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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, 2003
| 
|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

Preferred Stock Purchase Rights




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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

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Exchange Act
Rule 12b-2).
Yes x     No o

As of September 30, 2002, there were
50,883,905 shares of the registrants Common Stock
outstanding. The aggregate market value of such shares held by
non-affiliates of the registrant, based upon the closing sale
price ($4.83) of such shares on the Nasdaq National Market for
such date, was approximately $132,400,000. Shares of the
registrants Common Stock held by each executive officer
and director of the registrant, and by each entity publicly
reporting that it owns 5% or more of the outstanding shares of
the registrants Common Stock, have been excluded, as such
persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination
for any other purpose.

As of June 13, 2003, there were outstanding
51,827,112 shares of the registrants Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the definitive Proxy
Statement to be used in connection with the registrants
2003 Annual Meeting of Stockholders are incorporated by
reference into Part III of this Form 10-K to the extent
stated. That Proxy Statement will be filed within 120 days
of registrants fiscal year ended March 31, 2003.









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##### Table of Contents



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 
|        |  | Global Customer Services                                |  | 8 
|        |  | Product Development                                     |  | 9 
|        |  | Competition                                             |  | 9 
|        |  | Intellectual Property and Other
    Proprietary Rights  |  | 10
|        |  | Corporate Information                                   |  | 12
|        |  | Available Information                                   |  | 12
|        |  | Employees                                               |  | 12
|        |  | Executive Officers of webMethods                        |  | 13
|        |  | 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 |  | 23

|           |  |                                                                                                 |  |   
|---------- |  | ----------------------------------------------------------------------------------------------- |  | --
|Part II    |  |                                                                                                
|Item 5.    |  | Market for Registrants Common Stock and
    Related Stockholder Matters                        |  | 23
|Item 6.    |  | Selected Financial Data                                                                         |  | 24
|Item 7.    |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations       |  | 26
|           |  | Overview                                                                                        |  | 26
|           |  | Results of Operations                                                                           |  | 30
|           |  | Liquidity and Capital Resources                                                                 |  | 37
|           |  | Recently Issued Accounting
    Pronouncements                                                   |  | 38
|Item 7A.   |  | Quantitative and Qualitative Disclosures about
    Market Risk                                  |  | 40
|Item 8.    |  | Financial Statements and Supplementary Data                                                     |  | 40
|Item 9.    |  | Changes in and Disagreements with Accountants on
    Accounting and Financial Disclosure 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
|Item 14.   |  | Controls and Procedures                                                                         |  | 41
|Part IV    |  |                                                                                                
|Item 16.   |  | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                            |  | 42
|Signatures |  | 44                                                                                             



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TABLE OF CONTENTS



|                                           |                                                                                                 |  |  |  |  |  |  | 
|------------------------------------------ | ----------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                    
|                                           | Item 1. BUSINESS                                                                               
|                                           | Item 2. PROPERTIES                                                                             
|                                           | Item 3. LEGAL PROCEEDINGS                                                                      
|                                           | Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                    
|PART II                                   
|                                           | Item 5. MARKET FOR REGISTRANTS COMMON STOCK AND RELATED STOCKHOLDER MATTERS                   
|                                           | Item 6. SELECTED FINANCIAL DATA                                                                
|                                           | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations  
|                                           | Item 7a.   Quantitative and Qualitative Disclosures About Market Risk                          
|                                           | Item 8.   Financial Statements and Supplementary Data                                          
|                                           | Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
|PART III                                  
|                                           | Item10.   Directors and Executive Officers of the Registrant                                   
|                                           | Item11.   Executive Compensation                                                               
|                                           | Item12.   Security Ownership of Certain Beneficial Owners and Management                       
|                                           | Item13.   Certain Relationships and Related Transactions                                       
|                                           | Item14.   Controls and Procedures                                                              
|PART IV                                   
|                                           | Item16.   Exhibits, Financial Statement Schedules and Reports on Form8-K                       
|                                           | SIGNATURES                                                                                     
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|Subsidiaries of webMethods                
|Consent of PricewaterhouseCoopers LLP     
|Certification of Chief Executive Officer  
|Certification of Chief Financial Officer  
|Section 1350 Certification of CEO         
|Section 1350 Certification of CFO         



