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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, 2002
| 
|o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    
     SECURITIES EXCHANGE ACT OF 1934                                     

Commission File Number

1-15681




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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: None

Securities registered pursuant to
Section 12(g) of the Act: Common Stock, $0.01 par value



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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 o

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. o

The aggregate market value of webMethods Common
Stock held by non-affiliates of the registrant as of
June 12, 2002, based upon the closing price of webMethods
Common Stock on the Nasdaq National Market for such date, was
$423,510,111.

As of June 12, 2002, there were outstanding
50,681,681 shares of webMethods, Inc. Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the definitive Proxy
Statement to be used in connection with webMethods annual
meeting of stockholders, to be held in August 2002, and to
be mailed to stockholders in July 2002, are incorporated by
reference into Part III of this Form 10-K.



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WEBMETHODS, INC.

FORM 10-K

TABLE OF CONTENTS

|           |  |                                                                                                 |  |   
|---------- |  | ----------------------------------------------------------------------------------------------- |  | --
|Part I     |  |                                                                                                
|Item 1.    |  | Business                                                                                        |  | 1 
|           |  | Overview                                                                                        |  | 1 
|           |  | Industry Background                                                                             |  | 2 
|           |  | webMethods Solution                                                                            |  | 3 
|           |  | webMethods Strategy                                                                            |  | 5 
|           |  | Customers                                                                                       |  | 6 
|           |  | Sales and Marketing                                                                             |  | 6 
|           |  | Partners and Strategic Relationships                                                            |  | 7 
|           |  | Customer Care                                                                                   |  | 8 
|           |  | Product Development                                                                             |  | 8 
|           |  | Competition                                                                                     |  | 9 
|           |  | Intellectual Property and Other
    Proprietary Rights                                          |  | 9 
|           |  | Corporate Information                                                                           |  | 11
|           |  | Employees                                                                                       |  | 12
|           |  | Executive Officers of webMethods                                                                |  | 12
|           |  | Factors that May Affect Future
    Operating Results                                            |  | 14
|Item 2.    |  | Properties                                                                                      |  | 22
|Item 3.    |  | Legal Proceedings                                                                               |  | 22
|Item 4.    |  | Submission of Matters to a Vote of Security
    Holders                                         |  | 22
|Part II    |  |                                                                                                
|Item 5.    |  | Market for Registrants Common Stock and
    Related Stockholder Matters                        |  | 22
|Item 6.    |  | Selected Consolidated Financial Data                                                            |  | 25
|Item 7.    |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations       |  | 27
|           |  | Overview                                                                                        |  | 27
|           |  | Results of Operations                                                                           |  | 30
|           |  | Liquidity and Capital Resources                                                                 |  | 37
|           |  | Recently Issued Accounting
    Pronouncements                                                   |  | 38
|Item 7A.   |  | Quantitative and Qualitative Disclosures about
    Market Risk                                  |  | 39
|Item 8.    |  | Financial Statements and Supplementary Data                                                     |  | 40
|Item 9.    |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure Issues |  | 40
|Part III   |  |                                                                                                
|Item 10.   |  | Directors and Executive Officers of the Registrant                                              |  | 41
|Item 11.   |  | Executive Compensation                                                                          |  | 41
|Item 12.   |  | Security Ownership of Certain Beneficial Owners
    and Management                              |  | 41
|Item 13.   |  | Certain Relationships and Related Transactions                                                  |  | 41
|Part IV    |  |                                                                                                
|Item 14.   |  | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                            |  | 42
|Signatures |  | 44                                                                                             



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PART I

Item 1.  BUSINESS

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

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

OVERVIEW

webMethods, Inc. is a leading provider of
software and services for comprehensive end-to-end integration
solutions. We develop and deliver software products and provide
related services that give large organizations the ability,
seamlessly and in real-time, to integrate disparate information
resources, to connect customers, vendors and business partners
with the organization and its employees, to view and manage the
connected information resources, data, business processes and
human workflows and to provide web services at the enterprise
level. Our integration platform is a comprehensive solution for
linking business processes, enterprise and legacy application
software products, databases, human workflows and web services,
both within and across business enterprises and government
organizations.

The webMethods integration platform allows
customers to achieve quantifiable return on their investment in
our software within a brief timeframe, as well as in their other
information technology investments, by linking business
processes, seamlessly integrating enterprise and legacy
applications and databases, and managing human workflows both
within and across enterprises. By deploying the webMethods
integration platform, customers can reduce costs, create new
revenue opportunities, strengthen relationships with customers,
vendors and business partners, substantially increase supply
chain efficiencies, streamline internal business processes and
provide Enterprise Web Services. The webMethods integration
platform enables our customers to rapidly and cost-effectively
meet the full range of business integration requirements with a
single, globally-scalable infrastructure and provides our
customers with a comprehensive, real-time view of customers,
vendors and business partners, projects, orders, assets,
business processes, human workflows, information system
resources and data, which we refer to as Global Business
Visibility.

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We had over 800 customers at March 31, 2002,
including many major business enterprises, often referred to as
the Global 2000, and government organizations. Our
customers include leaders in manufacturing, process industries
(such as chemicals, oil and gas, metals, paper and plastics),
financial services, telecommunications, government, consumer
goods manufacturing and retail, utilities and transportation and
logistics. We license our software primarily through our direct
sales force. In the Asia Pacific region and, to a lesser extent,
in Europe, we also license our software through resellers. We
pursue joint promotional and selling efforts with strategic
partners who provide leading enterprise application software
products, many of whom embed our software directly into their
application products. We also pursue joint promotional and
selling efforts through strategic alliances with major systems
integrators. Through those joint efforts with our strategic
partners, we leverage our direct sales force, reach a broader
range of prospective customers and create opportunities to
upsell our products to customers already using limited versions
of our software embedded in their enterprise application
products. In addition, we license our products through a number
of major resellers and distributors.

Our goal is to continue establishing webMethods
as the leading independent provider of integration software. Our
strategy is based on driving the success of our customers and
partners, making our software ubiquitous by expanding and
maximizing our strategic software vendor partnerships,
leveraging our sales force and technical services team by
expanding our strategic alliances with leading systems
integrators and providing the most comprehensive integration and
web services solution by extending our technology and product
leadership.

INDUSTRY BACKGROUND

With the widespread proliferation of mainframes,
distributed computing environments, application servers,
databases, packaged and custom software applications and Web
services within each organization or enterprise, as well as
these same information resources and technologies throughout its
chain of vendors, customers, affiliates and business partners
(collectively comprising the extended enterprise),
the ability to integrate these disparate systems and
applications has become a strategic part of an
organizations information systems infrastructure. In
addition, the need for integration software is driven by the
widespread adoption of enterprise resource planning (ERP),
supply chain management (SCM), financial management and customer
relationship management (CRM) software application products,
whose benefits are largely dependent on integration with other
information systems. Organizations that have purchased such
software or systems often seek to streamline internal processes
and enable communication and collaboration internally and with
their customers, vendors and partners to increase productivity,
create new revenue opportunities, reduce costs and strengthen
relationships with customers, vendors and partners.

In parallel with the increased demand for
software integration, there has been a comparable increase in
the need for greater sophistication of integration technology.
Integration systems today require the ability not only to
integrate the numerous disparate resource types (databases,
legacy mainframe applications, packaged applications, custom
applications, trading partners, people and web services), but
also to manage the business processes that govern the
interactions between these resources. This business process
management (BPM) capability is the foundation that allows an
organization or enterprise to truly manage its business with its
information systems.

The ability of integration technology to define
business processes in a minimal amount of time and without
coding has become an expectation of prospective customers. This
demand for ease of use has caused a fundamental shift in
integration technology away from complex software programming
techniques to a more intuitive, highly-graphical modeling
approach. It has also driven the demand for comprehensive,
fully-integrated integration software and tools that allow users
to do a wide variety of integrations without learning multiple
software tools or writing software code.

Integration technology is often rated as the top
strategic priority for most Global 2000 companies and government
organizations due to the benefits available from comprehensive
integration of information resources. As a result, integration
systems are considered mission-critical, and the need for
industry-

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standard operations and systems management
capabilities has evolved from nicety to necessity. However, to
preserve their significant investments, many Global 2000
companies and government organizations require that integration
products support their existing systems management software
products, such as those from BMC Software, Inc., Computer
Associates International, Inc., Hewlett-Packard Company and IBM/
Tivoli.


As the integration market has evolved, Global
2000 companies and government organizations have increasingly
used integration technology to link their disparate information
system resources under the control of a business process
management capability. In many cases, these business process
management functions have revealed that most projects involve
certain processes that people must perform manually.
Consequently, Global 2000 companies and government organizations
are putting pressure on integration software vendors to provide
integrated workflow capabilities that allow users to define
business processes to include manual steps and to manage the
complete business process with their integration technology, and
not some non-integrated workflow engine or software program.
Global 2000 companies and government organizations are also
increasingly demanding software toolsets that allow for the
rapid creation of user interfaces to support these human steps.

During our fiscal year ended March 31, 2002,
there was a rapid increase in the popularity of web services
standards among Global 2000 companies. The interest in web
services arises from the promise of cross-platform
standardization of the low-level integration points for a wide
range of computing resources, thereby allowing a user or
software product to seamlessly access functionality or business
processes provided by other software products operating within
the enterprise. The standardization is considered very valuable,
as it offers significant benefit with respect to lowering the
services costs associated with integration. Although a number of
companies outside the integration software industry promote
their individual web services offerings as the ideal solution
for this problem, many industry analysts agree that web
services-based integration solutions will be delivered by
integration software companies.

WEBMETHODS SOLUTION

The webMethods integration platform is designed
to provide customers with a multi-faceted solution for solving
the unique challenges associated with implementing a
comprehensive enterprise integration, Enterprise Web Services
and business process management backbone. A backbone
represents a single integration infrastructure that is capable
of meeting all of the integration requirements of an enterprise
customer. The webMethods integration platform enables our
customers to implement a single integration solution that allows
them to not only integrate their internal systems (Enterprise
Application Integration  EAI) but also those of their
trading partners  customers, vendors and business
partners  allowing them to seamlessly integrate
cross-enterprise information resources and business processes
(Business-to-Business Integration  B2Bi).

Historically, companies may have selected
multiple products from different vendors to accomplish this
level of integration. By combining these best-of-breed
capabilities, we are able to lower our customers total
cost of ownership and streamline the integration process. By
enabling this end-to-end integration of all internal and
external resources, we allow our customers to gain greater
access to the information that is necessary to gain true Global
Business Visibility within their enterprise and across connected
enterprises, such as their customers, vendors and business
partners. This provides our customers with the ability to
realize the greatest value from their current investments in
information technology resources, including databases, legacy
mainframe applications, packaged applications, custom
applications and application servers.

The following are the leading elements of our
solution:

Service-Oriented Architecture.The webMethods integration
platforms service-oriented architecture allows us to
easily expand our product as new protocols and standards evolve.
This also allows our customers to define integrations and
business processes that can be deployed as web services without
requiring the substantial programming typical of most web
services development tools.

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Comprehensive Library of Adapters.We provide a comprehensive library of
adapters so that the webMethods integration platform can
integrate the numerous proprietary interfaces presented by a
broad variety of enterprise applications (e.g., supply
chain management and customer relationship management software
from i2 Technologies, inter-enterprise software solutions from
SAP, sales, marketing and customer relationship management
software from Siebel Systems, customer relationship management
and enterprise management software from PeopleSoft, and
enterprise resource planning software from J.D. Edwards).
The webMethods integration platform can also be extended by
customers and partners through the use of webMethods toolkits
that allow them to develop interfaces for custom applications or
other software.

Enterprise Application Integration (EAI).One of the most frequent uses of the
webMethods integration platform is for the integration of two or
more internal resources that a customer may use for their
internal operations. These can include databases, packaged and
custom applications, application servers, legacy mainframe
applications, Enterprise Web Services and a variety of low-level
middleware technologies (e.g., IBMs
Websphere MQ or Microsofts MSMQ offerings). These
configurations can be very large and may be flexibly configured
to support a wide variety of optimization configurations.

Support for eCommerce
Protocols.Our software also provides
support for a wide range of electronic commerce, or eCommerce,
protocols that enable our customers to automate and integrate
their commercial transactions with their business partners.
Examples of these types of transactions include purchasing and
procurement, supply chain management, collaborative product
design and vendor-managed inventory. Our software supports a
broad range of capabilities to support these and other
initiatives of an enterprise to integrate its information
resources with those of its trading partners. These include XML,
traditional and Internet EDI, Commerce Ones xCBL,
RosettaNet, Chem eStandards, ebXML and Microsoft BizTalk. In
addition, our software also supports the latest web services
standards such as Simple Object Access Protocol (SOAP) and
Web Services Description Language (WSDL). Networks of trading
partners can be administered utilizing a powerful management
system that allows our customers to define sophisticated rules
for the automatic processing of business transactions submitted
via Internet protocols.

Business Process
Management.The webMethods integration
platform provides an environment that allows our customers to
define business processes, which can include multiple enterprise
resources, in a single business process definition. This allows
our customers to use a highly graphical modeling tool to define
complex rules that govern the flow of information between
systems and dynamically modify the flow based on any combination
of business data that is accessible to the business process
instance. When the business process is invoked in an operating
environment, our business process management environment
provides a powerful user interface for query, selection and
viewing of any business process.

webMethods WorkFlow.We also offer a separately licensed, fully-integrated module
named webMethods Workflow that allows our customers to
incorporate their human resources into their business processes.
Our WorkFlow product is designed to allow our customers to
seamlessly mix automated and manual business process steps in a
single overall business process. This powerful capability also
allows them to monitor the human workflow steps as an integrated
part of the overall business process using the same monitoring
tools that are employed for automated or electronic steps in the
business process.

webMethods
Mainframe.In order to provide an
integration solution for IBM and compatible mainframe
environments, we offer another separately licensed,
fully-integrated module called webMethods Mainframe. We have
received patent protection on this modules innovative
Direct Transaction Mapping capability. Access to legacy
mainframe resources using webMethods Mainframe can be
incorporated into any overall business process, as with all
other resources.

webMethods Manager.We have defined and are developing the
first industry standard systems management solution for an
integration system, including access to all business process and
transaction information. The results of our efforts, co-authored
with the Hewlett-Packard Company, is called the Open Management
Interface (OMI) Specification. We have also partnered with
three of the dominant systems management vendors (BMC Software,
Inc., Computer Associates International, Inc. and Hewlett-Packard

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Company). Each of these companies has committed
to develop a version of their product that exploits this
management capability as part of their systems management
solution.


WEBMETHODS STRATEGY

We believe our focused business strategy enables
us to be the leading independent integration software provider.
Our strategy is based on investing our efforts in our customers
and partners to ensure their success and developing and
delivering the most comprehensive industry-leading integration
tools available. By executing on our strategy, we believe we are
helping to ensure the success of our customers and partners. The
key elements of our strategy include the following:

Customer Success.A
core part of our strategy is a tremendous focus on customers to
ensure their success and referenceability. We invest in
resources and efforts that will improve our customers
success rates by reducing their time to deploy our software,
minimizing their runtime costs and maximizing their return on
investment for the integration project. We attempt to accomplish
this by working with customers to understand the foreseeable
return on investment for their integration projects and then
working closely with them to ensure they achieve it. Our
satisfied customers often assist with references and site visits
for prospective customers.

Expand and Maximize Our Strategic Software
Vendor Partnerships.We have strong
relationships with leading enterprise application software
vendors, including BroadVision, i2 Technologies, J.D.
Edwards, Lawson Software, SAP AG, and Siebel Systems, many of
whom embed a limited version of webMethods software into their
software. For example, i2 Technologies has selected
webMethods as their preferred integration platform, and has
licensed webMethods software to tightly integrate their
applications. i2 Technologies sales representatives
can sell both the integrated software as well as other
webMethods products. As a result, any customer that licenses
Release Five.Two of i2 Technologies software receives
a license-limited version of webMethods software integrated with
Release Five.Two, and we believe this customer of
i2 Technologies will be a likely candidate to purchase
additional webMethods integration software from
i2 Technologies or webMethods. We continue to build upon
existing strategic relationships and develop new ones. In our
fiscal year ended March 31, 2002, we created new
partnerships with Siebel Systems and Lawson Software and renewed
our strategic relationship with SAP AG.

We believe these relationships differentiate us
from other integration software providers and provide a
competitive advantage for webMethods. These relationships
leverage our direct sales force and provide us with an
incumbency advantage that we believe positions webMethods as the
lowest risk option for customers of these software products when
implementing an integration project.

Concentrate on Leading Systems Integrators.In addition, we have expanded and
strengthened our alliances with major system integrators to
provide services and sales leverage to our software
product-based business model. We have established a series of
formal alliance relationships with leading system integrators,
such as Accenture, American Management Systems (AMS), Cap Gemini
Ernst & Young Group, Computer Sciences Corporation
(CSC), Deloitte Consulting, Electronic Data Systems Corporation
(EDS), KPMG Consulting and Science Applications International
Corporation (SAIC). Each of these partners has established a
formal webMethods practice, thus increasing dramatically the
number of webMethods-trained resources available through our
system integrator partners.

As a result of this expanded knowledge base, as
well as implementation successes on which the partner and
webMethods have worked jointly, these alliances have resulted in
a virtual extension of our direct sales force. This results in
the third-party introduction and subsequent endorsement of
webMethods products in opportunities of which we may not
be aware or with customers or prospects of the partner with
which we may not be otherwise already be engaged.

Extend Technology and Product Leadership to
Provide the Most Comprehensive Integration and Web Services
Solution.We believe that we have
developed the broadest and most comprehensive integration
software currently available, supporting more
application-to-application, business-to-business, mainframe
integration and web services protocols and data format standards
than any competing product. In addition,

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we have integrated leading-edge workflow
technology to allow our customers and their business partners to
automate not only the unattended business process but also those
critical business functions where a person plays a key role. We
also are developing the OMI specification as the first industry
standard systems management solution for an integration system
so that all business processes and transaction information from
the webMethods integration platform can be accessed and managed
by webMethods Manager or many of the dominant systems management
solutions.


Building on our pioneering role in the
application of extensible markup language (XML) and Java
technologies for all areas of integration and e-commerce, we
believe we are positioned to lead what we believe may be the
next technology wave in the integration marketplace: web
services based integration. We are a leading provider of
standard protocol-based services for integrating information
resources both within the enterprise and across the extended
enterprise. This expertise, coupled with our service-based
architecture, has allowed webMethods to take a leadership role
in defining an extremely comprehensive and competitive
Enterprise Web Services offering. Our extensive knowledge of
integration technology, combined with our long-standing support
of web services concepts, enables webMethods to create an
unparalleled platform for delivering web services technology.
This combination of web services technology with the extensive
integration capabilities of the webMethods integration platform
results in the creation of Enterprise Web Services 
web services capability optimized for the unique challenges of
solving integration problems.

CUSTOMERS

As of March 31, 2002, we had licensed our
software to over 800 customers. Many of our customers are Global
2000 companies and represent a broad spectrum of vertical
markets. We also have a number of government organizations as
customers. Our customers include leaders in manufacturing,
process industries (such as chemicals, oil and gas, metals,
paper and plastics), financial services, telecommunications,
government, consumer goods manufacturing and retail, utilities
and transportation and logistics.

In each of the fiscal years ended March 31,
2002, 2001 and 2000 no individual customer accounted for more
than 10% of our total revenue. From time to time, we may have a
customer that accounts for 10% or more of our total quarterly
revenue, as we did in the fourth quarter of our fiscal 2002, but
we do not expect to have a significant number of customers
accounting for 10% or more of our quarterly revenue.

The percentage of total revenue for our fiscal
year ended March 31, 2002 from geographical regions outside
of the Americas increased to 27% from 11% for the year ended
March 31, 2001 and 8% for the year ended March 31,
2000. We believe that revenue from geographical regions outside
of the Americas will continue to be a significant percentage of
our total revenue for the foreseeable future. Information on
revenue we derived from our Americas, Europe and Asia Pacific
operations, as well as long lived assets located in those
geographic areas, is included in Note 19 of the Notes to
Consolidated Financial Statements of webMethods, Inc. included
elsewhere in this report.

SALES AND MARKETING

We sell our software and services primarily
through our direct sales organization augmented by other sales
channels, including our strategic software vendor partners,
major systems integrators with whom we have strategic alliances
and other partners and distributors. Our application software
and system integrator partners actively assist us in selling the
full webMethods product line to their customers, often giving us
an incumbency advantage when the customer implements an
enterprise-wide integration initiative. Information on our
strategic partners is included in this section under the
captions webMethods Strategy and
Partners and Strategic Relationships.

Our direct sales organization consists of sales
representatives and pre-sales consultants supported by personnel
with experience within the industries we serve. At
March 31, 2002, our sales and marketing group consisted of
333 employees. At that date, our sales and marketing personnel
serving North America were located in our headquarters in
Fairfax, Virginia, and in approximately 20 other offices in the
United States and Canada. At that date, our sales and marketing
personnel in Europe were located in five

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countries, and our sales and marketing personnel
in Asia Pacific were located in six countries. Information on
revenue we derived from our Americas, Europe and Asia Pacific
operations, as well as long lived assets located in those
geographic areas, is included in Note 19 of the Notes to
Consolidated Financial Statements of webMethods, Inc. included
elsewhere in this report. We expect to continue expanding our
sales and marketing group through targeted recruitment of
qualified individuals.


During our fiscal year ended March 31, 2002,
we created specialized teams to focus on key vertical markets.
Those teams focus on customers, prospective customers and
business partners in manufacturing industries and in financial
services. We also expanded our specialized team focused on sales
to the US Government and other public sector organizations.

We license our software on a perpetual basis or
on a renewable term basis. At the end of the renewable license
term, customers can either pay a new license fee or their
license will terminate.

The sales cycle for our software typically ranges
from 90 to 270 days. A prospective customers decision
to use our products may involve a substantial financial
commitment, which may require a significant evaluation period
and approval of the customers senior management. A
customers decision to license certain of our products may
also involve significant user education and deployment costs, as
well as substantial involvement of the customers
personnel. Due to the nature of our business, we have no
inventory.

We have experienced significant quarterly
fluctuations in our operating results and anticipate
fluctuations in the future. We experience certain general
seasonal factors, such as: revenue in our second fiscal quarter
(ending September 30) can be positively impacted by
budgeting cycles of the US Government, and can be negatively
impacted because businesses  particularly in
Europe  often defer purchase decisions during
summer months. In addition, revenue in our third fiscal quarter
(ending December 31) can be positively impacted by the
end-of-year budgeting cycles of many Global 2000 customers, and
revenue in our fourth fiscal quarter (ending March 31) can
be positively impacted by the annual nature of our sales
compensation plans. Quarterly revenue and operating results
depend on the volume and timing of orders received, which may be
affected by large individual transactions that sometimes are
difficult to predict.

PARTNERS AND STRATEGIC RELATIONSHIPS

We believe that our strategic relationships
represent one of the most significant advantages we have over
our competition. As described above in webMethods
Strategy, we utilize our strategic partnerships with
leading software vendors, such as BroadVision,
i2 Technologies, J.D. Edwards, Lawson Software, SAP and
Siebel Systems, to provide a unique differentiator when selling
to a prospective customer that owns or plans to purchase one or
more products from these companies in which a license-limited
version of our software is embedded or utilized. We believe that
this provides us with an incumbency advantage for many of the
new business opportunities in which we compete. We also expect
to continue to benefit from these relationships through the
promotion of our products by their sales and other personnel.

We believe that our multiple strategic alliances
with major systems integrators also constitute a significant
advantage over some competitors. As described above in
webMethods Strategy, we work very closely with
many major systems integrators. We believe that our investment
in these relationships is important because they augment our
direct sales force by promoting our products as the most
appropriate solution for their clients and greatly increase our
implementation capabilities.

We also license our software through resellers
and distributors, who may also sell our consulting and
implementation services. We have relationships with a number of
resellers or distributors with expertise in certain industry
sectors or countries in which we do not currently have a
significant number of direct sales personnel.

We believe our partners influenced, directly or
indirectly, a substantial portion of our license revenue during
our fiscal year ended March 31, 2002, and we expect this to
increase in future periods. During our fiscal 2002, we entered
into a number of new or expanded partnership agreements,
including agreements

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with BroadVision, J.D. Edwards, Lawson
Software and Siebel Systems and we renewed our strategic
relationship with SAP AG. During our fiscal 2002,
i2 Technologies and J.D. Edwards began shipping the
latest versions of their application suites, in which our
software is embedded to provide real-time integration.


Under our typical partnerships with software
vendor partners, the partner may resell or embed our software
with their applications under limited use licenses for a license
fee or royalty fee. Under certain partnership arrangements, we
may share license fees derived from joint selling opportunities
with our partner. In other partnership arrangements, we may pay
a sales assistance fee to a partner who performs or assists in
certain sales activities, and that fee usually is paid once
payment from the joint customer of license fees is received.

CUSTOMER CARE

We offer our customers a variety of software
support and maintenance options designed to meet their varied
needs. Our most sophisticated enterprise customers may choose
options that include 24-hour coverage, seven days per week.
We have established a follow-the sun support model
with integrated, major support centers in Virginia and
California in the United States and in Australia, Japan and the
Netherlands. Our resellers and distributors generally provide
initial software support to their customers, and we provide
support on more complicated support issues. Our customers and
business partners can also receive support from our webMethods
Advantage support website, which includes extensive discussion
groups, technical advisory papers and provides online access to
our customer service management system so that they can submit
and monitor the status of any technical issues.

Many of our customers purchase consulting
services from us to support their full range of integration
initiatives. We may provide all of these services directly or we
may augment the efforts of a systems integration partner in
performing these services. We offer these professional services
both during the initial deployment of our products and
thereafter to address our customers needs through the
entire project lifecycle. We provide professional services
ranging from initial architectural planning to the complete
deployment of our products. We also offer comprehensive training
courses and other education products at our facilities, as well
as on-site at customer and partner facilities.

While we are able to provide a wide range of
consulting services from introductory training to full-scale
implementation, we primarily focus on providing consulting in a
mentorship capacity. In this role we commonly augment an
internal development team or a systems integration partner that
performs the bulk of the integration effort.

