
|                                            
|                                            
|B2B Technology Relationships                 |  | Collaborate on new            |  | Microsoft, Ariba           
|                                             |  | technologies and standards    |  |                            
|                                             |  | that build on our B2B and XML |  |                            
|                                             |  | expertise.                    |  |                            
|                                            
|                                            
|                                            
|                                            
|System Integrators                           |  | Provide consulting and        |  | KPMG, Deloitte Consulting, 
|                                             |  | technical services support    |  | EDS, Sera Nova, Collaborex,
|                                             |  | for our products, including   |  | Lante                      
|                                             |  | implementation and            |  |                            
|                                             |  | maintenance.                  |  |                            

Relationship with SAP AG

In March 1999, we entered into a development partner
agreement with SAP AG. In the fiscal year ended
March 31, 2000, SAP AG accounted for approximately 22%
of our total revenues.

Our relationship with SAP AG provides us with an important
endorsement of our software, will expose the capabilities of a
restricted version of webMethods B2B software to the SAP AG
customer base and gives us the opportunity to license the
unrestricted version of webMethods B2B software to the
SAP AG customer base.

SAP AG provides our software to their customers as the SAP
Business Connector. In addition, webMethods B2B provides the
transaction integration infrastructure that links mySAP.com, an
open electronic hub that creates intercompany relationships for
buying and selling and collaborating within and across
industries. SAP AG customers already utilizing SAP R/3
connect to this marketplace using the SAP Business Connector. We
provide non-SAP customers the ability to connect to mySAP.com via
 webMethods B2B.

Under the development partner agreement, we granted SAP AG a
 perpetual license to include webMethods B2B in their software.
The license limits SAP AG to using our software to connect
SAP installations solely to other SAP installations. The license
prevents us from selling webMethods B2B to any user seeking to
connect SAP installations solely to SAP installations. However,
we are able to sell our fully featured version of webMethods B2B
to SAP AGs customers, which would enable them to
integrate their SAP systems to enterprise applications of other
vendors. Under the development partner agreement,

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Upon expiration of the initial term of the agreement in
March 2002, and subject to payment of all amounts due to us
under the development partner agreement, SAP AG will have
the right to obtain a perpetual limited license for the version
of our software that is then embedded in its products. In
addition, SAP AG will have access to the source code for
this version of our software for purposes of integrating and
embedding the software into SAP AGs products. SAP
AGs right to the perpetual license may be accelerated if:



| |   |                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a major competitor of SAP AG in enterprise resource planning
	 or supply chain management acquires an equity interest in us
	that exceeds SAP AGs investment;
|
| |  | we assign the assets representing the licensed software to a
	third party; or                                                                                 
|
| |  | a person other than Phillip Merrick who is not reasonably
	acceptable to SAP AG acquires 30% of our voting shares.                                            

SAP AG has become a significant customer, accounting for
approximately 22% of our revenues for the fiscal year ended
March 31, 2000, as a result of the development partner
agreement. Under the agreement, SAP AG agreed to pay a fixed
 fee payable in 11 quarterly installments beginning with the
quarter ended June 30, 1999. This fee is, and may continue
to be, a significant portion of our revenue if we are not able to
 expand our revenue base. SAP AG must pay this fee even if
the agreement is terminated. In addition, we receives revenue as
a result of SAP AG customers that upgrade to the fully
featured version of webMethods B2B. If SAP AG chooses not to
 renew the license arrangement to receive access to the latest
version of our software at the expiration of the development
license agreement, our revenue may decline and our business could
 be adversely affected.

Sales and marketing

We sell our software through our direct sales force, resellers
who package our software with their product suites and
third-party systems integrators. While the majority of our sales
are made by our direct sales force or through resellers, a number
 of our sales are the direct result of leads generated by
strategic relationships with systems integrators. The sales cycle
 for our software typically ranges from 60 to 180 days. As
of March 31, 2000, our sales and marketing group consisted
of 112 professionals located in our headquarters in Fairfax,
Virginia, and offices in San Francisco and Los Angeles,
California; Englewood, Colorado; New York, New York; Plano,
Texas; Alpharetta, Georgia; Columbus, Ohio; Chicago, Illinois;
Wellesley Hills, Massachusetts; Hilversum, Netherlands;
Frankfurt, Germany and Reading, United Kingdom. We plan to expand
 our sales and marketing group through aggressive recruitment of
qualified individuals.

Our sales strategy involves targeting entities we view to be
critical e-commerce users, which are generally Global 2000
companies. Because we believe that our products can increase an
enterprises return on investment, we direct our marketing
efforts to officers and executives with responsibility for areas
such as procurement and supply chain management, as well as chief
 information officers. In addition, we frequently participates in
 trade shows, seminars and conferences. We intend to leverage our
 existing customer relationships and strategic alliances to gain
new customers through exposure of our software to the business
partners of our customers, resellers and systems integrators,
some of which, in turn, may purchase our software. We plan to
continue conducting joint marketing and selling efforts, such as
informational seminars and joint sales calls, with our customers.
 In the past, we have conducted such joint efforts with
SAP AG, Ariba, Eastman Chemical and Dell Computer.

We use a variety of marketing programs to build customer
awareness of the company, our brand name and our software. We use
 a broad mix of programs to accomplish these goals, including
market research, product and strategy updates with industry
analysts, public relations activities, direct mail and
relationship marketing programs, seminars, trade shows, speaking
engagements and Web site marketing.

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Research and development

We have made substantial investments in research and development,
 primarily through internal development. We believe that we have
demonstrated significant innovations in our application of Java
and XML technologies to the problems of B2Bi. While we evaluate
externally-developed technologies for integration into our
software, most enhancements to the software have been, and is
expected to continue to be, developed internally. The majority of
 our research and development activity consists of developing new
 versions of and enhancements to the webMethods B2B software to
better serve the needs of our customers. We originally introduced
 our webMethods B2B software in March 1998 and began
shipping it in June 1998. A number of enhancements have been
 added in subsequent releases.

As of March 31, 2000, we had 69 employees dedicated to
research and development. Our research and development
expenditures in the fiscal years 1998, 1999 and 2000 were
approximately $569,000, $1,655,000 and $6,418,000, respectively.
We expect to continue committing significant resources to
research and development in the future.

In addition to our proprietary research, we actively participate
in a number of major XML-based standards initiatives and industry
 consortia and some non-XML-based B2B standards initiatives and
consortia. We participate in the following B2B standards
initiatives: Microsoft BizTalk (B2B e-commerce), Information
& Content Exchange (content syndication), ACORD (insurance),
OBI (B2B e-commerce), Commerce XML (procurement), FpML (financial
 derivatives), Directory Interoperability Forum
(directories) and RosettaNet (information technology supply
chain). We are also a member of the World Wide Web Consortium
where we have participated in and contributed to several of the
XML working groups. We have collaborated with Microsoft on new
XML standards and technologies, such as the eXtensible Query
Language, or XQL, for querying against data contained in XML
documents.

Competition

The market for B2Bi solutions is rapidly changing and intensely
competitive and is likely to become more competitive as the
number of entrants and new technologies increases. While none of
our competitors or potential competitors currently produces a
solution that is identical to our solution, we are subject to
current or potential competition from large software vendors; B2B
 marketplaces that develop their own B2B integration solutions;
certain EDI vendors; and vendors of proprietary EAI and
application server products, such as Extricity, escrow.com,
Citibank and Bluestone, who have added XML capabilities to their
products. In addition, customers and other companies with whom we
 have strategic relationships may become competitors in the
future.

We believe that the principal competitive factors affecting our
market include breadth and depth of solution, interoperability of
 solution with existing applications, a substantial base of
customers and strategic alliances, core technology, product
quality and performance, product features (including security),
customer service, and speed and ease of deployment. We believe
our solution currently competes favorably with respect to these
factors. However, our market is relatively new and evolving
rapidly. We may not be able to maintain our competitive position
against current and potential competitors, especially those with
significantly greater financial, marketing, service, support,
technical and other resources.

Some large potential competitors have longer operating histories,
 larger customer bases, greater brand recognition, and
significantly greater financial, marketing and other resources
than we do and may enter strategic or commercial relationships
with larger, more established and well-financed companies. Some
of our competitors may be able to secure alliances with customers
 and affiliates on more favorable terms, devote greater resources
 to marketing and promotional campaigns and devote substantially
more resources to systems development than we do. In addition,
new technologies and the expansion of existing technologies may
increase competitive pressures on us. We may not be able to
compete successfully

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Intellectual property and other proprietary rights

Our success is heavily dependent upon its proprietary technology,
 the webMethods brand name, and the goodwill associated with it.
We rely primarily on a combination of copyright, trade secret,
trademark and patent laws, confidentiality procedures,
contractual provisions and other similar measures to protect its
proprietary information and intellectual property rights. As part
 of its confidentiality procedures, we enter into non-disclosure
agreements with certain of our employees, consultants, customers,
 prospective customers and companies with which we have strategic
 relationships. We also enter into license agreements with
respect to our technology, documentation and other proprietary
information. Such licenses are generally non-transferable, are
renewable and have terms of two years for end-users and up to
five years for original equipment manufacturers which integrate
our technology into their products. A small number of the
agreements we have entered into contain provisions that, under
certain circumstances, would allow third parties to obtain the
source code for our software.

The unauthorized reproduction or other misappropriation of our
proprietary technology could enable third parties to benefit from
 the technology developed by us without paying for it. In
addition, the steps we have taken to protect our proprietary
rights and intellectual property may not be adequate to deter
misappropriation. We may not be able to detect unauthorized use
of our proprietary information or take appropriate steps to
enforce our intellectual property rights. Despite our efforts to
protect our proprietary rights, unauthorized parties may attempt
to copy or otherwise obtain and use software or technology that
we consider proprietary and third parties may attempt to develop
similar technology independently.

We currently hold a trademark registration in the United States
for the webMethods name. We also have a pending application for
the trademark registration of the B2B Integration Server name in
the United States and have pending applications for the
registration of the webMethods name in the European Union, Japan
and Australia. In addition, we have two pending patent
applications for technology related to webMethods B2B. It is
possible that the patents, copyrights or trademarks held by us
could be challenged and invalidated. In addition, existing
patent, copyright and trademark laws afford only limited
protections. Effective protection of intellectual property rights
 may be unavailable or limited in certain countries because the
laws of some foreign countries do not protect proprietary rights
to the same extent as do the laws of the United States.
Monitoring unauthorized use of patents and trademarks is
difficult and expensive, particularly given the global nature and
 reach of the Internet. Furthermore, it is possible that our
competitors will adopt similar product or service names, impeding
 its ability to protect its intellectual property and possibly
leading to customer confusion. While we are not aware that any of
 our products, patents, trademarks, copyrights or other
proprietary rights infringe the proprietary rights of third
parties, any infringement claims, with or without merit, brought
by such third parties could be time-consuming and expensive to
defend.

Employees

As of March 31, 2000, we employed 276 full-time employees.
These included 112 in sales and marketing, 63 in professional
services and customer care, 69 in research and development and 32
 in administration and finance. Our future success will depend in
 part on our ability to attract, retain and motivate highly
qualified technical and management personnel, for whom
competition is intense. From time to time, we have employed, and
will continue to employ, independent contractors and consultants
to support research and development, marketing and sales, and
business development. Our employees are not represented by a
collective bargaining agreement and we have never experienced a
strike or similar work stoppage. We consider relations with our
employees to be good.

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FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS RISK FACTORS

Risks Related To Our Business

We are an early stage company, so we have only a limited
operating history with which you can evaluate our business and
prospects.

We commenced operations in June 1996 and first shipped
webMethods B2B in June 1998. Accordingly, we have only a
limited operating history with which you can evaluate our
business and our prospects. In addition, our prospects must be
considered in light of the risks encountered by companies in the
early stages of development in new and rapidly evolving markets,
especially the business-to-business integration software market.
Some of the risks we face include our ability to:



| |   |                                                              
| | - | -------------------------------------------------------------
| |  | attract and retain a broad customer base;                    
|
| |  | negotiate and maintain favorable strategic relationships; and
|
| |  | plan and manage our growth effectively.                      

If we fail to manage these risks successfully, our business could
 be harmed.

We expect to incur losses in the future.

We have never been profitable. We have incurred net losses in
every fiscal period since we began operations. For the year ended
 March 31, 2000, our net loss was approximately
$10.4 million. For the fiscal year ended March 31,
1999, our net loss was approximately $3.3 million. As of
March 31, 2000, our accumulated deficit was approximately
$32 million. We expect to substantially increase our sales
and marketing, research and development and general and
administrative expenses. As a result, we will need to generate
significant additional revenues to achieve and maintain
profitability in the future. We are not certain when we will
become profitable, if ever. Even if we do achieve profitability,
we may not sustain or increase profitability on a quarterly or
annual basis. Failure to achieve or maintain profitability will
materially and adversely affect the market price of our common
stock.

We have not been able to fund our operations from cash
generated by our business, and we may not be able to do so in the
 future.

We have principally financed our operations to date through the
private placement of shares of our mandatorily redeemable,
convertible preferred stock and bank borrowings. If we do not
generate sufficient cash resources from our business to fund
operations, our growth could be limited unless we are able to
obtain additional capital through equity or debt financings. Our
inability to grow as planned may reduce our chances of achieving
profitability, which, in turn, could have a material adverse
effect on the market price of our common stock.

Our quarterly financial results fluctuate and are difficult
 to predict and, if our future results are below the expectations
 of the public market analysts and investors, the price of our
common stock may decline.

Our quarterly revenue and results of operations are difficult to
predict. We have experienced, and expect to continue to
experience, fluctuations in revenue and operating results from
quarter-to-quarter. As a result, we believe that
quarter-to-quarter comparisons of our revenue and operating
results are not necessarily meaningful, and that such comparisons
 may not be accurate indicators of future performance. The
reasons for these fluctuations include, but are not limited to:



| |   |                                                                                                                 
| | - | ----------------------------------------------------------------------------------------------------------------
| |  | the amount and timing of operating costs relating to expansion of
	 our business, operations and infrastructure;
|
| |  | the number and timing of new hires;                                                                             
|
| |  | our utilization rate for our professional services personnel; and                                               
|
| |  | changes in our pricing policies or our competitors pricing
	policies.                                          

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We plan to significantly increase our operating expenses to
expand our sales and marketing operations and fund greater levels
 of research and development. Our operating expenses, which
include sales and marketing, research and development and general
 and administrative expenses, are based on our expectations of
future revenues and are relatively fixed in the short term. If
revenue falls below our expectations in a quarter and we are not
able to quickly reduce our spending in response, our operating
results for that quarter could be harmed. It is likely that in
some future quarter our operating results may be below the
expectations of public market analysts and investors and, as a
result, the price of our common stock may fall.

Variations in our sales cycle could impact the timing of
our revenue, causing our quarterly operating results to
fluctuate.

The period between our initial contact with a potential customer
and the purchase of our software and services is often long and
subject to delays associated with the budgeting, approval, and
competitive evaluation processes which frequently accompany
significant capital expenditures. A lengthy sales cycle may have
an impact on the timing of our revenue, which in turn could cause
 our quarterly operating results to fluctuate. We believe that a
customers decision to purchase our software and services is
 discretionary, involves a significant commitment of resources,
and is influenced by customer budgetary cycles. To successfully
sell our software and services, we generally must educate our
potential customers regarding their use and benefits, which can
require significant time and resources.

We expect to depend on webMethods B2B for all of our
revenue for the foreseeable future and if it does not achieve
broad market acceptance, our revenue could decline.

We currently derive all of our revenue from licensing our
webMethods B2B software and providing related professional
services, maintenance and support. We expect that we will
continue to depend on webMethods B2B for our revenue for the
foreseeable future. Consequently, a decline in the price of, or
demand for, webMethods B2B, or its failure to achieve broad
market acceptance, could seriously harm our business and results
of operations.

webMethods B2B is based in large part on XML, which has not
 yet achieved broad market acceptance and if broad market
acceptance for XML does not develop, webMethods B2B may not
achieve commercial acceptance.

webMethods B2B is currently based in large part upon XML, or
eXtensible Markup Language, an emerging standard for sharing data
 over the Internet. While we anticipate that XML will achieve
broad market acceptance in the near future, it is possible that a
 competing standard perceived to be superior could replace XML,
in which case the market may not accept an XML-based product. If
a new standard were perceived to be superior, our software might
not be compatible with the new standard or we might not be able
to develop a product using this standard in a timely manner.
Consequently, a failure of XML-based products to achieve broad
market acceptance or the introduction of a competing standard
perceived to be superior in the market could harm our business.

If our strategic relationships terminate, we may lose
important sales and marketing opportunities.

We have established strategic relationships with B2B e-commerce
marketplaces, resellers, enterprise application software
providers, system integrators and other technology leaders. These
 relationships expose our software to many potential customers to
 which we may not otherwise have access. In addition, these
relationships provide us with insights into new technology and
with third-party service providers that our customers can use for
 implementation assistance. If our relationships with any of
these organizations were terminated, we might lose important
opportunities, including sales and marketing opportunities, and
our business may suffer.

If our relationship with SAP AG terminates, our
revenues may decline and we may lose important sales and
marketing opportunities.

In March 1999, we entered into a development partner
agreement with SAP AG. The partnership was expanded in June
2000 when we signed an amendment to the development partner
agreement under which

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SAP AG has become a significant customer, accounting for
approximately 22% of our revenues for the fiscal year ended
March 31, 2000 and 12% for the quarter ended March 31,
2000, as a result of the development partner agreement. Under the
 agreement, SAP AG agreed to pay a fixed fee payable in eleven
quarterly installments beginning with the quarter ended
June 30, 1999. This fee is, and may continue to be, a
significant portion of our revenue if we are not able to expand
our revenue base. SAP AG must pay this fee even if the
agreement is terminated. In addition, we may receive revenue as a
 result of SAP AG customers that upgrade to an unrestricted
version of webMethods B2B. Under the terms of the amendment, we
have set up a formula to compensate SAP AG for sales
referrals for our products. If SAP AG chooses not to renew
the license agreement in order to receive access to the latest
version of our software at the expiration of the development
license agreement, our revenue may decline and our business could
 be adversely affected.

If our customers do not renew their licenses, our revenue
may decline.

Although most enterprise software providers offer perpetual
licenses with a single payment received at the time of the
license grant, we typically license our webMethods B2B software
on a two-year renewable basis. We first shipped webMethods B2B in
 June 1998 and, to date, none of our initial two-year
licenses has reached its renewal date. If a significant portion
of our customers were to elect not to renew their licenses for
our software or were to seek perpetual licenses in the future, we
 would lose a recurring revenue stream on which we base our
business model, which could cause our revenue to decline and harm
 our business, operating results and financial condition.

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

We need to substantially expand our direct and indirect sales and
 distribution efforts, both domestically and internationally, in
order to increase market awareness and sales of our webMethods
B2B software and the related services we offer. We have recently
expanded our direct sales force and plan to hire additional sales
 personnel. webMethods B2B requires a sophisticated sales effort
targeted at multiple departments within an organization.
Competition for qualified sales and marketing personnel is
intense, and we might not be able to hire and retain adequate
numbers of such personnel to maintain our growth. New hires will
require training and take time to achieve full productivity. Our
competitors have attempted to hire our employees away from us and
 we expect that they will continue such attempts in the future.
We also plan to expand our relationships with system integrators,
 enterprise software vendors and other third-party resellers to
further develop our indirect sales channel. As we continue to
develop our indirect sales channel, we will need to manage
potential conflicts between our direct sales force and
third-party reselling efforts.

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

We cannot be certain that we can attract or retain a sufficient
number of highly qualified professional services personnel.
Customers that license our software typically engage our
professional services staff to assist with support, training,
consulting and implementation. We believe that growth in our
software sales

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The business-to-business e-commerce industry is highly
competitive and we may not be able to compete effectively.

The market for B2B e-commerce solutions is rapidly changing and
intensely competitive. We expect competition to intensify as the
number of entrants and new technologies increases. We may not be
able to compete successfully against current or future
competitors. The competitive pressures facing us may harm our
business, operating results and financial condition.

Our current and potential competitors include, among others,
large software vendors, companies and trading networks that
develop their own business-to-business integration e-commerce
solutions, electronic data interchange, or EDI, vendors, vendors
of proprietary enterprise application integration, or EAI,
solutions and application server vendors who have added XML
capabilities to their products. In addition, our customers and
companies with whom we currently have strategic relationships may
 become competitors in the future. Many of our competitors and
potential competitors have more experience developing
Internet-based software, larger technical staffs, larger customer
 bases, more established distribution channels, greater brand
recognition and greater financial, marketing and other resources
than we do. Our competitors may be able to develop products and
services that are superior to our software and services, that
achieve greater customer acceptance or that have significantly
improved functionality as compared to our existing software and
future products and services. In addition, negotiating and
maintaining favorable customer and strategic relationships is
critical to our business. Our competitors may be able to
negotiate strategic relationships on more favorable terms than we
 are able to negotiate. Many of our competitors may also have
well-established relationships with our existing and prospective
customers. Increased competition may result in reduced margins,
loss of sales or decreased market share which in turn could harm
our business, operating results and financial condition.

We have experienced significant growth in our business in
recent periods and we may not be able to manage our future growth
 successfully.

Our ability to successfully offer software and services and
implement our business plan in a rapidly evolving market requires
 an effective planning and management process. We have increased,
 and plan to continue to increase, the scope of our operations at
 a rapid rate. The number of people we employ has grown and will
continue to grow substantially. As of March 31, 2000, we had
 a total of 276 employees, an increase from 65 employees at
March 31, 1999. Future expansion efforts could be expensive
and may strain our managerial and other resources. To manage
future growth effectively, we must maintain and enhance our
financial and accounting systems and controls, integrate new
personnel and manage expanded operations. If we do not manage
growth properly, it could harm our business, operating results
and financial condition.