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PART I




Item 1.  BUSINESS

This annual report on Form 10-K 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. 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, sufficiency of working capital 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, contributions to webMethods revenue by its
business partners, implementation and effect of sales and
marketing initiatives by webMethods, strength of results from
geographic or specific vertical markets and allocation of
resources to those markets, 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, economic conditions or the impact of recent changes
in accounting standards and (iv) assumptions underlying any
of the foregoing. In some instances, forward-looking statements
can be identified by the use of the words believes,
anticipates, plans, expects,
intends, may, will,
should, estimates, predicts,
continue, the negative thereof or similar
expressions. Although we believe that the expectations reflected
in the forward-looking statements are reasonable, our
expectations or the forward-looking statements could prove to be
incorrect, and actual results could differ materially from those
indicated by the forward-looking statements. Our future
financial condition and results of operations, as well as any
forward-looking statements, are subject to risks and
uncertainties, including (but not limited to) those discussed in
this Item 1 under the caption Factors That May Affect
Future Operating Results. Achieving the future results or
accomplishments described or projected in forward-looking
statements depends upon events or developments that are often
beyond our ability to control. All forward-looking statements
and all reasons why actual results may differ that are included
in this report are made as of the date of this report, and
webMethods disclaims any obligation to publicly update or revise
such forward-looking statements or reasons why actual results
may differ.

OVERVIEW

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 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 has enabled
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 925 customers as of March 31,
2003 including many major business enterprises included in the
top 2,000 business enterprises worldwide (the Global
2000) and government organizations. Our customers include
leaders in manufacturing, process industries (such as chemicals,
oil and gas, life sciences, 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, and indirectly the
sales forces of our partners, to 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.

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
proliferation of 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.

More recently, integration technology has further
evolved to include technologies that allow enterprises to access
and analyze real-time data flowing through the integration
system associated with business transactions and to govern the
interactions between the many information resources that
comprise the enterprise information technology environment. This
business activity monitoring (BAM) capability allows enterprises
to realize real-time visibility into their business operations
and provides them with the ability to effect more timely changes
to their business operations resulting in the ability to
optimize those operations to best meet the needs of the
enterprise.

The ability of integration technology solutions
to define business processes and business activity monitoring
schemas in a minimal amount of time and without coding has
become an expectation of

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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-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, 2003,
there was a continued increase in the popularity of web services
standards among Global 2000 companies and government
organizations. 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,
business process management and business activity monitoring
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 offer customers the ability to lower their
total cost of ownership and streamline the integration process.
By enabling this end-to-end integration of 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

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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.

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 AG, 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.

Business Activity Monitoring (BAM).To meet the needs of organizations to
not only access information but to also utilize that information
to improve the overall performance of their operations, through
product features and partnerships, we offer capabilities that
allow our customers to correlate real-time information regarding
key performance indicators that allow our customers to make
real-time adjustments to their business operations to maximize
their return from operations

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 webMethods WorkFlow product is designed
to allow our customers to seamlessly mix

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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 developed 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
Company). Each of these companies have developed a version of
their products 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, Hewlett-Packard Company,
Informatica, i2 Technologies, J.D. Edwards, SAP AG and
Siebel Systems, many of whom embed a limited version of
webMethods software into their software and may then sell both
the integrated software as well as other webMethods products. As
a result, any customer of our partner who licenses its product
in which our software is embedded receives a license-limited
version of webMethods software, and we believe will be a likely
candidate to purchase additional webMethods integration
software. We continue to build upon existing strategic
relationships and develop new ones.

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),
BearingPoint, Cap Gemini Ernst & Young Group (CGE&Y),
Computer Sciences Corporation (CSC), Deloitte Consulting,
Electronic Data Systems Corporation (EDS) and Tata Consulting
Services (TCS). Each of these partners has

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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 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, 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 have also developed 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, 2003, we had licensed our
software to over 925 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,
2003, 2002 and 2001 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.

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.

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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, 2003, 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 nine countries, and our
sales and marketing personnel in Asia Pacific were located in
seven 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,
which we expanded during our fiscal year ended March 31,
2003. Those teams focus on customers, prospective customers and
business partners in vertical markets such as 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 primarily on a perpetual
basis and to a lesser extent, 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 a significant advantage over our competition. As
described above in webMethods Strategy, we
utilize our strategic partnerships with leading software
vendors, such as BroadVision, Hewlett-Packard Company,
i2 Technologies, J.D. Edwards, SAP AG 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 utilize our
strategic partnerships with leading software vendors, such as
Informatica Corporation and JBoss Group, to integrate or
incorporate products with the webMethods Integration Platform to
provide a Business Activity PlatformTM and J2EE-based
application server integration. We also expect to continue to
benefit from these relationships through their promotion of our
products.