PRODUCT DEVELOPMENT

We pursue a judicious mix of building and
acquiring strategic technologies. This has allowed us to
assemble a comprehensive integration platform more quickly than
our competitors.

We focus our ongoing product development efforts
on enhancing, broadening and deepening the functionality of our
core products and services to address new software alliances,
industries, marketplaces and geographic markets. These products
and services are evolving and have been developed using an
architecture that is intended to be (i) modular, so
components may be substituted, (ii) flexible, to respond to
changing business conditions, (iii) open, to support
multiple protocols, and (iv) scalable, to handle messaging
and transaction loads that are typical in a complex, enterprise
environment.

Our development staff has developed our products
utilizing project teams focused on independent components of the
software under development. We maintain product release planning
procedures to ensure integration, testing and version control
among the different project development teams. We maintain our
primary development centers in Fairfax, Virginia and Sunnyvale,
California and have special expertise teams in Berkeley,
California, Bellevue, Washington, and Westborough,
Massachusetts. At March 31, 2002, we had 251 employees
dedicated to research and development. Our research and
development expenditures, excluding stock-based compensation,
were $49.6 million in our fiscal year ended

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March 31, 2002, $45.2 million in our
fiscal year ended March 31, 2001 and $14.8 million in
our fiscal year ended March 31, 2000. We expect to continue
committing significant resources to product development in the
future.


COMPETITION

The market for our software and services is
extremely competitive and subject to rapid change. We offer a
comprehensive suite of application integration software that we
believe to be the best and most comprehensive integration
solution available. We are not aware of another company that can
demonstrate the in-depth expertise in trading partner
integration and management, our long history of web services
experience, the deep knowledge of legacy IBM mainframe
integration as well as the broad expertise in Enterprise
Application Integration (EAI) as we do. We compete primarily
with providers of integration software products, including
International Business Machines Corporation (IBM), SeeBeyond
Technology Corporation and TIBCO Software, Inc. We also compete
with BEA Systems, Inc., Mercator Software, Inc., Microsoft
Corporation, Vitria Technology, Inc. and a wide range of
companies that are emerging in this category. We expect
additional competition primarily from other emerging companies.
In addition, we may face pricing pressures from our current
competitors and new market entrants in the future. We believe
that the competitive factors affecting the market for our
software and services are numerous and the specific importance
of any one of these factors varies significantly for each
specific customer environment. These competitive factors include
product functionality and features; performance and price; ease
of product implementation; vendor and product reputation;
quality of customer support services; customer training and
documentation; and quality of professional services offerings.
Although we believe that our software and services currently
compete favorably with respect to such factors, we may not be
able to maintain our competitive position against current and
potential competitors.

Some of our current and potential competitors
have longer operating histories, significantly greater
financial, technical, product development and marketing
resources, greater brand recognition and larger installed
customer bases than we do. Our present or future competitors may
be able to develop software similar to or even superior in
functionality to what we offer, some may be able to adapt more
quickly than we do to new technologies, evolving industry trends
or new customer requirements, or devote greater resources to the
marketing, design and development, and sale of their products
than we do. Accordingly, it is possible that we may not be able
to compete effectively in our markets, which may harm our
business and operating results. If we are not successful in
developing new software and enhancements to our existing
software or in achieving customer acceptance, our gross margins
may decline, and our business and operating results may suffer.

INTELLECTUAL PROPERTY AND OTHER PROPRIETARY
RIGHTS

Our success is heavily dependent upon the
technological and creative skills of our personnel and how
successfully we can safeguard their efforts in developing and
enhancing our software and related technology through the
protection of our intellectual property rights, brand name, and
associated goodwill. We depend upon our ability to develop and
protect our proprietary technology and intellectual property
rights to distinguish our software from our competitors
products. We rely on a combination of confidentiality
agreements, confidentiality procedures and contractual
provisions, as well as trade secret, copyright, trademark and
patent laws, to establish and protect our proprietary rights and
accomplish these goals.

For example, we take measures to avoid disclosure
of our trade secrets, including, but not limited to, requiring
certain employees, consultants, customers, prospective
customers, and others with which we have business relationships
to execute confidentiality agreements that prohibit the
unauthorized use and disclosure of our trade secrets and other
proprietary materials and information. Further, we enter into
license agreements with our customers, business partners and
resellers that limit the unauthorized access to, use and
distribution of our software, documentation and other
proprietary information. Our license agreements with our
customers, business partners and resellers impose restrictions
on the use of our technology, including prohibiting the reverse
engineering or de-compiling of our software, impose

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restrictions on the licensees ability to
utilize the software and provide for specific remedies in the
event of a breach of these restrictions. We also restrict access
to our source code. While some of our license agreements require
us to place the source code for our software in escrow for the
benefit of the licensee, these agreements generally provide
these licensees with a limited, non-exclusive license to use
this code in the event we cease to do business without a
successor or there is a bankruptcy proceeding by or against
webMethods; certain agreements may provide that the licensee can
use the escrowed source code if we fail to provide the necessary
software maintenance and support.


We also seek to protect our technology, software,
documentation and other proprietary information under the
copyright, trademark and patent laws. We assert copyright in our
software, documentation and other works of authorship, and
periodically register copyrights with the U.S. Copyright
Office in qualifying works of authorship. We assert trademark
rights in and to our name, product names, logos and other
markings that are designed to permit consumers to identify our
goods and services. We routinely file for and have been granted
trademark protection from the U.S. Patent and Trademark
Office for qualifying marks. We currently hold a trademark
registration in the United States for the webMethods
and B2B Integration Server marks, a trademark
registration in Australia and Japan for the
webMethods mark, and have pending applications for
the registration of the webMethods mark in the
European Union. We have a patent issued in the United States and
several patent applications pending for technology related to
our software. We may file additional patent applications in the
United States or other countries in the future.

Despite our efforts to protect our proprietary
rights, contractual provisions, licensing restrictions and
existing laws and remedies afford us only limited protection.
The steps we have taken to protect our proprietary rights and
intellectual property may not be adequate to deter
misappropriation of our technology, and the protections we have
may not prevent our competitors from developing products with
functionality or features similar to our software. The use by
others of our proprietary rights could materially harm our
business.

It is possible that the copyrights, trademarks or
patent held by us could be challenged and invalidated. For
example, we cannot be certain that the patent we hold, those
that we have applied for, if issued, or our potential future
patents will not be successfully challenged. Further, we cannot
be certain that we will be able to develop proprietary products
or technologies that are patentable, that any patent issued to
us will provide us with any competitive advantage or that the
patents of others will not seriously limit or harm our ability
to do business.

We may not be able to detect unauthorized use of
our proprietary information or take appropriate steps to enforce
our intellectual property rights effectively, and the use by
others of our proprietary rights could materially harm our
business. Policing the unauthorized use of our products and
other proprietary rights is difficult and expensive,
particularly given the global nature and reach of the Internet.
In the event we increase our international operations in the
future, 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. For more
information regarding our proprietary rights, see Factors
That May Affect Future Operating Results  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.

Despite efforts by us to protect our proprietary
rights, parties may breach confidentiality agreements or other
protective licenses and contracts into which we have entered,
and we may not be able to enforce our rights effectively in the
event of these breaches. There can be no assurance that we will
be able to prevent unauthorized attempts to copy or reverse
engineer aspects of our software or to obtain and use
information that we regard as proprietary. Further, 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. It is
possible that our competitors will adopt similar product or
service names, impeding our ability to protect our intellectual
property and possibly leading to customer

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confusion. 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.


The software industry is characterized by the
existence of a large number of patents and frequent litigation
based on allegations of patent infringement and the violation of
other intellectual property rights. We believe that software
developers in our market will increasingly be subject to
infringement claims as the number of products in different
software industry segments overlap. Although we attempt to avoid
infringing known proprietary rights of third parties in our
product development efforts, it is also possible that third
parties will claim that we have infringed on their intellectual
property rights currently existing or developed in the future.
We may increasingly be subject to infringement claims as the
number of products and competitors in our industry grows and
functionalities of products overlap. Furthermore, former
employers of our current and future employees may assert that
their employees have improperly disclosed confidential or
proprietary information to us.

Expensive litigation may be necessary in the
future to enforce our intellectual property rights. We expect
that we may be subject to legal proceedings and claims for
alleged infringement by us or our licensees of third party
proprietary rights, such as copyrights, trademarks, patents or
trade secrets, from time to time in the ordinary course of our
business. While we are not aware that any of our software,
documentation, copyrights, trademarks, patents, or other
proprietary rights infringe the proprietary rights of third
parties, it is possible that third parties will claim that we
have infringed their current or future products, technology or
intellectual property rights. Any infringement claims, with or
without merit, brought by such third parties could be
time-consuming, result in costly litigation, prevent product
shipment, cause delays, distract us from managing our business
or require us to enter into royalty or licensing agreements
which are not advantageous to us, any of which could materially
harm our business. Patent litigation in particular has complex
technical issues and inherent uncertainties.

Parties making claims against us could secure
substantial damages, as well as injunctive or other equitable
relief that could effectively block our ability to license our
software in the United States or abroad. Such a judgment could
materially harm our business. In the event an infringement claim
against us was successful and we could not obtain a license on
acceptable terms, license a substitute technology or redesign to
avoid infringement, our business would be harmed materially. In
addition, parties making these claims may be able to obtain an
injunction, which could prevent us from selling our software in
the United States or abroad. Any of these results could harm our
business materially.

For more information regarding our proprietary
rights, see Factors That May Affect Future Operating
Results  Third party claims that we infringe upon
their intellectual property rights could be costly to defend or
settle.

In addition, we license technology from third
parties that is incorporated into our software, and any
significant interruption in the supply or support of any
technology we license from third parties could adversely affect
our business, unless and until we can replace the functionality
provided by the licensed technology. Our products could infringe
the intellectual property rights of others causing costly
litigation and the loss of significant rights. For more
information regarding our proprietary rights, see Factors
That May Affect Future Operating Results  Because our
products incorporate technology licensed from third parties, the
loss of our right to use this licensed technology could harm our
business.

webMethods, B2B Integration
Server, Global Business Visibility and the
names of our software are our trademarks or our registered
trademarks in the United States and/or other countries.

CORPORATE INFORMATION

webMethods, Inc. was organized in Delaware in
1996. We completed our initial public offering in February 2000.
In August 2000, webMethods, Inc. acquired Active Software, Inc.,
a publicly-held software company that developed and delivered
enterprise application integration software. In February 2001,
we acquired IntelliFrame Corporation, its workflow technology
and its research and development team. References to
webMethods, we, us or
our include webMethods, Inc. and its subsidiaries
unless a

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statement specifically refers to webMethods, Inc.
Our executive offices are located at 3930 Pender Drive, Fairfax,
Virginia 22030, and our main telephone number is
(703) 460-2500. We operate in a single segment of software
and related services.


EMPLOYEES

As of March 31, 2002, we employed
888 full-time employees. These included 333 in sales and
marketing, 195 in professional services and customer care, 251
in research and development and 109 in other administrative
areas, including accounting, finance, human resources,
facilities and information technology. 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.

EXECUTIVE OFFICERS OF WEBMETHODS

Our executive officers and their ages and
positions as of May 31, 2002 are as follows:

|                   |  |     |    |          |  |                                                                           
|------------------ |  | --- | -- | -------- |  | --------------------------------------------------------------------------
|Name               |  | Age |    | Position
|                   |  |     |    |         
|Phillip Merrick    |  |     | 39 |          |  | Chairman of the Board and Chief Executive Officer                         
|David Mitchell     |  |     | 37 |          |  | President and Chief Operating Officer                                     
|Mary Dridi         |  |     | 41 |          |  | Chief Financial Officer, Executive Vice President
    and Treasurer       
|R. James Green     |  |     | 52 |          |  | Chief Technology Officer and Executive Vice
    President                 
|Douglas W. McNitt  |  |     | 37 |          |  | General Counsel, Executive Vice President,
    Assistant Secretary        
|Thomas N. Erickson |  |     | 43 |          |  | Senior Vice President, International and General
    Manager, Asia Pacific
|Laurie Mascott     |  |     | 37 |          |  | General Manager, EMEA and Senior Vice President                           
|Donna M. Angiulo   |  |     | 47 |          |  | Senior Vice President                                                     

Phillip Merrickthe
founder of webMethods, has served as Chairman of the Board and
Chief Executive Officer since its inception in June 1996; he
served as President of webMethods from inception in June 1996 to
August 2000. Before founding webMethods, he served from December
1994 to February 1996 as Vice President of Engineering at Open
Software Associates, an Internet and graphic user interface
tools company. From 1990 to 1994, Mr. Merrick was Director
of Development at Magna Software Corporation. Mr. Merrick
holds a B.S. in Computer Science from the University of
Melbourne in Australia.

David Mitchelljoined webMethods in December 1997 as Vice President, Sales,
became Chief Operating Officer in January 2000 and became
President in August 2000. Mr. Mitchell served as Vice
President of Worldwide Sales from September 1999 to December
1999. From 1995 to 1997, Mr. Mitchell served as Director of
Worldwide Sales for the help desk and network management group
at McAfee Software, now Network Associates, Inc. From 1993 to
1995, Mr. Mitchell was President and Chief Executive
Officer of VYCOR Corporation, a vendor of help desk and customer
interactivity software, which was acquired in 1995 by McAfee
Software. Mr. Mitchell served as Vice President of Sales of
VYCOR from 1989 to 1993. Mr. Mitchell holds a B.S. in
Marketing from Virginia Commonwealth University.

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Mary Dridijoined
webMethods in May 1998 as Chief Financial Officer and Treasurer.
She became an Executive Vice President in January 2002. From
July 1991 to April 1998, she served as the Controller and Vice
President of Finance for SRA International, Inc., an information
technology company. From 1987 to 1991, Ms. Dridi served as
the Director of Finance at Geostar Corporation, a mobile
satellite communications company. From 1983 to 1987,
Ms. Dridi provided audit and other business services with
the accounting firm of Peat Marwick. Ms. Dridi is a
Certified Public Accountant and holds a B.S. in Commerce and
Accounting from the University of Virginia.

R. James Greenbecame Chief Technology Officer and Executive Vice President of
webMethods in August 2000 upon the completion of its acquisition
of Active Software, Inc. Mr. Green founded Active Software
in September 1995, and served as its President and Chief
Executive Officer from October 1997 until August 2000, as a
Director from November 1995 until August 2000 and as its
Chairman from April 1996 until August 2000. Prior to founding
Active Software, Mr. Green established and managed the
distributed objects program at Sun Microsystems, Inc., a
provider of network computing products, where he was Director of
Engineering from 1988 to 1995. Mr. Green holds a B.A.
degree from Hanover College, an M.S. degree from North Carolina
State University and an M.S. degree in Computer Science from San
Jose State University.

Douglas W. McNittjoined webMethods in October 2000 as
General Counsel, and became Executive Vice President in January
2002. Mr. McNitt served as Senior Counsel for America
Online, Inc. from December 1997 to September 2000. From May 1996
to December 1997, he was an associate with the law firm of
Tucker, Flyer & Lewis, a professional corporation, and
was an associate with the law firm of McDermott, Will &
Emery from April 1994 to May 1996. Mr. McNitt holds a B.A. from
Stanford University and a J.D. from Notre Dame Law School.

Thomas N. Ericksonjoined webMethods in May 2000 as Vice
President of Asia Pacific operations. He has served as
webMethods General Manager, Asia Pacific since October
2000 and has served as a Senior Vice President since January
2002. In April 2002, he became webMethods Senior Vice
President, International. Prior to joining webMethods,
Mr. Erickson was President of Asia Pacific at Baan Company
NV, an enterprise software vendor, from 1999 to May 2000 and
President of BaanMSO from 1998 to 1999. Mr. Erickson served
as a Consultant at Prides Management, Inc., a management
consulting business assisting emerging growth companies, from
July 1996 to January 1998. From March 1995 to June 1996 he
served as Vice President of Sales at Watermark Software, a
startup in the document imaging industry which was acquired by
FileNET in July 1995. Mr. Erickson served as Group Vice
President of Marketing for Thomson Software/ Alsys (now Aonix)
from March 1992 to August 1993. Mr. Erickson held various
management positions at Project Software and Development from
1980 to 1992. Mr. Erickson holds a B.S. in Electrical
Engineering from the University of Wisconsin.

Laurie Mascottjoined webMethods in October 2000 as
Vice President of Sales for EMEA (Europe, Middle East and Asia).
He has served as webMethods General Manager, EMEA since
January 2001, and as a Senior Vice President since January 2002.
He has held a number of senior management positions in the
enterprise software marketplace. From 1995 to 2000, he was EMEA
Sales Director for Systems Union Group plc, an international ERP
vendor, where he was responsible for operations in all the
primary European countries. Prior to 1995, Mr. Mascott ran
his own business as an independent marketing consultant and held
sales management roles within Systems Union, including starting
and running the international government unit. Mr. Mascott
graduated from the University of Staffordshire with a joint
honors degree in economics and French and received a
post-graduate diploma in international marketing in a program
run and sponsored by the European Community.

Donna Angiulojoined
webMethods in February 2001 as Vice President of Finance and has
served as a Senior Vice President since January 2002.
Ms. Angiulo served as Vice President of Finance and
Operations for Collaborex, Inc., a business-to-business
e-commerce services provider, from August 2000 to January 2001.
Ms. Angiulo served as Chief Financial Officer 
Americas for the enterprise software vendor Baan Company NV from
August 1998 to August 2000. She also served as Chief
Operating Officer  Corporate Office Solutions at Baan
from May 1998 to July 1998. Ms. Angiulo served as
Chief

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Financial Officer at CODA Plc, a provider of
financial accounting software from September 1997 to
May 1998. From 1986 to 1997, Ms. Angiulo served in a
variety of positions including Controller, Director of Finance,
Vice President of Product Development, and Vice President of
International Business Development at Banyan Systems
Incorporated, a provider of enterprise solutions for networking
environments. Ms. Angiulo provided financial consulting
services to emerging technology businesses from 1984 to 1986,
and was an Audit Manager at Coopers and Lybrand from 1976 to
1984. Ms. Angiulo is a Certified Public Accountant and holds a
B.S. in Accounting from Utica College of Syracuse University.


FACTORS THAT MAY AFFECT FUTURE OPERATING
RESULTS

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

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

We believe that quarter-to-quarter or
year-to-year comparisons of our financial results are not
necessarily meaningful indicators of our future revenue or
operating results and should not be relied on as an indication
of our future performance. If our quarterly or annual revenue or
operating results fail to meet the expectations of investors or
analysts, the market price of webMethods stock could be
negatively affected. Our quarterly operating results have varied
substantially in the past and may vary substantially in the
future depending upon a number of factors, including the changes
in demand for our products and services, economic conditions,
competitive pressures, amount and timing of operating costs and
changes that we may make in our business, operations and
infrastructure. In addition, uncertainties and economic
after-effects of terrorist acts or other major, unanticipated
events may impact our quarterly operating results. In our fiscal
2002, we closed a substantial number of license transactions in
the last month of each quarter, which makes it more difficult to
gauge the level of license revenue we will have in any quarter
until near to, or after, its conclusion. We expect to continue
devoting resources to our sales and marketing operations and our
research and development activities. Our operating expenses,
which include sales and marketing, research and development and
general and administrative expenses, are based on our
expectations of future revenue and are relatively fixed in the
short term. If revenue falls below our expectations in a quarter
and we are not able to quickly reduce our spending in response,
our operating results for that quarter could be significantly
below the expectations of investors or analysts. It is possible
that our revenue or operating results in the future may be below
the expectations of investors or analysts and, as a result, the
market price of webMethods stock may fall. In addition,
the stock market, particularly the stock prices of
infrastructure software companies, has been very volatile. This
volatility is often not related to the operating performance of
the companies. From our initial public offering in February 2000
until June 1, 2002, the closing price of webMethods
stock on The Nasdaq National Market has ranged from a high of
$308.06 to a low of $6.32.

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

Due to customer demand, economic conditions,
competitive pressures or seasonal factors, we may experience a
lower growth rate for, no growth in, or a decline in quarterly
or annual revenue from sales of our software and services. For
example, the growth rate for revenue from sales of our software
and services during summer months may be slower than at other
times during year, particularly in European markets. We also may
experience declines in expected revenue due to patterns in the
capital budgeting and purchasing cycles of our current and
prospective customers, changes in demand for our software and
services and deferrals of purchases due to uncertainties and
economic after-effects of terrorist acts or other major,
unanticipated events. These periods of slower or no growth may
lead to lower revenue, which could cause fluctuations in our
quarterly operating results. In addition, variations in sales
cycles may have an impact on the timing of our revenue, which in
turn could cause our quarterly operating results to fluctuate.
To successfully sell our software and services, we generally
must educate our potential customers regarding

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their use and benefits, which can require
significant time and resources. Any delay in sales of our
software and services could cause our revenue and operating
results to vary significantly from quarter to quarter, which
could result in volatility in the market price of
webMethods stock.


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

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

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

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

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

We currently have a number of strategic partners
who provide leading enterprise application software products,
many of whom embed our software directly into their application
products. We also have strategic alliances with major systems
integrators. These strategic partners provide us with important
sales and marketing opportunities, leverage our direct sales
force, create opportunities to upsell our products to customers
already using our software embedded in their enterprise
application products, and greatly increase our implementation
capabilities. If our relationships with any of these
organizations were impaired, if a significant number of our
strategic partners decide to compete against us in providing

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


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

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

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

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

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demands, it could result in increased costs or an
inability to take advantage of certain opportunities that may
present themselves in the future. US Government agencies
routinely investigate and audit government contractors
administrative processes. They may audit our performance and our
pricing, and review our compliance with rules and regulations.
If they find that we have improperly allocated costs, they may
require us to refund those costs or may refuse to pay us for
outstanding balances related to the improper allocation. An
unfavorable audit could result in a reduction of revenue, and
may result in civil or criminal liability if the audit uncovers
improper or illegal activities. This could harm our business,
financial results and reputation.


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

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

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

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

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

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

17



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success will also depend in large part on our
ability to attract and retain experienced technical, sales,
marketing and management personnel.


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

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

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

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

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

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

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

The market for integration software solutions and
technology to implement enterprise web services is rapidly
changing and intensely competitive. There are a variety of
methods available to integrate software applications and to
implement web services. We expect that competition will remain
intense as the number of entrants and new technologies
increases. We do not know if our target markets will widely
adopt and deploy integration products such as our software. If
our software and enterprise web services are not widely adopted
by our target markets or if we are not able to compete
successfully against current or future competitors, our
business, operating results and financial condition may be
harmed. Our current and potential competitors include, among
others, large software vendors, companies and trading exchanges
that develop their own integration and web service solutions,
electronic data interchange, or EDI, vendors, vendors of
proprietary enterprise application integration (EAI), solutions
and application server vendors. We also face competition from
various providers of application integration solutions
technologies to implement web services and companies offering
products and services that address specific aspects of
application integration or web services integration. Further, we
face competition for some aspects of our

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software and service offerings from major system
integrators, both independently and in conjunction with
corporate in-house information technology departments, which
have traditionally been the prevalent resource for application
integration. In addition, our customers and companies with whom
we currently have strategic relationships may become competitors
in the future. Some of our competitors or potential competitors
may have more experience developing integration software or
implementing web services, larger technical staffs, larger
customer bases, more established distribution channels, greater
brand recognition and greater financial, marketing and other
resources than we do. Our competitors may be able to develop
products and services that are superior to our software and
services, that achieve greater customer acceptance or that have
significantly improved functionality or performance as compared
to our existing software and future software and services. In
addition, negotiating and maintaining favorable customer and
strategic relationships is critical to our business. Our
competitors may be able to negotiate strategic relationships on
more favorable terms than we are able to negotiate. Many of our
competitors may also have well-established relationships with
our existing and prospective customers. Increased competition
may result in reduced margins, loss of sales or decreased market
share, which in turn could harm our business, operating results
and financial condition.


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

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

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

Our software is integrated with our
customers networks and software applications and is often
used for mission critical applications. Errors, defects or other
performance problems could result in financial or other damages
to our customers. Customers could seek damages for losses from
us, which, if successful, could have a material adverse effect
on our business, operating results or financial condition. In
addition, the failure of our software to perform to customer
expectations could give rise to warranty claims. Although our
license agreements typically contain provisions designed to
limit our exposure to product liability claims, existing or
future laws or unfavorable judicial decisions could negate these
limitation of liability provisions. We have not experienced any
product liability claims to date. However, a product liability
claim brought against us, even if not successful, could be time
consuming and costly to defend and could harm our reputation. In
addition, although we carry general liability insurance, our
current insurance

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coverage would likely be insufficient to protect
us from all liability that may be imposed under these types of
claims.


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

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

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

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

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

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

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

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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 software industry. We expect that integration
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. Furthermore, former employers of our
current and future employees may assert that our employees have
improperly disclosed confidential or proprietary information to
us. In addition, we have agreed, and may agree in the future, to
indemnify certain of our customers against claims that our
software infringes upon the intellectual property rights of
others. We could incur substantial costs in defending ourself
and our customers against infringement claims. In the event of a
claim of infringement, we, as well as our customers, may be
required to obtain one or more licenses from third parties. 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.

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

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

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

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

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

Our Board of Directors adopted a shareholder
rights plan and declared a dividend distribution of one right
for each outstanding share of webMethods stock, payable to
stockholders of record at the close of business on October 18,
2001. Each right, when exercisable, entitles the registered
holder to purchase certain securities at a specified purchase
price, subject to adjustment. The rights plan may have the
anti-takeover effect of causing substantial dilution to a person
or group that attempts to acquire webMethods on terms not
approved by our Board of Directors. The existence of the rights
plan could limit the price that certain investors might be
willing to pay in the future for shares of webMethods
stock and could

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discourage, delay or prevent a merger or
acquisition of webMethods, Inc. that stockholders may consider
favorable. In addition, provisions of the current certificate of
incorporation and bylaws of webMethods, Inc., as well as
Delaware corporate law, could make it more difficult for a third
party to acquire us with the support of our Board of Directors,
even if doing so would be beneficial to our stockholders.