If our software contains defects, we could lose customers
and revenue.

Software as complex as ours often contains known and undetected
errors or performance problems. Many serious defects are
frequently found during the period immediately following
introduction of new software or enhancements to existing
software. Although we attempt to resolve all errors that we
believe would be considered serious by our customers, our
software is not error-free. Undetected errors or performance
problems may be discovered in the future and known errors
considered minor by us may be

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If we cannot develop our software in a timely and effective
 manner, our operating results could suffer.

Because of the complexity of our software, internal quality
assurance testing and customer testing may reveal product
performance issues or desirable feature enhancements that could
lead us to postpone the release of new versions of our software.
In addition, the reallocation of resources associated with any
postponement could cause delays in the development and release of
 future enhancements to our currently available software. We may
not be able to successfully complete the development of currently
 planned or future enhancements in a timely and efficient manner.
 Any such failure or delay could harm our operating results.

Our executive officers and certain key personnel are
critical to our business and these officers and key personnel may
 not remain with us in the future.

Our future success depends upon the continued service of our
executive officers and other key personnel and none of our
officers or key employees is bound by an employment agreement for
 any specific term. If we lose the services of one or more of our
 executive officers or key employees, or if one or more of them
decide to join a competitor or otherwise compete directly or
indirectly with us, our business, operating results and financial
 condition could be harmed. In particular, Phillip Merrick, our
Chairman of the Board, President and Chief Executive Officer,
would be particularly difficult to replace.

If we cannot meet our future capital requirements, we may
not be able to develop or enhance our products, take advantage of
 business opportunities and respond to competitive pressures.

We currently anticipate that the net proceeds from this offering,
 together with our existing working capital immediately prior to
this offering, will be sufficient to meet our anticipated working
 capital and capital expenditure requirements through at least
the next twelve months. The time period for which we believe our
capital is sufficient is an estimate; the actual time period may
differ materially as a result of a number of factors, risks and
uncertainties. We may need to raise additional funds in the
future through public or private debt or equity financings in
order to:



| |   |                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------
| |  | take advantage of opportunities, including more rapid
	international expansion or acquisitions of complementary
	businesses or technologies;
|
| |  | develop new products or services; or                                                                                                        
|
| |  | respond to competitive pressures.                                                                                                           

Additional financing we may need in the future may not be
available on terms favorable to us, if at all. If adequate funds
are not available or are not available on acceptable terms, we
may not be able to take advantage of opportunities, develop new
products or services or otherwise respond to unanticipated
competitive pressures. In such case, our business, operating
results and financial condition could be harmed.

We intend to continue expanding our international sales
efforts but do not have substantial experience in international
markets.

We intend to expand our international sales efforts in the
future. We have very limited experience in marketing, selling and
 supporting our software and services abroad. Expansion of our
international operations requires a significant amount of
attention from our management and substantial financial
resources. If we are unable to continue to grow our international
 operations successfully and in a timely manner, our business and
 operating results could be harmed. In addition, doing business
internationally involves additional risks, particularly:



| |   |                                                                               
| | - | ------------------------------------------------------------------------------
| |  | unexpected changes in regulatory requirements, taxes, trade laws
	and tariffs;
|
| |  | restrictions on repatriation of earnings;                                     

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| |   |                                                                               
| | - | ------------------------------------------------------------------------------
| |  | differing intellectual property rights;                                       
|
| |  | differing labor regulations;                                                  
|
| |  | changes in a specific countrys or regions political
	or economic conditions;
|
| |  | greater difficulty in staffing and managing foreign operations;
	and          
|
| |  | fluctuating currency exchange rates.                                          

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

Our success depends, in part, upon our proprietary technology and
 other intellectual property rights. To date, we have relied
primarily on a combination of copyright, trade secret, trademark
and patent laws, and nondisclosure and other contractual
restrictions on copying and distribution to protect our
proprietary technology. We have two pending patent applications
for technology related to our software, but we cannot assure you
that these applications will be successful. A small number of our
 agreements with our customers and systems integrators contain
provisions regarding the rights of third parties to obtain the
source code for our software, which may limit our ability to
protect our intellectual property rights in the future.
Litigation to enforce our intellectual property rights or protect
 our trade secrets could result in substantial costs and may not
be successful. Any inability to protect our intellectual property
 rights could seriously harm our business, operating results and
financial condition. In addition, the laws of certain foreign
countries may not protect our intellectual property rights to the
 same extent as do the laws of the United States. Our means of
protecting our intellectual property rights in the United States
or abroad may not be adequate to fully protect our intellectual
property rights.

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

Litigation regarding intellectual property rights is common in
the Internet and software industries. We expect that Internet
technologies and software products and services may be
increasingly subject to third-party infringement claims as the
number of competitors in our industry segment grows and the
functionality of products in different industry segments
overlaps. We may from time to time encounter disputes over rights
 and obligations concerning intellectual property. Although we
believe that our intellectual property rights are sufficient to
allow us to market our software without incurring liability to
third parties, third parties may bring claims of infringement
against us. Such claims may be with or without merit. Any
litigation to defend against claims of infringement or invalidity
 could result in substantial costs and diversion of resources.
Furthermore, a party making such a claim could secure a judgment
that requires us to pay substantial damages. A judgment could
also include an injunction or other court order that could
prevent us from selling our software. Our business, operating
results and financial condition could be harmed if any of these
events occurred.

In addition, we have agreed, and may agree in the future, to
indemnify certain of our customers against claims that our
software infringes upon the intellectual property rights of
others. We could incur substantial costs in defending ourselves
and our customers against infringement claims. In the event of a
claim of infringement, we and our customers may be required to
obtain one or more licenses from third parties. We, or our
customers, may be unable to obtain necessary licenses from third
parties at a reasonable cost, or at all. Defense of any lawsuit
or failure to obtain any such required licenses could harm our
business, operating results and financial condition.

If we become subject to product liability claims, they
could be time consuming and costly to defend.

Since our customers use our software for mission critical
applications such as Internet commerce, errors, defects or other
performance problems could result in financial or other damages
to our customers. They could seek damages for losses from us,
which, if successful, could have a material adverse effect on our
 business, operating results or financial condition. Although our
 license agreements typically contain provisions designed to
limit our exposure to product liability claims, existing or
future laws or unfavorable

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Risks Relating To Our Industry

Our market is subject to rapid technological change and our
 future success will depend on our ability to meet the changing
needs of our industry.

Our market is characterized by rapidly changing technology,
evolving industry standards and frequent new product
announcements. To be successful, we must adapt to our rapidly
changing market by continually improving the performance,
features and reliability of our software and services. We could
incur substantial costs to modify our software, services or
infrastructure in order to adapt to these changes. Our business
could be harmed if we incur significant costs without adequate
results, or if we are unable to adapt rapidly to these changes.

Continued adoption of the Internet as a method of
conducting business is necessary for our future growth.

The market for Internet-based, business-to-business integration
software is relatively new and is evolving rapidly. Our future
revenues and any future profits depend upon the widespread
acceptance and use of the Internet as an effective medium for
business-to-business commerce. The failure of the Internet to
continue to develop as a commercial or business medium could harm
 our business, operating results and financial condition. The
acceptance and use of the Internet for business-to-business
commerce could be limited by a number of factors, such as the
growth and use of the Internet in general, the relative ease of
conducting business on the Internet, the efficiencies and
improvements that conducting commerce on the Internet provides,
concerns about transaction security and taxation of transactions
on the Internet.

We depend on the speed and reliability of the Internet and
our customers internal networks.

The recent growth in Internet traffic has caused frequent periods
 of decreased performance. If Internet usage continues to grow
rapidly, its infrastructure may not be able to support these
demands and its performance and reliability may decline. If
outages or delays on the Internet occur frequently or increase in
 frequency, business-to-business e-commerce could grow more
slowly or decline, which may reduce the demand for our software.
The ability of our webMethods B2B software to satisfy our
customers needs is ultimately limited by and depends upon
the speed and reliability of both the Internet and our
customers internal networks. Consequently, the emergence
and growth of the market for our software depends upon
improvements being made to the entire Internet as well as to our
individual customers networking infrastructures to
alleviate overloading and congestion. If these improvements are
not made, the ability of our customers to utilize our solution
will be hindered, and our business, operating results and
financial condition may suffer.

Increased security risks of online commerce may deter
future use of our software and services.

A fundamental requirement to conduct Internet-based,
business-to-business e-commerce is the secure transmission of
confidential information over public networks. Advances in
computer capabilities, new discoveries in the field of
cryptography, or other developments may result in a compromise or
 breach of the security features contained in our software or the
 algorithms used by our customers and their business partners to
protect content and transactions on Internet e-commerce
marketplaces or proprietary information in our customers
and their business partners databases. Anyone who is able
to circumvent security measures could misappropriate proprietary,
 confidential customer information or cause interruptions in our
customers and their business partners operations. Our
 customers and their business partners may be required to incur
significant costs to protect against security breaches or to
alleviate problems caused by breaches, reducing their demand for
our software. Further, a well-publicized compromise of security
could deter businesses from using the Internet to conduct
transactions that involve transmitting confidential information.
The failure of the security features of our software to prevent
security breaches,

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Internet-related laws could limit the market for our
software.

Regulation of the Internet is largely unsettled. The adoption of
laws or regulations that increase the costs or administrative
burdens of doing business using the Internet could cause
companies to seek an alternative means of transacting business.
If the adoption of new Internet laws or regulations causes
companies to seek alternative methods for conducting business,
the demand for our software could decrease and our business could
 be adversely affected.




Item 2.  PROPERTIES

Facilities

Our principal administrative, sales, marketing and research and
development facility is located in Fairfax, Virginia, and
consists of approximately 64,725 square feet of office space held
 under a lease that expires in March 2005. In
March 1999, we leased 4,000 square feet of office space in
San Francisco, California, under a three-year lease expiring in
February 2002. We also maintain offices for sales and
support personnel in New York, New York; Los Angeles, California;
 Alpharetta, Georgia; Plano, Texas; Columbus, Ohio; Chicago,
Illinois; Englewood, Colorado; Wellesley Hills, Massachusetts;
Hilversum, The Netherlands; Frankfurt, Germany; and Reading,
United Kingdom.




Item 3.  LEGAL PROCEEDINGS

We are involved from time to time in routine litigation that
arises in the ordinary course of our business, but are not
currently involved in any litigation that we believe could
reasonably be expected to have a material adverse impact on our
financial position, results of operations or cash flows.




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

None.

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##### Table of Contents






PART II






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

Since February 11, 2000, webMethods Common Stock has
been publicly traded on the Nasdaq National Market under the
symbol WEBM. Prior to February 11, 2000,
webMethods common stock was not publicly traded. The high and low
 sales prices of the Common Stock as reported by the Nasdaq
National Market were:

|                                        |  |      |        |     |  |   |        | 
|--------------------------------------- |  | ---- | ------ | --- |  | - | ------ | 
|                                        |  | High |        | Low
|                                        |  |      |        |    
|Fourth quarter (from February 11, 2000) |  | $    | 336.25 |     |  | $ | 165.00 | 

Holders of Record

As of March 31, 2000, there were 309 holders of record of
webMethods Common Stock. The number of holders of record of
 Common Stock is not representative of the number of beneficial
holders because many shares are held by depositories, brokers or
other nominees.

Dividends

The Company has never declared or paid any cash dividends on its
Common Stock. The Company currently intends to retain earnings,
if any, to support its growth strategy and does not anticipate
paying cash dividends in the foreseeable future.

Recent Sales of Unregistered Securities

The information required by this section for the period ended
February 11, 2000 is incorporated by reference to
Item 15 of webMethods Registration Statement on
Form S-1 (File No. 333-91039). In addition, on
February 16, 2000, webMethods issued and sold an aggregate
of 518,135 shares of common stock to a total of four investors
for $33.78 or an aggregate of $17,502,600 in a private placement
concurrent with the closing of its IPO.

None of the foregoing transactions involved any underwriters,
underwriting discounts or commissions, or any public offering,
and the registrant believes that each transaction was exempt from
 the registration requirements of the Securities Act of 1933, as
amended, by virtue of Section 4(2) thereof,
Regulation D promulgated thereunder or Rule 701
promulgated under Section 3(b) thereof, pursuant to
compensatory benefit plans and contracts relating to compensation
 as provided under such Rule 701. The recipients in such
transactions represented their intention to acquire the
securities for investment only and not with a view to or for sale
 in connection with any distribution thereof, and appropriate
legends were affixed to the share certificates and instruments
issued in such transactions. All recipients had adequate access,
through their relationships with the registrant, to information
about the registrant.




Item 6.  SELECTED FINANCIAL DATA

The following selected historical consolidated financial data for
 webMethods should be read in conjunction with the consolidated
financial statements and the notes to the consolidated financial
statements and Managements Discussion and Analysis of
Financial Condition and Results of Operations of webMethods,
which are included elsewhere in this report. The historical
consolidated statement of operations data for the years ended
March 31, 2000, 1999 and 1998 and the historical consolidated
balance sheet data as of March 31, 2000 and 1999 are derived
 from the consolidated financial statements of webMethods, which
have been audited by PricewaterhouseCoopers LLP, independent
accountants for webMethods, and are included elsewhere in this
report. The historical consolidated statement of operations data
for the period from inception (June 12, 1996) through
March 31, 1997 and the historical consolidated balance sheet
 data as of March 31, 1998 and 1997 are derived from
consolidated financial

25



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|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |     |     | 
|----------------------------------------------------------------------------------- | ------------------------------------------- | ------------------------------------- | ------- | --------------- | ------ | ---- | ------ | -------------- | ----- | - | ------ | --- | ----- | - | ----- | --- | --- | 
|                                                                                    |                                             |                                       |         |                 |        |      |        | Period from   
|                                                                                    |                                             |                                       |         | Inception      
|                                                                                    |                                             | Year Ended March 31,                  |         | (June 12, 1996)
|                                                                                    |                                             |                                       |         | through        
|                                                                                    |                                             | 2000                                  |         | 1999            |        | 1998 |        | March 31, 1997
|                                                                                    |                                             |                                       |         |                 |        |      |        |               
|                                                                                    |                                             |                                      
|                                                                                    |                                             | (in thousands, except per share data)
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|Consolidated Statement of Operations Data:                                          |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|Revenue:                                                                            |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | License                                     |                                       | $       | 15,495          |        |      | $      | 3,707          |       |   | $      | 99  |       |   | $     | 11  |    
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Professional services                       |                                       |         | 5,177           |        |      |        | 582            |       |   |        | 57  |       |   |       |    |    
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Maintenance                                 |                                       |         | 2,330           |        |      |        | 173            |       |   |        | 10  |       |   |       | 1   |    
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|                                                                                    |                                             | Total revenue                         |         |                 | 23,002 |      |        |                | 4,462 |   |        |     | 166   |   |       |     | 12  | 
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|Cost of revenue:                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | License                                     |                                       |         | 984             |        |      |        | 172            |       |   |        |    |       |   |       |    |    
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Professional services and maintenance(a)    |                                       |         | 7,717           |        |      |        | 482            |       |   |        |    |       |   |       |    |    
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|                                                                                    |                                             | Total cost of revenue                 |         |                 | 8,701  |      |        |                | 654   |   |        |     |      |   |       |     |    | 
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|Gross profit                                                                        |                                             |                                       | 14,301  |                 |        |      | 3,808  |                |       |   | 166    |     |       |   | 12    |    
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|Operating expenses:                                                                 |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Sales and marketing(a)                      |                                       |         | 20,366          |        |      |        | 4,551          |       |   |        | 697 |       |   |       | 123 |    
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Research and development(a)                 |                                       |         | 6,419           |        |      |        | 1,655          |       |   |        | 569 |       |   |       | 94  |    
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | General and administrative(a)               |                                       |         | 5,940           |        |      |        | 1,032          |       |   |        | 287 |       |   |       | 79  |    
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Amortization of deferred stock compensation |                                       |         | 1,767           |        |      |        |               |       |   |        |    |       |   |       |    |    
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Write-off of intellectual property          |                                       |         |                |        |      |        |               |       |   |        |    |       |   |       | 150 |    
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|                                                                                    |                                             | Total operating expenses              |         |                 | 34,492 |      |        |                | 7,238 |   |        |     | 1,553 |   |       |     | 446 | 
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|Operating loss                                                                      |                                             |                                       | (20,191 | )               |        |      | (3,430 | )              |       |   | (1,387 | )   |       |   | (434  | )  
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|Interest income, net                                                                |                                             |                                       | 2,080   |                 |        |      | 134    |                |       |   | 24     |     |       |   |      |    
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|Loss before income taxes                                                            |                                             |                                       | (18,111 | )               |        |      | (3,296 | )              |       |   | (1,363 | )   |       |   | (434  | )  
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|Deferred tax provision                                                              |                                             |                                       | 46      |                 |        |      |       |                |       |   |       |     |       |   |      |    
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|Net loss                                                                            |                                             |                                       | (18,157 | )               |        |      | (3,296 | )              |       |   | (1,363 | )   |       |   | (434  | )  
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|Accretion and accrued dividends related to mandatorily redeemable
	 preferred stock |                                             |                                       | (10,223 | )               |        |      | (606   | )              |       |   | (112   | )   |       |   |      |    
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|Net loss attributable to common shareholders                                        |                                             | $                                     | (28,380 | )               |        | $    | (3,902 | )              |       | $ | (1,475 | )   |       | $ | (434  | )  
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|Basic and diluted net loss per common share                                         |                                             | $                                     | (3.00   | )               |        | $    | (0.71  | )              |       | $ | (0.24  | )   |       | $ | (0.08 | )  
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    
|Shares used in computing basic and diluted net loss per common
	share               |                                             |                                       | 9,448   |                 |        |      | 5,527  |                |       |   | 6,269  |     |       |   | 5,519 |    
|                                                                                    |                                             |                                       |         |                 |        |      |        |                |       |   |        |     |       |   |       |    




|    |                                                                                                                                                                                 
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | For the year ended March 31, 2000, excludes non-cash stock
	compensation as described in the webMethods consolidated
	financial statements included elsewhere in this Form 10-K.

|                                              |  |                 |         |      |  |      |        |      |  |   |        |   |  |   |     | 
|--------------------------------------------- |  | --------------- | ------- | ---- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | --- | 
|                                              |  |                
|                                              |  | As of March 31,
|                                              |  |                
|                                              |  | 2000            |         | 1999 |  | 1998 |        | 1997
|                                              |  |                 |         |      |  |      |        |     
|                                              |  |                
|                                              |  | (in thousands) 
|                                             
|                                             
|                                             
|                                             
|Consolidated Balance Sheet Data:              |  |                 |         |      |  |      |        |      |  |   |        |   |  |   |     | 
|                                             
|                                             
|                                             
|                                             
|Cash and cash equivalents                     |  | $               | 156,778 |      |  | $    | 3,129  |      |  | $ | 2,375  |   |  | $ | 193 | 
|                                             
|                                             
|                                             
|                                             
|Working capital                               |  |                 | 154,261 |      |  |      | 3,715  |      |  |   | 2,204  |   |  |   | 96  | 
|                                             
|                                             
|                                             
|                                             
|Total assets                                  |  |                 | 216,300 |      |  |      | 8,430  |      |  |   | 2,649  |   |  |   | 252 | 
|                                             
|                                             
|                                             
|                                             
|Long-term obligations, net of current portion |  |                 | 5,941   |      |  |      | 381    |      |  |   |       |   |  |   |    | 
|                                             
|                                             
|                                             
|                                             
|Mandatorily redeemable preferred stock        |  |                 |        |      |  |      | 11,118 |      |  |   | 4,076  |   |  |   |    | 
|                                             
|                                             
|                                             
|                                             
|Total stockholders equity (deficit)          |  |                 | 187,734 |      |  |      | (5,574 | )    |  |   | (1,741 | ) |  |   | 121 | 

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

The following discussion and analysis of the financial
condition and results of operations of webMethods should be read
in conjunction with Selected Consolidated Financial
Data, contained in Item 6 and the Financial Statements
 contained in Item 8, and webMethods consolidated
financial statements and related notes appearing elsewhere in
this report. This discussion and analysis contains
forward-looking statements that involve risks, uncertainties and
assumptions. Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of
certain factors, including, but not limited to, those set forth
under Risk Factors, in Item 1, and elsewhere in
this report.

Overview

We are a leading provider of infrastructure software and services
 for achieving business-to-business integration, or B2Bi. Our
software, webMethods B2B, enables companies to work more closely
with their customers, suppliers and other business partners
through the real-time exchange of information and transactions
over the Internet.

webMethods was founded in June 1996. We have grown from
17 employees as of March 31, 1998 to 276 employees as
of March 31, 2000. We shipped the first version of
webMethods B2B in June 1998 and have released five
subsequent versions of webMethods B2B, the most recent of which
we began shipping in April 2000.

Our revenue is derived from sales of licenses of our webMethods
B2B software, professional services, and maintenance and support.
 We generally license our software on a two-year renewable basis,
 which includes maintenance and support for the term of the
renewable license. Periodically, we license our software over a
different renewable term or on a perpetual basis. License fees
are generally billed upon shipment. Maintenance, which includes
the right to receive product upgrades on a when-and-if available
basis, is included in renewable licenses for the term of the
license. Maintenance on perpetual licenses is generally billed
annually in advance. We offer implementation and other
professional services on a time and materials basis and training
on a fixed fee basis. We began our international direct sales
efforts in July 1999 and expect that our revenue from
international licenses will grow as we expand our sales efforts
abroad.