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

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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 years ended March 31, 2003 and March 31,
2002, and we expect this to increase in future periods. During
our fiscal year 2002, we entered into a number of new or
expanded partnership agreements, including agreements with
BroadVision, J.D. Edwards, Lawson Software and Siebel Systems,
and we renewed our strategic relationship with SAP AG. During
our fiscal year 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. During our fiscal year 2003, we expanded our
partnership with Informatica to make Business Activity
Monitoring more easily attainable and announced our integration
of the JBoss application server directly into the webMethods
Integration Platform. During fiscal year 2003, we also continued
to extend our depth of relationships with our software vendor
partners and continued to support the latest versions of their
product offerings. This included the addition of support for
Siebels Universal Application Network (UAN) initiative and
SAPs NetWeaver program.

Under our typical partnerships with software
vendor partners, the partner may 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 systems integrator and 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.

GLOBAL CUSTOMER SERVICES

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 limited access extranet, 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.

We believe our strong focus and track record of
ensuring that our software is successfully put into production
(production event) is a strong competitive advantage
and differentiator. During fiscal year 2003, our global customer
services group reported and documented over 340 separate
production events as compared to 178 such events in the prior
year. In many instances during fiscal year 2003, these customers
deployed our software within 17 weeks or less. Ensuring
that our customers successfully implement our software in a
timely manner enables them to achieve a greater return on their
investment and, in many cases, encourages them to purchase
additional software for other integration projects and serve as
a reference customer for us in our future sales efforts.

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PRODUCT DEVELOPMENT

We pursue a judicious mix of building, acquiring
and partnering to allow us to offer the most optimal mix of
strategic technologies to meet the needs of our market. This has
allowed us to assemble a comprehensive integration platform more
quickly than our competitors.

We focus our ongoing product development efforts
on a combination of enhancing, broadening and deepening the
functionality of our core products and services to address new
software alliances, industries, marketplaces and geographic
markets as well as new product development to meet emerging
opportunities based on new technologies. During our fiscal year
ended March 31, 2003, we released the latest version of our
flagship integration platform, webMethods 6 and webMethods
Manager. 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, VA and Sunnyvale, CA and
have special development teams in Berkeley, CA, Bellevue, WA,
and Westborough, MA. Our research and development expenditures,
excluding stock-based compensation, were $47.4 million in
our fiscal year ended March 31, 2003, $49.6 million in
our fiscal year ended March 31, 2002 and $45.2 million in
our fiscal year ended March 31, 2001. 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) and TIBCO
Software, Inc. We also compete with BEA Systems, Inc., Mercator
Software, Inc., Microsoft Corporation, SeeBeyond Technology
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

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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
all employees and certain 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 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

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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 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, third parties have claimed, and may
in the future claim, that we have infringed on their
intellectual property rights (including those intellectual
property rights currently existing or developed in the future)
or the use our software in certain situations infringe on their
intellectual property rights. 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 are, and
may in the future 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 do not currently believe that any of our
software, documentation, copyrights, trademarks, patents, or
other proprietary rights infringe the proprietary rights of
third parties, third parties have claimed and may in the future
claim, that we have infringed their current or future products,
technology or intellectual property rights or that use of our
software in certain situations may infringe on their
intellectual property rights. Any infringement claims, with or
without merit, brought by such third parties may 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

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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 may be costly to defend or
settle and could damage our business.

In addition, we license technology from third
parties that is incorporated into our software, and we bundle
technology from third parties with our software. 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,
Enterprise Dial Tone 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 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.