Item 2.     PROPERTIES

Our principal administrative, sales, marketing
and research and development facility is located in Fairfax,
Virginia, and consists of approximately 126,000 square feet of
office space held under leases that expire in March 2005 and
July 2007. We maintain offices for sales and research and
development in Sunnyvale, California, Westborough, Massachusetts
and Bellevue, Washington. We also maintain small offices for
sales personnel in the United States in California, Colorado,
Georgia, Illinois, Indiana, Massachusetts, Michigan, Minnesota,
Missouri, New York, New Jersey, North Carolina, Ohio,
Pennsylvania and Texas. We maintain offices outside the United
States for sales and administrative personnel in Australia,
Canada, the Peoples Republic of China, France, Germany, Japan,
Korea, Malaysia, the Netherlands, Singapore, Taiwan and the
United Kingdom.

We provide customer technical support from our
facilities in Virginia and California in the United States and
in Australia, Japan and the Netherlands. We regularly evaluate
the suitability and adequacy of our existing facilities and the
availability of space for facilities in new locations, and we
believe that suitable space for new, replacement or expanded
facilities, as needed, generally will be available on
commercially reasonable terms.

Item 3.     LEGAL
PROCEEDINGS

On November 30, 2001, a purported class
action lawsuit was filed in the Southern District of New York
naming webMethods, several of its executive officers at the time
of our initial public offering and the managing underwriters of
our initial public offering as defendants. The complaint alleged
that webMethods initial public offering registration
statement and final prospectus contained material
misrepresentations and omissions related in part to certain
commissions allegedly solicited and received by the
underwriters, and tie-in arrangements allegedly demanded by the
underwriters, in connection with their allocation of shares in
our initial public offering. The complaint seeks unspecified
damages on behalf of a purported class of purchasers of common
stock between February 10, 2000 and December 6, 2000.
This case is at a very early stage, and webMethods has not
formally responded to the allegations. However, management
believes that the claims against webMethods and its officers are
without merit, and we intend to defend against the complaint
vigorously.

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

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

No matters were submitted to a vote of security
holders during the fourth quarter of the fiscal year covered by
this report.

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

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was not publicly traded. The high and low sales
prices of our common stock as reported by the Nasdaq National
Market to the nearest penny were:


|                           |                                           |      |   |        |  |  |   |       | 
|-------------------------- | ----------------------------------------- | ---- | - | ------ |  |  | - | ----- | 
|                           |                                           | High |   | Low   
|                           |                                           |      |   |       
|Year ended March 31, 2001: |                                           |      |   |        |  |  |   |      
|                           | First Quarter (ended June 30, 2000)       |      | $ | 236.00 |  |  | $ | 44.50 | 
|                           | Second Quarter (ended September 30, 2000) |      |   | 194.88 |  |  |   | 83.25 | 
|                           | Third Quarter (ended December 31, 2000)   |      |   | 119.88 |  |  |   | 50.75 | 
|                           | Fourth Quarter (ended March 31, 2001)     |      |   | 98.38  |  |  |   | 20.25 | 
|Year ended March 31, 2002: |                                           |      |   |        |  |  |   |      
|                           | First Quarter (ended June 30, 2001)       |      |   | 40.40  |  |  |   | 14.38 | 
|                           | Second Quarter (ended September 30, 2001) |      |   | 23.14  |  |  |   | 6.30  | 
|                           | Third Quarter (ended December 31, 2001)   |      |   | 18.57  |  |  |   | 6.13  | 
|                           | Fourth Quarter (ended March 31, 2002)     |      |   | 25.86  |  |  |   | 15.56 | 

As of June 12, 2002, there were
approximately 469 holders of record of webMethods common
stock. The number of holders of record our common stock is not
representative of the number of beneficial holders because many
shares are held by depositories, brokers or other nominees. As
of June 12, 2002, the closing price of webMethods
common stock was $9.15.

webMethods has never declared or paid any cash
dividends on its common stock. We currently intend to retain
earnings, if any, to support our growth strategy and do not
anticipate paying cash dividends in the foreseeable future.

The following table provides information
concerning webMethods securities authorized for issuance under
equity compensation plans at March 31, 2002.

Equity Compensation Plan Information

|                                                                 |  |                      |            |                      |  |                                |         |     |  |  |         |    
|---------------------------------------------------------------- |  | -------------------- | ---------- | -------------------- |  | ------------------------------ | ------- | --- |  |  | ------- | ---
|                                                                 |  | Number of securities |            |                      |  | Number of securities remaining
|                                                                 |  | to be issued         |            | Weighted-average     |  | available for future issuance 
|                                                                 |  | upon exercise of     |            | exercise price of    |  | under equity compensation     
|                                                                 |  | outstanding options, |            | outstanding options, |  | plans (excluding securities   
|Plan category                                                    |  | warrants and rights  |            | warrants and rights  |  | reflected in column(a))       
|                                                                 |  |                      |            |                      |  |                               
|                                                                 |  | (a)                  |            | (b)                  |  | (c)                           
|Equity compensation plans approved by security
    holders       |  |                      | 15,066,222 | (1)                  |  | $                              | 19.5784 | (1) |  |  | 560,686 | (1)
|Equity compensation plans not approved by
    securities holders |  |                      | 511,989    | (2)                  |  |                                | 25.5684 | (2) |  |  | 0       |    
|                                                                 |  |                      |            |                      |  |                                |         |     |  |  |         |    
|Total                                                            |  |                      | 15,578,211 |                      |  | $                              | 19.7753 |     |  |  | 560,686 |    
|                                                                 |  |                      |            |                      |  |                                |         |     |  |  |         |    



---

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes webMethods Employee Stock Purchase
    Plan, under which, as of March 31, 2002, a total of
    3,000,000 shares have been reserved for issuance,
    339,053 shares had been issued at an average purchase price
    of $21.22 and 2,660,947 shares remained available for
    future issuance. Also does not reflect an additional 2,462,195
    shares that were reserved for issuance under the webMethods,
    Inc. Amended and Restated Stock Option Plan as of April 1,
    2002.                                                                                                                                   
|   
|(2) | Consists only of shares of webMethods, Inc.
    common stock to be issued upon the exercise of stock options
    issued by Active Software under its 1999 Stock Option Plan, its
    1996 and 1996A Stock Option Plans and its 1999 Director Option
    Plan, and stock options assumed by Active Software that had been
    granted by the respective company under the TransLink Software,
    Inc. Stock Option Plan, Alier, Inc. 1997 Stock Option Plan and
    Alier, Inc. 1996 Stock Option Plan, all such options having been
    granted prior to the acquisition of Active Software by
    webMethods, Inc. in August 2000.

23



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##### 



When webMethods, Inc. acquired Active Software in
August 2000, webMethods, Inc. assumed stock options granted by
Active Software prior to the completion of that acquisition
under Active Softwares 1999 Stock Option Plan and 1996 and
1996A Stock Option Plans. Options granted under those plans
generally had exercise prices not less than the fair market
value of Active Softwares common stock on the date of
grant, vested over 50 months and expired 10 years from
the date of grant. In connection with that acquisition,
webMethods, Inc. also assumed stock options granted by Active
Software prior to the completion of that acquisition under
Active Softwares 1999 Director Option Plan, under which
each newly elected director of Active Software was eligible to
receive an option to purchase a fixed number of shares of Active
Software common stock and each non-employee director was
eligible to receive an option to purchase a fixed number of
shares at each annual meeting of stockholders of Active Software
commencing in 2000; all such options vested immediately upon
grant and expired 10 years from the date of grant.

During our fiscal years ended March 31, 2001
and 2000, we sold certain securities that were not registered
under the Securities Act of 1933, as amended, at the time of
issuance, as described below.



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | On February 16, 2000, we sold a total of
    518,135 shares of our common stock to a total of four investors
    for $33.78 per share, or an aggregate of $17,502,600, in a
    private placement concurrent with our initial public offering.
    We also sold unregistered securities prior to our IPO in
    February 2000, as described in information in Item 15 of
    webMethods Registration Statement on Form S-1 (File
    No. 333-91039), which is incorporated by reference.
|
| | On February 5, 2001, we issued to Computer
    Network Technology Corporation 273,542 shares of our common
    stock with a fair value of $23.3 million, in addition to a
    cash payment, in exchange for all of the issued and outstanding
    securities of IntelliFrame Corporation, a wholly-owned
    subsidiary of Computer Network Technology Corporation.                                                                                                                      
|
| | In March 2001, we entered into an OEM/ Reseller
    agreement with i2 Technologies and issued a warrant which, as
    amended, permits i2 Technologies to purchase up to 710,000
    shares of our common stock at an exercise price per share of
    $28.70. We believe that the fair value of the amended warrant
    did not exceed the fair value of the original warrant at the
    date of amendment.                                                                              

None of the foregoing transactions involved any
underwriters, underwriting discounts or commissions, or any
public offering, and webMethods 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
or Regulation D promulgated thereunder. 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 webMethods, to
information about webMethods.

24



---



##### 



Item 6.     SELECTED
FINANCIAL DATA

The following selected historical consolidated
financial data for webMethods should be read in conjunction with
the consolidated financial statements of webMethods and
Managements Discussion and Analysis of Financial
Condition and Results of Operations, which are included
elsewhere in this report. The historical consolidated statement
of operations data for the years ended March 31, 2002, 2001
and 2000 and the historical consolidated balance sheet data as
of March 31, 2002 and 2001 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
years ended March 31, 1999 and 1998 and the historical
consolidated balance sheet data as of March 31, 2000, 1999
and 1998 are derived from consolidated financial statements of
webMethods not contained in this report. Historical results are
not necessarily indicative of future results.

25



---



##### 



|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |       |       |        | 
|------------------------------------------------------------------------------------- | ---------------------------------------- | ------------------------------------------- | ------------------------ | ------- | ------- | ------- | -------- | ------- | ------- | ------- | ------- | ------ | ------ | ------ | ------- | ------ | ------ | ------ | ------ | ----- | ----- | ------ | 
|                                                                                      |                                          |                                            
|                                                                                      |                                          | Year Ended March 31,                       
|                                                                                      |                                          |                                            
|                                                                                      |                                          | 2002                                        |                          | 2001    |         | 2000    |          | 1999    |         | 1998   
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |        
|                                                                                      |                                          |                                            
|                                                                                      |                                          | (in thousands, except per share data)      
|Consolidated Statements of Operations
    Data:                                       |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|Revenue:                                                                              |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|                                                                                      | License                                  |                                             | $                        | 121,803 |         |         | $        | 143,514 |         |         | $       | 42,822 |        |        | $       | 10,775 |        |        | $      | 3,458 |      
|                                                                                      | Professional services                    |                                             |                          | 35,800  |         |         |          | 34,945  |         |         |         | 11,699 |        |        |         | 2,459  |        |        |        | 817   |      
|                                                                                      | Maintenance                              |                                             |                          | 38,393  |         |         |          | 23,498  |         |         |         | 5,624  |        |        |         | 1,036  |        |        |        | 10    |      
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|                                                                                      |                                          |                                             | Total revenue            |         |         | 195,996 |          |         |         | 201,957 |         |        |        | 60,145 |         |        |        | 14,270 |        |       |       | 4,285  | 
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|Cost of revenue:                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|                                                                                      | License                                  |                                             |                          | 2,335   |         |         |          | 5,189   |         |         |         | 2,612  |        |        |         | 799    |        |        |        | 30    |      
|                                                                                      | Professional services and maintenance:   |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |       |      
|                                                                                      |                                          | Stock based compensation                    |                          |         | 436     |         |          |         | 1,188   |         |         |        | 560    |        |         |        | 71     |        |        |       |      |       
|                                                                                      |                                          | Other professional services and maintenance |                          |         | 42,124  |         |          |         | 46,304  |         |         |        | 16,102 |        |         |        | 3,803  |        |        |       | 804   |       
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|                                                                                      |                                          |                                             | Total cost of revenue    |         |         | 44,895  |          |         |         | 52,681  |         |        |        | 19,274 |         |        |        | 4,673  |        |       |       | 834    | 
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|Gross profit                                                                          |                                          |                                             | 151,101                  |         |         |         | 149,276  |         |         |         | 40,871  |        |        |        | 9,597   |        |        |        | 3,451  |      
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|Operating expenses:                                                                   |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|                                                                                      | Sales and marketing:                     |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |       |      
|                                                                                      |                                          | Stock based compensation and warrant charge |                          |         | 2,865   |         |          |         | 4,813   |         |         |        | 1,471  |        |         |        | 267    |        |        |       | 22    |       
|                                                                                      |                                          | Other sales and marketing costs             |                          |         | 106,377 |         |          |         | 100,154 |         |         |        | 44,033 |        |         |        | 14,741 |        |        |       | 4,854 |       
|                                                                                      | Research and development:                |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |       |      
|                                                                                      |                                          | Stock based compensation                    |                          |         | 12,526  |         |          |         | 12,447  |         |         |        | 1,250  |        |         |        | 182    |        |        |       |      |       
|                                                                                      |                                          | Other research and development costs        |                          |         | 49,634  |         |          |         | 45,158  |         |         |        | 14,780 |        |         |        | 6,066  |        |        |       | 3,525 |       
|                                                                                      | General and administrative:              |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |       |      
|                                                                                      |                                          | Stock based compensation                    |                          |         | 433     |         |          |         | 1,640   |         |         |        | 307    |        |         |        | 57     |        |        |       |      |       
|                                                                                      |                                          | Other general and administrative costs      |                          |         | 19,372  |         |          |         | 20,837  |         |         |        | 9,753  |        |         |        | 3,171  |        |        |       | 2,163 |       
|                                                                                      | Restructuring costs                      |                                             |                          | 7,243   |         |         |          |        |         |         |         |       |        |        |         |       |        |        |        |      |      
|                                                                                      | Acquisition related expenses             |                                             |                          |        |         |         |          | 34,039  |         |         |         |       |        |        |         |       |        |        |        |      |      
|                                                                                      | Amortization of goodwill and intangibles |                                             |                          | 38,697  |         |         |          | 41,395  |         |         |         | 1,305  |        |        |         |       |        |        |        |      |      
|                                                                                      | In-process research and development      |                                             |                          |        |         |         |          | 34,910  |         |         |         | 2,737  |        |        |         |       |        |        |        |      |      
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|                                                                                      |                                          |                                             | Total operating expenses |         |         | 237,147 |          |         |         | 295,393 |         |        |        | 75,636 |         |        |        | 24,484 |        |       |       | 10,564 | 
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|Operating loss                                                                        |                                          |                                             | (86,046                  | )       |         |         | (146,117 | )       |         |         | (34,765 | )      |        |        | (14,887 | )      |        |        | (7,113 | )    
|Interest income, net                                                                  |                                          |                                             | 8,537                    |         |         |         | 14,503   |         |         |         | 3,315   |        |        |        | 415     |        |        |        | 172    |      
|Impairment of equity investments in private
    companies                             |                                          |                                             | (5,200                   | )       |         |         |         |         |         |         |        |        |        |        |        |        |        |        |       |      
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|Net loss                                                                              |                                          |                                             | (82,709                  | )       |         |         | (131,614 | )       |         |         | (31,450 | )      |        |        | (14,472 | )      |        |        | (6,941 | )    
|Accretion and accrued dividends related to
    mandatorily redeemable preferred stock |                                          |                                             |                         |         |         |         |         |         |         |         | (10,223 | )      |        |        | (605    | )      |        |        | (113   | )    
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|Net loss attributable to common shareholders                                          |                                          | $                                           | (82,709                  | )       |         | $       | (131,614 | )       |         | $       | (41,673 | )      |        | $      | (15,077 | )      |        | $      | (7,054 | )    
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|Basic and diluted net loss per share                                                  |                                          | $                                           | (1.67                    | )       |         | $       | (2.81    | )       |         | $       | (2.23   | )      |        | $      | (1.75   | )      |        | $      | (0.83  | )    
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      
|Shares used in computing basic and diluted net
    loss per common share              |                                          |                                             | 49,493                   |         |         |         | 46,860   |         |         |         | 18,717  |        |        |        | 8,633   |        |        |        | 8,490  |      
|                                                                                      |                                          |                                             |                          |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        |        |      

|                                                                                   |  |                |         |      |  |      |         |      |  |      |         |  |  |   |        |  |  |   |        | 
|---------------------------------------------------------------------------------- |  | -------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------ |  |  | - | ------ | 
|                                                                                   |  |               
|                                                                                   |  | March 31,     
|                                                                                   |  |               
|                                                                                   |  | 2002           |         | 2001 |  | 2000 |         | 1999 |  | 1998
|                                                                                   |  |                |         |      |  |      |         |      |  |     
|                                                                                   |  |               
|                                                                                   |  | (in thousands)
|Consolidated Balance Sheet Data:                                                   |  |                |         |      |  |      |         |      |  |      |         |  |  |   |        |  |  |   |        | 
|Cash, cash equivalents and short-term marketable
    securities available for sale |  | $              | 211,842 |      |  | $    | 206,389 |      |  | $    | 196,972 |  |  | $ | 9,129  |  |  | $ | 11,450 | 
|Working capital                                                                    |  |                | 178,909 |      |  |      | 190,722 |      |  |      | 181,355 |  |  |   | 8,462  |  |  |   | 13,071 | 
|Total assets                                                                       |  |                | 324,063 |      |  |      | 375,288 |      |  |      | 299,187 |  |  |   | 19,738 |  |  |   | 14,236 | 
|Long-term liabilities, net of current portion and
    other                        |  |                | 21,653  |      |  |      | 25,409  |      |  |      | 6,208   |  |  |   | 465    |  |  |   |       | 
|Mandatorily redeemable preferred stock                                             |  |                |        |      |  |      |        |      |  |      |        |  |  |   | 11,118 |  |  |   | 4,076  | 
|Total stockholders equity                                                         |  |                | 215,544 |      |  |      | 265,609 |      |  |      | 252,169 |  |  |   | 345    |  |  |   | 7,916  | 

26



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

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

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

OVERVIEW

Background

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

In August 2000, webMethods acquired Active
Software, Inc. (Active) in a transaction that was
accounted for as a pooling of interests. We have combined our
financial statements for prior periods as if the merger had
occurred at the beginning of all prior periods presented.

Fiscal 2002 Overview

We decreased our net loss to $82.7 million
in our fiscal year ended March 31, 2002, from
$131.6 million in the previous year and decreased our net
cash used in operations from $16.7 million in fiscal 2001
to $4.1 million in fiscal 2002.

During fiscal 2002, our ability to increase
software license revenue, our principal source of revenue, was
significantly impacted by the slowing global economy and the
decrease in spending on information technology immediately
following the tragic events of September 11, 2001. We
experienced two consecutive quarters of lower license revenue in
the first half of fiscal 2002. In our first fiscal quarter ended

27



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##### 



June 30, 2001, license revenue declined 16%
from the prior quarter to $36.8 million. In early July
2001, we took decisive actions to align our cost structure to
meet the changing market conditions through a restructuring.
License revenue was $21.7 million in the quarter ended
September 30, 2001, a 41% decline from the prior quarter
reflecting the impact of September 11, 2001, the continued
decline in the global economic conditions and extended sales
cycles for enterprise software products. For the quarters ended
December 31, 2001 and March 31, 2002, however, license
revenue increased sequentially by 40% to $30.4 million and
8% to $32.8 million, respectively. License revenue
increased by 51% from the quarter ended September 30, 2001
to the quarter ended March 31, 2002. We believe that we
were the only public independent integration software vendor to
report an increase in license revenue for two consecutive
quarters following September 30, 2001. Our professional
services revenue decreased in each quarter during fiscal 2002
reflecting an increase in the number of customer implementations
performed by system integrators, a decrease in billable
consultants, and to a lesser extent a decrease in average
billing rates. Maintenance revenue grew in each quarter of
fiscal 2002 reflecting the increase in our customer base and the
cumulative effect of maintenance contracts which are recognized
as revenue ratably over the term of the contract.


We maintained our intense focus on expense
management throughout fiscal 2002. In early July 2001, we
reduced our headcount by approximately 150, or 14%, from our
June 30, 2001 headcount of 1,067. The headcount reductions
were across all departments with the exception of customer
support positions, which were maintained in order to minimize
the impact on our ability to support customers.

We sell our integration platform to Global 2000
customers through our direct sales force augmented by system
integrators, our relationships with application software
partners, and to a lesser extent, resellers. We license our
software to customers under either a renewable term or a
perpetual license. As of March 31, 2002 we had over
800 customers and as of March 31, 2001 we had over
625 customers. Existing customers accounted for 50% of our
revenue as a result of their expanded use of our software. No
customer accounted for more than 10% of our total revenue in
fiscal 2002, 2001 or 2000. One customer accounted for more than
10% of our total fiscal 2002 fourth quarter revenue and 20% of
our accounts receivable balance as of March 31, 2002.

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

We believe the software integration market will
continue to provide opportunity for growth within the
constraints of current global economic conditions. Our focus on
customer success and satisfaction has resulted in an increasing
number of referenceable customers and a substantial portion of
our license revenue in fiscal 2002 coming from our existing
customers. We strive to provide the most comprehensive
integration platform available, and will continue to invest to
ensure an advantageous positioning relative to our competition
resulting in recognized industry and technology leadership and
increasing market share.

28



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##### 



Critical Accounting Policies and
Estimates

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

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

Revenue Recognition

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

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

Allowance for Doubtful
Accounts

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

29



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Valuation of Private Company Equity
Investments

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

Goodwill and Indefinite Lived Intangibles
Assets

Upon adoption of SFAS 142, all of our goodwill
will be associated with our corporate reporting unit as we do
not have multiple reporting units. On an annual basis we will
evaluate whether an impairment of the goodwill may exist by
comparing the book value of our outstanding common stock to the
market value of our outstanding common stock. If the market
value exceeds the book value, impairment does not exist. If the
market value is less than the book value, we will evaluate
whether the condition is other than temporary based primarily on
fluctuations in our stock price. If we determine that the
condition is other than temporary, we will record an impairment
equal to the excess book value. A new accounting standard that
impacts goodwill was issued in fiscal 2002. See Recently
Issued Accounting Pronouncements, for more information.

Accounting for Income Taxes

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

RESULTS OF OPERATIONS

The following table summarizes the results of our
operations for each of the past three fiscal years (all
percentages are calculated using the underlying data in
thousands):

|                         |  |                  |         |            |  |           |       |            |  |           |          |    |  |  |       |   |  |  |         |   
|------------------------ |  | ---------------- | ------- | ---------- |  | --------- | ----- | ---------- |  | --------- | -------- | -- |  |  | ----- | - |  |  | ------- | --
|                         |  | March 31,        |         | Percentage |  | March 31, |       | Percentage |  | March 31,
|                         |  | 2002             |         | Change     |  | 2001      |       | Change     |  | 2000     
|                         |  |                  |         |            |  |           |       |            |  |          
|                         |  |                 
|                         |  | ($ in thousands)
|Total revenue            |  |                  | 195,996 |            |  |           | (3.0  | )%         |  |           | 201,957  |    |  |  | 235.8 | % |  |  | 60,145  |   
|Gross Profit             |  |                  | 151,101 |            |  |           | 1.2   | %          |  |           | 149,276  |    |  |  | 265.2 | % |  |  | 40,871  |   
|% of total revenue       |  |                  | 77.1    | %          |  |           |       |            |  |           | 73.9     | %  |  |  |       |   |  |  | 68.0    | % 
|Total operating expenses |  |                  | 237,147 |            |  |           | (19.7 | )%         |  |           | 295,393  |    |  |  | 290.5 | % |  |  | 75,636  |   
|% of total revenue       |  |                  | 121.0   | %          |  |           |       |            |  |           | 146.3    | %  |  |  |       |   |  |  | 125.8   | % 
|Operating loss           |  |                  | (86,046 | )          |  |           | (41.1 | )%         |  |           | (146,117 | )  |  |  | 320.3 | % |  |  | (34,765 | ) 
|% of total revenue       |  |                  | (43.9   | )%         |  |           |       |            |  |           | (72.4    | )% |  |  |       |   |  |  | (57.8   | )%
|Net loss                 |  |                  | (82,709 | )          |  |           | (37.2 | )%         |  |           | (131,614 | )  |  |  | 318.5 | % |  |  | (31,450 | ) 
|% of total revenue       |  |                  | (42.2   | )%         |  |           |       |            |  |           | (65.2    | )% |  |  |       |   |  |  | (52.3   | )%

During fiscal 2002, the global economic weakness
and decline in information technology spending resulted in a 3%
decline in total revenue from the prior fiscal year to
$196.0 million and a net loss of $82.7 million. The
decrease in net loss of $48.9 million from fiscal 2001 to
2002 is attributable to

30



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decreases in acquisition costs and purchases of
in-process research and development. This decrease was offset by
lower revenue, higher operating expenses, a restructuring
charge, a charge for the impairment of equity investments in
private companies and a decrease in interest income.


During the fiscal year ended March 31, 2001
and the first quarter of fiscal 2002, we increased
headcount and infrastructure costs to support the growth we were
experiencing. In our first quarter of fiscal 2002 (ended
June 30, 2001), the extent and impact of the economic
slowdown became clearer. We took actions in early July 2001 to
align our cost structure through reductions in our workforce and
consolidations of facilities. Since the restructuring, we have
reduced our quarterly fiscal 2002 operating expenses, excluding
stock based compensation and warrant charge, amortization of
goodwill and intangibles and restructuring charge, by 15% from
$49.4 million in the first fiscal quarter to $42.2 million in
the fourth fiscal quarter.