We recognize revenue from the sale of software licenses upon
shipment of our software, provided that the fee is fixed and
determinable, persuasive evidence of an arrangement exists and
collection of the resulting receivable is considered probable.
Historically, we have not experienced significant returns or
exchanges of our software. We recognize software license revenue
over the term of the license if the license requires us to
deliver unspecified software during its term or if the license
contains extended payment terms. Maintenance revenue is
recognized ratably over the maintenance period as payment becomes
 due. The portion of revenue from the two-year renewable licenses
 that is allocated to maintenance and support is recognized over
the term of the license. Payments received in advance of revenue
recognition are recorded as deferred revenue. Professional
services revenue is recognized as the service is performed.

Our cost of license revenue primarily includes royalties to third
 parties for software used in its software and a provision for
warranty obligations. Our cost of professional services and
maintenance revenue includes salaries and related expenses for
our professional services and technical support organizations,
costs of third-party consultants we use to provide professional
services to customers and an allocation of overhead and
recruitment costs.

Although revenue has consistently increased from quarter to
quarter, we have incurred significant costs to develop our
technology and products and to recruit and train personnel for
our research and development, sales, marketing, professional
services and administration departments. As a result, we have
incurred significant losses since inception, and as of
March 31, 2000, had an accumulated deficit of approximately
$32.1 million. We believe our success depends on rapidly
increasing our customer base,

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We had 276 full-time employees as of March 31, 2000, and
intend to hire a significant number of employees in the future.
This expansion places significant demands on our management and
operational resources. To manage this rapid growth and increase
demand, we must invest in and implement scalable operational
systems, procedures and controls. We must also be able to recruit
 qualified candidates to manage our expanding operations. We
expect future expansion to continue to challenge
managements ability to hire, train, manage and retain our
employees.

RECENT DEVELOPMENTS

Acquisition of Active Software, Inc.

On May 20, 2000, we entered into an Agreement and Plan of
Merger, along with Wolf Acquisition, Inc., a wholly owned
subsidiary of ours, and Active Software, Inc. (Active
Software), a publicly held software company based in
Santa Clara, California that provides eBusiness
infrastructure software. Subject to the terms and conditions of
the Agreement and Plan of Merger, Wolf Acquisition will merge
with and into Active Software, with Active Software surviving as
a wholly owned subsidiary of webMethods. As more specifically set
 forth in the Agreement and Plan of Merger, which we filed with a
 Form 8-K on May 24, 2000, each issued and outstanding
share of Active Softwares common stock, par value $0.001
per share, will be converted into 0.527 of a share of webMethods
common stock, par value $0.01 per share. We will assume all
outstanding options to purchase Active Software common stock, as
well as the plans under which the options were granted. As of
May 20, 2000, Active Software had 25,937,281 shares of its
common stock issued and outstanding, and had granted options to
purchase approximately 3.9 million shares of its common
stock. We expect to account for the acquisition of Active
Software as a pooling-of-interests transaction.

The closing of the merger is subject to a number of conditions,
including adoption of the merger agreement by the stockholders of
 Active Software and approval of the issuance of shares of
webMethods common stock in connection with the merger by our
stockholders.

Amendment to Development Partner Agreement with SAP AG

In June 2000, we signed an amendment to the development partner
agreement with SAP AG. The amendment expanded our
relationship with SAP AG by making us the supplier of
enterprise application integration technology for
SAP AGs Business Connector. In addition, we have set
up a formula to compensate SAP AG for sales referrals for
webMethods products. The amendment did not change the term of the
 original agreement, nor did it change the fixed fee payable
under the terms of the original agreement.

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Results of operations

The following table sets forth our historical consolidated
statement of operations data for each of the periods indicated as
 a percentage of total revenue.

|                             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |         |          |         | 
|---------------------------- | ------------------------------------------- | -------------------- | ------------------------ | --------- | ----- | ----- | ----- | -------------- | ----- | ----- | ------ | ----- | ------ | ----- | -------- | ------- | -------- | ------- | 
|                             |                                             |                      |                          |           |       |       |       | Period from   
|                             |                                             |                      |                          |           |       |       |       | Inception     
|                             |                                             |                      |                          | (June 12,
|                             |                                             | Year Ended March 31, |                          | 1996)    
|                             |                                             |                      |                          | through  
|                             |                                             | 2000                 |                          | 1999      |       | 1998  |       | March 31, 1997
|                             |                                             |                      |                          |           |       |       |       |               
|Percentage of Total Revenue: |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|                            
|                            
|                            
|                            
|Revenue:                     |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|                            
|                            
|                            
|                            
|                             | License                                     |                      |                          | 67.4      | %     |       |       | 83.1           | %     |       |        | 59.6  | %      |       |          | 91.7    | %       
|                            
|                            
|                            
|                            
|                             | Professional services                       |                      |                          | 22.5      |       |       |       | 13.0           |       |       |        | 34.4  |        |       |          |        |         
|                            
|                            
|                            
|                            
|                             | Maintenance                                 |                      |                          | 10.1      |       |       |       | 3.9            |       |       |        | 6.0   |        |       |          | 8.3     |         
|                             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|                             |                                             |                      | Total revenue            |           |       | 100.0 |       |                |       | 100.0 |        |       |        | 100.0 |          |         |          | 100.0   | 
|                             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|Cost of revenue:             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|                            
|                            
|                            
|                            
|                             | License                                     |                      |                          | 4.3       |       |       |       | 3.9            |       |       |        |      |        |       |          |        |         
|                            
|                            
|                            
|                            
|                             | Professional services and maintenance       |                      |                          | 33.5      |       |       |       | 10.8           |       |       |        |      |        |       |          |        |         
|                             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|                             |                                             |                      | Total cost of revenue    |           |       | 37.8  |       |                |       | 14.7  |        |       |        |      |          |         |          |        | 
|                             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|Gross profit                 |                                             |                      | 62.2                     |           |       |       | 85.3  |                |       |       | 100.0  |       |        |       | 100.0    |        
|                             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|Operating expenses:          |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|                            
|                            
|                            
|                            
|                             | Sales and marketing                         |                      |                          | 88.5      |       |       |       | 102.0          |       |       |        | 419.9 |        |       |          | 1,025.0 |         
|                            
|                            
|                            
|                            
|                             | Research and development                    |                      |                          | 27.9      |       |       |       | 37.1           |       |       |        | 342.8 |        |       |          | 783.4   |         
|                            
|                            
|                            
|                            
|                             | General and administrative                  |                      |                          | 25.8      |       |       |       | 23.1           |       |       |        | 172.9 |        |       |          | 658.3   |         
|                            
|                            
|                            
|                            
|                             | Amortization of deferred stock compensation |                      |                          | 7.7       |       |       |       |               |       |       |        |      |        |       |          |        |         
|                            
|                            
|                            
|                            
|                             | Write-off of intellectual property          |                      |                          |          |       |       |       |               |       |       |        |      |        |       |          | 1,250.0 |         
|                             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|                             |                                             |                      | Total operating expenses |           |       | 149.9 |       |                |       | 162.2 |        |       |        | 935.6 |          |         |          | 3,716.7 | 
|                             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|Operating loss               |                                             |                      | (87.7                    | )         |       |       | (76.9 | )              |       |       | (835.6 | )     |        |       | (3,616.7 | )      
|                            
|                            
|                            
|                            
|Interest income, net         |                                             |                      | 9.0                      |           |       |       | 3.0   |                |       |       | 14.5   |       |        |       |         |        
|                             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|Loss before income taxes     |                                             |                      | (78.7                    | )         |       |       | (73.9 | )              |       |       | (821.1 | )     |        |       | (3,616.7 | )      
|                            
|                            
|                            
|                            
|Deferred tax provision       |                                             |                      | 0.2                      |           |       |       |      |                |       |       |       |       |        |       |         |        
|                             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        
|                             |                                             | Net loss             |                          |           | (78.9 | )%    |       |                | (73.9 | )%    |        |       | (821.1 | )%    |          |         | (3,616.7 | )%     
|                             |                                             |                      |                          |           |       |       |       |                |       |       |        |       |        |       |          |        

Year Ended March 31, 2000 compared to Year Ended
March 31, 1999

Revenue

Total revenue increased by approximately $18.5 million, or
416%, to $23.0 million for the year ended March 31, 2000
from $4.5 million for the year ended March 31, 1999. In
 March 1999, we agreed to license our webMethods B2B
software to SAP AG to include in their software and to provide
SAP AG with development services. For this license and these
services, SAP AG agreed to pay to us a fixed license and
development fee payable in eleven quarterly installments
beginning with the quarter ended June 30, 1999. We are
recognizing revenue under this contract as the payments become
due in accordance with SOP 97-2. As a result, SAP AG accounted
for approximately 22% of our revenues during the year ended
March 31, 2000 and 12% for the quarter ended March 31,
2000.

License. License revenue increased by approximately
$11.8 million, or 318%, to $15.5 million for the year
ended March 31, 2000 from $3.7 million for the year
ended March 31, 1999. This increase is primarily
attributable to an increase in sales to new and existing
customers resulting from increased sales force headcount and a
growing acceptance of our webMethods B2B software. License
revenue from our relationship with SAP AG, which commenced in
March 1999, accounted for approximately $3.7 million,

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Professional Services. Professional services revenue
increased by approximately $4.6 million, or 790%, to
$5.2 million for the year ended March 31, 2000 from
$582,000 for the year ended March 31, 1999. This increase is
 attributable to the increased licensing activity described
above, which has resulted in increased customer implementation
activity and follow-on professional services.



Maintenance.Maintenance revenue increased by
approximately $2.2 million, or 1,247%, to $2.3 million
for the year ended March 31, 2000 from $173,000 for the year
 ended March 31, 1999. This increase is attributable to the
increased licensing activity described above. Because a majority
of the license contracts include post-contract maintenance and
support, an increased level of license revenue results in an
increased amount of maintenance revenue recognized ratably over
the term of the maintenance agreement. Maintenance revenue
attributable to the SAP AG relationship was approximately
$553,000, or 24%, of total maintenance revenue for the year ended
 March 31, 2000 and 14.6% for the quarter ended
March 31, 2000.

Cost of revenue

License.Cost of license revenue increased by
approximately $812,000, or 472%, to $984,000 for the year ended
March 31, 2000 from $172,000 for the year ended
March 31, 1999. This increase in the cost of licenses is
primarily due to the write-off of $318,000 of prepaid third party
 software licensing fees and, to a lesser extent, to higher
license fees paid to third party software developers and $205,000
 related to the provision for warranty obligations. During the
year ended March 31, 1999, we paid $590,000 to a third party
 for a 30-month license for two products to be embedded into our
software product offerings. During the year ended March 31,
2000, we developed a solution to replace the functionality of one
 of the third party products. As a result, we wrote off $318,000,
 representing the unamortized portion of the third party product
no longer being utilized in the product offering. Gross profit
margin on license revenue decreased to 94% for the year ended
March 31, 2000 compared to 95% for the year ended
March 31, 1999. This decrease was primarily due to the
expensing of $318,000 of third party software licensing fees in
the year ended March 31, 2000.

Professional Services and Maintenance.Cost of
professional services and maintenance increased by approximately
$7.2 million, or 1,501% to $7.7 million for the year
ended March 31, 2000 from $482,000 for the year ended
March 31, 2000. This increase is primarily attributable to
increases in the number of professional service and technical
support personnel, which increased to 59 people as of
March 31, 2000 from 5 people as of March 31, 1999.
 In addition, subcontractor, travel, and recruiting expenses
contributed to the increase in cost of professional services and
maintenance for the year ended March 31, 2000. Gross profit
margin on professional services and maintenance decreased to (3)%
 of professional services and maintenance revenue in the year
ended March 31, 2000 compared to 36% for the year ended
March 31, 1999.

Gross profit

Gross profit increased by approximately $10.5 million, or
276%, to $14.3 million for the year ended March 31,
2000 from $3.8 million for the year ended March 31,
1999. The increase is attributable to the growth in our customer
base, which contributed to increased revenue from software
licenses, professional services and maintenance. The gross profit
 margin was 62% for the year ended March 31, 1999 down from
85.3% for the year ended March 31, 1999. The reduction in
the gross profit margin is primarily attributable to the
increased proportion of professional services revenue, which
generates a lower margin than license revenue, during the year
ended March 31, 2000. The gross profit margin for the year
ended March 31,

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Operating expenses

Sales and Marketing.Sales and marketing expenses
increased by approximately $15.8 million, or 348%, to
$20.4 million for the year ended March 31, 2000 from
$4.6 million for the year ended March 31, 1999. The
increase in sales and marketing expenses is primarily
attributable to an increase in the number of sales and marketing
employees and, to a lesser extent, increases in marketing
programs. We believe that these expenses will continue to
increase in absolute dollar amounts in future periods as it
continues to expand its sales and marketing efforts.

Research and Development.Research and development
expenses increased by approximately $4.8 million, or 288%,
to $6.4 million for the year ended March 31, 2000 from
$1.7 million for the year ended March 31, 1999. The
increase in research and development expenses is attributable to
increases in the number of software development, pre-commercial
release quality assurance and documentation personnel and in
third-party development costs. We believe that continued
investment in research and development is critical to attaining
its strategic objectives, and, as a result, expect research and
development expenses to increase significantly in future periods.

General and Administrative.General and administrative
expenses increased by approximately $4.9 million, or 476%,
to $5.9 million for the year ended March 31, 2000 from
$1.0 million for the year ended March 31, 1999. This
increase is primarily attributable to increases in the number of
accounting and finance, human resources, and office
administration personnel. In addition, professional service fees,
 corporate insurance and other general corporate costs increased
to support organizational growth. We expect general and
administrative costs to continue to increase in absolute dollars
as we add personnel to support our expanding operations and incur
 additional costs related to the growth of our business.

Amortization of Deferred Stock Compensation.Certain
options granted during the year ended March 31, 2000 have
been treated as compensatory because the estimated fair value for
 accounting purposes was greater than the exercise price as
determined by our Board of Directors on the date of grant. The
total deferred stock compensation associated with these options
as of March 31, 2000 amounted to approximately
$9.3 million, net of amortization. Of the total deferred
stock compensation, approximately $1.8 million was amortized
 in the year ended March 31, 2000. These amounts are being
amortized over the respective vesting periods of these equity
arrangements, generally 48 months.

Interest income, net

Interest income, net increased by approximately
$1.9 million, or 1,451%, to $2.1 million for the year
ended March 31, 2000 from $134,000 for the year ended
March 31, 1999. This increase is attributable to increases
in interest income that resulted from the approximately
$169.4 million in net cash proceeds that we generated from
the issuance of common stock in our initial public offering and
the concurrent private placement in February 2000.

Fiscal Year Ended March 31, 1999 compared to Fiscal
Year Ended March 31, 1998

Revenue

Total revenue increased by approximately $4.3 million, or
2,588%, to $4.5 million in fiscal 1999, from $166,000 in fiscal
1998 as we first shipped webMethods B2B at the end of the first
quarter of fiscal 1999. During fiscal 1999, two customers
accounted for an aggregate of approximately 23% of our total
revenue. Telstra accounted for approximately 13% and Object
Design accounted for approximately 10% of total revenue. In
fiscal 1998, Ericsson, Cisco Systems, JP Morgan and AnswerThink
Consulting Group accounted for an aggregate of approximately 63%
of our total revenue.

License.License revenue increased by approximately
$3.6 million, or 3,644%, to $3.7 million in fiscal 1999
 from $99,000 in fiscal 1998. This increase is primarily
attributable to the initial shipment of

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Professional Services.Professional services revenue
increased approximately $525,000, or 921%, to $582,000 in fiscal
1999 from $57,000 in fiscal 1998. This increase is
attributable to the increased license activity described above
which resulted in customer implementation activity and follow-on
professional services.

Maintenance.Maintenance revenue increased by
approximately $163,000, or 1,630%, to $173,000 in fiscal 1999
from $10,000 in fiscal 1998. This increase is attributable to the
 increased licensing activity described above.

Cost of revenue

License.Cost of license revenue increased to $172,000 in
fiscal 1999 from $0 in fiscal 1998. This increase in
the cost of licenses is due to license fees paid to third party
software developers for software included in our software and
provisions for warranty obligations. Gross profit margin on
license revenue decreased to 95% in fiscal 1999 compared to 100%
in fiscal 1998. This decrease was attributable to fiscal 1999
costs associated with the above mentioned license fees and
warranty obligations, neither of which were incurred in fiscal
1998.

Professional Services and Maintenance.Cost of
professional services and maintenance increased to $482,000 in
fiscal 1999 from $0 in fiscal 1998. This increase is
primarily attributable to increases in the number of professional
 service and technical support personnel, which increased to five
 people at March 31, 1999 from none at March 31, 1998.
Gross profit margin on professional services and maintenance
decreased to 36% of professional services and maintenance revenue
 in fiscal 1999 compared to 100% in fiscal 1998. The margin on
professional services and maintenance declined due to the costs
incurred in expanding the professional services and customer care
 organization.

Gross profit

Gross profit increased by approximately $3.6 million, or
2,194%, to $3.8 million in fiscal 1999 from $166,000 in
fiscal 1998. The increase is attributable to the growth in our
customer base, which contributed to increased revenue from
software licenses, professional services and maintenance. The
gross profit margin was 85.3% for the year ended March 31,
1999, down from 100% for the year ended March 31, 1998. The
reduction in the gross profit margin is attributable to the
increased proportion of professional services revenue, which
generates a lower margin than license revenue, during the year
ended March 31, 1999.

Operating expenses

Sales and Marketing.Sales and marketing expenses
increased by approximately $3.9 million, or 553%, to
$4.6 million in fiscal 1999 from $697,000 in fiscal 1998.
The increase in the total amount of sales and marketing expenses
is primarily attributable to an increase in the number of sales
and marketing employees and, to a lesser extent, increases in
marketing programs.

Research and Development.Research and development
expenses increased by approximately $1.1 million, or 191%,
to $1.7 million in fiscal 1999 from $569,000 in fiscal 1998.
 The increase in the total amount of research and development
expenses is attributable to increases in the number of software
developers and pre-commercial release quality assurance and
documentation personnel.

General and Administrative.General and administrative
expenses increased by approximately $745,000, or 260%, to
$1.0 million in fiscal 1999 from $287,000 in fiscal 1998.
This increase is primarily attributable to increases in the
number of administrative and professional services personnel and
other general corporate expenses as we grew from 17 employees as
of March 31, 1998 to 65 employees as of March 31,
1999.

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Interest income, net

Interest income, net increased by approximately $110,000, or
458%, to $134,000 in fiscal 1999 from $24,000 in fiscal 1998.
This increase is attributable to increases in interest income,
which resulted from approximately $6.4 million in net cash
proceeds we generated from the issuance of mandatorily
redeemable, convertible preferred stock in September 1998.