AVAILABLE INFORMATION

Our internet address is
www.webMethods.com. Our Investor Relations page of our
web site provides a link to a service giving access to our
securities filings as soon as reasonably practical after we
electronically file with the Securities and Exchange Commission
our annual reports, quarterly reports, current reports and any
amendments to those reports filed or furnished pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of 1934.
We do not charge for access to and viewing of those filings.
Other information on our Investor Relations page and our web
site is not part of this Form 10-K or any other webMethods
securities filing unless specifically incorporated. In addition,
our reports, proxy statements and other information are filed
with the SEC through the SECs Electronic Data Gathering,
Analysis and Retrieval system and are publicly available through
the SECs site on the World Wide Web, at
www.sec.gov. All statements made in any of our securities
filings, including all forward-looking statements or
information, are made as of the date of that document in which
the statement is included, and we do not assume or undertake any
obligation to update any of those statements or documents unless
we are required to do so by law.

EMPLOYEES

As of March 31, 2003, we employed 845
full-time employees. These included 295 in sales and marketing,
196 in professional services and technical support, 238 in
research and development and 116 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

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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, 2003 are as follows:

|                   |  |     |    |          |  |                                                                             
|------------------ |  | --- | -- | -------- |  | ----------------------------------------------------------------------------
|Name               |  | Age |    | Position
|                   |  |     |    |         
|Phillip Merrick    |  |     | 40 |          |  | Chairman of the Board and Chief Executive Officer                           
|David Mitchell     |  |     | 38 |          |  | President and Chief Operating Officer                                       
|Mary Dridi         |  |     | 42 |          |  | Chief Financial Officer, Executive Vice President
    and Treasurer         
|Kristin A. Weller  |  |     | 32 |          |  | Executive Vice President, Product Development                               
|Douglas W. McNitt  |  |     | 38 |          |  | General Counsel, Executive Vice President and
    Secretary                 
|Thomas N. Erickson |  |     | 44 |          |  | Senior Vice President, International and General
    Manager of Asia Pacific
|Donna M. Angiulo   |  |     | 48 |          |  | 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 January 2001. 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.

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 holds a B.S. in
Commerce and Accounting from the University of Virginia.

Kristin A. Wellerjoined webMethods as Vice President of
Professional Services and Customer Care in September 1998. She
became Vice President of Product Development in January 2000,
Senior Vice President of Product Development in October 2001 and
Executive Vice President of Product Development in March 2003.
From 1994 to September 1998, Ms. Weller served as Senior
Manager for Deloitte & Touche Consulting Group, where
she participated in the development of their enterprise resource
planning (ERP) implementation methodology. Ms. Weller
holds a B.A. in Economics from Rhodes College.

Douglas W. McNittjoined webMethods in October 2000 as
General Counsel, became Executive Vice President in January
2002, and became Secretary in May 2003. Mr. McNitt served
in various capacities, including Senior Counsel and Assistant
General Counsel for America Online, Inc. during his service
there 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

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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 holds
a B.S. in Electrical Engineering from the University of
Wisconsin.

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 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 significantly 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, economic uncertainties, economic
consequences or after-effects of terrorist acts, geopolitical
developments or uncertainties, infectious outbreaks like SARS,
travel limitations and other major, unanticipated events may
impact our quarterly operating results. During our fiscal year
2003, 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 independent
infrastructure software companies, has been very

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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, 2003, the
closing price of webMethods stock on the Nasdaq National
Market has ranged from a high of $336.25 to a low of $4.32.


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, seasonal factors or major, unanticipated
events, 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 in some or all of the geographic regions
in which we operate. For example, the growth rate for revenue
from sales of our software and services during summer months may
be lower than at other times during the 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 economic uncertainties and economic consequences or
after-effects of terrorist acts, geopolitical developments or
uncertainties, infectious outbreaks like SARS, travel
limitations 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 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.

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 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 application software vendors with whom we currently have
strategic relationships are offering competitive solutions or
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

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existing and prospective customers. Increased
competition may result in reduced margins, loss of sales or
decreased market share, which in turn could harm our business,
operating results and financial condition.


We 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 may lose
important deals and marketing opportunities.

We have established strategic relationships with
enterprise application software vendors and system integration
partners. These strategic partners provide us with important
sales and marketing opportunities, create opportunities to
upsell our products to customers already using our software
embedded in their enterprise application products, and greatly
increase our implementation capabilities. We also have 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 strategic partners, resellers
and distributors, 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 or if they terminate, our
revenue and operating results could be materially adversely
affected, our ability to increase our penetration of the market
for integration software could be impaired, we may 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 could harm our business.