Revenue

The following table summarizes webMethods
revenue for each of the past three fiscal years:

|                      |  |                  |         |            |  |           |       |            |  |           |         |  |  |  |       |   |  |   |        | 
|--------------------- |  | ---------------- | ------- | ---------- |  | --------- | ----- | ---------- |  | --------- | ------- |  |  |  | ----- | - |  | - | ------ | 
|                      |  | March 31,        |         | Percentage |  | March 31, |       | Percentage |  | March 31,
|                      |  | 2002             |         | Change     |  | 2001      |       | Change     |  | 2000     
|                      |  |                  |         |            |  |           |       |            |  |          
|                      |  |                 
|                      |  | ($ in thousands)
|License               |  | $                | 121,803 |            |  |           | (15.1 | )%         |  | $         | 143,514 |  |  |  | 235.1 | % |  | $ | 42,822 | 
|Professional services |  |                  | 35,800  |            |  |           | 2.4   | %          |  |           | 34,945  |  |  |  | 198.7 | % |  |   | 11,699 | 
|Maintenance           |  |                  | 38,393  |            |  |           | 63.4  | %          |  |           | 23,498  |  |  |  | 317.8 | % |  |   | 5,624  | 
|                      |  |                  |         |            |  |           |       |            |  |           |         |  |  |  |       |   |  |   |        | 
|Total revenue         |  | $                | 195,996 |            |  |           | (3.0  | )%         |  | $         | 201,957 |  |  |  | 235.8 | % |  | $ | 60,145 | 
|                      |  |                  |         |            |  |           |       |            |  |           |         |  |  |  |       |   |  |   |        | 

The following table summarizes webMethods
net revenue by geographic region for each of the past three
fiscal years:

|              |  |                  |         |            |  |           |       |            |  |           |         |  |  |  |       |   |  |   |        | 
|------------- |  | ---------------- | ------- | ---------- |  | --------- | ----- | ---------- |  | --------- | ------- |  |  |  | ----- | - |  | - | ------ | 
|              |  | March 31,        |         | Percentage |  | March 31, |       | Percentage |  | March 31,
|              |  | 2002             |         | Change     |  | 2001      |       | Change     |  | 2000     
|              |  |                  |         |            |  |           |       |            |  |          
|              |  |                 
|              |  | ($ in thousands)
|Americas      |  | $                | 143,003 |            |  |           | (20.6 | )%         |  | $         | 180,192 |  |  |  | 227.3 | % |  | $ | 55,051 | 
|Europe        |  |                  | 35,666  |            |  |           | 100.4 | %          |  |           | 17,800  |  |  |  | 249.4 | % |  |   | 5,094  | 
|Asia Pacific  |  |                  | 17,327  |            |  |           | 337.0 | %          |  |           | 3,965   |  |  |  | 100.0 | % |  |   |       | 
|              |  |                  |         |            |  |           |       |            |  |           |         |  |  |  |       |   |  |   |        | 
|Total revenue |  | $                | 195,996 |            |  |           | (3.0  | )%         |  | $         | 201,957 |  |  |  | 235.8 | % |  | $ | 60,145 | 
|              |  |                  |         |            |  |           |       |            |  |           |         |  |  |  |       |   |  |   |        | 

Total revenue decreased by 3%, to
$196.0 million for the year ended March 31, 2002 due
to a decrease in license revenue, which was partially offset by
an increase in maintenance revenue and, to lesser extent an
increase in professional services revenue. Total revenue
increased 236% to $202.0 million in the year ended
March 31, 2001 as a result of increases in license,
maintenance and professional services revenue in the Americas
and, to a lesser extent, international markets.

In fiscal 2002, revenue from the Americas
declined 21% to $143.0 million due primarily to the
reduction in information technology spending associated with the
economic slowdown and the extension of sales cycles for
enterprise software sales. International revenue increased
$31.2 million to $53.0 million primarily due to
increased sales capacity and the increased customer base.
International revenue accounted for 27% of our total revenue in
fiscal 2002 as compared to 11% and 8% in 2001 and 2000,
respectively.

License revenue decreased by $21.7 million
to $121.8 million in fiscal 2002, primarily due to a
decline in license revenue in the Americas offset, in part, by
increases in international license revenue. The economic slow
down and decrease in technology spending resulted in a decrease
in license revenue in the Americas. International revenue
increased in fiscal 2002 as a result of our expanded direct
sales capacity in Europe and Asia Pacific which began in fiscal
2000.

License revenue increased by $100.7 million,
or 235%, to $143.5 million in fiscal 2001 from
$42.8 million in fiscal 2000. The increase was primarily
attributable to an increase in sales force

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headcount, new product features and enhancements,
a growing acceptance of our integration software, new and
expanded relationships with systems integrators and software
application vendors and an increased presence internationally.


Professional services revenue increased 2% to
$35.8 million in the year ended March 31, 2002. During
fiscal 2002 professional services revenue declined in each
quarter reflecting the increase in system integrator led
customer implementations, a decrease in billable consultants and
to a lesser extent a decrease in billing rates. Professional
services revenue was $34.9 million in fiscal 2001, an
increase of 199% over fiscal 2000 revenue of $11.7 million.
Professional services revenue increased in fiscal 2001 due to an
increased need for implementation services and for follow on
services as customers expand their use of our software.

Maintenance revenue increased 63% and 318% in
fiscal 2002 and 2001, respectively. This increase is due
primarily to the increase in customers licensing our software,
as most contracts include post-contract maintenance and support,
which is recognized as revenue ratably over the term of the
contract.

Gross Profit

The following table summarizes our gross profit,
excluding stock based compensation, by type of revenue for each
of the past three fiscal years:

|                                      |  |                   |      |           |  |           |      |   |  |  |      |  
|------------------------------------- |  | ----------------- | ---- | --------- |  | --------- | ---- | - |  |  | ---- | -
|                                      |  |                  
|                                      |  | Fiscal Year Ended
|                                      |  |                  
|                                      |  | March 31,         |      | March 31, |  | March 31,
|                                      |  | 2002              |      | 2001      |  | 2000     
|                                      |  |                   |      |           |  |          
|License                               |  |                   | 98.1 | %         |  |           | 96.4 | % |  |  | 93.9 | %
|Professional services and maintenance |  |                   | 43.2 | %         |  |           | 20.8 | % |  |  | 7.0  | %
|Total revenue                         |  |                   | 77.3 | %         |  |           | 74.5 | % |  |  | 68.9 | %

We improved our total gross profit, excluding
stock based compensation, to 77% in fiscal 2002 from 75% and 69%
in fiscal 2001 and 2000, respectively. This improvement was due
to a reduction in our cost of licenses as well as improvements
in our professional services and maintenance margins.

Our cost of license revenue consists of royalties
for products licensed from third parties. Our gross profit on
license revenue was 98%, 96% and 94% in fiscal 2002, 2001 and
2000, respectively. The improvement in license gross profit is
due to our licensing of less royalty bearing products, and, to a
lesser extent, due to the end of the amortization period under
certain third party contracts.

Our cost of professional services and maintenance
consists of costs related to internal professional services and
support personnel, and subcontractors hired to provide
implementation and support services. Our gross profit on
maintenance and services, excluding stock based compensation,
was 43%, 21% and 7% in fiscal 2002, 2001 and 2000, respectively.

The improvement in total gross profit in fiscal
2002 is primarily due to an increase in maintenance revenue and
a decrease in the cost of professional services and maintenance.
The cost of professional services and maintenance, excluding
stock based compensation, in fiscal 2002 decreased
$4.2 million primarily due to a decrease in the use of
subcontractors and lower travel expenses, offset, in part, by an
increase in the cost of professional service and technical
support personnel.

The improvement in gross profit in fiscal 2001 is
primarily due to the increase in maintenance revenue and an
increase in the rates charged for professional services. The
cost of professional services and maintenance, excluding stock
based compensation, in fiscal 2001 increased $30.2 million
due to increases in the number of professional service and
technical support personnel, and, to a lesser extent, an
increase in subcontractor and travel expenses.

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Operating Expenses

The following table presents certain information
regarding webMethods operating expenses during each of the
past three fiscal years:

|                                            |  |                   |         |            |  |           |        |            |  |           |         |   |  |  |         |   |  |  |        |  
|------------------------------------------- |  | ----------------- | ------- | ---------- |  | --------- | ------ | ---------- |  | --------- | ------- | - |  |  | ------- | - |  |  | ------ | -
|                                            |  |                  
|                                            |  | Fiscal Year Ended
|                                            |  |                  
|                                            |  | March 31,         |         | Percentage |  | March 31, |        | Percentage |  | March 31,
|                                            |  | 2002              |         | Change     |  | 2001      |        | Change     |  | 2000     
|                                            |  |                   |         |            |  |           |        |            |  |          
|                                            |  |                  
|                                            |  | ($ in thousands) 
|Operating Expenses:                         |  |                   |         |            |  |           |        |            |  |           |         |   |  |  |         |   |  |  |        |  
|Sales and marketing*                        |  |                   | 106,377 |            |  |           | 6.2    | %          |  |           | 100,154 |   |  |  | 127.5   | % |  |  | 44,033 |  
|% of total revenue                          |  |                   | 54.3    | %          |  |           |        |            |  |           | 49.6    | % |  |  |         |   |  |  | 73.2   | %
|Research and development*                   |  |                   | 49,634  |            |  |           | 9.9    | %          |  |           | 45,158  |   |  |  | 205.5   | % |  |  | 14,780 |  
|% of total revenue                          |  |                   | 25.3    | %          |  |           |        |            |  |           | 22.4    | % |  |  |         |   |  |  | 24.6   | %
|General and administrative*                 |  |                   | 19,372  |            |  |           | (7.0   | )%         |  |           | 20,837  |   |  |  | 113.6   | % |  |  | 9,753  |  
|% of total revenue                          |  |                   | 9.9     | %          |  |           |        |            |  |           | 10.3    | % |  |  |         |   |  |  | 16.2   | %
|Stock based compensation and warrant charge |  |                   | 15,824  |            |  |           | (16.3  | )%         |  |           | 18,900  |   |  |  | 524.2   | % |  |  | 3,028  |  
|% of total revenue                          |  |                   | 8.1     | %          |  |           |        |            |  |           | 9.4     | % |  |  |         |   |  |  | 5.0    | %
|Restructuring charge                        |  |                   | 7,243   |            |  |           | 100.0  | %          |  |           |        |   |  |  | 0.0     | % |  |  |       |  
|% of total revenue                          |  |                   | 3.7     | %          |  |           |        |            |  |           | 0.0     | % |  |  |         |   |  |  | 0.0    | %
|Acquisition related expenses                |  |                   |        |            |  |           | (100.0 | )%         |  |           | 34,039  |   |  |  | 100.0   | % |  |  |       |  
|% of total revenue                          |  |                   | 0.0     | %          |  |           |        |            |  |           | 16.9    | % |  |  |         |   |  |  | 0.0    | %
|Amortization of goodwill and intangibles    |  |                   | 38,697  |            |  |           | (6.5   | )%         |  |           | 41,395  |   |  |  | 3,072.0 | % |  |  | 1,305  |  
|% of total revenue                          |  |                   | 19.7    | %          |  |           |        |            |  |           | 20.5    | % |  |  |         |   |  |  | 2.2    | %
|In-process research and development         |  |                   |        |            |  |           | (100.0 | )%         |  |           | 34,910  |   |  |  | 1,175.5 | % |  |  | 2,737  |  
|% of total revenue                          |  |                   | 0.0     | %          |  |           |        |            |  |           | 17.3    | % |  |  |         |   |  |  | 4.6    | %
|Operating expense                           |  |                   | 237,147 |            |  |           | (19.7  | )%         |  |           | 295,393 |   |  |  | 290.5   | % |  |  | 75,636 |  
|% of total revenue                          |  |                   | 121.0   | %          |  |           |        |            |  |           | 146.3   | % |  |  |         |   |  |  | 125.8  | %



---



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

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

During the year ended March 31, 2001 and the
quarter ended June 30, 2001 we increased personnel and
infrastructure costs as we experienced significant growth and
anticipated that growth to continue. In early July 2001, we took
decisive actions to reduce our operating expenses to realign our
cost structure to address the changing market conditions
resulting from the slow down in the global economy. As part of
this action, we reduced headcount by 14% or 150 employees
through a reduction in force, closed excess sales offices and
consolidated our California facilities into two locations. The
headcount reductions were across all departments with the
exception of customer support. We recorded a restructuring
charge of $7.2 million, consisting of $2.5 million for
headcount reductions, $4.0 million for consolidation of
facilities, and $700,000 for other related restructuring
charges. Of these amounts we have paid $4.2 million in cash
since the restructuring. The remaining restructuring charges of
$3.0 million related to rent on the excess facilities which
has been accrued and will be paid over the remaining rental
period.

Since the restructuring, we have reduced our
quarterly fiscal 2002 operating expenses, excluding stock based
compensation and warrant charge, amortization of goodwill and
intangibles and restructuring charge, by 15% from
$49.4 million in the first fiscal quarter to
$42.2 million in the fourth fiscal quarter.

33



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Sales and marketing expense, excluding stock
based compensation and warrant charge, was 54%, 50% and 73% of
total revenue in fiscal 2002, 2001 and 2000, respectively. In
fiscal 2002, sales and marketing expense increased to
$106.4 million from $100.2 million in fiscal 2001.
This increase was primarily due to an increase in the employee
compensation and benefit expense arising from increased average
headcount, sales assistance fees paid to partners, and our
international expansion and was partially offset by a decrease
in marketing programs, travel and commission expense. Sales and
marketing expense, excluding stock based compensation expense
and warrant charge, increased $56.1 million or 128% to
$100.2 million in fiscal 2001. This increase was primarily
due to an increase in sales and marketing headcount, increased
commissions, international expansion, and, to a lesser extent,
an increase in sales assistance fees paid to partners and costs
incurred for marketing programs which include trade shows,
public relations, promotional costs and marketing collateral.

Research and development expense, excluding stock
based compensation, was $49.6 million, $45.2 million
and $14.8 million which represents 25%, 22% and 25% of
total revenue in fiscal 2002, 2001 and 2000, respectively.
During fiscal 2002, we shipped several new products and features
including a new release of our webMethods integration platform
version 4.6, webMethods Workflow, a number of new adapters
and a fully localized version of our integration platform for
Japan. In fiscal 2002, research and development expense,
excluding stock based compensation, increased $4.5 million
primarily due to employee compensation and benefit expenses
related to increased average headcount. This increase was offset
by lower third party development expenses. In fiscal 2001,
research and development expense, excluding stock based
compensation, increased $30.4 million principally due to
increases in the number of software development, pre-commercial
release quality assurance and documentation personnel, and, to a
lesser extent, third party development costs.

General and administrative expense, excluding
stock based compensation, as a percentage of total revenue was
10%, 10% and 16% for the fiscal years ended 2002, 2001 and 2000,
respectively. In fiscal 2002, general and administrative
expense, excluding stock based compensation, decreased
$1.5 million from fiscal 2001 to $19.4 million. This
decrease is primarily due to a decrease in the provision for
doubtful accounts due to the improved quality and aging of our
accounts receivable. This decrease was partially offset by
employee compensation and benefit expense related to increased
average headcount. General and administrative expense, excluding
stock based compensation, increased $11.1 million to
$20.8 million in fiscal 2001 due to increased external
legal, accounting and other professional fees, provision for
doubtful accounts, increases in accounting, finance and human
resources personnel and the implementation of systems
infrastructure.

Stock based compensation and warrant charge was
$16.3 million, $20.1 million and $3.6 million in
fiscal 2002, 2001 and 2000, respectively, of which $436,000,
$1.2 million, and $560,000 was included in cost of sales.
Deferred stock based compensation and warrant charge was
recorded for the following transactions:



| |                                                                                                                                                                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (i) In connection with the grant of stock
    options to employees and non-employee directors during the years
    ended March 31, 2000 and 1999, we recorded aggregate
    unearned compensation of $15.5 million, representing the
    difference between the deemed fair value of our common stock at
    the date of grant and the exercise price of such options.
|
| | (ii) As a result of the acquisitions of
    Translink Software, Inc., Premier Software Technology, Inc. and
    Alier, Inc. we recorded a deferred stock compensation charge of
    $27.9 million related to restricted stock issued to
    stockholders of the acquired companies.                                                                                   
|
| | (iii) In connection with the Active merger,
    in August 2000, 50% of Actives remaining options vested
    upon consummation of the merger which resulted in an
    acceleration of amortization of deferred stock compensation.                                                                                                                                    
|
| | (iv) In March 2001 we entered into an OEM/
    Reseller agreement with i2 Technologies (i2) and issued a
    warrant which, as amended, permits i2 to
    purchase 710,000 shares of our common stock at an
    exercise price of $28.70 per share. The fair value of the
    warrant was based on the Black-Scholes                                                  

34



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##### 



| |                                                                                                                                                                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | valuation model was $23.6 million on the
    date of issuance which has been recorded as a deferred warrant
    charge. As part of the agreement, i2 will pay us OEM fees of
    $10.0 million over the term of the OEM/Reseller agreement
    which will be recorded as a reduction to the deferred warrant
    charge and will not be recorded as revenue.

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

In connection with our acquisition of Active
during fiscal 2001, we expensed $34.0 million in
acquisition related expenses. These expenses included investment
banking, regulatory, legal and accounting fees.

We recorded goodwill and intangible assets in
connection with the acquisition of Premier and Translink in
fiscal 2001 and Alier in fiscal 2000. Amortization of goodwill
and acquired intangibles was $38.7 million,
$41.4 million and $1.3 million in fiscal 2002, 2001
and 2000, respectively. The estimated useful life of the
goodwill and the acquired intangibles is three years for
trained and acquired assembled workforce, one year for license
agreements, two years for non-compete agreements,
three years for goodwill and four years for favorable
lease terms. Amortization of the goodwill and acquired
intangibles will cease beginning April 1, 2002 upon our
adoption of SFAS 142 (see Recently Issued Accounting
Pronouncements for more information).

In-process research and development charge was
$34.9 million for the year ended March 31, 2001 and
$2.7 million for the year ended March 31, 2000. The
$34.9 million charge during March 31, 2001 consists
of: (i) a one-time charge of $32.1 million recorded in
connection with the acquisition and write-off of the
Intelliframe workflow technology because in the opinion of
management, the product into which the acquired workflow
technology is to be incorporated had not met technological
feasibility; (ii) $490,000 in expenses related to the
Intelliframe acquisition; and (iii) $2.3 million of
in-process research and development acquired and written off in
connection with the Translink acquisition. The charge during the
year ended March 31, 2000 represents a one-time charge of
$2.7 million recorded upon the acquisition of Alier in
February 2000. These charges relate to the in-process research
and development that was expensed upon consummation of the
acquisition as technology acquired had not reached technological
feasibility, and in the opinion of management, had no
alternative future use.

Interest income, net

Net interest income decreased by approximately
$6.0 million or 41% to $8.5 million for the year ended
March 31, 2002 from $14.5 million for the year ended
March 31, 2001. This decrease was primarily attributable to
lower interest rates on corporate paper, bonds and money market
funds in the fiscal year ended March 31, 2002, compared to
those in the same period in the prior year. In fiscal 2001, net
interest income increased by approximately $11.2 million or
339%, to $14.5 million from fiscal 2000. This increase is
primarily due to increases in interest income that resulted from
the $169.4 million of net cash proceeds received from the
issuance of common stock in webMethods initial public
offering and concurrent private placement in February 2000.

Impairment of equity investment in private
companies

For the year ended March 31, 2002, we
recognized an other-than-temporary decline in value of
$5.2 million in four private company equity investments.
There was no impairment on these investments for the years ended
March 31, 2001 and 2000.

Income taxes

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

35



---



##### 



As of March 31, 2002, we had net operating
loss carry-forwards of approximately $209.0 million. These
net operating loss carry-forwards are available to reduce future
taxable income and begin to expire in fiscal 2010. Under the
provisions of the Internal Revenue Code, certain substantial
changes in our ownership have limited the amount of net
operating loss carry-forwards that could be utilized annually in
the future to offset taxable income.

Quarterly results of operations

The following tables set forth consolidated
statement of operations data for each of the eight quarters
ended March 31, 2002, as well as that data expressed as a
percentage of the total revenue for the quarters presented. This
information has been derived from our unaudited consolidated
financial statements, which have been retroactively restated to
give effect to the pooling of interests in connection with the
merger between webMethods, Inc. and Active. The unaudited
consolidated financial statements have been prepared on the same
basis as the audited consolidated financial statements contained
elsewhere in 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
elsewhere in 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,
|                                                          |                                        | 2002                                        |                          | 2001     |        | 2001      |         | 2001     |        | 2001     |         | 2000     |        | 2000      |         | 2000    
|                                                          |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |         
|                                                          |                                        |                                            
|                                                          |                                        | (In thousands)                             
|Revenue:                                                  |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          | License                                |                                             | $                        | 32,823   |        |           | $       | 30,434   |        |          | $       | 21,742   |        |           | $       | 36,804   |        |        | $       | 43,679 |        |        | $       | 43,425 |        |        | $       | 32,424 |        |        | $       | 23,986 |       
|                                                          | Professional services                  |                                             |                          | 7,856    |        |           |         | 8,852    |        |          |         | 9,401    |        |           |         | 9,691    |        |        |         | 9,981  |        |        |         | 8,780  |        |        |         | 8,441  |        |        |         | 7,743  |       
|                                                          | Maintenance                            |                                             |                          | 10,069   |        |           |         | 9,828    |        |          |         | 9,594    |        |           |         | 8,902    |        |        |         | 8,114  |        |        |         | 7,175  |        |        |         | 4,873  |        |        |         | 3,336  |       
|                                                          |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          |                                        |                                             | Total revenue            |          |        | 50,748    |         |          |        | 49,114   |         |          |        | 40,737    |         |          |        | 55,397 |         |        |        | 61,774 |         |        |        | 59,380 |         |        |        | 45,738 |         |        |        | 35,065 | 
|                                                          |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|Cost of revenue:                                          |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          | License                                |                                             |                          | 370      |        |           |         | 613      |        |          |         | 651      |        |           |         | 701      |        |        |         | 1,225  |        |        |         | 1,659  |        |        |         | 1,303  |        |        |         | 1,002  |       
|                                                          | Professional services and maintenance: |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |        |       
|                                                          |                                        | Stock based compensation                    |                          |          | 68     |           |         |          | 47     |          |         |          | 129    |           |         |          | 192    |        |         |        | 172    |        |         |        | 270    |        |         |        | 529    |        |         |        | 217    |       
|                                                          |                                        | Other professional services and maintenance |                          |          | 9,707  |           |         |          | 10,050 |          |         |          | 9,968  |           |         |          | 12,399 |        |         |        | 12,911 |        |         |        | 12,533 |        |         |        | 10,755 |        |         |        | 10,105 |       
|                                                          |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          |                                        |                                             | Total cost of revenue    |          |        | 10,145    |         |          |        | 10,710   |         |          |        | 10,748    |         |          |        | 13,292 |         |        |        | 14,308 |         |        |        | 14,462 |         |        |        | 12,587 |         |        |        | 11,324 | 
|                                                          |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|Gross profit                                              |                                        |                                             | 40,603                   |          |        |           | 38,404  |          |        |          | 29,989  |          |        |           | 42,105  |          |        |        | 47,466  |        |        |        | 44,918  |        |        |        | 33,151  |        |        |        | 23,741  |       
|                                                          |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|Operating expenses:                                       |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          | Sales and marketing:                   |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |        |       
|                                                          |                                        | Stock based compensation and warrant charge |                          |          | 788    |           |         |          | 411    |          |         |          | 434    |           |         |          | 1,232  |        |         |        | 720    |        |         |        | 1,060  |        |         |        | 2,006  |        |         |        | 1,027  |       
|                                                          |                                        | Other sales and marketing                   |                          |          | 26,005 |           |         |          | 26,063 |          |         |          | 24,109 |           |         |          | 30,200 |        |         |        | 31,261 |        |         |        | 27,317 |        |         |        | 22,102 |        |         |        | 19,474 |       
|                                                          | Research and development:              |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |        |       
|                                                          |                                        | Stock based compensation                    |                          |          | 449    |           |         |          | 1,872  |          |         |          | 6,715  |           |         |          | 3,490  |        |         |        | 3,051  |        |         |        | 3,007  |        |         |        | 3,637  |        |         |        | 2,752  |       
|                                                          |                                        | Other research and development              |                          |          | 12,006 |           |         |          | 12,219 |          |         |          | 12,110 |           |         |          | 13,299 |        |         |        | 13,851 |        |         |        | 12,774 |        |         |        | 10,872 |        |         |        | 7,661  |       
|                                                          | General and administrative:            |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |        |       
|                                                          |                                        | Stock based compensation                    |                          |          | 267    |           |         |          | 27     |          |         |          | 52     |           |         |          | 87     |        |         |        | 66     |        |         |        | 402    |        |         |        | 310    |        |         |        | 862    |       
|                                                          |                                        | Other general and administrative            |                          |          | 4,184  |           |         |          | 4,573  |          |         |          | 4,711  |           |         |          | 5,904  |        |         |        | 5,901  |        |         |        | 5,723  |        |         |        | 4,754  |        |         |        | 4,459  |       
|Restructuring costs                                       |                                        |                                             |                         |          |        |           |        |          |        |          | 7,243   |          |        |           |        |          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|Acquisition related expenses                              |                                        |                                             |                         |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |        |        |        |        |        |        |        |        | 34,039  |        |        |        |        |       
|Amortization of goodwill and intangibles                  |                                        |                                             | 8,797                    |          |        |           | 8,876   |          |        |          | 10,516  |          |        |           | 10,508  |          |        |        | 10,507  |        |        |        | 10,604  |        |        |        | 10,604  |        |        |        | 9,680   |       
|In-process research and development                       |                                        |                                             |                         |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        | 32,599  |        |        |        |        |        |        |        |        |        |        |        | 2,311   |       
|                                                          |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          |                                        |                                             | Total operating expenses |          |        | 52,496    |         |          |        | 54,041   |         |          |        | 65,890    |         |          |        | 64,720 |         |        |        | 97,956 |         |        |        | 60,887 |         |        |        | 88,324 |         |        |        | 48,226 | 
|                                                          |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|Operating loss                                            |                                        |                                             | (11,893                  | )        |        |           | (15,637 | )        |        |          | (35,901 | )        |        |           | (22,615 | )        |        |        | (50,490 | )      |        |        | (15,969 | )      |        |        | (55,173 | )      |        |        | (24,485 | )     
|Interest income, net                                      |                                        |                                             | 1,348                    |          |        |           | 1,782   |          |        |          | 2,730   |          |        |           | 2,677   |          |        |        | 3,653   |        |        |        | 3,300   |        |        |        | 3,984   |        |        |        | 3,566   |       
|Impairment of equity investments in private
    companies |                                        |                                             | (5,200                   | )        |        |           |        |          |        |          |        |          |        |           |        |          |        |        |        |        |        |        |        |        |        |        |        |        |        |        |        |       
|                                                          |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|Net loss                                                  |                                        | $                                           | (15,745                  | )        |        | $         | (13,855 | )        |        | $        | (33,171 | )        |        | $         | (19,938 | )        |        | $      | (46,837 | )      |        | $      | (12,669 | )      |        | $      | (51,189 | )      |        | $      | (20,919 | )     
|                                                          |                                        |                                             |                          |          |        |           |         |          |        |          |         |          |        |           |         |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       