Quarterly results of operations

The following tables set forth consolidated statement of
operations data for webMethods for each of the eight quarters
ended March 31, 2000, as well as that data expressed as a
percentage of the total revenue for the quarter presented. This
information has been derived from our unaudited consolidated
financial statements. The unaudited consolidated financial
statements have been prepared on the same basis as the audited
consolidated financial statements contained in Section 8 of
this report and include all adjustments, consisting only of
normal recurring adjustments that we consider necessary for a
fair presentation of such information. You should read this
information in conjunction with our annual audited consolidated
financial statements and related notes appearing in
Section 8 of this report. You should not draw any
conclusions about our future results from the results of
operations for any quarter.

|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |     |       | 
|------------------------ | ------------------------------------------- | ------------------------ | ------ | -------- | ------ | --------- | ------ | -------- | ----- | -------- | ------ | -------- | ----- | --------- | ----- | -------- | ----- | - | ----- | ----- | ----- | - | ---- | ----- | ----- | - | ---- | --- | ----- | - | ---- | --- | ----- | 
|                         |                                             |                         
|                         |                                             | Three Months Ended      
|                         |                                             |                         
|                         |                                             | Mar. 31,                 |        | Dec. 31, |        | Sept. 30, |        | June 30, |       | Mar. 31, |        | Dec. 31, |       | Sept. 30, |       | June 30,
|                         |                                             | 2000                     |        | 1999     |        | 1999      |        | 1999     |       | 1999     |        | 1998     |       | 1998      |       | 1998    
|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |         
|                         |                                             |                         
|                         |                                             | (in thousands)          
|                        
|                        
|                        
|                        
|Revenue:                 |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|                        
|                        
|                        
|                        
|                         | License                                     |                          | $      | 6,663    |        |           | $      | 3,959    |       |          | $      | 2,719    |       |           | $     | 2,154    |       |   | $     | 1,777 |       |   | $    | 1,064 |       |   | $    | 633 |       |   | $    | 233 |      
|                        
|                        
|                        
|                        
|                         | Professional services                       |                          |        | 2,759    |        |           |        | 1,122    |       |          |        | 732      |       |           |       | 564      |       |   |       | 386   |       |   |      | 93    |       |   |      | 72  |       |   |      | 31  |      
|                        
|                        
|                        
|                        
|                         | Maintenance                                 |                          |        | 955      |        |           |        | 657      |       |          |        | 397      |       |           |       | 321      |       |   |       | 91    |       |   |      | 51    |       |   |      | 21  |       |   |      | 10  |      
|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|                         |                                             | Total revenue            |        |          | 10,377 |           |        |          | 5,738 |          |        |          | 3,848 |           |       |          | 3,039 |   |       |       | 2,254 |   |      |       | 1,208 |   |      |     | 726   |   |      |     | 274   | 
|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|Cost of revenue:         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|                        
|                        
|                        
|                        
|                         | License                                     |                          |        | 334      |        |           |        | 245      |       |          |        | 324      |       |           |       | 81       |       |   |       | 98    |       |   |      | 53    |       |   |      | 14  |       |   |      | 7   |      
|                        
|                        
|                        
|                        
|                         | Professional services and maintenance       |                          |        | 4,282    |        |           |        | 2,101    |       |          |        | 894      |       |           |       | 440      |       |   |       | 233   |       |   |      | 177   |       |   |      | 43  |       |   |      | 29  |      
|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|                         |                                             | Total cost of revenue    |        |          | 4,616  |           |        |          | 2,346 |          |        |          | 1,218 |           |       |          | 521   |   |       |       | 331   |   |      |       | 230   |   |      |     | 57    |   |      |     | 36    | 
|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|Gross profit             |                                             |                          | 5,761  |          |        |           | 3,392  |          |       |          | 2,630  |          |       |           | 2,518 |          |       |   | 1,923 |       |       |   | 978  |       |       |   | 669  |     |       |   | 238  |    
|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|Operating expenses:      |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|                        
|                        
|                        
|                        
|                         | Sales and marketing                         |                          |        | 8,928    |        |           |        | 5,288    |       |          |        | 3,987    |       |           |       | 2,163    |       |   |       | 1,814 |       |   |      | 1,291 |       |   |      | 821 |       |   |      | 625 |      
|                        
|                        
|                        
|                        
|                         | Research and development                    |                          |        | 2,461    |        |           |        | 1,736    |       |          |        | 1,561    |       |           |       | 661      |       |   |       | 579   |       |   |      | 458   |       |   |      | 361 |       |   |      | 257 |      
|                        
|                        
|                        
|                        
|                         | General and administrative                  |                          |        | 2,167    |        |           |        | 1,692    |       |          |        | 1,392    |       |           |       | 689      |       |   |       | 496   |       |   |      | 222   |       |   |      | 175 |       |   |      | 139 |      
|                        
|                        
|                        
|                        
|                         | Amortization of deferred stock compensation |                          |        | 1,386    |        |           |        | 381      |       |          |        |         |       |           |       |         |       |   |       |      |       |   |      |      |       |   |      |    |       |   |      |    |      
|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|                         |                                             | Total operating expenses |        |          | 14,942 |           |        |          | 9,097 |          |        |          | 6,940 |           |       |          | 3,513 |   |       |       | 2,889 |   |      |       | 1,971 |   |      |     | 1,357 |   |      |     | 1,021 | 
|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|Operating loss           |                                             |                          | (9,181 | )        |        |           | (5,705 | )        |       |          | (4,310 | )        |       |           | (995  | )        |       |   | (966  | )     |       |   | (993 | )     |       |   | (688 | )   |       |   | (783 | )  
|                        
|                        
|                        
|                        
|Interest income, net     |                                             |                          | 1,511  |          |        |           | 251    |          |       |          | 217    |          |       |           | 101   |          |       |   | 51    |       |       |   | 64   |       |       |   | 2    |     |       |   | 17   |    
|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|Loss before income taxes |                                             | $                        | (7,670 | )        |        | $         | (5,454 | )        |       | $        | (4,093 | )        |       | $         | (894  | )        |       | $ | (915  | )     |       | $ | (929 | )     |       | $ | (686 | )   |       | $ | (766 | )  
|                        
|                        
|                        
|                        
|Deferred tax provision   |                                             |                          | 46     |          |        |           |       |          |       |          |       |          |       |           |      |          |       |   |      |       |       |   |     |       |       |   |     |     |       |   |     |    
|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    
|Net loss                 |                                             | $                        | (7,716 | )        |        | $         | (5,454 | )        |       | $        | (4,093 | )        |       | $         | (894  | )        |       | $ | (915  | )     |       | $ | (929 | )     |       | $ | (686 | )   |       | $ | (766 | )  
|                         |                                             |                          |        |          |        |           |        |          |       |          |        |          |       |           |       |          |       |   |       |       |       |   |      |       |       |   |      |     |       |   |      |    

|         |                       |                                  |  |          |       |           |  |          |       |          |  |          |       |           |  |          |       |  |  |      |       |  |  |      |       |  |  |      |       |  |  |      |       | 
|-------- | --------------------- | -------------------------------- |  | -------- | ----- | --------- |  | -------- | ----- | -------- |  | -------- | ----- | --------- |  | -------- | ----- |  |  | ---- | ----- |  |  | ---- | ----- |  |  | ---- | ----- |  |  | ---- | ----- | 
|         |                       |                                 
|         |                       | As a Percentage of Total Revenue
|         |                       |                                 
|         |                       | Mar. 31,                         |  | Dec. 31, |       | Sept. 30, |  | June 30, |       | Mar. 31, |  | Dec. 31, |       | Sept. 30, |  | June 30,
|         |                       | 2000                             |  | 1999     |       | 1999      |  | 1999     |       | 1999     |  | 1998     |       | 1998      |  | 1998    
|         |                       |                                  |  |          |       |           |  |          |       |          |  |          |       |           |  |         
|Revenue: |                       |                                  |  |          |       |           |  |          |       |          |  |          |       |           |  |          |       |  |  |      |       |  |  |      |       |  |  |      |       |  |  |     
|        
|        
|        
|        
|         | License               |                                  |  | 64.2     | %     |           |  | 69.0     | %     |          |  | 70.7     | %     |           |  | 70.9     | %     |  |  | 78.9 | %     |  |  | 88.1 | %     |  |  | 87.2 | %     |  |  | 85.0 | %    
|        
|        
|        
|        
|         | Professional services |                                  |  | 26.6     |       |           |  | 19.6     |       |          |  | 19.0     |       |           |  | 18.6     |       |  |  | 17.1 |       |  |  | 7.7  |       |  |  | 9.9  |       |  |  | 11.3 |      
|        
|        
|        
|        
|         | Maintenance           |                                  |  | 9.2      |       |           |  | 11.4     |       |          |  | 10.3     |       |           |  | 10.5     |       |  |  | 4.0  |       |  |  | 4.2  |       |  |  | 2.9  |       |  |  | 3.7  |      
|         |                       |                                  |  |          |       |           |  |          |       |          |  |          |       |           |  |          |       |  |  |      |       |  |  |      |       |  |  |      |       |  |  |     
|         |                       | Total revenue                    |  |          | 100.0 |           |  |          | 100.0 |          |  |          | 100.0 |           |  |          | 100.0 |  |  |      | 100.0 |  |  |      | 100.0 |  |  |      | 100.0 |  |  |      | 100.0 | 
|         |                       |                                  |  |          |       |           |  |          |       |          |  |          |       |           |  |          |       |  |  |      |       |  |  |      |       |  |  |      |       |  |  |     

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|                         |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |          |       |  |       |      |       |  |       |       |       |  |       |       |       |  |        |       |       | 
|------------------------ | ------------------------------------------- | -------------------------------- | ----- | -------- | ----- | --------- | ----- | -------- | ----- | -------- | ------ | -------- | ----- | --------- | ----- | -------- | ----- |  | ----- | ---- | ----- |  | ----- | ----- | ----- |  | ----- | ----- | ----- |  | ------ | ----- | ----- | 
|                         |                                             |                                 
|                         |                                             | As a Percentage of Total Revenue
|                         |                                             |                                 
|                         |                                             | Mar. 31,                         |       | Dec. 31, |       | Sept. 30, |       | June 30, |       | Mar. 31, |        | Dec. 31, |       | Sept. 30, |       | June 30,
|                         |                                             | 2000                             |       | 1999     |       | 1999      |       | 1999     |       | 1999     |        | 1998     |       | 1998      |       | 1998    
|                         |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |         
|Cost of revenue:         |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |          |       |  |       |      |       |  |       |       |       |  |       |       |       |  |        |      
|                        
|                        
|                        
|                        
|                         | License                                     |                                  |       | 3.2      |       |           |       | 4.3      |       |          |        | 8.5      |       |           |       | 2.7      |       |  |       | 4.3  |       |  |       | 4.4   |       |  |       | 2.0   |       |  |        | 2.5   |      
|                        
|                        
|                        
|                        
|                         | Professional services and maintenance       |                                  |       | 41.3     |       |           |       | 36.6     |       |          |        | 23.2     |       |           |       | 14.4     |       |  |       | 10.4 |       |  |       | 14.6  |       |  |       | 5.9   |       |  |        | 10.6  |      
|                         |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |          |       |  |       |      |       |  |       |       |       |  |       |       |       |  |        |      
|                         |                                             | Total cost of revenue            |       |          | 44.5  |           |       |          | 40.9  |          |        |          | 31.7  |           |       |          | 17.1  |  |       |      | 14.7  |  |       |       | 19.0  |  |       |       | 7.9   |  |        |       | 13.1  | 
|                         |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |          |       |  |       |      |       |  |       |       |       |  |       |       |       |  |        |      
|Gross profit             |                                             |                                  | 55.5  |          |       |           | 59.1  |          |       |          | 68.3   |          |       |           | 82.9  |          |       |  | 85.3  |      |       |  | 81.0  |       |       |  | 92.1  |       |       |  | 86.9   |      
|                         |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |          |       |  |       |      |       |  |       |       |       |  |       |       |       |  |        |      
|Operating expenses:      |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |          |       |  |       |      |       |  |       |       |       |  |       |       |       |  |        |      
|                        
|                        
|                        
|                        
|                         | Sales and marketing                         |                                  |       | 86.0     |       |           |       | 92.2     |       |          |        | 103.6    |       |           |       | 71.2     |       |  |       | 80.5 |       |  |       | 106.9 |       |  |       | 113.1 |       |  |        | 228.1 |      
|                        
|                        
|                        
|                        
|                         | Research and development                    |                                  |       | 23.7     |       |           |       | 30.2     |       |          |        | 40.6     |       |           |       | 21.8     |       |  |       | 25.7 |       |  |       | 37.9  |       |  |       | 49.7  |       |  |        | 93.8  |      
|                        
|                        
|                        
|                        
|                         | General and administrative                  |                                  |       | 20.9     |       |           |       | 29.5     |       |          |        | 36.1     |       |           |       | 22.6     |       |  |       | 22.0 |       |  |       | 18.4  |       |  |       | 24.1  |       |  |        | 50.7  |      
|                        
|                        
|                        
|                        
|                         | Amortization of deferred stock compensation |                                  |       | 13.4     |       |           |       | 6.6      |       |          |        |         |       |           |       |         |       |  |       |     |       |  |       |      |       |  |       |      |       |  |        |      |      
|                         |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |          |       |  |       |      |       |  |       |       |       |  |       |       |       |  |        |      
|                         |                                             | Total operating expenses         |       |          | 144.0 |           |       |          | 158.5 |          |        |          | 180.3 |           |       |          | 115.6 |  |       |      | 128.2 |  |       |       | 163.2 |  |       |       | 186.9 |  |        |       | 372.6 | 
|                         |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |          |       |  |       |      |       |  |       |       |       |  |       |       |       |  |        |      
|Operating loss           |                                             |                                  | (88.5 | )        |       |           | (99.4 | )        |       |          | (112.0 | )        |       |           | (32.7 | )        |       |  | (42.9 | )    |       |  | (82.2 | )     |       |  | (94.8 | )     |       |  | (285.7 | )    
|                        
|                        
|                        
|                        
|Interest income, net     |                                             |                                  | 14.6  |          |       |           | 4.4   |          |       |          | 5.6    |          |       |           | 3.3   |          |       |  | 2.3   |      |       |  | 5.3   |       |       |  | .3    |       |       |  | 6.2    |      
|                         |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |          |       |  |       |      |       |  |       |       |       |  |       |       |       |  |        |      
|Loss before income taxes |                                             |                                  | (73.9 | )%       |       |           | (95.0 | )%       |       |          | (106.4 | )%       |       |           | (29.4 | )%       |       |  | (40.6 | )%   |       |  | (76.9 | )%    |       |  | (94.5 | )%    |       |  | (279.5 | )%   
|                        
|                        
|                        
|                        
|Deferred tax provision   |                                             |                                  | .5    |          |       |           |      |          |       |          |       |          |       |           |      |          |       |  |      |      |       |  |      |       |       |  |      |       |       |  |       |      
|                         |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |          |       |  |       |      |       |  |       |       |       |  |       |       |       |  |        |      
|Net loss                 |                                             |                                  | (74.4 | )%       |       |           | (95.0 | )%       |       |          | (106.4 | )%       |       |           | (29.4 | )%       |       |  | (40.6 | )%   |       |  | (76.9 | )%    |       |  | (94.5 | )%    |       |  | (279.5 | )%   
|                         |                                             |                                  |       |          |       |           |       |          |       |          |        |          |       |           |       |          |       |  |       |      |       |  |       |       |       |  |       |       |       |  |        |      

Our total revenue has increased in each quarter since it released
 webMethods B2B in June 1998. The quarterly increase is due
to growth in the number of customers resulting from increased
market awareness and acceptance of webMethods software,
expansion of the companys sales organization and an
increase in professional services and maintenance revenue that
reflects the growth in the installed base of product licenses.

The cost of revenue has increased each quarter in conjunction
with increases in total revenue. Cost of license revenue
decreased during the quarter ended June 30, 1999 due to the
modification of a third-party software license agreement, and
increased in the quarter ended September 30, 1999 due to a
write-off of $235,000 included in the previously mentioned
$318,000 write-off of prepaid third-party software licensing
fees. The contract modification in the quarter ended
June 30, 1999 resulted in a prepaid fixed licensing fee that
 is being amortized over the estimated useful life of the
license. The original licensing arrangement established a defined
 royalty to be paid based on the type and quantity of software
licenses sold by us. Cost of professional services and
maintenance increased due to the expansion of the professional
services and customer care organizations and increased
subcontractor costs.

Operating expenses have generally increased in absolute dollars
each quarter because of increased staffing in sales and
marketing, research and development and general and
administrative functions. In addition, sales and marketing
expenses have increased due to increases in marketing programs,
sales commissions, sales office expenses and expansion into
Europe in June 1999. In addition to costs related to
increased headcount, general and administrative expenses have
increased due to increases in legal, accounting and other
professional fees.

Provision for income taxes

We recorded a provision for income taxes of $46,000 for the year
ended March 31, 2000, which relates to the write-off of the
deferred tax asset recorded in connection with the unrealized
holding losses on marketable securities available for sale, no
other provisions for income taxes has been recorded as we have
incurred operating losses since inception. We have recorded a
valuation allowance for the full amount of our net deferred tax
assets, as the realizability of the deferred tax assets is not
currently predictable.

As of March 31, 2000, we had net operating loss
carry-forwards of approximately $12.1 million. These net
operating loss carryforwards are available to reduce future
taxable income and begin to expire in fiscal 2012. Under the
provisions of the Internal Revenue Code, certain substantial
changes in our ownership

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##### Table of Contents





Liquidity and capital resources

We have financed our operations through an initial public
offering of our common stock which was completed on
February 10, 2000, private sales of mandatorily redeemable,
convertible preferred stock, resulting in net proceeds from
inception to March 31, 2000, of approximately
$38.7 million, and, to a lesser extent, through bank loans
and equipment leases. As of March 31, 2000, we had
approximately $156.8 million in cash and cash equivalents,
approximately $8.3 million in short-term investments,
approximately $32.6 million in long-term investments and
approximately $154.3 million in working capital.

Net cash used in operating activities was approximately $784,000
in fiscal 2000, approximately $4.0 million in fiscal 1999,
approximately $1.3 million in fiscal 1998 and $221,000 in
fiscal 1997. Net cash flows from operating activities in each
period reflect increasing net losses and, to a lesser extent,
increases in accounts receivable offset in part by increases in
accounts payable, accrued expenses and accrued compensation. In
fiscal 1997, net cash flow from operating activities was also
offset by the non-cash expense related to intellectual property.
Net cash used in operating activities for the year ended
March 31, 2000 reflects an increase of approximately
$13.9 million of deferred revenue from customer payments
that were not recognized as revenue.

Net cash used in investing activities was approximately
$43.8 million in fiscal 2000, approximately
$1.9 million in fiscal 1999, $81,000 in fiscal 1998, $21,000
 in fiscal 1997. Cash used in investing activities reflects
purchases of property and equipment in each period, and purchases
 of marketable securities available for sale in fiscal 1999 and
fiscal 2000. Capital expenditures were approximately
$3.2 million in fiscal 2000, approximately $385,000 in
fiscal 1999, approximately $81,000 in fiscal 1998 and
approximately $21,000 in fiscal 1997. Capital expenditures
consisted of purchases of operating resources to manage
operations, including computer hardware and software, office
furniture and equipment and leasehold improvements. Since
inception we have generally funded capital expenditures either
through capital leases, the use of working capital, or bank
loans. We expect that our capital expenditures will continue to
increase in the future. In connection with the relocation of
corporate headquarters in March 2000, we incurred
approximately $1.6 million in leasehold improvements and
furniture and equipment purchases.

Net cash from financing activities was approximately
$198.2 million in fiscal 2000, approximately
$6.7 million in fiscal 1999, approximately $3.6 million
 in fiscal 1998 and approximately $435,000 in 1997. These
cash flows primarily reflect net cash proceeds from private sales
 of mandatorily redeemable, convertible preferred stock in
fiscal 1999, fiscal 1998 and the year ended
March 31, 2000. In addition, we received an additional
$165 million in net proceeds from the issuance of common
stock from our initial public offering in February 2000 and
$17.5 million in proceeds from the sale of shares of common
stock issued in a private transaction concurrent with the closing
 of our initial public offering. Cash from financing activities
in fiscal 1997 primarily reflects net proceeds from private
sales of common stock. We have an outstanding balance of $153,000
 as of March 31, 2000 under a credit agreement. This loan
bears interest at the banks prime rate plus 1.5% per annum
and is secured by substantially all of our assets. In
December 1999 we entered into a new revolving promissory
note to borrow up to a maximum principal amount of $3,000,000
with a maturity date of December 2, 2000. Borrowings under
this note are limited to a borrowing base of 75% of eligible
accounts receivable. This note bears interest at the banks
prime rate plus 1% per annum. As of March 31, 2000, we had
not borrowed against this revolving promissory note. In
connection with the revolving promissory note, we obtained a
letter of credit totaling $750,000 which expires in
June 2001 and relates to the new office lease.

We expect to experience significant growth in our operating
expenses, particularly research and development and sales and
marketing expenses, for the foreseeable future in order to
execute our business plan. As a result, we anticipate that such
operating expenses, as well as planned capital expenditures, will
 constitute a material use of its cash resources. In addition, we
 may utilize cash resources to fund acquisitions or investments
in complementary businesses, technologies or product lines. We
believe that

35



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##### Table of Contents





Recently Issued Accounting Pronouncements

In December 1999, the Securities and Exchange Commission
(SEC) released Staff Accounting Bulletin
(SAB) No. 101, Revenue Recognition in
Financial Statements, which provides guidance on the
recognition, presentation and disclosure of revenue in financial
statements filed with the SEC. Subsequently, the SEC released
SAB 101A, which delayed the implementation date of
SAB 101 for registrants with fiscal years that begin between
 December 16, 1999 and March 15, 2000. We are required
to conform with the provisions of SAB 101, as amended by SAB
 101A, no later than April 1, 2000 and do not expect a
material effect on our financial position, results of operations
or cash flows as a result of SAB 101.

In June 1999, the Financial Accounting Standards Board
(FASB) issued SFAS No. 137, which delays the
effective date of SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, which will
be effective for our fiscal year 2001. This statement
establishes accounting and reporting standards requiring that
every derivative instrument, including certain derivative
instruments embedded in other contracts, be recorded in the
balance sheet as either an asset or liability measured at its
fair value. The statement also requires that changes in the
derivatives fair value be recognized in earnings unless
specific hedge accounting criteria are met. We have not entered
into derivative contracts and do not have near term plans to
enter into derivative contracts, accordingly the adoption of SFAS
 No. 133 and SFAS No. 137 is not expected to have a
material effect on our financial statements.

In March 2000, FASB issued Interpretation
(FIN) No. 44, Accounting for Certain Transactions
 Involving Stock Compensation  An Interpretation of
APB Opinion No. 25. FIN 44 clarifies the
application of APB Opinion No. 25 and, among other
issues, clarifies the following: the definition of an employee
for purposes of applying APB Opinion No. 25; the
criteria for determining whether a plan qualifies as a
non-compensatory plan; the accounting consequence of various
modifications to the terms of previously fixed stock options or
awards; and the accounting for an exchange of stock compensation
awards in a business combination. FIN 44 is effective
July 1, 2000, but certain conclusions in FIN 44 cover
specific events that occurred after either December 15, 1998
 or January 12, 2000. We do not expect the application of
FIN 44 to have a material impact on our financial position or
results of operations.

Item 7a.  QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK

Qualitative and Quantitative Disclosures about Market Risk

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

Interest rate risk.We maintain our funds in money market
and certificate of deposit accounts at financial institutions.
Our exposure to market risk due to fluctuations in interest rates
 relates primarily to its interest earnings on its cash deposits.
 These securities are subject to interest rate risk in as much as
 their fair value will fall if market interest rates increase. If
 market interest rates were to increase immediately and uniformly
 by 10% from the levels prevailing as of March 31, 2000, the
 fair value of the portfolio would not decline by a material
amount. We do not use derivative financial instruments to
mitigate risks. However, we do have an investment policy that
would allow us to invest in short-term and long-term investments
such as money market instruments and corporate debt securities.
Our policy attempts to reduce such risks by typically limiting
the maturity date of such securities to no more than twenty-four
months with a maximum average maturity to its whole portfolio of
such investments at twelve months, placing its investments with
high credit quality issuers and limiting the amount of credit
exposure with any one issuer.