36



---



##### 



|                                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |      |      |       | 
|--------------------------------------------------------- | ---------------------------------------- | ------------------------------------------- | ------------------------ | -------- | ---- | --------- | ----- | -------- | ---- | -------- | ----- | -------- | ---- | --------- | ----- | -------- | ---- | ----- | ----- | ---- | ---- | ----- | ----- | ---- | ---- | ----- | ------ | ---- | ---- | ----- | ----- | ---- | ---- | ----- | 
|                                                          |                                          |                                            
|                                                          |                                          | As a Percentage of Total Revenue           
|                                                          |                                          |                                            
|                                                          |                                          | Mar. 31,                                    |                          | Dec. 31, |      | Sept. 30, |       | June 30, |      | Mar. 31, |       | Dec. 31, |      | Sept. 30, |       | June 30,
|                                                          |                                          | 2002                                        |                          | 2001     |      | 2001      |       | 2001     |      | 2001     |       | 2000     |      | 2000      |       | 2000    
|                                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |         
|Revenue:                                                  |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     
|                                                          | License                                  |                                             |                          | 64.7     | %    |           |       | 62.0     | %    |          |       | 53.4     | %    |           |       | 66.4     | %    |       |       | 70.7 | %    |       |       | 73.1 | %    |       |        | 70.8 | %    |       |       | 68.4 | %   
|                                                          | Professional services                    |                                             |                          | 15.5     |      |           |       | 18.0     |      |          |       | 23.0     |      |           |       | 17.5     |      |       |       | 16.2 |      |       |       | 14.8 |      |       |        | 18.5 |      |       |       | 22.1 |     
|                                                          | Maintenance                              |                                             |                          | 19.8     |      |           |       | 20.0     |      |          |       | 23.6     |      |           |       | 16.1     |      |       |       | 13.1 |      |       |       | 12.1 |      |       |        | 10.7 |      |       |       | 9.5  |     
|                                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     
|                                                          |                                          |                                             | Total revenue            |          |      | 100.0     |       |          |      | 100.0    |       |          |      | 100.0     |       |          |      | 100.0 |       |      |      | 100.0 |       |      |      | 100.0 |        |      |      | 100.0 |       |      |      | 100.0 | 
|                                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     
|Cost of revenue:                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     
|                                                          | License                                  |                                             |                          | 0.7      |      |           |       | 1.2      |      |          |       | 1.6      |      |           |       | 1.3      |      |       |       | 2.0  |      |       |       | 2.8  |      |       |        | 2.8  |      |       |       | 2.9  |     
|                                                          | Professional services and maintenance:   |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |      |     
|                                                          |                                          | Stock based compensation                    |                          |          | 0.1  |           |       |          | 0.1  |          |       |          | 0.3  |           |       |          | 0.3  |       |       |      | 0.3  |       |       |      | 0.5  |       |        |      | 1.2  |       |       |      | 0.6  |      
|                                                          |                                          | Other professional services and maintenance |                          |          | 19.2 |           |       |          | 20.5 |          |       |          | 24.5 |           |       |          | 22.4 |       |       |      | 20.9 |       |       |      | 21.1 |       |        |      | 23.5 |       |       |      | 28.8 |      
|                                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     
|                                                          |                                          |                                             | Total cost of revenue    |          |      | 20.0      |       |          |      | 21.8     |       |          |      | 26.4      |       |          |      | 24.0  |       |      |      | 23.2  |       |      |      | 24.4  |        |      |      | 27.5  |       |      |      | 32.3  | 
|                                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     
|Gross profit                                              |                                          |                                             | 80.0                     |          |      |           | 78.2  |          |      |          | 73.6  |          |      |           | 76.0  |          |      |       | 76.8  |      |      |       | 75.6  |      |      |       | 72.5   |      |      |       | 67.7  |     
|                                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     
|Operating expenses:                                       |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     
|                                                          | Sales and marketing:                     |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |      |     
|                                                          |                                          | Stock based compensation and warrant charge |                          |          | 1.6  |           |       |          | 0.8  |          |       |          | 1.1  |           |       |          | 2.2  |       |       |      | 1.2  |       |       |      | 1.8  |       |        |      | 4.4  |       |       |      | 2.9  |      
|                                                          |                                          | Other sales and marketing                   |                          |          | 51.2 |           |       |          | 53.1 |          |       |          | 59.2 |           |       |          | 54.5 |       |       |      | 50.6 |       |       |      | 46.0 |       |        |      | 48.3 |       |       |      | 55.5 |      
|                                                          | Research and development:                |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |      |     
|                                                          |                                          | Stock based compensation                    |                          |          | 0.9  |           |       |          | 3.8  |          |       |          | 16.5 |           |       |          | 6.3  |       |       |      | 4.9  |       |       |      | 5.0  |       |        |      | 7.9  |       |       |      | 7.9  |      
|                                                          |                                          | Other research and development              |                          |          | 23.7 |           |       |          | 24.8 |          |       |          | 29.7 |           |       |          | 24.0 |       |       |      | 22.4 |       |       |      | 21.5 |       |        |      | 23.8 |       |       |      | 21.8 |      
|                                                          | General and administrative:              |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |      |     
|                                                          |                                          | Stock based compensation                    |                          |          | 0.5  |           |       |          | 0.1  |          |       |          | 0.1  |           |       |          | 0.1  |       |       |      | 0.1  |       |       |      | 0.7  |       |        |      | 0.7  |       |       |      | 2.5  |      
|                                                          |                                          | Other general and administrative            |                          |          | 8.2  |           |       |          | 9.3  |          |       |          | 11.6 |           |       |          | 10.7 |       |       |      | 9.5  |       |       |      | 9.6  |       |        |      | 10.4 |       |       |      | 12.7 |      
|                                                          | Restructuring costs                      |                                             |                          |         |      |           |       |         |      |          |       | 17.7     |      |           |       |         |      |       |       |     |      |       |       |     |      |       |        |     |      |       |       |     |     
|                                                          | Acquisition related expenses             |                                             |                          |         |      |           |       |         |      |          |       |         |      |           |       |         |      |       |       |     |      |       |       |     |      |       |        | 74.4 |      |       |       |     |     
|                                                          | Amortization of goodwill and intangibles |                                             |                          | 17.3     |      |           |       | 18.1     |      |          |       | 25.8     |      |           |       | 19.0     |      |       |       | 17.0 |      |       |       | 17.9 |      |       |        | 23.2 |      |       |       | 27.6 |     
|                                                          | In-process research and development      |                                             |                          |         |      |           |       |         |      |          |       |         |      |           |       |         |      |       |       | 52.8 |      |       |       |     |      |       |        |     |      |       |       | 6.6  |     
|                                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     
|                                                          |                                          |                                             | Total operating expenses |          |      | 103.4     |       |          |      | 110.0    |       |          |      | 161.7     |       |          |      | 116.8 |       |      |      | 158.5 |       |      |      | 102.5 |        |      |      | 193.1 |       |      |      | 137.5 | 
|                                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     
|Operating loss                                            |                                          |                                             | (23.4                    | )        |      |           | (31.8 | )        |      |          | (88.1 | )        |      |           | (40.8 | )        |      |       | (81.7 | )    |      |       | (26.9 | )    |      |       | (120.6 | )    |      |       | (69.8 | )   
|Interest income, net                                      |                                          |                                             | 2.6                      |          |      |           | 3.6   |          |      |          | 6.7   |          |      |           | 4.8   |          |      |       | 5.9   |      |      |       | 5.6   |      |      |       | 8.7    |      |      |       | 10.1  |     
|Impairment of equity investments in private
    companies |                                          |                                             | (10.2                    | )        |      |           |      |          |      |          |      |          |      |           |      |          |      |       |      |      |      |       |      |      |      |       |       |      |      |       |      |     
|                                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     
|Net loss                                                  |                                          |                                             | (31.0                    | )%       |      |           | (28.2 | )%       |      |          | (81.4 | )%       |      |           | (36.0 | )%       |      |       | (75.8 | )%   |      |       | (21.3 | )%   |      |       | (111.9 | )%   |      |       | (59.7 | )%  
|                                                          |                                          |                                             |                          |          |      |           |       |          |      |          |       |          |      |           |       |          |      |       |       |      |      |       |       |      |      |       |        |      |      |       |       |     

LIQUIDITY AND CAPITAL RESOURCES

The following table presents selected financial
statistics and information for each of the past three fiscal
years:

|                                                                    |  |                |         |           |  |           |         |  |  |   |         | 
|------------------------------------------------------------------- |  | -------------- | ------- | --------- |  | --------- | ------- |  |  | - | ------- | 
|                                                                    |  | March 31,      |         | March 31, |  | March 31,
|                                                                    |  | 2002           |         | 2001      |  | 2000     
|                                                                    |  |                |         |           |  |          
|                                                                    |  |               
|                                                                    |  | (in thousands)
|Cash, marketable securities and long term
    marketable securities |  | $              | 211,842 |           |  | $         | 206,389 |  |  | $ | 234,110 | 
|Working Capital                                                     |  | $              | 178,909 |           |  | $         | 190,722 |  |  | $ | 181,355 | 

Historically we have financed our operations and
met our capital requirements though the sales of equity
securities. Our liquidity and financial position at
March 31, 2002 showed a 3% increase in our cash and
investments and a 6% decrease in our working capital from the
prior year. The decrease in working

37



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##### 



capital is primarily due to a decrease in our
accounts receivable balance and an increase in our accounts
payable and accrual balances at March 31, 2002 as compared
to March 31, 2001.


Net cash used in operating activities was
$4.1 million, $16.7 million, and $3.2 million in
fiscal 2002, 2001 and 2000, respectively. The decrease in net
cash used in operating activities from fiscal 2001 to fiscal
2002 was due primarily to a $48.9 million decrease in our
net loss and a decrease in accounts receivable at March 31,
2002. This decrease is offset by a decrease in deferred revenue
and an increase in other non-current assets.

Net cash used in investing activities was
$21.2 million, $65.1 million and $73.1 million in
fiscal 2002, 2001 and 2000, respectively. Cash used in investing
activities reflects purchases of property, equipment and
marketable securities, offset by proceeds from the repayment of
an investment in a private company. Capital expenditures were
$5.9 million, $10.7 million, and $5.7 million in
fiscal 2002, 2001 and 2000, respectively. 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.

Net cash provided by financing activities was
$14.4 million, $19.9 million and $239.1 million
in fiscal 2002, 2001 and 2000, respectively. These cash flows
primarily reflect net cash proceeds from exercises of stock
options in fiscal 2002 and 2001 and from private sales of
mandatorily redeemable, convertible preferred stock in fiscal
2000. In addition, we received $169.4 million in net
proceeds from the issuance of common stock from the initial
public offering of webMethods and our concurrent private
placement in fiscal 2000. We also received $40.0 million in
net proceeds from the initial public offering of Active Software
in fiscal 2000.

We have a line of credit to borrow up to a
maximum principal amount of $10,000,000 with a maturity date of
July 10, 2002, which we expect to renew. Any borrowings
under this line bear interest at the banks prime rate per
annum. As of March 31, 2002, we had not borrowed against
this line of credit. In connection with the line of credit, we
have a letter of credit totaling $475,000 related to an office
lease. Borrowings under this line are limited to 80% of eligible
accounts receivable. Interest is payable on the unpaid principal
balance at the banks prime rate.

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

RECENTLY ISSUED ACCOUNTING
PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards
Board issued SFAS No. 141, Business
Combinations and SFAS No. 142, Goodwill and
Other Intangible Assets. SFAS No. 141 requires that
all business combinations initiated after June 30, 2001 be
accounted for under the purchase method and addresses the
initial recognition and measurement of goodwill and other
intangible assets acquired in a business combination. SFAS
No. 142 addresses the initial recognition and measurement
of intangible assets acquired outside of a business combination
and the accounting for goodwill and other intangible assets
subsequent to their acquisition. SFAS No. 142 provides that
intangible assets with finite useful lives be amortized and that
goodwill and intangible assets with indefinite lives will not be
amortized, but will rather be tested at least annually for
impairment. Under the provisions of SFAS No. 142, any
impairment loss identified upon adoption of this standard is
recognized as a cumulative effect of a change in accounting
principle. Any impairment loss incurred subsequent to initial
adoption of SFAS No. 142 is recorded as a charge to current
period earnings.

In accordance with SFAS No. 141, goodwill
acquired in purchase business combination completed before
June 30, 2001, has been amortized through March 31,
2002, and will be tested for impairment at

38



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##### 



least annually. We adopted SFAS No. 142 on
April 1, 2002 and had an unamortized goodwill balance of
$29.8 million. The goodwill carrying value will be subject
to the transition provision of SFAS No. 142. Amortization
expense related to goodwill was $38.7 million,
$41.4 million and $1.3 million for the years ended
March 31, 2002, 2001 and 2000, respectively. We do not
expect the adoption of SFAS 141 to have an impact on its
consolidated financial position or results of operations. Upon
adoption of SFAS 142, we will cease amortization of
goodwill which will eliminate amortization expense. We did not
have an impairment charge of the unamortized goodwill balance at
the time of adoption.


In October 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, which supercedes SFAS No. 121
Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. SFAS No. 144
addresses the accounting and reporting for the impairment or
disposal of long-lived assets, including discontinued
operations. SFAS No. 144 is effective April 1, 2002
for the Company. We are reviewing the provisions of SFAS
No. 144 and do not anticipate that the adoption will have a
material impact on our financial condition or results of
operations.

In November 2001, the Emerging Issues Task Force,
or EITF, issued Topic No. D-103, Income Statement
Characterization of Reimbursement Received for Out-of-Pocket
Expenses Incurred. EITF Topic No. D-103 requires that
companies report reimbursements received for out-of-pocket
expenses incurred as revenue, rather than as a reduction of
expenses. The provisions of EITF Topic No. D-103 is
effective for financial statements issued for fiscal years
beginning after December 15, 2001. As the Company has
historically accounted for reimbursements of out-of-pocket
expenses in the manner provided for under EITF Topic
No. D-103, we do not expect the adoption of the provisions
of EITF Topic No. D-103 to have an impact on its
consolidated financial position or results of operations.

Item 7a.     QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Interest rate risk.We maintain our funds in money market
accounts, corporate bonds, commercial paper, Treasury notes, and
agency notes. Our exposure to market risk due to fluctuations in
interest rates relates primarily to our interest earnings on our
cash deposits. These securities are subject to interest rate
risk inasmuch as their fair value will fall if market interest
rates increase. If market interest rates were to increase
immediately and uniformly by 10% from the levels prevailing as
of March 31, 2002, the fair value of the portfolio would
not decline by a material amount. We do not use derivative
financial instruments to mitigate risks. However, we do have an
investment policy that would allow us to invest in short-term
and long-term investments such as money market instruments and
corporate debt securities. Our policy attempts to reduce such
risks by typically limiting the maturity date of such securities
to no more than twenty-four months with a maximum average
maturity to our whole portfolio of such investments at twelve
months, placing our investments with high credit quality issuers
and limiting the amount of credit exposure with any one issuer.

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

Notwithstanding the foregoing, the direct effects
of interest rate and foreign currency exchange rate fluctuations
on the value of certain of our investments and accounts, and the
indirect effects of fluctuations

39



---



##### 



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.


Item 8.     FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements of
webMethods are submitted on pages F-1 through F-23 of this
report.



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

None.

40



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##### 



PART III

The following information contained in the
definitive Proxy Statement of webMethods in connection with our
2002 annual meeting of stockholders is incorporated by reference
into this report.

Item 10.     DIRECTORS
AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information regarding directors of webMethods
will be set forth in the definitive Proxy Statement for the 2002
annual meeting of stockholders and is incorporated into this
report by reference. Information regarding executive officers of
webMethods is set forth in Item 1 of this report.

Item 11.     EXECUTIVE
COMPENSATION

Information regarding executive compensation will
be set forth in the definitive Proxy Statement for the 2002
annual meeting of stockholders and is incorporated into this
report 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 definitive Proxy Statement for the 2002 annual meeting of
stockholders and is incorporated into this report by reference.

Item 13.     CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS

Information regarding certain relationships and
related transactions will be set forth in the definitive Proxy
Statement for the 2002 annual meeting of stockholders and is
incorporated into this report by reference.

41



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##### 



PART IV



|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 14. | EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND
    REPORTS ON FORM 8-K

(a) Documents filed as part of the report:



| |     |                                  
| | --- | ---------------------------------
| | (1) | Report of Independent Accountants

INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

|                                                                                                                       |                                                                       |      |     |      | 
|---------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------- | ---- | --- | ---- | 
|                                                                                                                       |                                                                       | Page
|                                                                                                                       |                                                                       |     
|Report of Independent Accountants                                                                                      |                                                                       |      | F-1 |     
|Consolidated Balance Sheets at March 31,
    2002 and 2001                                                             |                                                                       |      | F-2 |     
|Consolidated Statements of Operations and
    Comprehensive Loss for the years ended March 31, 2002, 2001
    and 2000 |                                                                       |      | F-3 |     
|Consolidated Statements of Changes in
    Stockholders Equity for the years ended March 31,
    2002, 2001 and 2000   |                                                                       |      | F-4 |     
|Consolidated Statements of Cash Flows for the
    years ended March 31, 2002, 2001 and 2000                            |                                                                       |      | F-5 |     
|Notes to Consolidated Financial Statements                                                                             |                                                                       |      | F-6 |     
|                                                                                                                       | (2) Financial Statement Schedule and Report
    thereon               |      |     |      | 
|                                                                                                                       | Schedule II 
    Valuation and Qualifying Accounts                   |      |     | F-24 | 
|                                                                                                                       | Report of Independent
    Accountants on Financial Statement Schedule |      |     | F-25 | 
|                                                                                                                       | (3) Exhibits                                                          |      |     | F-26 | 

|        |  |             |  |                                                                                                                                               
|------- |  | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|        |  |            
|Exhibit |  |            
|Number  |  | Description
|        |  |            
|2.1     |  | (1)         |  | Agreement and Plan of Merger dated as of
    May 20, 2000, by and among webMethods, Inc., Wolf
    Acquisition, Inc. and Active Software, Inc.
|3.1     |  | (2)         |  | Fifth Amended and Restated Certificate of
    Incorporation of webMethods, Inc., as amended                                                   
|3.2     |  | (3)         |  | Amended and Restated Bylaws of webMethods, Inc.                                                                                               
|4.1     |  | (3)         |  | Specimen certificate for shares of webMethods,
    Inc. Common Stock                                                                          
|4.2     |  | (4)         |  | Rights Agreement dated as of October 18,
    2001 between webMethods, Inc. and American Stock
    Transfer & Trust Company                    
|10.1    |  | (3)         |  | Second Amended and Restated Investor Rights
    Agreement                                                                                     
|10.2    |  | *           |  | webMethods, Inc. Amended and Restated Stock
    Option Plan, as amended                                                                       
|10.3    |  | (3)         |  | Employee Stock Purchase Plan                                                                                                                  
|10.4    |  | (3)         |  | Indemnification Agreement entered into between
    webMethods, Inc. and each of its directors                                                 
|21.1    |  | *           |  | Subsidiaries of webMethods, Inc.                                                                                                              
|23.1    |  | *           |  | Consent of PricewaterhouseCoopers LLP                                                                                                         
|24      |  |             |  | Power of Attorney (included on signature page of
    this report)                                                                             




|    |                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to webMethods
    Registration Statement on Form S-4, as amended (File
    No. 333-39572).
|   
|(2) | Incorporated by reference to webMethods
    Form 10-K for the year ended March 31, 2001 (File
    No. 1-15681).     
|   
|(3) | Incorporated by reference to webMethods
    Registration Statement on Form S-1, as amended (File
    No. 333-91309).
|   
|(4) | Incorporated by reference to webMethods
    Registration Statement on Form 8-A (File No. 1-15681).                  
|   
|*   | Filed herewith.                                                                                                      

42



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##### 



(b) Reports on Form 8-K. No
reports on Form 8-K have been filed by webMethods, Inc.
since the beginning of its fiscal quarter on January 1,
2002:

(c) Exhibits. The exhibits required
by this Item are listed under Item 14(a)(3).

(d) Financial Statement Schedule. The
consolidated financial statement schedule required by this Item
is listed under Item 14(a)(2).

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

All other schedules for which provision is made
in the applicable accounting regulation of the Securities and
Exchange Commission are not required under the related
instructions or are applicable, and therefore have been omitted.

43



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##### 



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 12th day of June, 2002.



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



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

| |                          
| | -------------------------
| |                          
| | Phillip Merrick          
| | Chairman of the Board 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 and Chief Executive Officer |  | June 12, 2002
|/s/ MARY DRIDIMary Dridi                     |  | Chief Financial Officer and Treasurer             |  | June 12, 2002
|/s/ BETSY S. ATKINSBetsy S. Atkins           |  | Director                                          |  | June 12, 2002
|/s/ JAMES P. GAUERJames P. Gauer             |  | Director                                          |  | June 12, 2002
|/s/ R. JAMES GREENR. James Green             |  | Director                                          |  | June 12, 2002
|/s/ JERRY JASINOWSKIJerry Jasinowski         |  | Director                                          |  | June 12, 2002
|/s/ MICHAEL J. LEVINTHALMichael J. Levinthal |  | Director                                          |  | June 12, 2002
|/s/ JACK L. LEWISJack L. Lewis               |  | Director                                          |  | June 12, 2002
|/s/ GENE RIECHERSGene Riechers               |  | Director                                          |  | June 12, 2002
|/s/ ROBERT T. VASANRobert T. Vasan           |  | Director                                          |  | June 12, 2002

44



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##### 



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 and cash flows present fairly, in all material respects,
the financial position of webMethods, Inc. and its subsidiaries
at March 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in
the period ended March 31, 2002 in conformity with
accounting principles generally accepted in the United States of
America. 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 of
America, 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 our opinion.

/s/ PRICEWATERHOUSECOOPERS LLP

McLean, Virginia

April 24, 2002


F-1



---



##### 



WEBMETHODS, INC.

CONSOLIDATED BALANCE SHEETS

|                                       |                                                                                                                               |                                            |        |          |         |  |        |          |         | 
|-------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | ------- |  | ------ | -------- | ------- | 
|                                       |                                                                                                                               |                                           
|                                       |                                                                                                                               | Year Ended March 31,                      
|                                       |                                                                                                                               |                                           
|                                       |                                                                                                                               | 2002                                       |        | 2001    
|                                       |                                                                                                                               |                                            |        |         
|                                       |                                                                                                                               |                                           
|                                       |                                                                                                                               | (In thousands, except                     
|                                       |                                                                                                                               | share data)                               
|ASSETS                                 |                                                                                                                               |                                            |        |          |         |  |        |         
|Current assets:                        |                                                                                                                               |                                            |        |          |         |  |        |         
|                                       | Cash and cash equivalents                                                                                                     |                                            | $      | 98,497   |         |  | $      | 109,713  |        
|                                       | Marketable securities available for sale                                                                                      |                                            |        | 113,345  |         |  |        | 96,676   |        
|                                       | Accounts receivable, net of allowance of $3,685
    and $4,342                                                                |                                            |        | 46,417   |         |  |        | 58,757   |        
|                                       | Prepaid expenses and other current assets                                                                                     |                                            |        | 7,516    |         |  |        | 9,846    |        
|                                       |                                                                                                                               |                                            |        |          |         |  |        |         
|                                       |                                                                                                                               | Total current assets                       |        |          | 265,775 |  |        |          | 274,992 | 
|Property and equipment, net            |                                                                                                                               |                                            | 17,181 |          |         |  | 17,364 |         
|Goodwill and acquired intangibles, net |                                                                                                                               |                                            | 29,838 |          |         |  | 68,535 |         
|Other assets                           |                                                                                                                               |                                            | 11,269 |          |         |  | 14,397 |         
|                                       |                                                                                                                               |                                            |        |          |         |  |        |         
|                                       |                                                                                                                               | Total assets                               |        | $        | 324,063 |  |        | $        | 375,288 | 
|                                       |                                                                                                                               |                                            |        |          |         |  |        |         
|LIABILITIES AND STOCKHOLDERS EQUITY   |                                                                                                                               |                                            |        |          |         |  |        |         
|Current liabilities:                   |                                                                                                                               |                                            |        |          |         |  |        |         
|                                       | Accounts payable                                                                                                              |                                            | $      | 15,105   |         |  | $      | 8,368    |        
|                                       | Accrued expenses                                                                                                              |                                            |        | 16,170   |         |  |        | 13,008   |        
|                                       | Accrued salaries and commissions                                                                                              |                                            |        | 15,594   |         |  |        | 15,536   |        
|                                       | Deferred revenue                                                                                                              |                                            |        | 37,298   |         |  |        | 45,585   |        
|                                       | Current portion of capital lease obligations                                                                                  |                                            |        | 2,699    |         |  |        | 1,773    |        
|                                       |                                                                                                                               |                                            |        |          |         |  |        |         
|                                       |                                                                                                                               | Total current liabilities                  |        |          | 86,866  |  |        |          | 84,270  | 
|                                       | Capital lease obligations, net of current portion
    and other                                                               |                                            |        | 1,765    |         |  |        | 2,613    |        
|                                       | Long term deferred revenue                                                                                                    |                                            |        | 19,888   |         |  |        | 22,796   |        
|                                       |                                                                                                                               |                                            |        |          |         |  |        |         
|                                       |                                                                                                                               | Total liabilities                          |        |          | 108,519 |  |        |          | 109,679 | 
|                                       |                                                                                                                               |                                            |        |          |         |  |        |         
|Commitments and contingencies          |                                                                                                                               |                                            |        |          |         |  |        |         
|Stockholders equity:                  |                                                                                                                               |                                            |        |          |         |  |        |         
|                                       | Common stock, $0.01 par value;
    500,000,000 shares authorized; 50,477,383 and
    48,732,800 shares issued and outstanding |                                            |        | 505      |         |  |        | 487      |        
|                                       | Additional paid-in capital                                                                                                    |                                            |        | 510,281  |         |  |        | 499,825  |        
|                                       | Deferred stock compensation and warrant charge                                                                                |                                            |        | (14,875  | )       |  |        | (38,154  | )      
|                                       | Accumulated deficit                                                                                                           |                                            |        | (279,864 | )       |  |        | (197,155 | )      
|                                       | Accumulated other comprehensive (loss) gain                                                                                   |                                            |        | (503     | )       |  |        | 606      |        
|                                       |                                                                                                                               |                                            |        |          |         |  |        |         
|                                       |                                                                                                                               | Total stockholders equity                 |        |          | 215,544 |  |        |          | 265,609 | 
|                                       |                                                                                                                               |                                            |        |          |         |  |        |         
|                                       |                                                                                                                               | Total liabilities and stockholders equity |        | $        | 324,063 |  |        | $        | 375,288 | 
|                                       |                                                                                                                               |                                            |        |          |         |  |        |         

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

F-2



---



##### 



WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE LOSS

|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |         |        |         |  
|------------------------------------------------------------------------------------- | -------------------------------------------- | ----------------------------------------------------------- | ------------------------ | ------- | ------- | ------- | ---------- | -------- | ------- | -------- | ---------- | ------- | ------ | ------- | -
|                                                                                      |                                              |                                                            
|                                                                                      |                                              | Year Ended March 31,                                       
|                                                                                      |                                              |                                                            
|                                                                                      |                                              | 2002                                                        |                          | 2001    |         | 2000   
|                                                                                      |                                              |                                                             |                          |         |         |        
|                                                                                      |                                              |                                                            
|                                                                                      |                                              | (In thousands, except share and                            
|                                                                                      |                                              | per share data)                                            
|Revenue:                                                                              |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|                                                                                      | License                                      |                                                             | $                        | 121,803 |         |         | $          | 143,514  |         |          | $          | 42,822  |       
|                                                                                      | Professional services                        |                                                             |                          | 35,800  |         |         |            | 34,945   |         |          |            | 11,699  |       
|                                                                                      | Maintenance                                  |                                                             |                          | 38,393  |         |         |            | 23,498   |         |          |            | 5,624   |       
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|                                                                                      |                                              |                                                             | Total revenue            |         |         | 195,996 |            |          |         | 201,957  |            |         |        | 60,145  |  
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|Cost of revenue:                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|                                                                                      | License                                      |                                                             |                          | 2,335   |         |         |            | 5,189    |         |          |            | 2,612   |       
|                                                                                      | Professional services and maintenance:       |                                                             |                          |         |         |         |            |          |         |          |            |         |       
|                                                                                      |                                              | Stock based compensation                                    |                          |         | 436     |         |            |          | 1,188   |          |            |         | 560    |        
|                                                                                      |                                              | Other professional services and maintenance                 |                          |         | 42,124  |         |            |          | 46,304  |          |            |         | 16,102 |        
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|                                                                                      |                                              |                                                             | Total cost of revenue    |         |         | 44,895  |            |          |         | 52,681   |            |         |        | 19,274  |  
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|Gross profit                                                                          |                                              |                                                             | 151,101                  |         |         |         | 149,276    |          |         |          | 40,871     |        
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|Operating expenses:                                                                   |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|                                                                                      | Sales and marketing:                         |                                                             |                          |         |         |         |            |          |         |          |            |         |       
|                                                                                      |                                              | Stock based compensation and warrant charge                 |                          |         | 2,865   |         |            |          | 4,813   |          |            |         | 1,471  |        
|                                                                                      |                                              | Other sales and marketing costs                             |                          |         | 106,377 |         |            |          | 100,154 |          |            |         | 44,033 |        
|                                                                                      | Research and development:                    |                                                             |                          |         |         |         |            |          |         |          |            |         |       
|                                                                                      |                                              | Stock based compensation                                    |                          |         | 12,526  |         |            |          | 12,447  |          |            |         | 1,250  |        
|                                                                                      |                                              | Other research and development costs                        |                          |         | 49,634  |         |            |          | 45,158  |          |            |         | 14,780 |        
|                                                                                      | General and administrative:                  |                                                             |                          |         |         |         |            |          |         |          |            |         |       
|                                                                                      |                                              | Stock based compensation                                    |                          |         | 433     |         |            |          | 1,640   |          |            |         | 307    |        
|                                                                                      |                                              | Other general and administrative costs                      |                          |         | 19,372  |         |            |          | 20,837  |          |            |         | 9,753  |        
|                                                                                      | Restructuring costs                          |                                                             |                          | 7,243   |         |         |            |         |         |          |            |        |       
|                                                                                      | Acquisition related expenses                 |                                                             |                          |        |         |         |            | 34,039   |         |          |            |        |       
|                                                                                      | Amortization of goodwill and intangibles     |                                                             |                          | 38,697  |         |         |            | 41,395   |         |          |            | 1,305   |       
|                                                                                      | In-process research and development          |                                                             |                          |        |         |         |            | 34,910   |         |          |            | 2,737   |       
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|                                                                                      |                                              |                                                             | Total operating expenses |         |         | 237,147 |            |          |         | 295,393  |            |         |        | 75,636  |  
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|Operating loss                                                                        |                                              |                                                             | (86,046                  | )       |         |         | (146,117   | )        |         |          | (34,765    | )      
|Interest income, net                                                                  |                                              |                                                             | 8,537                    |         |         |         | 14,503     |          |         |          | 3,315      |        
|Impairment of equity investment in private
    companies                              |                                              |                                                             | (5,200                   | )       |         |         |           |          |         |          |           |        
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|                                                                                      | Net loss                                     |                                                             |                          | (82,709 | )       |         |            | (131,614 | )       |          |            | (31,450 | )     
|Accretion and accrued dividends related to
    mandatorily redeemable preferred stock |                                              |                                                             |                         |         |         |         |           |          |         |          | (10,223    | )      
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|                                                                                      | Net loss attributable to common stockholders |                                                             | $                        | (82,709 | )       |         | $          | (131,614 | )       |          | $          | (41,673 | )     
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|Basic and diluted net loss per share                                                  |                                              | $                                                           | (1.67                    | )       |         | $       | (2.81      | )        |         | $        | (2.23      | )      
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|Shares used in computing basic and diluted net
    loss per common share              |                                              |                                                             | 49,492,654               |         |         |         | 46,860,324 |          |         |          | 18,716,943 |        
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|Comprehensive loss:                                                                   |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|                                                                                      | Net loss                                     |                                                             | $                        | (82,709 | )       |         | $          | (131,614 | )       |          | $          | (31,450 | )     
|                                                                                      | Other comprehensive loss:                    |                                                             |                          |         |         |         |            |          |         |          |            |         |       
|                                                                                      |                                              | Unrealized (loss) gain on securities available
    for sale |                          |         | (692    | )       |            |          | 919     |          |            |         | (114   | )      
|                                                                                      |                                              | Foreign currency cumulative translation adjustment          |                          |         | (417    | )       |            |          | (184    | )        |            |         | (14    | )      
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        
|                                                                                      |                                              |                                                             | Total comprehensive loss |         | $       | (83,818 | )          |          | $       | (130,879 | )          |         | $      | (31,578 | )
|                                                                                      |                                              |                                                             |                          |         |         |         |            |          |         |          |            |        

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

F-3



---



##### 



WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS EQUITY

for the years ended March 31, 2000, 2001
and 2002


|                                                                                                         |  |                |        |            |  |                |     |            |  |              |         |               |  |      |         |       |  |   |     |   |  |   |          |   |  |   |        |   |  |   |          |  
|-------------------------------------------------------------------------------------------------------- |  | -------------- | ------ | ---------- |  | -------------- | --- | ---------- |  | ------------ | ------- | ------------- |  | ---- | ------- | ----- |  | - | --- | - |  | - | -------- | - |  | - | ------ | - |  | - | -------- | -
|                                                                                                         |  |                |        |            |  | Deferred Stock |     | Notes      |  |              |         | Accumulated   |  |     
|                                                                                                         |  | Common Stock   |        | Additional |  | Compensation   |     | Receivable |  |              |         | Other         |  |     
|                                                                                                         |  |                |        | Paid-in    |  | and Warrant    |     | from       |  | Accumulated  |         | Comprehensive |  |     
|                                                                                                         |  | Shares         |        | Amount     |  | Capital        |     | Charge     |  | Stockholders |         | Deficit       |  | Loss |         | Total
|                                                                                                         |  |                |        |            |  |                |     |            |  |              |         |               |  |      |         |      
|                                                                                                         |  |               
|                                                                                                         |  | (in thousands)
|Balance, March 31, 1999                                                                                  |  |                | 16,224 |            |  | $              | 162 |            |  | $            | 30,415  |               |  | $    | (4,437  | )     |  | $ | (10 | ) |  | $ | (25,784  | ) |  | $ | (1     | ) |  | $ | 345      |  
|Stock options and warrants exercised, net                                                                |  |                | 2,362  |            |  |                | 24  |            |  |              | 1,185   |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 1,209    |  
|Fair value of warrants issued to non-employees                                                           |  |                |       |            |  |                |    |            |  |              | 585     |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 585      |  
|Repayments of notes receivable                                                                           |  |                |       |            |  |                |    |            |  |              |        |               |  |      |        |       |  |   | 10  |   |  |   |         |   |  |   |       |   |  |   | 10       |  
|Deferred compensation related to stock option
    grants                                                 |  |                |       |            |  |                |    |            |  |              | 11,079  |               |  |      | (11,079 | )     |  |   |    |   |  |   |         |   |  |   |       |   |  |   |         |  
|Amortization of deferred stock compensation                                                              |  |                |       |            |  |                |    |            |  |              |        |               |  |      | 3,588   |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 3,588    |  
|Deferred dividend in connection with the
    beneficial conversation feature in series E preferred stock |  |                |       |            |  |                |    |            |  |              | 8,307   |               |  |      |        |       |  |   |    |   |  |   | (8,307   | ) |  |   |       |   |  |   |         |  
|Accretion to redemption                                                                                  |  |                |       |            |  |                |    |            |  |              | (44     | )             |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | (44      | )
|Accrued dividends on preferred stock                                                                     |  |                |       |            |  |                |    |            |  |              | (1,871  | )             |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | (1,871   | )
|Issuance of common stock pursuant to webMethods
    initial public offering                              |  |                | 4,715  |            |  |                | 47  |            |  |              | 164,978 |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 165,025  |  
|Net issuance of common stock pursuant to
    Actives initial public offering                            |  |                | 2,121  |            |  |                | 21  |            |  |              | 39,974  |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 39,995   |  
|Issuance of common stock pursuant to the
    concurrent private placement                                |  |                | 518    |            |  |                | 5   |            |  |              | 17,495  |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 17,500   |  
|Initial public offering and concurrent private
    placement issuance costs                              |  |                |       |            |  |                |    |            |  |              | (13,158 | )             |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | (13,158  | )
|Conversion of preferred stock to common stock                                                            |  |                | 19,283 |            |  |                | 193 |            |  |              | 41,496  |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 41,689   |  
|Alier acquisition                                                                                        |  |                | 206    |            |  |                | 2   |            |  |              | 43,578  |               |  |      | (14,706 | )     |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 28,874   |  
|Other comprehensive loss                                                                                 |  |                |       |            |  |                |    |            |  |              |        |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   | (128   | ) |  |   | (128     | )
|Net loss                                                                                                 |  |                |       |            |  |                |    |            |  |              |        |               |  |      |        |       |  |   |    |   |  |   | (31,450  | ) |  |   |       |   |  |   | (31,450  | )
|                                                                                                         |  |                |        |            |  |                |     |            |  |              |         |               |  |      |         |       |  |   |     |   |  |   |          |   |  |   |        |   |  |   |          |  
|Balance, March 31, 2000                                                                                  |  |                | 45,429 |            |  |                | 454 |            |  |              | 344,019 |               |  |      | (26,634 | )     |  |   |    |   |  |   | (65,541  | ) |  |   | (129   | ) |  |   | 252,169  |  
|Stock options exercised, net                                                                             |  |                | 2,315  |            |  |                | 23  |            |  |              | 11,422  |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 11,445   |  
|ESPP common stock issuances                                                                              |  |                | 231    |            |  |                | 2   |            |  |              | 6,143   |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 6,145    |  
|Amortization of deferred compensation related to
    employee and non-employee directors stock options   |  |                |       |            |  |                |    |            |  |              |        |               |  |      | 19,805  |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 19,805   |  
|Adjustment of deferred stock compensation related
    to forfeitures                                     |  |                |       |            |  |                |    |            |  |              | (1,279  | )             |  |      | 1,279   |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   |         |  
|Premier acquisition                                                                                      |  |                | 64     |            |  |                | 1   |            |  |              | 12,992  |               |  |      | (5,932  | )     |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 7,061    |  
|Translink acquisition                                                                                    |  |                | 420    |            |  |                | 4   |            |  |              | 79,674  |               |  |      | (7,349  | )     |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 72,329   |  
|Acquisition of Intelliframe workflow technology                                                          |  |                | 274    |            |  |                | 3   |            |  |              | 23,248  |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 23,251   |  
|Deferred warrant charge related to i2 warrants                                                           |  |                |       |            |  |                |    |            |  |              | 23,606  |               |  |      | (23,606 | )     |  |   |    |   |  |   |         |   |  |   |       |   |  |   |         |  
|Cash collection from i2 applied to deferred
    warrant charge                                           |  |                |       |            |  |                |    |            |  |              |        |               |  |      | 4,000   |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 4,000    |  
|Amortization of deferred warrant charge related
    to i2 warrants                                       |  |                |       |            |  |                |    |            |  |              |        |               |  |      | 283     |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 283      |  
|Other comprehensive loss                                                                                 |  |                |       |            |  |                |    |            |  |              |        |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   | 735    |   |  |   | 735      |  
|Net loss                                                                                                 |  |                |       |            |  |                |    |            |  |              |        |               |  |      |        |       |  |   |    |   |  |   | (131,614 | ) |  |   |       |   |  |   | (131,614 | )
|                                                                                                         |  |                |        |            |  |                |     |            |  |              |         |               |  |      |         |       |  |   |     |   |  |   |          |   |  |   |        |   |  |   |          |  
|Balance, March 31, 2001                                                                                  |  |                | 48,733 |            |  |                | 487 |            |  |              | 499,825 |               |  |      | (38,154 | )     |  |   |    |   |  |   | (197,155 | ) |  |   | 606    |   |  |   | 265,609  |  
|Stock options exercised, net                                                                             |  |                | 1,442  |            |  |                | 15  |            |  |              | 10,497  |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 10,512   |  
|ESPP common stock issuances                                                                              |  |                | 302    |            |  |                | 3   |            |  |              | 4,978   |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 4,981    |  
|Amortization of deferred stock compensation
    related to options                                       |  |                |       |            |  |                |    |            |  |              |        |               |  |      | 954     |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 954      |  
|Deferred stock compensation related to
    accelerated vesting                                           |  |                |       |            |  |                |    |            |  |              | 264     |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 264      |  
|Adjustment of deferred compensation related to
    forfeitures                                           |  |                |       |            |  |                |    |            |  |              | (5,283  | )             |  |      | 5,283   |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   |         |  
|Amortization of deferred warrant charge                                                                  |  |                |       |            |  |                |    |            |  |              |        |               |  |      | 3,402   |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 3,402    |  
|Amortization of deferred stock compensation
    related to restricted stock                              |  |                |       |            |  |                |    |            |  |              |        |               |  |      | 11,640  |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 11,640   |  
|Cash collection from i2 applied to deferred
    warrant charge                                           |  |                |       |            |  |                |    |            |  |              |        |               |  |      | 2,000   |       |  |   |    |   |  |   |         |   |  |   |       |   |  |   | 2,000    |  
|Other comprehensive loss                                                                                 |  |                |       |            |  |                |    |            |  |              |        |               |  |      |        |       |  |   |    |   |  |   |         |   |  |   | (1,109 | ) |  |   | (1,109   | )
|Net loss                                                                                                 |  |                |       |            |  |                |    |            |  |              |        |               |  |      |        |       |  |   |    |   |  |   | (82,709  | ) |  |   |       |   |  |   | (82,709  | )
|                                                                                                         |  |                |        |            |  |                |     |            |  |              |         |               |  |      |         |       |  |   |     |   |  |   |          |   |  |   |        |   |  |   |          |  
|Balance, March 31, 2002                                                                                  |  |                | 50,477 |            |  | $              | 505 |            |  | $            | 510,281 |               |  | $    | (14,875 | )     |  |   |    |   |  | $ | (279,864 | ) |  | $ | (503   | ) |  | $ | 215,544  |  
|                                                                                                         |  |                |        |            |  |                |     |            |  |              |         |               |  |      |         |       |  |   |     |   |  |   |          |   |  |   |        |   |  |   |          |  

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

F-4



---



##### 



WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                             |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |         |         |  
|------------------------------------------------------------ | --------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------- | ------- | ------- | ---- | ------- | -------- | ------- | - | ------- | ------- | ------- | -
|                                                             |                                                                                   |                                                                                                                                                               
|                                                             |                                                                                   | Year Ended March 31,                                                                                                                                          
|                                                             |                                                                                   |                                                                                                                                                               
|                                                             |                                                                                   | 2002                                                                                                                                                           |         | 2001    |         | 2000
|                                                             |                                                                                   |                                                                                                                                                                |         |         |         |     
|                                                             |                                                                                   |                                                                                                                                                               
|                                                             |                                                                                   | (in thousands)                                                                                                                                                
|Cash flows from operating activities:                        |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        
|                                                             | Net loss                                                                          |                                                                                                                                                                | $       | (82,709 | )       |      | $       | (131,614 | )       |   | $       | (31,450 | )      
|                                                             | Adjustments to reconcile net loss to net cash
    used in operating activities:   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |         |        
|                                                             |                                                                                   | Depreciation and amortization                                                                                                                                  |         |         | 8,453   |      |         |          | 4,181   |   |         |         | 1,429   |  
|                                                             |                                                                                   | Provision for doubtful accounts                                                                                                                                |         |         | 2,840   |      |         |          | 4,808   |   |         |         | 917     |  
|                                                             |                                                                                   | Provision for warranty                                                                                                                                         |         |         |        |      |         |          | 88      |   |         |         | 205     |  
|                                                             |                                                                                   | Impairment of equity investments                                                                                                                               |         |         | 5,200   |      |         |          |        |   |         |         |        |  
|                                                             |                                                                                   | Loss on disposal of equipment                                                                                                                                  |         |         | 574     |      |         |          | 46      |   |         |         |        |  
|                                                             |                                                                                   | Expense related to fair value of options issued
    to non-employees                                                                                           |         |         |        |      |         |          |        |   |         |         | 585     |  
|                                                             |                                                                                   | Amortization of deferred stock compensation and
    compensation for accelerated vesting related to employee stock
    options and non-employee stock warrants |         |         | 16,260  |      |         |          | 20,088  |   |         |         | 3,588   |  
|                                                             |                                                                                   | Amortization of goodwill and acquired intangibles                                                                                                              |         |         | 38,697  |      |         |          | 41,395  |   |         |         | 1,305   |  
|                                                             |                                                                                   | Write off of in-process research and development                                                                                                               |         |         |        |      |         |          | 34,910  |   |         |         | 2,737   |  
|                                                             | Increase (decrease) in cash resulting from
    changes in assets and liabilities: |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |         |        
|                                                             |                                                                                   | Accounts receivable                                                                                                                                            |         |         | 9,373   |      |         |          | (45,459 | ) |         |         | (13,019 | )
|                                                             |                                                                                   | Prepaid expenses and other current assets                                                                                                                      |         |         | 2,720   |      |         |          | (3,250  | ) |         |         | (5,675  | )
|                                                             |                                                                                   | Other non-current assets                                                                                                                                       |         |         | (4,569  | )    |         |          | (1,937  | ) |         |         | (434    | )
|                                                             |                                                                                   | Accounts payable                                                                                                                                               |         |         | 6,596   |      |         |          | 5,320   |   |         |         | 2,483   |  
|                                                             |                                                                                   | Accrued expenses                                                                                                                                               |         |         | 3,386   |      |         |          | 4,787   |   |         |         | 6,198   |  
|                                                             |                                                                                   | Accrued salaries and commissions                                                                                                                               |         |         | 176     |      |         |          | 7,573   |   |         |         | 6,244   |  
|                                                             |                                                                                   | Deferred revenue                                                                                                                                               |         |         | (11,124 | )    |         |          | 42,369  |   |         |         | 21,947  |  
|                                                             |                                                                                   | Other current liabilities                                                                                                                                      |         |         |        |      |         |          |        |   |         |         | (108    | )
|                                                             |                                                                                   | Other non-current liabilities                                                                                                                                  |         |         |        |      |         |          | 34      |   |         |         | (148    | )
|                                                             |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        
|Net cash used in operating activities                        |                                                                                   |                                                                                                                                                                | (4,127  | )       |         |      | (16,661 | )        |         |   | (3,196  | )      
|                                                             |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        
|Cash flows from investing activities:                        |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        
|                                                             | Purchases of property and equipment                                               |                                                                                                                                                                |         | (5,859  | )       |      |         | (10,720  | )       |   |         | (5,715  | )      
|                                                             | Net purchases of marketable securities available
    for sale                     |                                                                                                                                                                |         | (17,360 | )       |      |         | (33,269  | )       |   |         | (56,495 | )      
|                                                             | (Purchases) repayments of investments in
    private companies                    |                                                                                                                                                                |         | 2,000   |         |      |         | (7,000   | )       |   |         | (3,000  | )      
|                                                             | Purchase of other assets                                                          |                                                                                                                                                                |         |        |         |      |         |         |         |   |         | (5,539  | )      
|                                                             | Purchase of Intelliframe workflow technology and
    related expenses             |                                                                                                                                                                |         |        |         |      |         | (9,324   | )       |   |         |        |        
|                                                             | Acquisition of businesses, net of cash acquired                                   |                                                                                                                                                                |         |        |         |      |         | (4,741   | )       |   |         | (2,316  | )      
|                                                             |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        
|Net cash used in investing activities                        |                                                                                   |                                                                                                                                                                | (21,219 | )       |         |      | (65,054 | )        |         |   | (73,065 | )      
|                                                             |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        
|Cash flows from financing activities:                        |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        
|                                                             | Borrowings under notes payable and lines of credit                                |                                                                                                                                                                |         |        |         |      |         |         |         |   |         | 87      |        
|                                                             | Repayments under notes payable and lines of credit                                |                                                                                                                                                                |         |        |         |      |         | (1,029   | )       |   |         | (94     | )      
|                                                             | Payments on capital leases                                                        |                                                                                                                                                                |         | (3,135  | )       |      |         | (685     | )       |   |         | (112    | )      
|                                                             | Repayments of notes receivable from shareholders                                  |                                                                                                                                                                |         |        |         |      |         |         |         |   |         | 10      |        
|                                                             | Proceeds from issuance of preferred stock                                         |                                                                                                                                                                |         |        |         |      |         |         |         |   |         | 28,852  |        
|                                                             | Issuance costs related to preferred stock
    offerings                           |                                                                                                                                                                |         |        |         |      |         |         |         |   |         | (196    | )      
|                                                             | Proceeds from exercise of stock options and
    warrants                          |                                                                                                                                                                |         | 10,512  |         |      |         | 11,445   |         |   |         | 1,208   |        
|                                                             | Proceeds from ESPP common stock issuances                                         |                                                                                                                                                                |         | 4,981   |         |      |         | 6,145    |         |   |         |        |        
|                                                             | Proceeds from OEM fees applied to deferred
    warrant charge                     |                                                                                                                                                                |         | 2,000   |         |      |         | 4,000    |         |   |         |        |        
|                                                             | Proceeds from concurrent private placement                                        |                                                                                                                                                                |         |        |         |      |         |         |         |   |         | 17,500  |        
|                                                             | Net proceeds from initial public offerings                                        |                                                                                                                                                                |         |        |         |      |         |         |         |   |         | 191,863 |        
|                                                             |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        
|Net cash provided by financing activities                    |                                                                                   |                                                                                                                                                                | 14,358  |         |         |      | 19,876  |          |         |   | 239,118 |        
|                                                             |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        
|Effect of the exchange rate on cash and cash
    equivalents |                                                                                   |                                                                                                                                                                | (228    | )       |         |      | (164    | )        |         |   | (15     | )      
|                                                             |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        
|Net (decrease) increase in cash and cash
    equivalents     |                                                                                   |                                                                                                                                                                | (11,216 | )       |         |      | (62,003 | )        |         |   | 162,842 |        
|Cash and cash equivalents at beginning of period             |                                                                                   |                                                                                                                                                                | 109,713 |         |         |      | 171,716 |          |         |   | 8,874   |        
|                                                             |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        
|Cash and cash equivalents at end of period                   |                                                                                   | $                                                                                                                                                              | 98,497  |         |         | $    | 109,713 |          |         | $ | 171,716 |        
|                                                             |                                                                                   |                                                                                                                                                                |         |         |         |      |         |          |         |   |         |        

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

F-5



---



##### 



WEBMETHODS, INC.



NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


1.     Organization

webMethods, Inc. (the Company) is a leading
provider of software and services for business integration. The
Companys products enable customers to integrate business
processes among different systems within the enterprise through
real-time exchange of information and to work closely with their
customers, suppliers and other business partners through
real-time exchange of information and transactions. The Company
was incorporated in Delaware on June 12, 1996 and changed
its name from TransactNet, Inc. to webMethods, Inc. on
January 21, 1997. The Company has subsidiaries in Europe
and Asia Pacific regions which provide technical, marketing and
sales 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.