36



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##### Table of Contents



Foreign currency exchange rate risk.Our exposure to
market risk due to fluctuations in foreign currency exchange
rates relates primarily to the intercompany balances with its UK,
 Netherland and German subsidiaries. Although we transact
business in various foreign countries, settlement amounts are
usually based on U.S. currency. Transaction gains or losses
have not been significant in the past, and there is no hedging
activity on foreign currencies. We would not experience a
material foreign exchange loss based on a hypothetical 10%
adverse change in the price of the pound, guilders or deutsche
mark against the U.S. dollar. Consequently, we do not expect
 that a reduction in the value of such accounts denominated in
foreign currencies resulting from even a sudden or significant
fluctuation in foreign exchange rates would have a direct
material impact on our financial position, results of operations
or cash flows.

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

37



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##### Table of Contents






Item 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY
 DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                                                                        |  |      |    | 
|----------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|                                                                                                                        |  | Page
|                                                                                                                        |  |     
|webMethods audited financial statements                                                                                |  |      |    | 
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|Report of Independent Accountants                                                                                       |  |      | 39 | 
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|Consolidated Balance Sheets at March 31, 2000 and 1999                                                                  |  |      | 40 | 
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|Consolidated Statements of Operations and Comprehensive Loss for
	the years ended March 31, 2000, 1999 and 1998         |  |      | 41 | 
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|Consolidated Statements of Changes in Stockholders Equity
	(Deficit) for the years ended March 31, 2000, 1999 and 1998 |  |      | 42 | 
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|Consolidated Statements of Cash Flows for the years ended
	March 31, 2000, 1999 and 1998                                |  |      | 43 | 
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|                                                                                                                       
|Notes to Consolidated Financial Statements                                                                              |  |      | 44 | 

38



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##### Table of Contents



REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and Stockholders of 
 webMethods, Inc.

In our opinion, the accompanying consolidated balance sheets and
the related consolidated statements of operations and
comprehensive loss, changes in stockholders equity
(deficit) and cash flows present fairly, in all material
respects, the financial position of webMethods, Inc. and its
subsidiaries at March 31, 2000 and 1999, and the results of
their operations and their cash flows for each of the three years
 in the period ended March 31, 2000 in conformity with
accounting principles generally accepted in the United States.
These financial statements are the responsibility of the
Companys management; our responsibility is to express an
opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States, which
 require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used
and significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed
above.



| |                               
| | ------------------------------
| | /s/ PRICEWATERHOUSECOOPERS LLP

McLean, Virginia




39



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##### Table of Contents



WEBMETHODS, INC.

CONSOLIDATED BALANCE SHEETS

|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |            |            |  
|--------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------- | ---------- | ----------- | ----------- |  | --------- | ---------- | ---------- | -
|                                                                                        |                                                                                                                       |                                                                                              
|                                                                                        |                                                                                                                       | March 31,                                                                                    
|                                                                                        |                                                                                                                       |                                                                                              
|                                                                                        |                                                                                                                       | 2000                                                                                          |            | 1999       
|                                                                                        |                                                                                                                       |                                                                                               |            |            
|ASSETS                                                                                  |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Current assets:                                                                         |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Cash and cash equivalents                                                                                             |                                                                                               | $          | 156,778,409 |             |  | $         | 3,128,500  |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Marketable securities available for sale                                                                              |                                                                                               |            | 8,339,660   |             |  |           | 254,850    |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Accounts receivable, net of allowances of $801,000 and $117,000,
	respectively                                        |                                                                                               |            | 6,782,822   |             |  |           | 2,497,589  |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Prepaid expenses and other current assets                                                                             |                                                                                               |            | 4,984,428   |             |  |           | 339,838    |           
|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                        |                                                                                                                       | Total current assets                                                                          |            |             | 176,885,319 |  |           |            | 6,220,777  |  
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Marketable securities available for sale                                                |                                                                                                                       |                                                                                               | 32,637,889 |             |             |  | 1,269,408 |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Property and equipment, net                                                             |                                                                                                                       |                                                                                               | 3,746,783  |             |             |  | 398,403   |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Other assets                                                                            |                                                                                                                       |                                                                                               | 3,029,940  |             |             |  | 541,692   |           
|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                        |                                                                                                                       | Total assets                                                                                  |            | $           | 216,299,931 |  |           | $          | 8,430,280  |  
|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|LIABILITIES, MANDATORILY REDEEMABLE PREFERRED STOCK AND
	STOCKHOLDERS EQUITY (DEFICIT) |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Current liabilities:                                                                    |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Accounts payable                                                                                                      |                                                                                               | $          | 2,041,323   |             |  | $         | 304,989    |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Accrued expenses                                                                                                      |                                                                                               |            | 4,653,664   |             |  |           | 561,912    |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Accrued salaries and commissions                                                                                      |                                                                                               |            | 5,152,392   |             |  |           | 504,872    |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Deferred revenue                                                                                                      |                                                                                               |            | 10,475,945  |             |  |           | 886,394    |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Current portion of capital lease obligations                                                                          |                                                                                               |            | 148,026     |             |  |           |           |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Line of credit                                                                                                        |                                                                                               |            | 153,054     |             |  |           | 247,275    |           
|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                        |                                                                                                                       | Total current liabilities                                                                     |            |             | 22,624,404  |  |           |            | 2,505,442  |  
|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                        | Capital lease obligations, net of current portion                                                                     |                                                                                               |            | 426,145     |             |  |           |           |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Long term deferred revenue                                                                                            |                                                                                               |            | 5,515,103   |             |  |           | 380,744    |           
|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                        |                                                                                                                       | Total liabilities                                                                             |            |             | 28,565,652  |  |           |            | 2,886,186  |  
|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|Commitments and contingencies                                                           |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|Mandatorily redeemable preferred stock:                                                 |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Convertible preferred stock, $0.01 par value, 650,477 
	shares authorized, issued and outstanding at March 31, 1999   |                                                                                               |            |            |             |  |           | 11,117,728 |           
|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|Stockholders equity (deficit):                                                         |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Common stock, $0.01 par value; 200,000,000 shares authorized;
	32,386,987 and 5,850,879 shares issued and outstanding |                                                                                               |            | 323,869     |             |  |           | 58,509     |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Additional paid-in capital                                                                                            |                                                                                               |            | 228,908,883 |             |  |           |           |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Deferred stock compensation                                                                                           |                                                                                               |            | (9,312,305  | )           |  |           |           |           
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Accumulated deficit                                                                                                   |                                                                                               |            | (32,095,877 | )           |  |           | (5,630,943 | )         
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                       
|                                                                                        | Accumulated other comprehensive loss                                                                                  |                                                                                               |            | (90,291     | )           |  |           | (1,200     | )         
|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                        |                                                                                                                       | Total stockholders equity (deficit)                                                          |            |             | 187,734,279 |  |           |            | (5,573,634 | )
|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |           
|                                                                                        |                                                                                                                       | Total liabilities, mandatorily redeemable preferred stock and
	stockholders equity (deficit) |            | $           | 216,299,931 |  |           | $          | 8,430,280  |  
|                                                                                        |                                                                                                                       |                                                                                               |            |             |             |  |           |           

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

40



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##### Table of Contents



WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |         |            |            |  
|----------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------- | -------------------------------------------------- | ---------- | ----------- | ----------- | ---------- | --------- | ---------- | ---------- | ---------- | ------- | ---------- | ---------- | -
|                                                                                    |                                                                                                                                  |                                             
|                                                                                    |                                                                                                                                  | Year Ended March 31,                        
|                                                                                    |                                                                                                                                  |                                             
|                                                                                    |                                                                                                                                  | 2000                                         |                                                    | 1999       |             | 1998       
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |            
|Revenue:                                                                            |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | License                                                                                                                          |                                              | $                                                  | 15,495,446 |             |             | $          | 3,707,224 |            |            | $          | 98,483  |           
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Professional services                                                                                                            |                                              |                                                    | 5,176,567  |             |             |            | 581,245   |            |            |            | 57,420  |           
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Maintenance                                                                                                                      |                                              |                                                    | 2,329,971  |             |             |            | 173,182   |            |            |            | 9,991   |           
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|                                                                                    |                                                                                                                                  |                                              | Total revenue                                      |            |             | 23,001,984  |            |           |            | 4,461,651  |            |         |            | 165,894    |  
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|Cost of revenue:                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | License                                                                                                                          |                                              |                                                    | 983,451    |             |             |            | 172,020   |            |            |            |        |           
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Professional services and maintenance (exclusive of amortization
	of deferred stock compensation of $428,864 at March 31,
	2000) |                                              |                                                    | 7,717,049  |             |             |            | 481,196   |            |            |            |        |           
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|                                                                                    |                                                                                                                                  |                                              | Total cost of revenue                              |            |             | 8,700,500   |            |           |            | 653,216    |            |         |            |           |  
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|Gross profit                                                                        |                                                                                                                                  |                                              | 14,301,484                                         |            |             |             | 3,808,435  |           |            |            | 165,894    |        
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|Operating expenses:                                                                 |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Sales and marketing (exclusive of amortization of deferred stock
	compensation of $855,014 at March 31, 2000)                    |                                              |                                                    | 20,366,194 |             |             |            | 4,551,381 |            |            |            | 696,187 |           
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Research and development (exclusive of amortization of deferred
	stock compensation of $303,746 at March 31, 2000)               |                                              |                                                    | 6,418,546  |             |             |            | 1,654,734 |            |            |            | 569,214 |           
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | General and Administrative (exclusive of amortization of deferred
	 stock compensation of $179,605 at March 31, 2000)            |                                              |                                                    | 5,940,165  |             |             |            | 1,031,884 |            |            |            | 287,036 |           
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    | Amortization of deferred stock compensation                                                                                      |                                              |                                                    | 1,767,229  |             |             |            |          |            |            |            |        |           
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|                                                                                    |                                                                                                                                  |                                              | Total operating expenses                           |            |             | 34,492,134  |            |           |            | 7,237,999  |            |         |            | 1,552,437  |  
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|Operating loss                                                                      |                                                                                                                                  |                                              | (20,190,650                                        | )          |             |             | (3,429,564 | )         |            |            | (1,386,543 | )      
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|Interest income, net                                                                |                                                                                                                                  |                                              | 2,079,807                                          |            |             |             | 133,288    |           |            |            | 23,869     |        
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|Loss before income taxes                                                            |                                                                                                                                  |                                              | (18,110,843                                        | )          |             |             | (3,296,276 | )         |            |            | (1,362,674 | )      
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|Deferred tax provision                                                              |                                                                                                                                  |                                              | (46,647                                            | )          |             |             |           |           |            |            |           |        
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|                                                                                    |                                                                                                                                  | Net loss                                     |                                                    |            | (18,157,490 | )           |            |           | (3,296,276 | )          |            |         | (1,362,674 | )         
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|Accretion and accrued dividends related to mandatorily redeemable
	 preferred stock |                                                                                                                                  |                                              | (10,222,510                                        | )          |             |             | (605,453   | )         |            |            | (112,792   | )      
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|                                                                                    |                                                                                                                                  | Net loss attributable to common shareholders |                                                    | $          | (28,380,000 | )           |            | $         | (3,901,729 | )          |            | $       | (1,475,466 | )         
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|Basic and diluted net loss per common share                                         |                                                                                                                                  | $                                            | (3.00                                              | )          |             | $           | (0.71      | )         |            | $          | (0.24      | )      
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|Shares used in computing basic and diluted net loss per common
	share               |                                                                                                                                  |                                              | 9,448,201                                          |            |             |             | 5,526,588  |           |            |            | 6,268,627  |        
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|Comprehensive loss:                                                                 |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    |                                                                                                                                  | Net loss                                     |                                                    | $          | (18,157,490 | )           |            | $         | (3,296,276 | )          |            | $       | (1,362,674 | )         
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    |                                                                                                                                  | Other comprehensive loss:                    |                                                    |            |             |             |            |           |            |            |            |         |            |           
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    |                                                                                                                                  |                                              | Unrealized loss on securities available for sale   |            |             | (74,679     | )          |           |            | (1,200     | )          |         |            |           |  
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                    |                                                                                                                                  |                                              | Foreign currency cumulative translation adjustment |            |             | (14,412     | )          |           |            |           |            |         |            |           |  
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        
|                                                                                    |                                                                                                                                  |                                              | Total comprehensive loss                           |            | $           | (18,246,581 | )          |           | $          | (3,297,476 | )          |         | $          | (1,362,674 | )
|                                                                                    |                                                                                                                                  |                                              |                                                    |            |             |             |            |           |            |            |            |        

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

41



---



##### Table of Contents



WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
EQUITY (DEFICIT)

for the years ended March 31, 1998, 1999 and 2000


|                                                                                                  |  |              |            |            |  |                |         |              |  |               |             |      |  |       |             |   |  |   |             |   |  |   |         |   |  |   |             |  
|------------------------------------------------------------------------------------------------- |  | ------------ | ---------- | ---------- |  | -------------- | ------- | ------------ |  | ------------- | ----------- | ---- |  | ----- | ----------- | - |  | - | ----------- | - |  | - | ------- | - |  | - | ----------- | -
|                                                                                                  |  |              |            |            |  |                |         |              |  | Accumulated   |             |     
|                                                                                                  |  | Common Stock |            | Additional |  |                |         |              |  | Other         |             |     
|                                                                                                  |  |              |            | Paid       |  | Deferred Stock |         | Accumulated  |  | Comprehensive |             |     
|                                                                                                  |  | Shares       |            | Amount     |  | in Capital     |         | Compensation |  | Deficit       |             | Loss |  | Total
|                                                                                                  |  |              |            |            |  |                |         |              |  |               |             |      |  |      
|Balance, March 31, 1997                                                                           |  |              | 6,898,684  |            |  | $              | 68,987  |              |  | $             | 486,120     |      |  |       |            |   |  | $ | (434,215    | ) |  |   |        |   |  | $ | 120,892     |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Exchange of common stock for Series A preferred stock                                             |  |              | (1,446,355 | )          |  |                | (14,464 | )            |  |               | (371,891    | )    |  |       |            |   |  |   |            |   |  |   |        |   |  |   | (386,355    | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Accretion of preferred stock                                                                      |  |              |           |            |  |                |        |              |  |               | (2,184      | )    |  |       |             |   |  |   |             |   |  |   |         |   |  |   | (2,184      | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Accrued dividends on preferred
	stock                                                             |  |              |           |            |  |                |        |              |  |               | (110,608    | )    |  |       |            |   |  |   |            |   |  |   |        |   |  |   | (110,608    | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Net loss                                                                                          |  |              |           |            |  |                |        |              |  |               |            |      |  |       |            |   |  |   | (1,362,674  | ) |  |   |        |   |  |   | (1,362,674  | )
|                                                                                                  |  |              |            |            |  |                |         |              |  |               |             |      |  |       |             |   |  |   |             |   |  |   |         |   |  |   |             |  
|Balance, March 31, 1998                                                                           |  |              | 5,452,329  |            |  |                | 54,523  |              |  |               | 1,437       |      |  |       |            |   |  |   | (1,796,889  | ) |  |   |        |   |  |   | (1,740,929  | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Stock options exercised                                                                           |  |              | 398,550    |            |  |                | 3,986   |              |  |               | 66,238      |      |  |       |            |   |  |   |            |   |  |   |        |   |  |   | 70,224      |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Accretion of preferred stock                                                                      |  |              |           |            |  |                |        |              |  |               | (13,166     | )    |  |       |            |   |  |   |            |   |  |   |        |   |  |   | (13,166     | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Accrued dividends on preferred stock                                                              |  |              |           |            |  |                |        |              |  |               | (54,509     | )    |  |       |            |   |  |   | (537,778    | ) |  |   |        |   |  |   | (592,287    | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Other comprehensive loss                                                                          |  |              |           |            |  |                |        |              |  |               |            |      |  |       |            |   |  |   |            |   |  |   | (1,200  | ) |  |   | (1,200      | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Net loss                                                                                          |  |              |           |            |  |                |        |              |  |               |            |      |  |       |            |   |  |   | (3,296,276  | ) |  |   |        |   |  |   | (3,296,276  | )
|                                                                                                  |  |              |            |            |  |                |         |              |  |               |             |      |  |       |             |   |  |   |             |   |  |   |         |   |  |   |             |  
|Balance, March 31, 1999                                                                           |  |              | 5,850,879  |            |  |                | 58,509  |              |  |               |            |      |  |       |            |   |  |   | (5,630,943  | ) |  |   | (1,200  | ) |  |   | (5,573,634  | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Stock options and warrants exercised                                                              |  |              | 2,019,377  |            |  |                | 20,193  |              |  |               | 390,886     |      |  |       |            |   |  |   |            |   |  |   |        |   |  |   | 411,079     |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Fair value of options issued to non-employees                                                     |  |              |           |            |  |                |        |              |  |               | 235,461     |      |  |       |            |   |  |   |            |   |  |   |        |   |  |   | 235,461     |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Deferred compensation related to stock option grants                                              |  |              |           |            |  |                |        |              |  |               | 11,079,534  |      |  |       | (11,079,534 | ) |  |   |            |   |  |   |        |   |  |   |            |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Amortization of deferred stock compensation                                                       |  |              |           |            |  |                |        |              |  |               |            |      |  |       | 1,767,229   |   |  |   |            |   |  |   |        |   |  |   | 1,767,229   |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Deemed dividend in connection with the beneficial conversion
	feature in Series E preferred stock |  |              |           |            |  |                |        |              |  |               | 8,307,444   |      |  |       |            |   |  |   | (8,307,444  | ) |  |   |        |   |  |   |            |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Accretion to redemption                                                                           |  |              |           |            |  |                |        |              |  |               | (43,573     | )    |  |       |            |   |  |   |            |   |  |   |        |   |  |   | (43,573     | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Accrued dividends on preferred stock                                                              |  |              |           |            |  |                |        |              |  |               | (1,871,493  | )    |  |       |            |   |  |   |            |   |  |   |        |   |  |   | (1,871,493  | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Issuance of common stock pursuant to the initial public offering                                  |  |              | 4,715,000  |            |  |                | 47,150  |              |  |               | 164,977,850 |      |  |       |            |   |  |   |            |   |  |   |        |   |  |   | 165,025,000 |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Issuance of common stock pursuant to the concurrent private
	placement                            |  |              | 518,058    |            |  |                | 5,181   |              |  |               | 17,494,819  |      |  |       |             |   |  |   |             |   |  |   |         |   |  |   | 17,500,000  |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Initial public offering and concurrent private placement issuance
	 costs                         |  |              |           |            |  |                |        |              |  |               | (13,158,338 | )    |  |       |            |   |  |   |            |   |  |   |        |   |  |   | (13,158,338 | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Conversion of preferred stock to common stock                                                     |  |              | 19,283,673 |            |  |                | 192,836 |              |  |               | 41,496,293  |      |  |       |            |   |  |   |            |   |  |   |        |   |  |   | 41,689,129  |  
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Other comprehensive loss                                                                          |  |              |            |            |  |                |        |              |  |               |            |      |  |       |             |   |  |   |             |   |  |   | (89,091 | ) |  |   | (89.091     | )
|                                                                                                 
|                                                                                                 
|                                                                                                 
|                                                                                                 
|Net loss                                                                                          |  |              |           |            |  |                |        |              |  |               |            |      |  |       |            |   |  |   | (18,157,490 | ) |  |   |        |   |  |   | (18,157,490 | )
|                                                                                                  |  |              |            |            |  |                |         |              |  |               |             |      |  |       |             |   |  |   |             |   |  |   |         |   |  |   |             |  
|Balance, March 31, 2000                                                                           |  |              | 32,386,987 |            |  | $              | 323,869 |              |  | $             | 228,908,883 |      |  | $     | (9,312,305  | ) |  | $ | (32,095,877 | ) |  | $ | (90,291 | ) |  | $ | 187,734,279 |  
|                                                                                                  |  |              |            |            |  |                |         |              |  |               |             |      |  |       |             |   |  |   |             |   |  |   |         |   |  |   |             |  

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

42



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##### Table of Contents



WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                 |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |            |           |  
|------------------------------------------------ | ------------------------------------------------------------------------------- | ---------------------------------------------------------------- | ----------- | ----------- | ----------- | ---- | --------- | ---------- | ---------- | - | --------- | ---------- | --------- | -
|                                                 |                                                                                 |                                                                 
|                                                 |                                                                                 | Year Ended March 31,                                            
|                                                 |                                                                                 |                                                                 
|                                                 |                                                                                 | 2000                                                             |             | 1999        |             | 1998
|                                                 |                                                                                 |                                                                  |             |             |             |     
|Cash flows from operating activities:            |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |           
|                                                
|                                                
|                                                
|                                                
|                                                 | Net loss                                                                        |                                                                  | $           | (18,157,490 | )           |      | $         | (3,296,276 | )          |   | $         | (1,362,674 | )        
|                                                
|                                                
|                                                
|                                                
|                                                 | Adjustments to reconcile net loss to net cash used in operating
	activities:    |                                                                  |             |             |             |      |           |            |            |   |           |            |          
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Depreciation and amortization                                    |             |             | 535,456     |      |           |            | 108,260    |   |           |            | 21,963    |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Provision for bad debts and returns                              |             |             | 523,343     |      |           |            | 105,000    |   |           |            | 13,708    |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Provision for warranty                                           |             |             | 204,737     |      |           |            |           |   |           |            |          |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Provision for deferred income taxes                              |             |             | 46,647      |      |           |            |           |   |           |            |          |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Expense related to fair value of options issued to non-employees |             |             | 235,461     |      |           |            |           |   |           |            |          |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Amortization of deferred stock compensation                      |             |             | 1,767,229   |      |           |            |           |   |           |            |          |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Loss on buyout of capital leases                                 |             |             |            |      |           |            | 10,226     |   |           |            |          |  
|                                                
|                                                
|                                                
|                                                
|                                                 | Increase (decrease) in cash resulting from changes in assets
	 and liabilities: |                                                                  |             |             |             |      |           |            |            |   |           |            |          
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Accounts receivable                                              |             |             | (4,842,125  | )    |           |            | (2,557,575 | ) |           |            | (95,205   | )
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Prepaid expenses and other current assets                        |             |             | (4,662,799  | )    |           |            | (290,770   | ) |           |            | (36,402   | )
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Other assets                                                     |             |             | (1,490,786  | )    |           |            | (532,936   | ) |           |            | (5,775    | )
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Accounts payable                                                 |             |             | 1,757,513   |      |           |            | 127,043    |   |           |            | 116,902   |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Accrued expenses                                                 |             |             | 3,885,669   |      |           |            | 599,918    |   |           |            | 15,788    |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Accrued salaries and commissions                                 |             |             | 4,670,567   |      |           |            | 434,172    |   |           |            | 10,526    |  
|                                                
|                                                
|                                                
|                                                
|                                                 |                                                                                 | Deferred revenue                                                 |             |             | 14,742,352  |      |           |            | 1,249,242  |   |           |            | 15,951    |  
|                                                 |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |           
|                                                 | Net cash used in operating activities                                           |                                                                  |             | (784,226    | )           |      |           | (4,043,696 | )          |   |           | (1,305,218 | )        
|                                                 |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |           
|Cash flows from investing activities:            |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |           
|                                                
|                                                
|                                                
|                                                
|                                                 | Purchases of property and equipment                                             |                                                                  |             | (3,200,304  | )           |      |           | (384,949   | )          |   |           | (81,293    | )        
|                                                
|                                                
|                                                
|                                                
|                                                 | Net purchases of marketable securities available for sale                       |                                                                  |             | (39,578,582 | )           |      |           | (1,525,458 | )          |   |           |           |          
|                                                
|                                                
|                                                
|                                                
|                                                 | Purchase of other assets                                                        |                                                                  |             | (999,999    | )           |      |           |           |            |   |           |           |          
|                                                 |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |           
|                                                 |                                                                                 | Net cash used in investing activities                            |             |             | (43,778,885 | )    |           |            | (1,910,407 | ) |           |            | (81,293   | )
|                                                 |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |           
|Cash flows from financing activities:            |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |           
|                                                
|                                                
|                                                
|                                                
|                                                 | Payments on capital leases                                                      |                                                                  |             | (111,897    | )           |      |           | (45,918    | )          |   |           | (8,274     | )        
|                                                
|                                                
|                                                
|                                                
|                                                 | Borrowings under line of credit                                                 |                                                                  |             |            |             |      |           | 282,664    |            |   |           |           |          
|                                                
|                                                
|                                                
|                                                
|                                                 | Repayments under line of credit                                                 |                                                                  |             | (94,221     | )           |      |           | (35,389    | )          |   |           |           |          
|                                                
|                                                
|                                                
|                                                
|                                                 | Proceeds from exercise of stock options                                         |                                                                  |             | 404,457     |             |      |           | 70,224     |            |   |           |           |          
|                                                
|                                                
|                                                
|                                                
|                                                 | Proceeds from exercise of warrants                                              |                                                                  |             | 6,622       |             |      |           |           |            |   |           |           |          
|                                                
|                                                
|                                                
|                                                
|                                                 | Proceeds from issuance of common stock                                          |                                                                  |             |            |             |      |           |           |            |   |           |           |          
|                                                
|                                                
|                                                
|                                                
|                                                 | Proceeds from initial public offering                                           |                                                                  |             | 165,025,000 |             |      |           |           |            |   |           |           |          
|                                                
|                                                
|                                                
|                                                
|                                                 | Proceeds from concurrent placement                                              |                                                                  |             | 17,500,000  |             |      |           |           |            |   |           |           |          
|                                                
|                                                
|                                                
|                                                
|                                                 | Issuance costs related to common stock offering                                 |                                                                  |             | (13,158,338 | )           |      |           |           |            |   |           |           |          
|                                                
|                                                
|                                                
|                                                
|                                                 | Proceeds from issuance of preferred stock                                       |                                                                  |             | 28,852,174  |             |      |           | 6,499,996  |            |   |           | 3,615,000  |          
|                                                
|                                                
|                                                
|                                                
|                                                 | Issuance costs related to preferred stock offerings                             |                                                                  |             | (195,839    | )           |      |           | (63,545    | )          |   |           | (38,324    | )        
|                                                 |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |           
|                                                 |                                                                                 | Net cash provided by financing activities                        |             |             | 198,227,958 |      |           |            | 6,708,032  |   |           |            | 3,568,402 |  
|                                                 |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |           
|Effect of the exchange rate on cash              |                                                                                 |                                                                  | (14,938     | )           |             |      |          |            |            |   |          |           
|                                                
|                                                
|                                                
|                                                
|Net increase in cash and cash equivalents        |                                                                                 |                                                                  | 153,649,909 |             |             |      | 753,929   |            |            |   | 2,181,891 |           
|                                                
|                                                
|                                                
|                                                
|Cash and cash equivalents at beginning of period |                                                                                 |                                                                  | 3,128,500   |             |             |      | 2,374,571 |            |            |   | 192,680   |           
|                                                 |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |           
|Cash and cash equivalents at end of period       |                                                                                 | $                                                                | 156,778,409 |             |             | $    | 3,128,500 |            |            | $ | 2,374,571 |           
|                                                 |                                                                                 |                                                                  |             |             |             |      |           |            |            |   |           |           

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

43



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##### Table of Contents



WEBMETHODS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  Organization

webMethods, Inc. (the Company) is a leading provider of
infrastructure software and services for achieving
business-to-business integration. The Companys products
enable companies to work more closely with their customers,
suppliers and other business partners through the real-time
exchange of information over the Internet and to complete
transactions electronically. The Company was incorporated in
Delaware on June 12, 1996 and changed its name from
TransactNet, Inc. to webMethods, Inc. on January 21, 1997.
During the fiscal year ended March 31, 2000, the company
established wholly-owned subsidiaries: webMethods Germany GmbH,
webMethods B.V., and webMethods UK Limited. These subsidiaries
provide technical support, marketing and distribution support in
their geographic regions.

The Companys operations are subject to certain risks and
uncertainties, including, among others, rapid technological
changes, success of the Companys product marketing and
product distribution strategies, the need to manage growth, the
need to retain key personnel and protect intellectual property,
and the availability of additional capital financing on terms
acceptable to the Company.

2.  Summary of significant accounting policies

Principles of Consolidation

The accompanying consolidated financial statements include the
accounts of webMethods, Inc. and all wholly-owned subsidiaries.
All material intercompany accounts and transactions have been
eliminated.

Use of estimates

The preparation of financial statements in conformity with
accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect
 the reported amounts of assets and liabilities and disclosures
of contingent assets and liabilities at the date of the financial
 statements and the reported amounts of revenue and expenses
during the period. Actual results could differ from these
estimates.

Fair value information

The carrying amount of current assets and current liabilities
approximates fair value because of the short maturity of these
instruments. The carrying amount of the Companys line of
credit approximates market based on the floating interest rates.

Cash and cash equivalents

The Company considers all highly liquid investments with original
 maturities of three months or less to be cash equivalents.

Marketable securities

The Companys marketable securities consist of corporate
bonds with maturities of less than two years. Securities are
classified as available for sale since management intends to hold
 the securities for an indefinite period and may sell the
securities prior to their maturity. The marketable securities are
 carried at aggregate fair value based generally on quoted market
 prices. Gains and losses are determined based on the specific
identification method. Available for sale securities that are
reasonably expected by management to be sold within one year from
 the balance sheet date are classified as current assets.

44



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



2.  Summary of significant accounting
policies  (Continued)


Property and equipment

Property and equipment are stated at cost. Depreciation is
computed on the straight-line method over the estimated useful
lives of the related assets, ranging from three to five years.
Leased property or equipment meeting certain criteria is
capitalized and the present value of the related lease payments
is recorded as a liability. Amortization of capitalized leased
assets is computed on the straight-line method over the term of
the lease. Repairs and maintenance are expensed as incurred. At
the time of retirement or other disposal of property and
equipment, the cost and related accumulated depreciation are
removed from their respective accounts and any resulting gain or
loss is included in operations.

Software development costs

Software development costs are expensed as incurred until
technological feasibility has been established, at which time
such costs are capitalized until the product is available for
general release to customers. The Company defines the
establishment of technological feasibility as the completion of
all planning, designing, coding and testing activities that are
necessary to establish products that meet design specifications
including functions, features and technical performance
requirements. Under the Companys definition, establishing
technological feasibility is considered complete only after the
majority of customer testing and customer feedback has been
incorporated into product functionality. To date, the period
between technological feasibility and general availability has
been short, and thus all software development costs qualifying
for capitalization are insignificant.

Impairment of long-lived assets

The Company periodically evaluates the recoverability of its
long-lived assets. This evaluation consists of a comparison of
the carrying value of the assets with the assets expected
future cash flows, undiscounted and without interest costs.
Estimates of expected future cash flows represent
managements best estimate based on reasonable and
supportable assumptions and projections. If the expected future
cash flows, undiscounted and without interest charges, exceed the
 carrying value of the asset, no impairment is recognized.
Impairment losses are measured as the difference between the
carrying value of long-lived assets and their fair value, based
on discounted future cash flows of the related asset.

Income taxes

Deferred tax assets and liabilities are recognized for the
estimated future tax consequences of temporary differences and
income tax credits. Temporary differences are primarily the
result of the differences between the tax bases of assets and
liabilities and their financial reporting amounts. Deferred tax
assets and liabilities are measured by applying enacted statutory
 tax rates applicable to the future years in which deferred tax
assets or liabilities are expected to be settled or realized.
Valuation allowances are established when necessary to reduce
deferred tax assets to the amount expected to be realized. The
Company has provided a full valuation allowance against its net
deferred tax asset as of March 31, 2000 and 1999.

Foreign Currency Translations

The functional currency for the Companys foreign
subsidiaries is the local currency. Assets and liabilities of the
 Companys foreign operations are translated into U.S.
dollars at the exchange rates in effect at the balance sheet
date; revenues and expenses are translated using the average
exchange rates in effect during the period. The cumulative
translation adjustments are included in accumulated other

45



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



2.  Summary of significant accounting
policies  (Continued)


comprehensive income or loss, which is a separate component of
stockholders equity (deficit). Foreign currency transaction
 gains or losses are included in the results of operations.

Revenue recognition

Revenue from the sale of software licenses is recognized upon
shipment of product, provided that the fee is fixed and
determinable, persuasive evidence of an arrangement exists and
collection of the resulting receivable is considered probable.
The Company does not offer exchanges of its products and
historically has not experienced significant returns. The Company
 recognizes software license revenue over the term of the license
 if the license requires delivery of unspecified products during
its term. Revenue related to customer support agreements is
deferred and recognized ratably over the term of the respective
agreements. When the Company provides a software license and the
related customer support arrangement for one bundled price, the
fair value of the customer support, based on the price charged
for that element separately, is deferred and recognized ratably
over the term of the respective agreement. If the license
agreement contains extended payment terms, revenue is recognized
as the payments become due, assuming that all other revenue
recognition criteria are met. Professional services revenue,
which includes training and consulting, is recognized at the time
 the service is performed.

Stock-based compensation

The Company measures compensation expense for its employee
stock-based compensation using the intrinsic value method and
provides pro forma disclosures of net loss as if the fair value
method had been applied in measuring compensation expense. Under
the intrinsic value method of accounting for stock-based
compensation, when the exercise price of options granted to
employees is less than the fair value of the underlying stock on
the grant date, compensation expense is recognized over the
applicable vesting period.

Net loss per share

Basic loss per share is computed based on the weighted average
number of outstanding shares of common stock. Diluted loss per
share adjusts the weighted average for the potential dilution
that could occur if stock options or warrants or convertible
securities were exercised or converted into common stock. Diluted
 loss per share is the same as basic loss per share for all
periods presented because the effects of such items were
anti-dilutive given the Companys losses.

Segment reporting

The Company operates as a single segment and will evaluate
additional segment disclosure requirements as it expands its
operations. See Note 15 for required geographic segment
information.

Recent accounting pronouncements

In December 1999, the Securities and Exchange Commission
(SEC) released Staff Accounting Bulletin (SAB) No. 101,
Revenue Recognition in Financial Statements, which
provides guidance on the recognition, presentation and disclosure
 of revenue in financial statements filed with the SEC.
Subsequently, the SEC released SAB 101A, which delayed the
implementation date of SAB 101 for registrants with fiscal years
that begin between December 16, 1999 and March 15, 2000. The
 Company is required to be in conformity with the provisions of
SAB 101, as amended by SAB 101A, no later than April 1, 2000
 and does not expect a material effect on the Companys
financial position, results of operations or cash flows as a
result of SAB 101.

46



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



2.  Summary of significant accounting
policies  (Continued)


In June 1999, the Financial Accounting Standards Board
(FASB) issued SFAS No. 137, which delays the
effective date of SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, which will
be effective for the Companys fiscal year 2001. This
statement establishes accounting and reporting standards
requiring that every derivative instrument, including certain
derivative instruments embedded in other contracts, be recorded
in the balance sheet as either an asset or liability measured at
its fair value. The statement also requires that changes in the
derivatives fair value be recognized in earnings unless
specific hedge accounting criteria are met. The Company has not
entered into derivative contracts and does not have near term
plans to enter into contracts, accordingly the adoption of SFAS
No. 133 and SFAS No. 137 is not expected to have a
material effect on the financial statements.

In March 2000, FASB issued Interpretation
(FIN) No. 44, Accounting for Certain Transactions
 Involving Stock Compensation  An Interpretation of APB
Opinion No. 25. FIN 44 clarifies the application of
APB Opinion No. 25 and, among other issues, clarifies the
following: the definition of an employee for purposes of applying
 APB Opinion No. 25; the criteria for determining whether a
plan qualifies as a non-compensatory plan; the accounting
consequence of various modifications to the terms of previously
fixed stock options or awards; and the accounting for an exchange
 of stock compensation awards in a business combination. FIN 44
is effective July 1, 2000, but certain conclusions in FIN 44
 cover specific events that occurred after either
December 15, 1998 or January 12, 2000. The Company does
 not expect the application of FIN 44 to have a material impact
on its financial position or results of operations.

3.  Related-party transactions

An individual who is a director, corporate secretary and
stockholder of the Company is associated with a law firm that has
 rendered various legal services for the Company. For the years
ended March 31, 2000, 1999 and 1998, the Company has paid
the firm approximately $909,000, $178,000, and $64,000
respectively. As of March 31, 2000 and 1999, the aggregate
amount due for these services was approximately $249,000 and
$137,000 respectively.

For the year ended March 31, 2000 the Company has entered
into certain contractual arrangements with several third parties
that invested in the Company through the purchase of
Series D and Series E mandatorily redeemable,
cumulative, convertible preferred stock (see Note 12). Revenue
generated from these related parties was $6,100,000 for the year
ended March 31, 2000. Accounts receivable from these related
 parties as of March 31, 2000 was $241,000. Additionally,
the Company paid $432,000 for services and equipment from related
 parties for the year ended March 31, 2000. Accounts payable
 to these related parties was $113,000 as of March 31, 2000.

4.  Concentrations of credit risk

Financial instruments which potentially expose the Company to
concentration of credit risk consist primarily of cash and cash
equivalents, marketable securities and accounts receivable. The
Company maintains its cash and cash equivalents in bank accounts
which, at times, may exceed federally insured limits. The Company
 has not experienced any losses on such accounts. Accounts
receivable consists principally of amounts due from large,
credit-worthy companies. The Company monitors the balances of
individual accounts to assess any collectibility issues. The
Company has not experienced significant losses related to
receivables in the past.

For the year ended March 31, 2000, one organization
individually accounted for approximately 22% of total revenue,
and one organization individually accounted for approximately 15%
 of accounts receivable as

47



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



4.  Concentrations of credit risk 
(Continued)


of March 31, 2000. For the year ended March 31, 1999,
two organizations individually accounted for approximately 13%
and 10% of total revenue, and three organizations individually
accounted for approximately 33%, 22% and 11% of accounts
receivable as of March 31, 1999. For the year ended
March 31, 1998, four organizations individually accounted
for approximately 20%, 17%, 14% and 12% of total revenue.

5.  Marketable Securities

The cost and estimated fair value of marketable securities, all
of which are corporate bonds, by contractual maturity are as
follows:

|                                     |  |                |            |                |  |      |            |            |  |   |           |  |  |   |           | 
|------------------------------------ |  | -------------- | ---------- | -------------- |  | ---- | ---------- | ---------- |  | - | --------- |  |  | - | --------- | 
|                                     |  |                |            |               
|                                     |  | March 31, 2000 |            | March 31, 1999
|                                     |  |                |            |               
|                                     |  | Cost           |            | Fair Value     |  | Cost |            | Fair Value
|                                     |  |                |            |                |  |      |            |           
|Due in one year or less              |  | $              | 8,349,240  |                |  | $    | 8,339,660  |            |  | $ | 255,129   |  |  | $ | 254,850   | 
|                                    
|                                    
|                                    
|                                    
|Due after one year through two years |  |                | 32,754,800 |                |  |      | 32,637,889 |            |  |   | 1,271,129 |  |  |   | 1,269,408 | 
|                                     |  |                |            |                |  |      |            |            |  |   |           |  |  |   |           | 
|                                     |  | $              | 41,104,040 |                |  | $    | 40,977,549 |            |  | $ | 1,526,258 |  |  | $ | 1,524,258 | 
|                                     |  |                |            |                |  |      |            |            |  |   |           |  |  |   |           | 

The gross unrealized holding losses were $126,491 and $2,000 for
the years ended March 31, 2000 and 1999, respectively. There
 were no gross unrealized holding gains for the years ended
March 31, 2000 and 1999. The unrealized holding losses have
been included, net of the related tax effect, in accumulated
other comprehensive loss which is a separate component of
stockholders equity (deficit), net of the related tax
effect.

6.  Property and equipment

Property and equipment consisted of the following:

|                                          |  |           |           |      |  |   |          |  
|----------------------------------------- |  | --------- | --------- | ---- |  | - | -------- | -
|                                          |  |          
|                                          |  | March 31,
|                                          |  |          
|                                          |  | 2000      |           | 1999
|                                          |  |           |           |     
|Equipment                                 |  | $         | 1,396,809 |      |  | $ | 404,029  |  
|                                         
|                                         
|                                         
|                                         
|Software                                  |  |           | 1,250,999 |      |  |   | 88,219   |  
|                                         
|                                         
|                                         
|                                         
|Furniture                                 |  |           | 851,435   |      |  |   | 38,972   |  
|                                         
|                                         
|                                         
|                                         
|Leasehold improvements                    |  |           | 899,387   |      |  |   | 1,470    |  
|                                          |  |           |           |      |  |   |          |  
|                                          |  |           | 4,398,630 |      |  |   | 532,690  |  
|                                         
|                                         
|                                         
|                                         
|Accumulated depreciation and amortization |  |           | (651,847  | )    |  |   | (134,287 | )
|                                          |  |           |           |      |  |   |          |  
|                                          |  | $         | 3,746,783 |      |  | $ | 398,403  |  
|                                          |  |           |           |      |  |   |          |  

During the year ended March 31, 2000, the Company acquired
certain equipment and software under capital leases. Included in
equipment as of March 31, 2000 is $428,225 in assets under
capital leases, and included in software as of March 31,
2000 is $257,843 in assets under capital leases. As of March 31,
2000, there was $90,440 of accumulated amortization under these
capital leases.

7.  Income taxes

The Company has recorded a provision for income taxes of $47,000
for the year ended March 31, 2000, which relates to the
write-off of the deferred tax asset recorded in connection with
the unrealized holding losses on marketable securities available
for sale, no other provisions for income taxes has been recorded
as the Company has incurred operating losses since its inception.
 Net operating loss carryforwards

48



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



7.  Income taxes  (Continued)


(NOLs) as of March 31, 2000 and 1999 are approximately
$12,100,000 and $3,100,000 respectively, both of which begin to
expire in 2012. The realization of the benefits of the NOLs is
dependent on sufficient taxable income in future years. Lack of
future earnings, a change in the ownership of the Company, or the
 application of the alternative minimum rules could adversely
affect the Companys ability to utilize the NOLs. Deferred
income taxes reflect the net tax effects of temporary differences
 between the carrying amount of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes. The tax effect of each temporary difference as of
March 31, 2000 and 1999 is as follows:

|                                 |                         |           |            |      |  |   |            |   | 
|-------------------------------- | ----------------------- | --------- | ---------- | ---- |  | - | ---------- | - | 
|                                 |                         |          
|                                 |                         | March 31,
|                                 |                         |          
|                                 |                         | 2000      |            | 1999
|                                 |                         |           |            |     
|Net operating loss carryforwards |                         |           | 4,600,000  |      |  | $ | 1,203,000  |  
|                                
|                                
|                                
|                                
|Accrued expenses                 |                         |           | 3,543,000  |      |  |   | 425,000    |  
|                                
|                                
|                                
|                                
|Deferred revenue                 |                         |           |           |      |  |   | 121,000    |  
|                                
|                                
|                                
|                                
|Accounts receivable              |                         |           | 218,000    |      |  |   | 25,000     |  
|                                
|                                
|                                
|                                
|Property and equipment           |                         |           | 4,000      |      |  |   | 4,000      |  
|                                
|                                
|                                
|                                
|Research and development credit  |                         |           | 171,000    |      |  |   | 104,000    |  
|                                
|                                
|                                
|                                
|Stock Option Compensation        |                         |           | 252,000    |      |  |   |           |  
|                                
|                                
|                                
|                                
|Other                            |                         |           | 10,000     |      |  |   |           |  
|                                
|                                
|                                
|                                
|Valuation allowance              |                         |           | (8,798,000 | )    |  |   | (1,882,000 | )
|                                 |                         |           |            |      |  |   |            |  
|                                 | Net Deferred Tax Assets |           | $          |     |  |   | $          |  | 
|                                 |                         |           |            |      |  |   |            |  

Though management believes that future taxable income of the
Company may be sufficient to utilize a substantial amount of the
benefits of the Companys net operating loss carryforwards
and to realize its deferred tax assets, a valuation allowance has
 been recorded to completely offset the carrying value of the
deferred tax assets as the realizability of the deferred tax
assets is not currently predictable.