The Company has incurred substantial losses for
each of the three years in the period ended March 31, 2002.
For the year ended March 31, 2002, the Company incurred a
loss from operations of $82,709,000 and negative cash flows from
operations of $4,127,000. As of March 31, 2002, the Company
had an accumulated deficit of $279,864,000. The Company has
taken several actions to align its cost structure to better
match its expected revenues, including reducing its workforce,
reducing and limiting discretionary operating expenses and
reducing capital expenditures. If the Company does not achieve
revenues at anticipated levels, it will need to take further
actions to reduce costs to minimize its losses from operations.
Management believes that existing cash and marketable securities
of $211,842,000 as of March 31, 2002, and cash generated
internally by operations, if any, will be sufficient to meet the
Companys working capital requirements and anticipated
capital expenditures through the year ended March 31, 2004.
If alternative debt or equity financing is required thereafter
it may not be available on an acceptable basis, if at all.

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 of America 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.



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

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

F-6



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



2.     Summary of
significant accounting policies 
(Continued)




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

The Companys marketable securities consist
of corporate bonds, commercial paper and U.S. government
and agency securities 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.



| |                       
| | ----------------------
| | 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. Leasehold improvements are amortized over the
shorter of the lease term or their useful life. 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.



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

Investments in private companies in which the
Company owns less than a 20% voting equity interest and has no
significant influence are accounted for using the cost method.
Included in other assets as of March 31, 2002 and 2001, is
$2,800,000 and $10,000,000, respectively, of preferred stock
carried at cost and convertible debt carried at book value of
various private companies, some of which are business partners.
The Company performs periodic reviews of its investment for
impairment. The investments in privately held companies are
considered impaired when a review of the investees
operations and other indicators of impairment indicate that the
carrying value of the investment is not likely to be
recoverable. Such indicators include, but are not limited to,
limited capital resources, limited prospects of receiving
additional financing, and prospects for liquidity of the related
securities. During fiscal 2002, the Company recorded an other
than temporary write down of $5,200,000 related to the
impairment of investments in private companies.



| |                           
| | --------------------------
| | 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.

F-7



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



2.     Summary of
significant accounting policies 
(Continued)




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

The cost of business acquisitions accounted for
using the purchase method is allocated first to identifiable
assets and liabilities based on estimated fair values. The
excess of cost over identifiable assets and liabilities is
recorded as goodwill. Identifiable intangible assets related to
the acquisition of favorable lease terms are amortized on a
straight-line basis over four years. Goodwill and assembled
workforce are amortized on a straight-line basis over three
years. Non-compete agreements are amortized on a straight-line
basis over two years. License agreements are amortized on a
straight-line basis over one year. The carrying amounts of
intangible assets and goodwill are reviewed if facts or changes
in circumstances suggest they may be impaired. If this review
indicates the carrying amounts of intangible assets and goodwill
will not be recoverable, as determined based on estimated
undiscounted future cash flows of the acquired assets, the
carrying amounts of the intangible assets and goodwill are
reduced based on the difference between the carrying value and
estimated fair value. Fair value is determined using discounted
cash flows or other methods. No impairments of intangible assets
have been identified as of March 31, 2002. As of
April 1, 2002, the amortization of any remaining book value
of goodwill will cease and goodwill will be tested for
impairment at least annually (see Recent Accounting
Pronouncements).



| |                                
| | -------------------------------
| | 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, 2002 and 2001.



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

F-8



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



2.     Summary of
significant accounting policies 
(Continued)




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

The Company enters into arrangements, which may
include the sale of licenses of the Companys B2B and
Enterprise software, professional services and maintenance or
various combinations of each element. The Company recognizes
revenue based on Statement of Position (SOP) 97-2,
Software Revenue Recognition, as amended, and
modified by SOP 98-9, Modification of SOP 97-2, Software
Revenue Recognition, With Respect to Certain Transactions.
SOP 98-9 modified SOP 97-2 by requiring revenue to be recognized
using the residual method if certain conditions are
met. Revenues are recognized based on the residual method when
an agreement has been signed by both parties, the fees are fixed
or determinable, collection of the fees is probable, delivery of
the product has occurred and no other significant obligations
remain. Historically the Company has not experienced significant
returns or offered exchanges of its products.

For multi-element arrangements, each element of
the arrangement is analyzed and the Company allocates a portion
of the total fee under the arrangement to the undelivered
elements, such as professional services, training and
maintenance. Revenues allocated to the undelivered elements are
deferred using vendor-specific objective evidence of fair value
of the elements and the remaining portion of the fee is
allocated to the delivered elements (generally the software
license), under the residual method. Vendor specific-objective
evidence of fair value is based on the price the customer is
required to pay when the element is sold separately (i.e. hourly
time and material rates charged for consulting services when
sold separately from a software license and the optional renewal
rates charged by the Company for maintenance arrangements).

For electronic delivery, the product is
considered to have been delivered when the access code to
download the software from the Companys web site and
activation key, as applicable, has been provided to the
customer. If an element of the license agreement has not been
delivered, revenue for the element is deferred based on its
vendor-specific objective evidence of fair value. If
vendor-specific objective evidence of fair value does not exist,
all revenue is deferred until sufficient objective evidence
exists or all elements have been delivered.

If the fee due from the customer is not fixed or
determinable, revenue is recognized as payments become due. If
collectibility is not considered probable, revenue is recognized
when the fee is collected.

License revenue:Amounts allocated to license revenues under the residual method
are recognized at the time of delivery of the software when
vendor-specific objective evidence of fair value exists for the
undelivered elements, if any, and all the other revenue
recognition criteria discussed above have been met.

Professional services
revenue:Revenues from professional
services are comprised of consulting, implementation services
and training. Consulting services are generally sold on a
time-and-materials basis and include services such as
installation and building non-complex interfaces to allow the
software to operate in customized environments. Services are
generally separable from the other elements under the
arrangement since the performance of the services is not
essential to the functionality (i.e. the services do not involve
significant production, modification or customization of the
software or building complex interfaces) of any other element of
the transaction. Revenues for professional services and training
are recognized when the services are performed.

Maintenance revenue:Maintenance revenues consist primarily of fees for providing
when-and-if-available unspecified software upgrades and
technical support over a specified term. Maintenance revenues
are recognized on a straight-line basis over the term of the
contract.

F-9



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



2.     Summary of
significant accounting policies 
(Continued)




| |                         
| | ------------------------
| | 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.



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

The Company measures expense for its non-employee
stock-based compensation and warrant charge using the fair value
method. Under the fair value method, the fair value of each
option or warrant is estimated on the date of the grant using
the Black-Scholes valuation model with the following weighted
average assumptions: risk-free interest rate at the date of
grant, expected life of the instrument, expected dividends and
volatility at the date of the grant. The risk-free interest rate
and the volatility are based on the expected term of the
instrument.



| |                   
| | ------------------
| | 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 19 for required geographic
segment information.



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

In July 2001, the Financial Accounting Standards
Board issued SFAS No. 141, Business
Combinations and SFAS No. 142, Goodwill and
Other Intangible Assets. SFAS No. 141 requires that
all business combinations initiated after June 30, 2001 be
accounted for under the purchase method and addresses the
initial recognition and measurement of goodwill and other
intangible assets acquired in a business combination. SFAS
No. 142 addresses the initial recognition and measurement
of intangible assets acquired outside of a business combination
and the accounting for goodwill and other intangible assets
subsequent to their acquisition. SFAS No. 142 provides that
intangible assets with finite useful lives be amortized and that
goodwill and intangible assets with indefinite lives will not be
amortized, but will rather be tested at least annually for
impairment. Under the provisions of SFAS No. 142, any
impairment loss identified upon adoption of this standard is
recognized as a cumulative effect of a change in accounting
principle. Any impairment loss incurred subsequent to initial
adoption of SFAS No. 142 is recorded as a charge to current
period earnings.

In accordance with SFAS No. 141, goodwill
acquired in purchase business combination completed before
June 30, 2001, has been amortized through March 31,
2002, and will be tested for impairment at least annually. The
Company will adopt SFAS No. 142 on April 1, 2002.
The Company expects to have an unamortized goodwill balance of
$29,838,000. The goodwill carrying value will be subject to the

F-10



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



2.     Summary of
significant accounting policies 
(Continued)


transition provision of SFAS No. 142.
Amortization expense related to goodwill was $38,697,000,
$41,395,000 and $1,305,000 for the years ended March 31,
2002, 2001 and 2000, respectively. The Company does not expect
the adoption of SFAS 141 to have an impact on its
consolidated financial position or results of operations. Upon
adoption of SFAS 142, the Company will cease amortization
of goodwill which will eliminate goodwill amortization expense.
The Company does not expect to have an impairment charge of the
unamortized goodwill balance at the time of adoption.

In October 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, which supercedes SFAS No. 121
Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. SFAS No. 144
addresses the accounting and reporting for the impairment or
disposal of long-lived assets, including discontinued
operations. SFAS No. 144 is effective April 1, 2002
for the Company. The Company is reviewing the provisions of SFAS
No. 144 and does not anticipate that the adoption will have
a material impact on the Companys financial condition or
results of operations.

In November 2001, the Emerging Issues Task Force,
or EITF, issued Topic No. D-103, Income Statement
Characterization of Reimbursement Received for Out-of-Pocket
Expenses Incurred. EITF Topic No. D-103 requires that
companies report reimbursements received for out-of-pocket
expenses incurred as revenue, rather than as a reduction of
expenses. The provisions of EITF Topic No. D-103 is
effective for financial statements issued for fiscal years
beginning after December 15, 2001. As the Company has
historically accounted for reimbursements of out-of-pocket
expenses in the manner provided for under EITF Topic
No. D-103, the Company does not expect the adoption of the
provisions of EITF Topic No. D-103 to have an impact on its
consolidated 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, 2002, 2001 and 2000,
the Company has paid the firm approximately $1,223,000,
$2,194,000, and $909,000, respectively. As of March 31,
2002 and 2001, the aggregate amounts in trade accounts payable
for these services was approximately $173,000 and $169,000,
respectively.

For the year ended March 31, 2000, the
Company 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 15). Revenue generated from these related parties was
$6,100,000 for the year ended March 31, 2000. Additionally,
the Company paid $432,000 for services and equipment from
related parties during the year ended March 31, 2001. These
individuals are not considered to be significant related parties
subsequent to the initial public offering, which converted their
mandatorily redeemable, convertible preferred stock for shares
of the Companys common stock.

For the year ended March 31, 2002, the
Company entered into certain contractual arrangements with a
third party in which the Company has invested. Revenue generated
from this third party was $41,000 for the year ended
March 31, 2002. Accounts receivable from this third party
as of March 31, 2002 was $42,000.

The Company also entered into an agreement to
purchase consulting services from another third party in which
the Company has invested. For the year ended March 31,
2002, the amount paid to that third party was $90,000.

F-11



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

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. One organization individually accounted for 20% of the
accounts receivables as of March 31, 2002.

5.     Marketable
securities

The cost and estimated fair value of marketable
securities, which consist of corporate bonds, commercial paper
and US government and agency securities, by contractual maturity
are as follows:

|                        |  |                |          |                |  |      |          |            |  |  |         |  |  |  |         | 
|----------------------- |  | -------------- | -------- | -------------- |  | ---- | -------- | ---------- |  |  | ------- |  |  |  | ------- | 
|                        |  |                |          |               
|                        |  | March 31, 2002 |          | March 31, 2001
|                        |  |                |          |               
|                        |  | Cost           |          | Fair Value     |  | Cost |          | Fair Value
|                        |  |                |          |                |  |      |          |           
|                        |  |                |          |               
|                        |  | (in thousands) |          | (in thousands)
|Due in one year or less |  |                | $112,912 |                |  |      | $113,345 |            |  |  | $95,551 |  |  |  | $96,676 | 

The gross unrealized holding gains were $433,000
and $1,125,000 for the years ended March 31, 2002 and 2001,
respectively. The unrealized holding gains have been included,
in accumulated other comprehensive loss, which is a separate
component of stockholders equity.

6.     Property and
equipment

Property and equipment consisted of the following:

|                                          |  |                |         |      |  |   |        |  
|----------------------------------------- |  | -------------- | ------- | ---- |  | - | ------ | -
|                                          |  |               
|                                          |  | March 31,     
|                                          |  |               
|                                          |  | 2002           |         | 2001
|                                          |  |                |         |     
|                                          |  |               
|                                          |  | (in thousands)
|Equipment                                 |  | $              | 18,968  |      |  | $ | 14,822 |  
|Software                                  |  |                | 6,518   |      |  |   | 3,428  |  
|Furniture                                 |  |                | 3,763   |      |  |   | 3,887  |  
|Leasehold improvements                    |  |                | 2,489   |      |  |   | 2,052  |  
|                                          |  |                |         |      |  |   |        |  
|                                          |  |                | 31,738  |      |  |   | 24,189 |  
|Accumulated depreciation and amortization |  |                | (14,557 | )    |  |   | (6,825 | )
|                                          |  |                |         |      |  |   |        |  
|                                          |  | $              | 17,181  |      |  | $ | 17,364 |  
|                                          |  |                |         |      |  |   |        |  

During the year ended March 31, 2002 and
2001, the Company acquired certain equipment and software under
capital leases. Assets under capital leases included in
equipment as of March 31, 2002 and 2001 is $7,856,000 and
$4,819,000, respectively. Assets under capital lease included in
software as of March 31, 2002 and 2001 is $515,000 and
$258,000, respectively. Related to these capital leases and
included in the accumulated depreciation and amortization is
$3,474,000 and $849,000 at March 31, 2002 and 2001,
respectively.

7.     Income
taxes

The Company has recorded no provision for income
taxes for the year ended March 31, 2002, as the Company has
incurred operating losses since its inception. Net operating
loss carryforwards (NOLs) as of March 31, 2002 is
approximately $209,039,000 which begins to expire in 2010.
Approximately $29,000,000

F-12



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



7.     Income
taxes  (Continued)


included in the current year NOL is related to
deductions associated with stock option exercises. 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 tax rules could adversely
affect the Companys ability to utilize the NOLs.

The tax effect of each temporary difference is as
follows:

|                                      |  |                |         |      |  |   |         |  
|------------------------------------- |  | -------------- | ------- | ---- |  | - | ------- | -
|                                      |  |               
|                                      |  | March 31,     
|                                      |  |               
|                                      |  | 2002           |         | 2001
|                                      |  |                |         |     
|                                      |  |               
|                                      |  | (in thousands)
|Net operating loss carryforwards      |  | $              | 79,417  |      |  | $ | 60,561  |  
|Accrued expenses                      |  |                | 4,106   |      |  |   | 4,583   |  
|Deferred revenue                      |  |                | 3,234   |      |  |   | 2,365   |  
|Accounts receivable                   |  |                | 1,009   |      |  |   | 1,946   |  
|Impairment loss in equity investments |  |                | 2,009   |      |  |   |        |  
|Property and equipment                |  |                | (365    | )    |  |   | 1,100   |  
|Prepaid assets                        |  |                |        |      |  |   | (2,966  | )
|Stock option compensation             |  |                | 5,680   |      |  |   | 252     |  
|Acquired intangibles                  |  |                | (9,222  | )    |  |   | 7,256   |  
|Research and development credit       |  |                | 4,493   |      |  |   |        |  
|Other                                 |  |                | 162     |      |  |   | 80      |  
|Valuation allowance                   |  |                | (90,523 | )    |  |   | (75,177 | )
|                                      |  |                |         |      |  |   |         |  
|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 management has
concluded that the realization of the deferred tax assets does
not meet the more likely than not criterion. The
change in the valuation allowance was an increase of
$15,346,000, which can be attributed primarily to accrued
deferred tax liabilities and additional operating losses.

F-13



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

7.     Income
taxes  (Continued)

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,
|                                                             |                    |          
|                                                             |                    | 2002      |       | 2001 |   | 2000
|                                                             |                    |           |       |      |   |     
|U.S. Federal statutory rate                                  |                    |           | 34.0  | %    |   |      | 34.0  | % |   |  | 34.0  | %
|State and local taxes, net of Federal income tax
    benefit |                    |           | 1.4   | %    |   |      | 2.6   |   |   |  | 3.8   |  
|Non-deductible items                                         |                    |           | (18.8 | )    |   |      |      |   |   |  |      |  
|Change in valuation allowance                                |                    |           | (6.6  | )    |   |      | (13.9 | ) |   |  | (32.7 | )
|Amortization of nondeductible goodwill                       |                    |           | (14.6 | )    |   |      | (5.9  | ) |   |  | (2.1  | )
|In-process research and development write-off                |                    |           |      |      |   |      |      |   |   |  | (3.0  | )
|Stock option compensation                                    |                    |           |      |      |   |      |      |   |   |  | (0.1  | )
|Change in general business credit                            |                    |           | 5.3   |      |   |      |      |   |   |  | 0.8   |  
|Acquisition costs                                            |                    |           |      |      |   |      | (8.9  | ) |   |  |      |  
|Foreign Rate differential                                    |                    |           | (0.3  | )    |   |      |      |   |   |  |      |  
|Purchase price adjustment                                    |                    |           |      |      |   |      | (7.1  | ) |   |  |      |  
|Other                                                        |                    |           | (0.4  | )    |   |      | (0.8  | ) |   |  | (0.7  | )
|                                                             |                    |           |       |      |   |      |       |   |   |  |       |  
|                                                             | Effective tax rate |           |       |     | % |      |       |  | % |  |       |  | %
|                                                             |                    |           |       |      |   |      |       |   |   |  |       |  

8.     Notes payable
and lines of credit

As of March 31, 2002, the Company had a line
of credit agreement with a bank to borrow up to a maximum
principal amount of $10,000,000 with a maturity date of
July 10, 2002 and an interest rate on unpaid principal
balances of the banks prime rate. Borrowings under this
note are limited to 80% of eligible accounts receivable.
Interest is payable on any unpaid principal balance at the
banks prime rate. The agreement includes restrictive
covenants which require the Company to maintain, among other
things, a ratio of quick assets to current liabilities,
excluding 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 the greater of $35,000,000 or 85% of the
total revenue for the immediately preceding fiscal quarter.

As of March 31, 2002, the Company had not
borrowed against this line of credit. In connection with the
line of credit agreement, the Company obtained a letter of
credit totaling $475,000 related to an office lease.

9.     Lease
commitments

The Company has 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 3.7%. Principal and interest is payable
under each lease in 36 monthly installments. At expiration
of the lease term, the Company 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 leases office space in various
locations under operating leases expiring through fiscal 2009.
Total rent expense was approximately $11,783,000, $8,148,000 and
$1,878,000 for the years ended March 31, 2002, 2001 and
2000, respectively. In December 1999, the Company entered into a
five-year lease agreement for office space for the
Companys headquarters in Fairfax Virginia.

F-14



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



9.     Lease
commitments  (Continued)


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

|                                                               |            |                |        |         |  |   |        |       | 
|-------------------------------------------------------------- | ---------- | -------------- | ------ | ------- |  | - | ------ | ----- | 
|                                                               |            | Operating      |        | Capital
|                                                               |            |                |        |        
|                                                               |            |               
|                                                               |            | (in thousands)
|Years ending March 31,                                         |            |                |        |         |  |   |        |      
|                                                               | 2003       |                | $      | 9,379   |  |   | $      | 2,982 | 
|                                                               | 2004       |                |        | 7,493   |  |   |        | 1,564 | 
|                                                               | 2005       |                |        | 6,885   |  |   |        | 47    | 
|                                                               | 2006       |                |        | 5,072   |  |   |        |      | 
|                                                               | 2007       |                |        | 5,235   |  |   |        |      | 
|                                                               | Thereafter |                |        | 2,604   |  |   |        |      | 
|                                                               |            |                |        |         |  |   |        |      
|                                                               |            | $              | 36,668 |         |  |   | 4,593  |      
|                                                               |            |                |        |         |  |   |        |      
|Less amounts representing interest                             |            |                |        |         |  |   | (357   | )    
|                                                               |            |                |        |         |  |   |        |      
|                                                               |            |                |        |         |  |   | 4,236  |      
|Less current portion                                           |            |                |        |         |  |   | (2,699 | )    
|                                                               |            |                |        |         |  |   |        |      
|Capital lease obligation, net of current portion               |            |                |        |         |  |   | 1,537  |      
|Other long term liabilities                                    |            |                |        |         |  |   | 228    |      
|                                                               |            |                |        |         |  |   |        |      
|Capital lease obligation, net of current portion
    and other |            |                |        |         |  | $ | 1,765  |      
|                                                               |            |                |        |         |  |   |        |      

10.     Stockholders
equity



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

The Companys Certificate of Incorporation,
as amended, includes 50,000,000 authorized shares of
undesignated preferred stock with a par value of $.01, none of
which were outstanding as of March 31, 2002.



| |                   
| | ------------------
| | Common stock split

In contemplation of the initial public offering,
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.



| |                                                             
| | ------------------------------------------------------------
| | Initial public offering and concurrent private
    placement

The Company completed its 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).

Prior to the Companys merger with Active
Software, Active completed its initial public offering of
2,121,175 shares of common stock at an initial public
offering price of $20.87 per share. The net proceeds from
the offering, after deducting underwriting discounts and
commissions and offering expenses incurred by Active, were
approximately $39,995,000.

F-15



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



10.     Stockholders
equity  (Continued)




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

In March 2001, the Company entered into an OEM/
Reseller agreement with i2 Technologies (i2). In
connection with the agreement the Company issued to i2 a warrant
to purchase 750,000 shares of the Companys
common stock at an exercise price of $40.88 per share. The
fair value of the warrant based on the Black-Scholes valuation
model was $23,606,000 on the date of issuance which has been
recorded as a deferred warrant charge. As part of the agreement,
i2 will pay the Company OEM fees of $10,000,000 over the term
which will reduce the deferred warrant charge. The Company
received $2,000,000 and $4,000,000, of OEM fees from i2 during
the years ended March 31, 2002 and 2001, respectively.
These fees were recorded as a deduction to the deferred warrant
charge and during the year ended March 31, 2002 and 2001,
respectively, the Company recorded $3,402,000 and $283,000, of
amortization of the deferred warrant charge to sales and
marketing expense. The Company signed an amended warrant
agreement which reduced the number of shares of common stock i2
can purchase from 750,000 to 710,000 and, in addition, reduced
the exercise price per share from $40.88 to $28.70. Based on the
remeasurement of the warrant using the Black-Scholes valuation
model the fair value of the amended warrant did not exceed the
current fair value of the original warrant. The Company did not
incur an additional charge as a result of this amendment. The
fair value of the warrants granted to i2 was estimated on the
date of grant and amendment, using the following weighted
average assumptions or range of weighted average assumption:
Risk-free interest rate of 4.9%, term of 3.75 to 4 years,
volatility of 114% to 159%, and no dividends anticipated. As of
March 31, 2002, 710,000 warrants remain outstanding with a
remaining life of approximately three years.

11.     Active
merger

On August 15, 2000, the Company completed a
merger with Active Software, Inc. (Active), a
publicly traded company that develops and markets software
products for businesses that allow users to integrate
incompatible software applications across their extended
enterprises of customers, suppliers and partners. Active
stockholders received .527 shares of common stock of
webMethods for each share of Active common stock, or an
aggregate of 13.9 million shares. The merger was accounted
for as a pooling of interests, and accordingly the financial
statements have been retroactively restated as if the merger had
occurred as of the beginning of the earliest period presented.
Prior to the acquisition, Active had a calendar fiscal year end.
In connection with the retroactive restatement the financial
statements of Active were recast to a March 31 year
end to conform to webMethods presentation. The Company incurred
transaction costs of $34,039,000 directly related to the merger.

12.     Business
acquisitions

In February 2000, the Company acquired Alier,
Inc. (Alier) a provider of enterprise application integration
solutions to financial institutions. In connection with this
transaction, all outstanding shares of capital stock of Alier
were exchanged for 205,991 shares of the Companys
common stock valued at $31,180,000 and cash of $2,000,000. In
addition, the outstanding options to purchase Alier capital
stock were converted into options to
purchase 83,412 shares of the Companys common
stock valued at $12,400,000. The Company incurred approximately
$316,000 in transaction costs. The purchase price was allocated,
based on an independent valuation, to goodwill and acquired
intangibles of $29,568,000, deferred stock compensation of
$14,706,000 related to restricted stock, and acquired in-process
research and development of $2,737,000. The $2,737,000 allocated
to in-process research and development was expensed upon
consummation of the acquisition as it had not reached
technological feasibility and, in the opinion of management, has
no alternative future use.

F-16



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



12.     Business
acquisitions  (Continued)


In April 2000, the Company acquired Premier
Software Technologies, Inc. (Premier), a provider of integration
products and services for e-commerce. In connection with this
transaction, the Company issued 63,929 shares of common
stock valued at $11,864,000 and paid cash of $500,000 in
exchange for all of the outstanding shares of capital stock of
Premier. In addition, outstanding options to purchase Premier
capital stock were converted into options to purchase an
aggregate of 6,081 shares of the Companys common
stock valued at $1,129,000. The Company incurred $166,000 in
transaction fees. The purchase price was allocated based on an
independent valuation, to goodwill and acquired intangibles of
$7,503,000 and deferred stock compensation of $5,932,000 related
to restricted stock.

In April 2000, the Company acquired TransLink
Software, Inc. (TransLink), a provider of high performance
mainframe integration solutions for e-commerce. In connection
with this transaction, the Company issued 419,683 shares of
its common stock valued at $76,053,000 and paid cash of
$4,500,000. In addition, the outstanding options to purchase
TransLink capital stock were converted into options to purchase
an aggregate of 22,683 shares of the Companys common
stock valued at $3,625,000. The Company incurred $248,000 in
transaction fees. The purchase price was allocated based on an
independent valuation, to goodwill and acquired intangibles of
$74,164,000, deferred stock compensation of $7,349,000 related
to restricted stock and acquired in-process research and
development of $2,311,000. The in-process research and
development was expensed upon consummation of the acquisition as
it had not reached technological feasibility and, in the opinion
of management has no alternative future use.

The acquisitions were accounted for as purchases
and, accordingly, their results of the operations have been
included in the Companys financial statements from the
date of acquisition. During the year ended March 31, 2002,
2001 and 2000 respectively, the Company recorded $11,640,000,
$12,998,000 and $613,000 of amortization of deferred stock
compensation which is based on the vesting period of related
restricted stock. Pro forma information for these acquisitions
is not considered necessary as differences between actual and
pro forma information are not material.