The provision for income taxes differs from the amount of taxes
determined by applying the U.S. Federal statutory rate to income
before income taxes as a result of the following:

|                                                         |  |           |       |      |  |      |       |   |  |  |       |  
|-------------------------------------------------------- |  | --------- | ----- | ---- |  | ---- | ----- | - |  |  | ----- | -
|                                                         |  |          
|                                                         |  | March 31,
|                                                         |  |          
|                                                         |  | 2000      |       | 1999 |  | 1998
|                                                         |  |           |       |      |  |     
|U.S. Federal statutory rate                              |  |           | 34.0  | %    |  |      | 34.0  | % |  |  | 34.0  | %
|                                                        
|                                                        
|                                                        
|                                                        
|State and local taxes, net of Federal income tax benefit |  |           | 4.5   |      |  |      | 4.5   |   |  |  | 4.5   |  
|                                                        
|                                                        
|                                                        
|                                                        
|Change in valuation allowance                            |  |           | (38.1 | )    |  |      | (40.2 | ) |  |  | (40.7 | )
|                                                        
|                                                        
|                                                        
|                                                        
|Change in research and development credit                |  |           | 0.4   |      |  |      | 2.4   |   |  |  | 2.2   |  
|                                                        
|                                                        
|                                                        
|                                                        
|Other                                                    |  |           | (0.8  | )    |  |      | (0.7  | ) |  |  |      |  
|                                                         |  |           |       |      |  |      |       |   |  |  |       |  
|Provision for income taxes                               |  |           |      | %    |  |      |      | % |  |  |      | %
|                                                         |  |           |       |      |  |      |       |   |  |  |       |  

8.  Line of credit

The Company has a loan agreement with a bank providing borrowings
 up to $500,000 for working capital purposes and equipment
advances. The Company was able to borrow under this agreement
through March 31, 1999, and the unpaid principal balance as
of that date is payable in 36 equal monthly installments that
commenced shortly thereafter. As of March 31, 2000 and 1999
the balance under this line was $153,054 and $247,275,
respectively. Interest is payable at the banks prime rate
plus 1.5% per annum. The line of credit is collateralized by
substantially all of the Companys assets. The related
agreement contains restrictive covenants which require the
Company to maintain, among other things, a

49



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



8.  Line of credit  (Continued)


ratio of quick assets to current liabilities, net of deferred
revenue, of at least 2 to 1. The Company was in compliance with
all covenants as of March 31, 2000 and 1999. Of the total
line of credit amount, $200,000 has been designated for the
issuance of letters of credit relating to an office lease
agreement. On March 31, 1999, $100,000 in letters of credit
were outstanding. The Company expects to repay all outstanding
balances under this loan agreement within one year from the
balance sheet date.

In connection with this line of credit, the Company issued the
bank options to purchase 46,788 shares of the Companys
common stock at approximately $0.27 per share. The fair value of
these options was determined using the Black Scholes valuation
model and was insignificant to the overall financial statements.

In December 1999, the Company entered into a new revolving
promissory note with the same bank to borrow up to a maximum
principal amount of $3,000,000 with a maturity date of
December 2, 2000. Borrowings under this note are limited to
a borrowing base equal to 75% of eligible accounts receivable.
Interest is payable on the unpaid principal balance at a rate of
the banks prime rate plus 1% per annum. This note is
collateralized by substantially all of the Companys assets.
 The related agreement includes restrictive covenants which
require the Company to maintain, among other things, a ratio of
quick assets to current liabilities, less deferred revenue of at
least 1.5 to 1.0 and a quarterly revenue covenant such that total
 revenue for each fiscal quarter must be equal to or greater than
 total revenue for the immediately preceding fiscal quarter. As
of March 31, 2000, the Company had not borrowed against this
 revolving promissory note. In connection with the revolving
promissory note, the Company obtained a letter of credit totaling
 $750,000 related to a new office lease. The letter of credit
expires in June 2001.

9.  Lease commitments

In August 1999, the Company entered into an equipment line
of credit with a leasing company for the purchase of equipment
and software. Under this arrangement, the Company can enter into
leases for equipment and software for a period of one year from
the date of the arrangement. The interest rate under these leases
 is fixed at the date of each individual lease, based on the 36
month treasury yield plus 547 basis points. Principal and
interest is payable under each lease in 36 monthly
installments. At expiration of the lease term, the lessee will
have the option to purchase the equipment at fair market value
not to exceed 10% of the original cost. This arrangement includes
 a restrictive covenant that requires the Company to maintain a
minimum of $2,500,000 of cash and marketable securities. The
Company was in compliance with this covenant as of March 31,
 2000.

The Company leases office space in various locations under
operating leases expiring through fiscal 2002. Total rent expense
 was approximately $803,000, $153,000, and $48,000 for the years
ended March 31, 2000, 1999 and 1998, respectively. In
May 1999, the Company entered into a lease for office space
in Virginia expiring in May 31, 2001. In December 1999,
 the Company entered into a new five year lease agreement for
office space for the Companys new headquarters in Virginia.
 The Company occupied the new facility in March 2000 and also
turned its previous premises over to a sublessee through the end

50



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



9.  Lease commitments  (Continued)


of the lease term. Future minimum lease payments under the
Companys capital and operating leases, net of expected
sublease income, are as follows:

|                                                 |      |           |           |           |  |   |          |         | 
|------------------------------------------------ | ---- | --------- | --------- | --------- |  | - | -------- | ------- | 
|                                                 |      | Operating |           | Capital  
|                                                 |      |           |           |          
|Years ending March 31,                           |      |           |           |           |  |   |          |        
|                                                
|                                                
|                                                
|                                                
|                                                 | 2001 |           | $         | 2,133,049 |  |   | $        | 212,520 | 
|                                                
|                                                
|                                                
|                                                
|                                                 | 2002 |           |           | 1,726,455 |  |   |          | 265,173 | 
|                                                
|                                                
|                                                
|                                                
|                                                 | 2003 |           |           | 1,567,140 |  |   |          | 185,239 | 
|                                                
|                                                
|                                                
|                                                
|                                                 | 2004 |           |           | 1,567,140 |  |   |          |        | 
|                                                
|                                                
|                                                
|                                                
|                                                 | 2005 |           |           | 1,567,140 |  |   |          |        | 
|                                                 |      |           |           |           |  |   |          |        
|                                                 |      | $         | 8,560,924 |           |  |   | 662,932  |        
|                                                 |      |           |           |           |  |   |          |        
|less amounts representing interest               |      |           |           |           |  |   | (88,760  | )      
|                                                 |      |           |           |           |  |   |          |        
|                                                 |      |           |           |           |  |   | 574,172  |        
|                                                
|                                                
|                                                
|                                                
|less current portion                             |      |           |           |           |  |   | (148,027 | )      
|                                                 |      |           |           |           |  |   |          |        
|capital lease obligation, net of current portion |      |           |           |           |  | $ | 426,145  |        
|                                                 |      |           |           |           |  |   |          |        

During the year ended March 31, 1999, the Company issued a
warrant to purchase 6,132 shares of the Companys common
stock at an exercise price of $1.08 per share to the landlord of
one of their leased facilities. The fair value of this warrant on
 the grant date was determined using the Black-Scholes valuation
model and was insignificant to the overall financial statements.

10.  Stockholders equity (deficit)

The Company completed an initial public offering of 4,715,000 of
its $.01 par value common stock, priced at $35.00 per share on
February 10, 2000 (the IPO) including 615,000 shares sold in
 connection with the exercise of the underwriters
over-allotment. Concurrent with the IPO, the Company sold an
additional 518,058 shares of its common stock in a private
placement transaction at a price per share equal to $33.78 (the
IPO price less one-half of the underwriting discounts and
commissions). In preparation for the IPO, on October 22,
1999, the board of directors and stockholders approved an
increase in the number of authorized shares of common stock from
20,000,000 shares to 200,000,000 shares. On February 10,
2000 in connection with the IPO, the Company consummated a 1.533
for one stock split. All references to the number of shares
authorized, issued and outstanding and per-share information for
all periods presented have been adjusted to reflect the effects
of the stock split and share authorization.

On October 10, 1997, the Companys Board of Directors
approved a stock split in the form of a stock dividend at a rate
of an additional 7.9 shares of common stock for each share of
common stock outstanding as of October 10, 1997. On
March 5, 1998, the Board approved a stock split in the form
of a stock dividend at a rate of an additional 19 shares of
common stock for each share of common stock outstanding as of
March 5, 1998. All share and per share data in these
financial statements have been retroactively restated to reflect
the March 5, 1998 split and the October 10, 1997 split.

11.  Stock based compensation

Stock incentive plan

On November 1, 1996, the Company adopted the 1996 Stock
Incentive Plan (the Plan). The Plan is administered by a
Committee appointed by the Board of Directors, which has the
authority to determine which officers, directors and key
employees are awarded options pursuant to the Plan and to
determine the

51



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



11.  Stock based compensation 
(Continued)


terms and option exercise prices of the stock options. At
March 31, 2000, the Company had reserved 10,731,000 shares
of the Companys common stock for issuance upon the exercise
 of options granted under the Plan. At March 31, 2000,
options to purchase 6,609,421 shares were outstanding and
1,725,114 shares were available for future grants.

Qualified incentive stock options granted pursuant to the Plan
have an exercise price equal to the fair value of the underlying
common stock at the date of grant, vest at either the rate of
33.3% or 25% per year, beginning one year after the date of
award, and have a term of ten years. Prior to the Companys
initial public offering, the Board of Directors determined the
fair value of the underlying common stock on the date of grant
based on contemporaneous sales of the Companys preferred
stock for cash to third party investors.

The following table summarizes the Companys activity for
all of its stock option awards:

|                           |           |               |           |                |   |                  |            |             |  |   |      |      | 
|-------------------------- | --------- | ------------- | --------- | -------------- | - | ---------------- | ---------- | ----------- |  | - | ---- | ---- | 
|                           |           |               |           | Range of       |   | Weighted average
|                           |           | Stock options |           | exercise price |   | Exercise price  
|                           |           |               |           |                |   |                 
|Outstanding March 31, 1997 |           |               | 693,376   |                |   | $                | 0.05 0.27 |             |  | $ | 0.22 |     
|                          
|                          
|                          
|                          
|                           | Granted   |               |           | 1,803,207      |   |                  |            | 0.27        |  |   |      | 0.27 | 
|                          
|                          
|                          
|                          
|                           | Exercised |               |           |               |   |                  |            |            |  |   |      |     | 
|                          
|                          
|                          
|                          
|                           | Forfeited |               |           | (92,072        | ) |                  |            | 0.27        |  |   |      | 0.27 | 
|                           |           |               |           |                |   |                  |            |             |  |   |      |     
|Outstanding March 31, 1998 |           |               | 2,404,511 |                |   |                  | 0.05 0.27 |             |  |   | 0.25 |     
|                          
|                          
|                          
|                          
|                           | Granted   |               |           | 3,902,264      |   |                  |            | 0.11 0.33  |  |   |      | 0.12 | 
|                          
|                          
|                          
|                          
|                           | Exercised |               |           | (383,220       | ) |                  |            | 0.11 0.27  |  |   |      | 0.16 | 
|                          
|                          
|                          
|                          
|                           | Cancelled |               |           | (2,062,376     | ) |                  |            | 0.05 0.27  |  |   |      | 0.25 | 
|                          
|                          
|                          
|                          
|                           | Forfeited |               |           | (176,201       | ) |                  |            | 0.11 0.27  |  |   |      | 0.13 | 
|                           |           |               |           |                |   |                  |            |             |  |   |      |     
|Outstanding March 31, 1999 |           |               | 3,684,978 |                |   |                  | 0.11 0.33 |             |  |   | 0.12 |     
|                          
|                          
|                          
|                          
|                           | Granted   |               |           | 5,207,495      |   |                  |            | 2.17 35.00 |  |   |      | 7.91 | 
|                          
|                          
|                          
|                          
|                           | Exercised |               |           | (2,013,245     | ) |                  |            | 0.11 6.06  |  |   |      | 0.20 | 
|                          
|                          
|                          
|                          
|                           | Forfeited |               |           | (269,807       | ) |                  |            | 0.11 6.05  |  |   |      | 2.46 | 
|                           |           |               |           |                |   |                  |            |             |  |   |      |     
|Outstanding March 31, 2000 |           |               | 6,609,421 |                |   | $                | 0.1135.00 |             |  | $ | 6.14 |     
|                           |           |               |           |                |   |                  |            |             |  |   |      |     

Certain options granted during the year ended March 31, 2000
 resulted in deferred stock compensation as the estimated fair
value (derived by reference to contemporaneous sales of
convertible preferred stock) was greater than the exercise price
on the date of grant. The total deferred stock compensation
associated with these options was approximately
$11.1 million. This amount is being amortized over the
respective vesting periods of these options, ranging from three
to four years. Approximately $1,767,000 was amortized during the
year ended March 31, 2000.

Included in the above table are options to purchase 46,788 shares
 of the Companys common stock granted to the Companys
 bank during the year ended March 31, 1998 (see Note 8) and
options to purchase an aggregate of 45,990 shares of the
Companys common stock granted to three non-employees during
 the year ended March 31, 2000. The options granted to
non-employees were granted in exchange for services provided.
Options to purchase 15,330 of these shares have an exercise price
 of $2.17 per share and the options to purchase the remaining
30,660 shares have an exercise price of $2.88 per share. All of
these options granted to non-employees were fully exercisable and
 non-forfeitable on September 30, 1999. These options were
recorded at their aggregate fair value on September 30, 1999
 of $235,461 and amortized over the terms of the respective
consulting agreements. As of March 31, 2000, they have been
fully amortized. The Company valued these options using the
Black-Scholes valuation model with the

52



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



11.  Stock based compensation 
(Continued)


following assumptions: Risk-free interest rate of 5.50%; expected
 life of 6 years; no anticipated dividends; expected
volatility of 85%; and a fair market value of the underlying
common stock on the date of grant equal to the exercise price.

Options to purchase 367,318, 909,284, and 193,546 shares of the
Companys common stock were exercisable at March 31,
2000 and 1999, and 1998, respectively, at a weighted average
exercise price of $0.94, $0.15, and $0.20, per share,
respectively.

Had compensation expense for the Plan been determined based on
the fair value of the related options at the grant dates,
consistent with SFAS No. 123, the Companys net loss
and net loss per share would have increased by the pro forma
amounts indicated below:

|                                                          |  |                      |             |      |  |      |            |   |  |   |            |  
|--------------------------------------------------------- |  | -------------------- | ----------- | ---- |  | ---- | ---------- | - |  | - | ---------- | -
|                                                          |  |                     
|                                                          |  | Year ended March 31,
|                                                          |  |                     
|                                                          |  | 2000                 |             | 1999 |  | 1998
|                                                          |  |                      |             |      |  |     
|Net loss attributable to common shareholders, as reported |  | $                    | (28,380,000 | )    |  | $    | (3,901,729 | ) |  | $ | (1,475,466 | )
|                                                         
|                                                         
|                                                         
|                                                         
|Net loss attributable to common shareholders, pro forma   |  |                      | (29,582,153 | )    |  |      | (3,930,687 | ) |  |   | (1,492,474 | )
|                                                         
|                                                         
|                                                         
|                                                         
|Basic and diluted net loss per common share, as reported  |  |                      | (3.00       | )    |  |      | (0.71      | ) |  |   | (0.24      | )
|                                                         
|                                                         
|                                                         
|                                                         
|Basic and diluted net loss per common share, pro forma    |  |                      | (3.13       | )    |  |      | (0.71      | ) |  |   | (0.24      | )

The fair value of each option grant is estimated on the date of
grant using the Black-Scholes valuation model with the following
weighted average assumptions: Risk-free interest rates of 6.10%,
4.69%, and 5.50% for the years ended March 31, 2000, 1999
and 1998, respectively; expected volatility of 90%, 0% and 0% for
 the years ended March 31, 2000, 1999 and 1998,
respectively; expected life of 4 years; and no anticipated
dividends.

The weighted average fair value per share for stock option grants
 that were awarded during the years ended March 31, 2000,
1999 and 1998 was $3.97, $0.02, and $0.05, respectively.

Employee Stock Purchase Plan

In January 2000, the Board of Directors approved the
Companys 2000 Employee Stock Purchase Plan (the ESPP). The
ESPP became effective upon the completion of the initial public
offering on February 10, 2000. A total of 1,500,000 shares
of common stock are initially available for issuance under the
ESPP. The number of shares of common stock available for issuance
 under the ESPP will be increased on the first day of each
calendar year during the remaining nine year term of the ESPP by
750,000 shares of common stock.

The ESPP, which is intended to qualify under Section 423 of
the IRS Code, will be implemented by a series of overlapping
offering periods of 24 months duration, with new
offering periods, other than the first offering period,
commencing on or about January 1 and July 1 of each year. Each
offering period will consist of four consecutive purchase periods
 of approximately six months duration, and at the end of
each offering period, an automatic purchase will be made for
participants. The initial offering period commenced on
February 10, 2000 and ends on December 31, 2001; the
initial purchase period began on February 10, 2000 and ends
on June 30, 2000. Participants generally may not purchase
more than 1,000 shares on any purchase date or stock having a
value measured at the beginning of the offering period greater
than $25,000 in any calendar year.

53



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



11.  Stock based compensation 
(Continued)


The purchase price per share will be 85% of the lower of
(1) the fair market value of the Companys common stock
 on the purchase date and (2) the fair market value of a
share of the Companys common stock on the last trading day
before the offering date, or, in the case of the first offering
period under the plan, the price at which one share of the
Companys common stock is offered to the public in the
Companys initial public offering.

12.  Mandatorily redeemable, convertible preferred stock

On October 23, 1997, the Company entered into a Share
Exchange Agreement whereby certain stockholders of the Company
exchanged an aggregate of 1,446,355 shares of common stock for
47,174 shares of mandatorily redeemable, convertible
Series A Preferred Stock. Each share of Series A
Preferred Stock had cumulative dividends at a rate equal to 8%
per annum payable on a liquidation value of $8.19 per share, as
adjusted for stock splits, stock dividends, stock combinations
and recapitalizations.

Also on October 23, 1997, the Board of Directors authorized
the issuance of up to 180,750 shares of mandatorily redeemable,
convertible Series B Preferred Stock at a purchase price of
$20.00 per share. The Company issued 180,750 shares of
Series B Preferred Stock for gross proceeds to the Company
of $3,615,000 and incurred $38,324 in direct issuance costs. Each
 share of Series B Preferred Stock had cumulative dividends at a
rate equal to 8% per annum payable on a liquidation value of $20
per share, as adjusted for stock splits, stock dividends, stock
combinations and recapitalizations.

On September 16, 1998, the Board of Directors authorized the
 issuance of up to 195,783 shares of mandatorily redeemable,
convertible Series C Preferred Stock at a purchase price of
$33.20. The Company issued 195,783 shares of Series C
Preferred Stock for gross proceeds of $6,499,996 and incurred
$63,545 in direct issuance costs. Each share of Series C
Preferred Stock had cumulative dividends at a rate equal to 8%
per annum payable on a liquidation value of $33.20 per share, as
adjusted for stock splits, stock dividends, stock combinations
and recapitalizations.

On March 17, 1999, the Board of Directors authorized the
issuance of up to 158,000 shares of mandatorily redeemable,
convertible Series D Preferred Stock and on May 12,
1999, the Company issued 134,075 shares of Series D
Preferred Stock for gross proceeds of $11,852,230 and incurred
$119,370 in direct issuance costs. Each share of Series D
Preferred Stock had cumulative dividends at a rate equal to 8%
per annum payable on a liquidation value of $88.40 per share, as
adjusted for stock splits, stock dividends, stock combinations
and recapitalizations. One of the investors in the round of
mandatorily redeemable, convertible Series D Preferred Stock
 had the right to purchase the number of common shares equal to
$2.5 million at the initial public offering price per share
less one-half of the underwriting discount and commission,
concurrent with an underwritten initial public offering. Such
right was exercised in connection with the concurrent private
placement.

On November 4, 1999, the Company authorized the issuance of
up to 68,770 shares of mandatorily redeemable, convertible
Series E Preferred Stock for gross proceeds of $16,999,944
and incurred $76,469 in direct issuance costs. Each share of
Series E Preferred Stock had cumulative dividends at a rate
equal to 8% per annum payable on a liquidation value of $247.20
per share, as adjusted for stock splits, stock dividends, stock
combinations and recapitalizations.

Based on the short period of time elapsed between the issuance of
 the Series E Preferred Stock on November 4, 1999 and
the initial filing of the Companys Registration Statement
on Form S-1 on November 19, 1999, the Company had
recorded a deemed dividend of $8.3 million. The deemed
dividend has been included in the accretion and accrued dividends
 related to mandatorily redeemable preferred stock for purposes
of determining basic and diluted net loss per common share.