13.     Acquisition
of technology

In February 2001, the Company acquired
Intelliframe Corporation, a wholly owned subsidiary of Computer
Network Technology Corporation (Intelliframe).
Through the acquisition, the Company acquired Intelliframe,
certain workflow intellectual property and a research and
development team of 14 people. The total purchase price for the
acquisition was $32,109,000, which is comprised of $8,834,000 of
cash and 273,542 shares of the Companys common stock
which had a fair value of $23,251,000 on the date of issuance.
The Company also paid $490,000 in acquisition related costs.

The Intelliframe workflow technology was
purchased with the intent of the Company to subsequently
integrate certain parts of the technology into a future product.
The efforts required to complete and incorporate the acquired
in-process research and development included the completion of
all planning, designing and testing activities that are
necessary to meet its design requirements, including functions,
features and technical performance requirements. There were no
other significant assets purchased. Because the product into
which the acquired technology was to be incorporated had not met
technological feasibility, substantially all the purchase price
and related acquisition costs were charged to in-process
research and development during the year ended March 31,
2001.

F-17



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

14.     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 terms and option exercise prices of the stock
options.

In August 2000, the Company increased the number
of shares to 20,731,000 shares of the Companys common
stock for issuance upon the exercise of options granted under
the Plan. Pursuant to an amendment to the Plan adopted by the
Board of Directors on June 6, 2001 and approved by the
Companys stockholders on September 7, 2001, the
number of shares of the Companys common stock available
for issuance under Plan was increased on April 1, 2002 by
2,462,195 shares of common stock (i.e., five percent of the
number of shares outstanding on the date of the Boards
approval of the 2001 amendment to the Plan), and, subject to the
Boards discretion, may be increased by up to the same
amount each April 1 thereafter during the remaining
four-year term of the Plan. At March 31, 2002, options to
purchase 15,578,211 shares were outstanding. In
connection with the Active merger, the Company assumed the
Active stock option plan.

Qualified incentive stock options granted
pursuant to the plans 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 25.0% per year beginning one
year after the date of award, and have a term of ten years.

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

|                            |           |         |            |                |   |                  |         |         |  |   |        |        |  |   |       |       | 
|--------------------------- | --------- | ------- | ---------- | -------------- | - | ---------------- | ------- | ------- |  | - | ------ | ------ |  | - | ----- | ----- | 
|                            |           |         |            |                |   |                 
|                            |           | Stock   |            | Range of       |   | Weighted Average
|                            |           | Options |            | Exercise Price |   | Exercise Price  
|                            |           |         |            |                |   |                 
|                            |           |         |            |                |   |                  |         |        
|Outstanding, March 31, 1999 |           |         | 5,605,613  |                |   | $                | 0.11   |         |  | $ | 33.15  |        |  | $ | 0.70  |      
|                            |           |         |            |                |   |                  |         |         |  |  
|                            | Granted   |         |            | 6,308,576      |   |                  |         | 2.17   |  |   |        | 254.27 |  |   |       | 20.91 | 
|                            | Exercised |         |            | (2,261,923     | ) |                  |         | 0.11   |  |   |        | 20.87  |  |   |       | 0.47  | 
|                            | Cancelled |         |            | (420,281       | ) |                  |         | 0.11   |  |   |        | 174.34 |  |   |       | 8.39  | 
|                            |           |         |            |                |   |                  |         |         |  |  
|Outstanding, March 31, 2000 |           |         | 9,231,985  |                |   |                  | 0.11   |         |  |   | 254.27 |        |  |   | 14.25 |      
|                            |           |         |            |                |   |                  |         |         |  |  
|                            | Granted   |         |            | 10,728,772     |   |                  |         | 23.84  |  |   |        | 187.00 |  |   |       | 84.02 | 
|                            | Exercised |         |            | (2,314,831     | ) |                  |         | 0.11   |  |   |        | 89.18  |  |   |       | 4.91  | 
|                            | Cancelled |         |            | (1,902,681     | ) |                  |         | 0.11   |  |   |        | 254.27 |  |   |       | 70.36 | 
|                            |           |         |            |                |   |                  |         |         |  |  
|Outstanding, March 31, 2001 |           |         | 15,743,245 |                |   |                  | 0.11   |         |  |   | 254.27 |        |  |   | 58.18 |      
|                            |           |         |            |                |   |                  |         |         |  |   |        |        |  |   |       |      
|                            | Granted   |         |            | 11,294,307     |   |                  |         | 6.32   |  |   |        | 34.17  |  |   |       | 15.65 | 
|                            | Exercised |         |            | (1,451,256     | ) |                  |         | 0.11   |  |   |        | 29.00  |  |   |       | 7.26  | 
|                            | Cancelled |         |            | (10,008,085    | ) |                  |         | 0.11   |  |   |        | 254.27 |  |   |       | 76.97 | 
|                            |           |         |            |                |   |                  |         |         |  |  
|Outstanding, March 31, 2002 |           |         | 15,578,211 |                |   | $                | 0.11   |         |  | $ | 161.29 |        |  | $ | 19.77 |      
|                            |           |         |            |                |   |                  |         |         |  |  

F-18



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



14.     Stock based
compensation  (Continued)


Information regarding stock options outstanding
as of March 31, 2002 is as follows:

|                  |  |             |            |                     |  |                  |      |           |  |                  |        |  |  |  |           |  |  |   |        | 
|----------------- |  | ----------- | ---------- | ------------------- |  | ---------------- | ---- | --------- |  | ---------------- | ------ |  |  |  | --------- |  |  | - | ------ | 
|                  |  |             |            |                    
|                  |  | Outstanding |            | Options Exercisable
|                  |  |             |            |                    
|                  |  |             |            | Weighted Average    |  |                  |      |          
|Range of          |  | Number of   |            | Remaining           |  | Weighted Average |      | Number of |  | Weighted Average
|Exercise Prices   |  | Shares      |            | Contractual Life    |  | Exercise Price   |      | Shares    |  | Exercise Price  
|                  |  |             |            |                     |  |                  |      |           |  |                 
|$  0.11  $  2.88 |  |             | 919,751    |                     |  |                  | 6.41 |           |  | $                | 0.74   |  |  |  | 707,135   |  |  | $ | 0.64   | 
|2.88     8.06    |  |             | 1,470,398  |                     |  |                  | 7.76 |           |  |                  | 4.56   |  |  |  | 711,534   |  |  |   | 4.31   | 
|8.06    12.00    |  |             | 881,850    |                     |  |                  | 8.26 |           |  |                  | 9.85   |  |  |  | 261,664   |  |  |   | 9.99   | 
|12.00    14.36   |  |             | 7,830,081  |                     |  |                  | 9.59 |           |  |                  | 14.30  |  |  |  | 2,471,849 |  |  |   | 14.28  | 
|14.70    22.80   |  |             | 1,823,714  |                     |  |                  | 9.28 |           |  |                  | 19.58  |  |  |  | 246,729   |  |  |   | 21.43  | 
|22.94    52.38   |  |             | 1,600,443  |                     |  |                  | 8.84 |           |  |                  | 29.25  |  |  |  | 316,475   |  |  |   | 31.32  | 
|60.50   115.75   |  |             | 1,043,575  |                     |  |                  | 8.35 |           |  |                  | 92.21  |  |  |  | 422,102   |  |  |   | 93.75  | 
|148.36   148.36  |  |             | 1,391      |                     |  |                  | 8.28 |           |  |                  | 148.36 |  |  |  | 1,391     |  |  |   | 148.36 | 
|151.09   151.09  |  |             | 3,478      |                     |  |                  | 8.26 |           |  |                  | 151.09 |  |  |  | 3,478     |  |  |   | 151.09 | 
|161.29   161.29  |  |             | 3,530      |                     |  |                  | 7.81 |           |  |                  | 161.29 |  |  |  | 3,530     |  |  |   | 161.2  | 
|                  |  |             |            |                     |  |                  |      |           |  |                  |        |  |  |  |           |  |  |   |        | 
|$  0.11  $161.29 |  |             | 15,578,211 |                     |  |                  | 8.96 |           |  | $                | 19.77  |  |  |  | 5,145,887 |  |  | $ | 18.95  | 
|                  |  |             |            |                     |  |                  |      |           |  |                  |        |  |  |  |           |  |  |   |        | 

Certain options for employee and non-employee
directors granted during the years ended March 31, 2000,
1999 and 1998 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
$16,093,000. This amount is being amortized over the respective
vesting periods of these options, ranging from three to four
years. Approximately $1,218,000, $6,807,000 and $2,975,000 was
amortized during the years ended March 31, 2002, 2001 and
2000 respectively, related to these options.

In April 2001, the Company implemented an option
exchange program whereby employees were offered the opportunity
to exchange stock options with split-adjusted exercise prices of
$40.00 and above for new options to purchase an equal number of
shares. These options were grants occurring more than six months
and a day following the date the options were accepted for
exchange and are treated as fixed awards. A total of 7,489,000
options were surrendered for exchange under this program. The
Board of Directors on November 16, 2001, approved the
exchange and on that date 6,015,713 new options were granted
with an exercise price of $14.36 per share. Employees who
surrendered 1,473,287 options left the Company prior to the new
grants.



| |                                             
| | --------------------------------------------
| | Proforma Net Loss and Earnings per
    Share

Had compensation expense for the Plans 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,
|                                                              |  |                     
|                                                              |  | 2002                 |         | 2001 |  | 2000
|                                                              |  |                      |         |      |  |     
|Net loss attributable to common shareholders, as
    reported |  | $                    | (82,709 | )    |  | $    | (131,614 | ) |  | $ | (41,673 | )
|Net loss attributable to common shareholders, pro
    forma   |  |                      | (97,433 | )    |  |      | (259,735 | ) |  |   | (46,188 | )
|Basic and diluted net loss per common share, as
    reported  |  |                      | (1.67   | )    |  |      | (2.81    | ) |  |   | (2.23   | )
|Basic and diluted net loss per common share, pro
    forma    |  |                      | (1.97   | )    |  |      | (5.35    | ) |  |   | (2.47   | )

F-19



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

14.     Stock based
compensation  (Continued)

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 4.40%, 4.90% and 6.10% for the years ended
March 31, 2002, 2001 and 2000, respectively; expected
volatility of 125%, 122% and 90% for the years ended
March 31, 2002, 2001 and 2000, 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, 2002, 2001 and 2000 was $15.65, $84.02 and
$10.49, 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
Companys initial public offering on February 10,
2000. A total of 3,000,000 shares of common stock have been
made available for issuance under the ESPP as of March 31,
2002. 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, is 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 consists of four consecutive purchase
periods of approximately six months duration, and at the
end of each offering period, the Company will make a purchase on
behalf of the participants. 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.

The purchase price per share is 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.

In June 1999, Active approved the 1999 Employee
Stock Purchase Plan (the Purchase Plan). In
connection with the merger of Active, the Company assumed the
Purchase Plan for all currently eligible employees of Active.
Eligible employees of the Purchase Plan may purchase a limited
number of shares of the Companys common stock. Each
participant can elect to purchase the Companys common
stock on the first day of each 24 month offering period
(which begins on May 1 and November 1 of each year)
and such option is automatically exercised on the last day of
each six month purchase period during the offering period. The
purchase price for the Companys common stock under the
Purchase Plan is 85% of the lesser of the fair market value of
the common stock (1) on the first day of the applicable
offering period and (2) on the last day of the applicable
purchase period.

The following table summarizes shares of common
stock available for issuance and shares purchased as of
March 31, 2002 (in thousands).

|                                        |  |  |       |  
|--------------------------------------- |  |  | ----- | -
|Balance at March 31, 2001               |  |  | 2,727 |  
|Additional authorized shares            |  |  | 750   |  
|Purchases                               |  |  | (302  | )
|Reduction of shares for terminated plan |  |  | (514  | )
|                                        |  |  |       |  
|Balance at March 31, 2002               |  |  | 2,661 |  
|                                        |  |  |       |  

F-20



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

14.     Stock based
compensation  (Continued)

Shareholder Rights Plan

In October 2001, the Board of Directors adopted a
Shareholder Rights Plan, which may cause substantial dilution to
a person or group that attempts to acquire webMethods on terms
not approved by the Board of Directors. Under the plan,
webMethods distributed one right for each share of its common
stock outstanding at the close of business on October 18,
2001. Initially, the rights trade with shares of webMethods
common stock and are represented by webMethods common stock
certificates. The rights are not immediately exercisable and
generally become exercisable if a person or group acquires, or
commences a tender or exchange offer to acquire, beneficial
ownership of 15% or more of webMethods common stock while the
plan is in place. Each right will become exercisable, unless
redeemed, by its holder (unless an acquiring person or member of
that group) for shares of webMethods or of the third-party
acquirer having a value of twice the rights then-current
exercise price. The rights are redeemable by webMethods and will
expire on October 18, 2011.

15.     Mandatorily
redeemable, convertible preferred stock

The Company raised capital prior to its initial
public offering through private sales of common stock and
mandatorily redeemable, convertible preferred stock (Preferred
Stock).

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 Companys 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.

The Series A, Series B, Series C,
Series D and Series E Preferred Stock activity during
the year ended March 31, 2000 is summarized as follows:

|                                                                        |  |          |         |          |  |          |          |          |  |          |          |        |  |        |            |        |  |        |          |        |  |   |            |   |  |  |          |   |  |   |             |   |  |  |         |   |  |   |             |  
|----------------------------------------------------------------------- |  | -------- | ------- | -------- |  | -------- | -------- | -------- |  | -------- | -------- | ------ |  | ------ | ---------- | ------ |  | ------ | -------- | ------ |  | - | ---------- | - |  |  | -------- | - |  | - | ----------- | - |  |  | ------- | - |  | - | ----------- | -
|                                                                        |  |          |         |          |  |          |          |          |  |         
|                                                                        |  | Series A |         | Series B |  | Series C |          | Series D |  | Series E
|                                                                        |  |          |         |          |  |          |          |          |  |         
|                                                                        |  | Shares   |         | Amount   |  | Shares   |          | Amount   |  | Shares   |          | Amount |  | Shares |            | Amount |  | Shares |          | Amount
|                                                                        |  |          |         |          |  |          |          |          |  |          |          |        |  |        |            |        |  |        |          |       
|Balance, April 1, 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  |   |  |   | 16,923,475  |  
|Accretion to redemption price                                           |  |          |        |          |  |          |         |          |  |          |         |        |  |        | 5,827      |        |  |        |         |        |  |   | 11,225     |   |  |  |         |   |  |   | 20,982      |   |  |  |        |   |  |   | 5,539       |  
|Accrued dividends                                                       |  |          |        |          |  |          | 29,655   |          |  |          |         |        |  |        | 256,844    |        |  |        |         |        |  |   | 461,822    |   |  |  |         |   |  |   | 732,989     |   |  |  |        |   |  |   | 390,183     |  
|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 | ) |  |   | (17,319,197 | )
|                                                                        |  |          |         |          |  |          |          |          |  |          |          |        |  |        |            |        |  |        |          |        |  |   |            |   |  |  |          |   |  |   |             |   |  |  |         |   |  |   |             |  
|Balance, March 31, 2000                                                 |  |          |        |          |  | $        |         |          |  |          |         |        |  | $      |           |        |  |        |         |        |  | $ |           |   |  |  |         |   |  | $ |            |   |  |  |        |   |  | $ |            |  
|                                                                        |  |          |         |          |  |          |          |          |  |          |          |        |  |        |            |        |  |        |          |        |  |   |            |   |  |  |          |   |  |   |             |   |  |  |         |   |  |   |             |  

There was no additional Preferred Stock activity
during the years ended March 31, 2002 and 2001.

16.     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, 2002, 2001
and 2000.

F-21



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

17.     Supplemental
disclosures of cash flow information:

|                                                                           |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |         |   | 
|-------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------- | -------------------- | --- | ----- |  | ---- | ----- | ------- | - | - | ------ | ------- | - | 
|                                                                           |                                                                                                      |                     
|                                                                           |                                                                                                      | Year Ended March 31,
|                                                                           |                                                                                                      |                     
|                                                                           |                                                                                                      | 2002                 |     | 2001  |  | 2000
|                                                                           |                                                                                                      |                      |     |       |  |     
|                                                                           |                                                                                                      |                     
|                                                                           |                                                                                                      | (In thousands)      
|Cash paid during the period for interest                                   |                                                                                                      | $                    | 511 |       |  | $    | 156   |         |   | $ | 93     |        
|                                                                           |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        
|Non-cash investing and financing activities:                               |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        
|                                                                           | Accrual of preferred stock dividends                                                                 |                      | $   |      |  |      | $     |        |   |   | $      | 1,871   |  
|                                                                           | Preferred stock accretion                                                                            |                      |     |      |  |      |       |        |   |   |        | 44      |  
|                                                                           | Equipment purchased under capital lease                                                              |                      |     | 3,061 |  |      |       | 4,350   |   |   |        | 686     |  
|                                                                           | Conversion of preferred stock to common stock                                                        |                      |     |      |  |      |       |        |   |   |        | 41,689  |  
|                                                                           | Deemed discount in connection with the beneficial
    conversion feature on Series E Preferred Stock |                      |     |      |  |      |       |        |   |   |        | 8,307   |  
|                                                                           | Change in net unrealized gain or loss on
    marketable securities                                   |                      |     | 692   |  |      |       | (1,125  | ) |   |        | 166     |  
|                                                                           | Fair value of option issued to non-employees                                                         |                      |     |      |  |      |       |        |   |   |        | 235     |  
|Alier Acquisitions Fair value of assets acquired,
    net of cash acquired |                                                                                                      | $                    |    |       |  | $    |      |         |   | $ | 44,623 |        
|                                                                           |                                                                                                      | Less:                |     |       |  |      |       |         |   |   |        |         |   | 
|                                                                           | Liabilities assumed                                                                                  |                      |     |      |  |      |       |        |   |   |        | (1,464  | )
|                                                                           | Common stock issued in connection with the
    acquisition                                           |                      |     |      |  |      |       |        |   |   |        | (43,580 | )
|                                                                           |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        
|                                                                           |                                                                                                      |                      |    |       |  |      |      |         |   |   | (421   | )      
|                                                                           | Write-off of in-process research and development                                                     |                      |     |      |  |      |       |        |   |   |        | 2,737   |  
|                                                                           |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        
|                                                                           | Cash paid for acquisition                                                                            |                      | $   |      |  |      | $     |        |   |   | $      | 2,316   |  
|                                                                           |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        
|Translink Acquisition:                                                     |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        
|                                                                           | Fair value of assets acquired, net of cash
    acquired                                              |                      | $   |      |  |      | $     | 82,209  |   |   | $      |        |  
|                                                                           |                                                                                                      | Less:                |     |       |  |      |       |         |   |   |        |         |   | 
|                                                                           | Liabilities assumed                                                                                  |                      |     |      |  |      |       | (593    | ) |   |        |        |  
|                                                                           | Common stock issued in connection with the
    acquisition                                           |                      |     |      |  |      |       | (79,678 | ) |   |        |        |  
|                                                                           |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        
|                                                                           |                                                                                                      |                      |    |       |  |      | 1,938 |         |   |   |       |        
|                                                                           | Write-off of in-process research and development                                                     |                      |     |      |  |      |       | 2,311   |   |   |        |        |  
|                                                                           |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        
|                                                                           | Cash paid for acquisition, net of cash acquired                                                      |                      | $   |      |  |      | $     | 4,249   |   |   | $      |        |  
|                                                                           |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        
|Premier Acquisition:                                                       |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        
|                                                                           | Fair value of assets acquired, net of cash
    acquired                                              |                      | $   |      |  |      | $     | 13,947  |   |   | $      |        |  
|                                                                           |                                                                                                      | Less:                |     |       |  |      |       |         |   |   |        |         |   | 
|                                                                           | Liabilities assumed                                                                                  |                      |     |      |  |      |       | (462    | ) |   |        |        |  
|                                                                           | Common stock issued in connection with the
    acquisition                                           |                      |     |      |  |      |       | (12,993 | ) |   |        |        |  
|                                                                           |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        
|                                                                           | Cash paid for acquisition, net of cash acquired                                                      |                      | $   |      |  |      | $     | 492     |   |   | $      |        |  
|                                                                           |                                                                                                      |                      |     |       |  |      |       |         |   |   |        |        

18.     Restructuring
Charge

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

F-22



---



##### 



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

19.     Segment
information

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

|                  |       |                      |         |         |  |      |         |         |  |   |        |        | 
|----------------- | ----- | -------------------- | ------- | ------- |  | ---- | ------- | ------- |  | - | ------ | ------ | 
|                  |       |                     
|                  |       | Year Ended March 31,
|                  |       |                     
|                  |       | 2002                 |         | 2001    |  | 2000
|                  |       |                      |         |         |  |     
|                  |       |                     
|                  |       | (In thousands)      
|Revenues          |       |                      |         |         |  |      |         |         |  |   |        |       
|Americas          |       | $                    | 143,003 |         |  | $    | 180,192 |         |  | $ | 55,051 |       
|Europe            |       |                      | 35,666  |         |  |      | 17,800  |         |  |   | 5,094  |       
|Asia Pacific      |       |                      | 17,327  |         |  |      | 3,965   |         |  |   |       |       
|                  |       |                      |         |         |  |      |         |         |  |   |        |       
|                  | Total |                      | $       | 195,996 |  |      | $       | 201,957 |  |   | $      | 60,145 | 
|                  |       |                      |         |         |  |      |         |         |  |   |        |       
|Long Lived Assets |       |                      |         |         |  |      |         |         |  |   |        |       
|Americas          |       | $                    | 55,360  |         |  | $    | 97,853  |         |  | $ | 39,742 |       
|Europe            |       |                      | 1,555   |         |  |      | 1,236   |         |  |   | 142    |       
|Asia Pacific      |       |                      | 1,373   |         |  |      | 1,207   |         |  |   |       |       
|                  |       |                      |         |         |  |      |         |         |  |   |        |       
|                  | Total |                      | $       | 58,288  |  |      | $       | 100,296 |  |   | $      | 39,884 | 
|                  |       |                      |         |         |  |      |         |         |  |   |        |       

F-23



---



##### 



SCHEDULE II  VALUATION AND
QUALIFYING ACCOUNTS

For the years ended March 31, 2000, 2001 and
2002.

|                                |  |                |       |            |  |            |       |            |  |  |       |  |  |  |       | 
|------------------------------- |  | -------------- | ----- | ---------- |  | ---------- | ----- | ---------- |  |  | ----- |  |  |  | ----- | 
|                                |  | Balance at     |       |            |  |            |       | Balance at
|                                |  | beginning of   |       |            |  |            |       | end of    
|                                |  | Period         |       | Provisions |  | Deductions |       | Period    
|                                |  |                |       |            |  |            |       |           
|                                |  |               
|                                |  | (in thousands)
|Year ended March 31, 2000       |  |                |       |            |  |            |       |            |  |  |       |  |  |  |       | 
|Allowance for doubtful accounts |  |                | 317   |            |  |            | 1,121 |            |  |  | 45    |  |  |  | 1,394 | 
|Year ended March 31, 2001       |  |                |       |            |  |            |       |            |  |  |       |  |  |  |       | 
|Allowance for doubtful accounts |  |                | 1,394 |            |  |            | 4,808 |            |  |  | 1,860 |  |  |  | 4,342 | 
|Year ended March 31, 2002       |  |                |       |            |  |            |       |            |  |  |       |  |  |  |       | 
|Allowance for doubtful accounts |  |                | 4,342 |            |  |            | 2,840 |            |  |  | 3,497 |  |  |  | 3,685 | 

F-24



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##### 



Report of Independent Accountants on

Financial Statement Schedule


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

Our audits of the consolidated financial
statements referred to in our report dated April 24, 2002,
appearing in this Form 10-K of webMethods, Inc. for the
year ended March 31, 2002 also included an audit of the
financial statement schedule listed in Item 14(a)(2) of
this Form 10-K. In our opinion, this financial statement
schedule presents fairly, in all material respects, the
information set forth therein when read in conjunction with the
related consolidated financial statements.



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

McLean, Virginia

April 24, 2002


F-25



---



##### 



EXHIBIT INDEX

|        |  |             |  |                                                                                                                                               
|------- |  | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|        |  |            
|Exhibit |  |            
|Number  |  | Description
|        |  |            
|2.1     |  | (1)         |  | Agreement and Plan of Merger dated as of
    May 20, 2000, by and among webMethods, Inc., Wolf
    Acquisition, Inc. and Active Software, Inc.
|3.1     |  | (2)         |  | Fifth Amended and Restated Certificate of
    Incorporation of webMethods, Inc., as amended                                                   
|3.2     |  | (3)         |  | Amended and Restated Bylaws of webMethods, Inc.                                                                                               
|4.1     |  | (3)         |  | Specimen certificate for shares of webMethods
    Common Stock                                                                                
|4.2     |  | (4)         |  | Rights Agreement dated as of October 18,
    2001 between webMethods, Inc. and American Stock
    Transfer & Trust Company.                   
|10.1    |  | (3)         |  | Second Amended and Restated Investor Rights
    Agreement                                                                                     
|10.2    |  | *           |  | webMethods, Inc. Amended and Restated Stock
    Option Plan, as amended                                                                       
|10.3    |  | (3)         |  | Employee Stock Purchase Plan                                                                                                                  
|10.4    |  | (3)         |  | Indemnification Agreement entered into between
    webMethods, Inc. and each of its directors                                                 
|21.1    |  | *           |  | Subsidiaries of webMethods, Inc.                                                                                                              
|23.1    |  | *           |  | Consent of PricewaterhouseCoopers LLP                                                                                                         
|24      |  |             |  | Power of Attorney (included on signature page of
    this report)                                                                             




|    |                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to webMethods
    Registration Statement on Form S-4, as amended (File
    No. 333-39572).
|   
|(2) | Incorporated by reference to webMethods
    Form 10-K for the year ended March 31, 2001 (File
    No. 1-15681).     
|   
|(3) | Incorporated by reference to webMethods
    Registration Statement on Form S-1, as amended (File
    No. 333-91309).
|   
|(4) | Incorporated by reference to webMethods
    Registration Statement on Form 8-A (File No. 1-15681).                  
|   
|*   | Filed herewith.                                                                                                      

F-26