54



---



##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



12.  Mandatorily redeemable, convertible preferred
stock  (Continued)


Each outstanding share of Series A, Series B,
Series C, Series D and Series E Preferred Stock
was automatically converted into 30.66 shares of the
Companys common stock immediately upon the closing of the
initial public offering. In addition, at the time of the initial
public offering common stock was issued for accrued and unpaid
dividends based on the $35.00 fair market value of the stock at
the time of the offering .

55



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##### Table of Contents



WEBMETHODS, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

12.  Mandatorily redeemable, convertible preferred
stock  (Continued)

The mandatorily redeemable, convertible Series A,
Series B, Series C, Series D and Series E
Preferred Stock activity is summarized as follows:

|                                                                             |                                                   |          |         |          |  |          |          |          |  |          |          |         |  |        |            |           |  |        |          |   |  |   |            |   |  |  |          |   |  |   |             |   |  |  |         |   | 
|---------------------------------------------------------------------------- | ------------------------------------------------- | -------- | ------- | -------- |  | -------- | -------- | -------- |  | -------- | -------- | ------- |  | ------ | ---------- | --------- |  | ------ | -------- | - |  | - | ---------- | - |  |  | -------- | - |  | - | ----------- | - |  |  | ------- | - | 
|                                                                             |                                                   |          |         |          |  |          |          |          |  |         
|                                                                             |                                                   | Series A |         | Series B |  | Series C |          | Series D |  | Series E
|                                                                             |                                                   |          |         |          |  |          |          |          |  |         
|                                                                             |                                                   | Shares   |         | Amount   |  | Shares   |          | Amount   |  | Shares   |          | Amount  |  | Shares |            | Amount    |  | Shares
|                                                                             |                                                   |          |         |          |  |          |          |          |  |          |          |         |  |        |            |           |  |       
|Balance, June 12, 1996                                                       |                                                   |          |        |          |  | $        |         |          |  |          |         |         |  | $      |           |           |  |        |         |   |  | $ |           |   |  |  |         |   |  | $ |            |   |  |  |        |  
|                                                                             |                                                   |          |         |          |  |          |          |          |  |          |          |         |  |        |            |           |  |        |          |   |  |   |            |   |  |  |          |   |  |   |             |   |  |  |         |  
|Balance, March 31, 1997.                                                     |                                                   |          |        |          |  |          |         |          |  |          |         |         |  |        |           |           |  |        |         |   |  |   |           |   |  |  |         |   |  |   |            |   |  |  |        |  
|Exchange of common Stock for Series A                                        |                                                   |          |         |          |  |          |          |          |  |          |          |         |  |        |            |           |  |        |          |   |  |   |            |   |  |  |          |   |  |   |             |   |  |  |         |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Preferred stock                                   |          |         | 47,174   |  |          |          | 386,355  |  |          |          |        |  |        |            |          |  |        |          |  |  |   |            |  |  |  |          |  |  |   |             |  |  |  |         |  | 
|Sale of Series B                                                             |                                                   |          |         |          |  |          |          |          |  |          |          |         |  |        |            |           |  |        |          |   |  |   |            |   |  |  |          |   |  |   |             |   |  |  |         |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Preferred stock, Net of issuance Costs of $38,324 |          |         |         |  |          |          |         |  |          |          | 180,750 |  |        |            | 3,576,676 |  |        |          |  |  |   |            |  |  |  |          |  |  |   |             |  |  |  |         |  | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accretion to Redemption price                                                |                                                   |          |        |          |  |          |         |          |  |          |         |         |  |        | 2,184      |           |  |        |         |   |  |   |           |   |  |  |         |   |  |   |            |   |  |  |        |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accrued dividends                                                            |                                                   |          |        |          |  |          | 14,736   |          |  |          |         |         |  |        | 95,872     |           |  |        |         |   |  |   |           |   |  |  |         |   |  |   |            |   |  |  |        |  
|                                                                             |                                                   |          |         |          |  |          |          |          |  |          |          |         |  |        |            |           |  |        |          |   |  |   |            |   |  |  |          |   |  |   |             |   |  |  |         |  
|Balance, March 31, 1998                                                      |                                                   |          | 47,174  |          |  |          | 401,091  |          |  |          | 180,750  |         |  |        | 3,674,732  |           |  |        |         |   |  |   |           |   |  |  |         |   |  |   |            |   |  |  |        |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Sale of Series C preferred stock, net of issuance costs of
        $63,545   |                                                   |          |        |          |  |          |         |          |  |          |         |         |  |        |           |           |  |        | 195,783  |   |  |   | 6,436,451  |   |  |  |         |   |  |   |            |   |  |  |        |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accretion to redemption price                                                |                                                   |          |        |          |  |          |         |          |  |          |         |         |  |        | 6,589      |           |  |        |         |   |  |   | 6,577      |   |  |  |         |   |  |   |            |   |  |  |        |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accrued dividends                                                            |                                                   |          |        |          |  |          | 33,828   |          |  |          |         |         |  |        | 289,200    |           |  |        |         |   |  |   | 269,260    |   |  |  |         |   |  |   |            |   |  |  |        |  
|                                                                             |                                                   |          |         |          |  |          |          |          |  |          |          |         |  |        |            |           |  |        |          |   |  |   |            |   |  |  |          |   |  |   |             |   |  |  |         |  
|Balance, March 31, 1999                                                      |                                                   |          | 47,174  |          |  |          | 434,919  |          |  |          | 180,750  |         |  |        | 3,970,521  |           |  |        | 195,783  |   |  |   | 6,712,288  |   |  |  |         |   |  |   |            |   |  |  |        |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Sale of Series D preferred stock, net of issuance costs of
        $119,370. |                                                   |          |        |          |  |          |         |          |  |          |         |         |  |        |           |           |  |        |         |   |  |   |           |   |  |  | 134,075  |   |  |   | 11,732,860  |   |  |  |         |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Sale of Series E preferred stock, net of issuance costs of
        $76,469   |                                                   |          |         |          |  |          |          |          |  |          |          |         |  |        |            |           |  |        |          |   |  |   |            |   |  |  |          |   |  |   |             |   |  |  | 68,770  |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accretion to redemption price                                                |                                                   |          |        |          |  |          |         |          |  |          |         |         |  |        | 5,827      |           |  |        |         |   |  |   | 11,225     |   |  |  |         |   |  |   | 20,982      |   |  |  |         |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accrued dividends                                                            |                                                   |          |        |          |  |          | 29,655   |          |  |          |         |         |  |        | 256,844    |           |  |        |         |   |  |   | 461,822    |   |  |  |         |   |  |   | 732,989     |   |  |  |         |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Conversion to common stock                                                   |                                                   |          | (47,174 | )        |  |          | (464,574 | )        |  |          | (180,750 | )       |  |        | (4,233,192 | )         |  |        | (195,783 | ) |  |   | (7,185,335 | ) |  |  | (134,075 | ) |  |   | (12,486,831 | ) |  |  | (68,770 | )
|                                                                             |                                                   |          |         |          |  |          |          |          |  |          |          |         |  |        |            |           |  |        |          |   |  |   |            |   |  |  |          |   |  |   |             |   |  |  |         |  
|Balance, March 31, 2000                                                      |                                                   |          |        |          |  | $        |         |          |  |          |         |         |  | $      |           |           |  |        |         |   |  | $ |           |   |  |  |         |   |  | $ |            |   |  |  |        |  
|                                                                             |                                                   |          |         |          |  |          |          |          |  |          |          |         |  |        |            |           |  |        |          |   |  |   |            |   |  |  |          |   |  |   |             |   |  |  |         |  

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                                                             |                                                   |          |             |   | 
|---------------------------------------------------------------------------- | ------------------------------------------------- | -------- | ----------- | - | 
|                                                                             |                                                   |         
|                                                                             |                                                   | Series E
|                                                                             |                                                   |         
|                                                                             |                                                   | Amount  
|                                                                             |                                                   |         
|Balance, June 12, 1996                                                       |                                                   | $        |            |  
|                                                                             |                                                   |          |             |  
|Balance, March 31, 1997.                                                     |                                                   |          |             |  
|Exchange of common Stock for Series A                                        |                                                   |          |             |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Preferred stock                                   |          |             |  | 
|Sale of Series B                                                             |                                                   |          |             |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|                                                                             | Preferred stock, Net of issuance Costs of $38,324 |          |             |  | 
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accretion to Redemption price                                                |                                                   |          |             |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accrued dividends                                                            |                                                   |          |            |  
|                                                                             |                                                   |          |             |  
|Balance, March 31, 1998                                                      |                                                   |          |            |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Sale of Series C preferred stock, net of issuance costs of
        $63,545   |                                                   |          |            |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accretion to redemption price                                                |                                                   |          |            |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accrued dividends                                                            |                                                   |          |            |  
|                                                                             |                                                   |          |             |  
|Balance, March 31, 1999                                                      |                                                   |          |            |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Sale of Series D preferred stock, net of issuance costs of
        $119,370. |                                                   |          |             |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Sale of Series E preferred stock, net of issuance costs of
        $76,469   |                                                   |          | 16,923,475  |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accretion to redemption price                                                |                                                   |          | 5,539       |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Accrued dividends                                                            |                                                   |          | 390,183     |  
|                                                                            
|                                                                            
|                                                                            
|                                                                            
|Conversion to common stock                                                   |                                                   |          | (17,319,197 | )
|                                                                             |                                                   |          |             |  
|Balance, March 31, 2000                                                      |                                                   | $        |            |  
|                                                                             |                                                   |          |             |  

56



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

13.  Employee benefit plan

As of April 1, 1997, the Company adopted a contributory
401(k) plan covering all full-time employees who meet prescribed
service requirements. There are no required Company matching
contributions. The plan provides for discretionary contributions
by the Company. The Company made no contributions during the
years ended March 31, 2000, 1999 and 1998.

14.  Supplemental disclosures of cash flow
information:

|                                             |                                                                                                          |                      |        |            |  |   |        |         | 
|-------------------------------------------- | -------------------------------------------------------------------------------------------------------- | -------------------- | ------ | ---------- |  | - | ------ | ------- | 
|                                             |                                                                                                          |                     
|                                             |                                                                                                          | Year Ended March 31,
|                                             |                                                                                                          |                     
|                                             |                                                                                                          | 2000                 |        | 1999      
|                                             |                                                                                                          |                      |        |           
|                                             |                                                                                                          |                     
|                                             |                                                                                                          | (unaudited)         
|                                            
|                                            
|                                            
|                                            
|Cash paid during the period for interest     |                                                                                                          | $                    | 26,689 |            |  | $ | 15,651 |        
|                                             |                                                                                                          |                      |        |            |  |   |        |        
|Non-cash investing and financing activities: |                                                                                                          |                      |        |            |  |   |        |        
|                                            
|                                            
|                                            
|                                            
|                                             | Accrual of preferred stock dividends                                                                     |                      | $      | 1,871,493  |  |   | $      | 592,287 | 
|                                             |                                                                                                          |                      |        |            |  |   |        |        
|                                             | Preferred stock accretion                                                                                |                      | $      | 43,573     |  |   | $      | 13,166  | 
|                                             |                                                                                                          |                      |        |            |  |   |        |        
|                                             | Equipment purchased under capital lease                                                                  |                      | $      | 686,068    |  |   | $      |        | 
|                                             |                                                                                                          |                      |        |            |  |   |        |        
|                                             | Conversion of preferred stock to common stock                                                            |                      | $      | 41,689,129 |  |   | $      |        | 
|                                             |                                                                                                          |                      |        |            |  |   |        |        
|                                             | Deemed discount in connection with the beneficial conversion
        feature on Series E preferred stock |                      | $      | 8,307,444  |  |   | $      |        | 
|                                             |                                                                                                          |                      |        |            |  |   |        |        
|                                             | Change in net unrealized loss of marketable securities                                                   |                      | $      | 126,941    |  |   | $      | 2,000   | 
|                                             |                                                                                                          |                      |        |            |  |   |        |        
|                                             | Fair value of options issued to non-employees                                                            |                      | $      | 235,461    |  |   | $      |        | 
|                                             |                                                                                                          |                      |        |            |  |   |        |        

15.  Segment Information

The Company markets it products in the United States and in
foreign countries. Information regarding geographic areas for the
 years ended March 31, 2000, 1999 and 1998 are as follow:

|              |       |                      |            |            |  |      |           |           |  |   |         |         | 
|------------- | ----- | -------------------- | ---------- | ---------- |  | ---- | --------- | --------- |  | - | ------- | ------- | 
|              |       |                     
|              |       | Year Ended March 31,
|              |       |                     
|Revenues      |       | 2000                 |            | 1999       |  | 1998
|              |       |                      |            |            |  |     
|North America |       | $                    | 21,962,484 |            |  | $    | 4,461,651 |           |  | $ | 165,894 |        
|             
|             
|             
|             
|Europe        |       |                      | 1,039,500  |            |  |      |          |           |  |   |        |        
|              |       |                      |            |            |  |      |           |           |  |   |         |        
|              | Total |                      | $          | 23,001,984 |  |      | $         | 4,461,651 |  |   | $       | 165,894 | 
|              |       |                      |            |            |  |      |           |           |  |   |         |        

|                  |       |  |  |      |  |      |           |           |  |   |         |         | 
|----------------- | ----- |  |  | ---- |  | ---- | --------- | --------- |  | - | ------- | ------- | 
|                  |       |  |  |     
|                  |       |  |  |      |  |      | March 31,
|                  |       |  |  |      |  |      |          
|Long Lived Assets |       |  |  | 2000 |  | 1999
|                  |       |  |  |      |  |     
|                  |       |  |  |      |  |     
|North America     |       |  |  |      |  | $    | 6,634,911 |           |  | $ | 940,095 |        
|                 
|                 
|                 
|                 
|Europe            |       |  |  |      |  |      | 141,812   |           |  |   |        |        
|                  |       |  |  |      |  |      |           |           |  |   |         |        
|                  | Total |  |  |      |  |      | $         | 6,776,723 |  |   | $       | 940,095 | 
|                  |       |  |  |      |  |      |           |           |  |   |         |        

17.  Subsequent Events

On May 20, 2000, the Company entered into a plan of merger,
by and among the Company, Wolf Acquisition, Inc., a Delaware
corporation that is a wholly owned subsidiary of the Company, and
 Active Software, Inc., (Active Software). Subject to
 the terms and conditions of the merger agreement, the Company
will merge with Active Software, and Active Software will become
a wholly owned subsidiary of

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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



17.  Subsequent Events  (Continued)


the Company. Per the merger agreement, each issued and
outstanding share of Active Software common stock, will be
converted into 0.527 fully paid and non-assessable shares of the
Companys common stock. All outstanding options to purchase
Active Software common stock, as well as the plans under which
the options were granted, will be assumed by the Company.

The merger is intended to be treated as a tax-free reorganization
 for federal income tax purposes and to be accounted for using
the pooling-of-interests method.

The closing of the merger is subject to a number of conditions,
including adoption of the merger agreement by the stockholders of
 Active Software, approval of the issuance of the shares of the
Companys common stock pursuant to the merger by the
stockholders of the Company and expiration of applicable waiting
periods or obtaining approvals under the Hart-Scott-Rodino
Antitrust Improvements Act.

In addition, the Company and Active Software have also entered
into a Strategic Relationship Agreement dated May 20, 2000,
pursuant to which Active Software grants to the Company the right
 to use, reproduce, and distribute Active Softwares
technology.






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

Not applicable.

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##### Table of Contents






PART III

The following information contained in the definitive joint proxy
 statement/ prospectus for the annual meeting of stockholders is
incorporated by reference into this Form 10-K Annual Report:




Item 10.  Directors and Executive Officers
of the Registrant

Information regarding directors and executive officers will be
set forth in the joint proxy statement/ prospectus for the annual
 meeting of stockholders and is incorporated into this document
by reference.




Item 11.  Executive Compensation

Information regarding executive compensation will be set forth in
 the joint proxy statement/ prospectus for the annual meeting of
stockholders and is incorporated into this document by reference.




Item 12.  Security Ownership of Certain
Beneficial Owners and Management

Information regarding security ownership of certain beneficial
owners and management will be set forth in the joint proxy
statement/ prospectus for the annual meeting of stockholders and
is incorporated into this document by reference.




Item 13.  Certain Relationships and Related
Transactions

Information regarding certain relationships and related
transactions will be set forth in the joint proxy statement/
prospectus for the annual meeting of stockholders and is
incorporated into this document by reference.

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##### Table of Contents






PART IV




Item 14.  Exhibits, Financial Statement
Schedules and Reports on Form 8-K

(a)  The following documents are filed as part of this
report:



| |    |                                                                                                                                                        
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. | Consolidated Financial Statements included in Item 8 of this document                                                                                  
| | 2. | The following exhibits are incorporated by reference to
        webMethods Registration Statement on Form S-1, as amended
        (File No. 333-91039):

|        |       |             |  |                                                                                                  
|------- | ----- | ----------- |  | -------------------------------------------------------------------------------------------------
|Exhibit |       |            
|No.     |       | Description
|        |       |            
|        | 3.2   |             |  | Fifth Amended and Restated Certificate of Incorporation of
        webMethods.                   
|        | 3.4   |             |  | Amended and Restated Bylaws of webMethods.                                                       
|        | 3.5   |             |  | Stock Option Plan.                                                                               
|        | 4.1   |             |  | Second Amended and Restated Investor Rights Agreement.                                           
|        | 10.1  |             |  | Indemnification Agreement entered into between the registrant and
         each of its directors.
|        | 10.2* |             |  | SAP Development Partner Software License and Distribution
        Agreement dated March 31, 1999 
|        | 21    |             |  | Subsidiaries                                                                                     

| | 
| | 
| | 

| |   |                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------
| | * | Certain portions of this exhibit have been omitted and filed
        separately with the Securities and Exchange Commission.

3.  Consent of Independent
Accountants.

4.  Power of Attorney (included on
signature page to this report).

5.  Financial Data Schedule

60



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned,
thereunto duly authorized, in the city of Fairfax, Virginia on
the 29th day of June, 2000.



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



| |     |                    
| | --- | -------------------
| | By: | /s/ PHILLIP MERRICK

| |                                     
| | ------------------------------------
| |                                     
| | Phillip Merrick                     
| | Chairman of the Board, President and
| | Chief Executive Officer             

We, the undersigned officers and directors of webMethods, Inc.,
hereby severally constitute and appoint Phillip Merrick and Mary
Dridi, and each of them individually, with full powers of
substitution and resubstitution, our true and lawful attorneys,
with full power to them, to sign for us in our names in the
capacities indicated below, amendments to this report, and
generally to do all things in our names and on our behalf in such
 capacities to enable webMethods, Inc. to comply with the
provisions of the Securities Exchange Act of 1934, as amended,
and call requirements of the Securities and Exchange Commission.

|                                             |  |                                                              |  |               |  | 
|-------------------------------------------- |  | ------------------------------------------------------------ |  | ------------- |  | 
|Signature                                    |  | Title                                                        |  | Date         
|                                             |  |                                                              |  |              
|/s/ PHILLIP MERRICKPhillip Merrick           |  | Chairman of the Board, President and Chief Executive Officer |  | June 29, 2000
|/s/ MARY DRIDIMary Dridi                     |  | Chief Financial Officer and Treasurer                        |  | June 29, 2000
|/s/ ROBERT E. COOKRobert E. Cook             |  | Director                                                     |  | June 29, 2000
|/s/ CHASE BAILEYChase Bailey                 |  | Director                                                     |  | June 29, 2000
|/s/ GENE RIECHERSGene Riechers               |  | Director                                                     |  | June 29, 2000
|/s/ JACK L. LEWISJack L. Lewis               |  | Director                                                     |  | June 29, 2000
|/s/ MICHAEL J. LEVINTHALMichael J. Levinthal |  | Director                                                     |  | June 29, 2000
|/s/ ROBERT T. VASANRobert T. Vasan           |  | Director                                                     |  | June 29, 2000
|/s/ DENNIS H. JONESDennis H. Jones           |  | Director                                                     |  | June 29, 2000

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##### Table of Contents



EXHIBIT INDEX

|            |  |                                                                                          
|----------- |  | -----------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                              
|            |  |                                                                                          
|3.1*        |  | Fifth Amended and Restated Certificate of Incorporation of
	webMethods                   
|3.2*        |  | Amended and Restated Bylaws of webMethods                                                
|3.5***      |  | Stock Option Plan                                                                        
|4.1**       |  | Second Amended and Restated Investor Rights Agreement                                    
|10.1**      |  | Indemnification Agreement entered into between webMethods and
	each of its directors     
|10.2***    |  | SAP Development Partner Software License and Distribution
	Agreement dated March 31, 1999
|21*         |  | Subsidiaries                                                                             
|23          |  | Consent of Independent Accountants                                                       
|24          |  | Power of Attorney (included on page 60 of this report)                                   
|27          |  | Financial Data Schedule                                                                  




|    |                                                                                                                                                                                          
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*   | Incorporated by reference to registrants registration
	statement on Form S-1, as amended
	(File No. 333-91309) http://www.sec.gov/
	Archives/edgar/data/1035096/0000950133-99-003716.txt
|   
|**  | Incorporated by reference to registrants registration
	statement on Form S-1, as amended
	(File No. 333-91309) http://www.sec.gov/
	Archives/edgar/data/1035096/0000950133-99-003861.txt
|   
|*** | Incorporated by reference to registrants registration
	statement on Form S-1, as amended
	(File No. 333-91309) http://www.sec.gov/
	Archives/edgar/data/1035096/0000950133-00-000146.txt



|  |                                                                                                                                                                   
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Commission has granted confidential treatment to certain
	portions of this exhibit. Such portions have been omitted and
	filed separately with the Commission.

62