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

We cannot be certain that our software and the
services do not infringe issued patents, copyrights or other
intellectual property rights of third-parties. Litigation
regarding intellectual property rights is common in the software
industry, and we are subject to, and may be increasingly subject
to, legal proceedings and claims from time to time, including
claims of alleged infringement of intellectual property rights
of third-parties by us or our licensees concerning their use of
our software products and integration technologies and services.
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. Because our software is integrated with
our customers networks and business processes, as well as
other software applications, third parties may bring claims of
infringement against us, as well as our customers and other
software suppliers, if the cause of the alleged infringement
cannot easily be determined. Such claims may be with or without
merit. Claims of alleged infringement may have a material
adverse effect on our business and may discourage potential
customers from doing business with us on acceptable terms, if at
all. Litigation to defend against claims of infringement or
contests of validity may be very time-consuming and may result
in substantial costs and diversion of resources, including our
managements attention to our business. 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 or require that we re-engineer some or all
of our products. Our business, operating results and financial
condition could be harmed significantly if any of these events
occurred, and the price of webMethods common stock could be
adversely affected. 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,
which may not be available on acceptable terms, if at all.
Defense of any lawsuit or failure to obtain any such required
licenses could harm our business, operating results and
financial condition and the price of webMethods common stock.

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In addition, although we carry general liability
insurance, our current insurance coverage may not apply to, and
likely would not protect us from, all liability that may be
imposed under these types of claims.


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

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 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. Further, some agencies within the US
Government may also require some or all of our personnel to
obtain a security clearance or may require us to add features or
functionality to our software. If our key personnel are unable
to obtain or retain this clearance or if we cannot or do not
provide required features or functionality, we may be
unsuccessful in our bid for some government contracts.

Contracts with the US Government or with many
state and local governments also 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. 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. 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 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. Competition
for qualified personnel and service providers is intense. Our
business may be harmed if we are unable to

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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,
would be particularly difficult to replace. Our future 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

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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.

We currently do not engage in any currency
hedging transactions. Our foreign sales generally are invoiced
in the local currency, and, as we expand our international
operations or if there is continued volatility in exchange
rates, our exposure to gains and losses in foreign currency
transactions may increase when we determine that foreign
operations are expected to repay intercompany debt in the
foreseeable future. Moreover, the costs of doing business abroad
may increase as a result of adverse exchange rate fluctuations.
For example, if the United States dollar declines in value
relative to a local currency and we are funding operations in
that country from our U.S. operations, we could be required to
pay more for salaries, commissions, local operations and
marketing expenses, each of which is paid in local currency. In
addition, exchange rate fluctuations, currency devaluations or
economic crises may reduce the ability of our prospective
customers to purchase our software and services.

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, unmarketable or
less desirable to prospective customers if we are unable to
adapt to new technologies or standards. 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 and could damage the reputation of our
software in the marketplace. 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.

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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, other
performance problems or failure to provide support 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 potential
product liability claims, existing or future laws or unfavorable
judicial decisions could negate these limitation of liability
provisions. Although we have not experienced any product
liability claims to date, sale and support of our software
entail the risk of such claims. The integration of our software
with our customers networks and software applications
increases the risk that a customer may bring a lawsuit against
several suppliers if an integrated computer system fails and the
cause of the failure cannot easily be determined. Even if our
software is not at fault, 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 coverage would likely be insufficient to protect us
from all liability that may be imposed under these types of
claims.

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

We commenced operations in June 1996. Active
Software, with which we completed a merger in August 2000, was
incorporated in September 1995. We have been operating as a
combined company since August 2000. If we do not generate
sufficient revenue 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 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 penetration of the integration software
market and the growth of our business achieved in our limited
operating history is not necessarily indicative of our ability
in the future to continue to penetrate that market and to grow
our business as we anticipate. Our software is complex and
generally involves significant capital expenditures by our
customers. 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, competitive, economic or other reasons. If the market
for our software fails to grow or grows more slowly than we
anticipate, or if our penetration of the integration software
market and the growth of our business is less or slower than we
anticipate, our business could suffer, and our ability to
achieve and maintain 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.

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

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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, may not result in
timely relief and may not be successful. Any inability to
protect our intellectual property rights could seriously harm
our business, operating results and financial condition.

Because some of our software products
incorporate technology licensed from, or provided by, third
parties, the loss of our right to use that technology could harm
our business.

Some of our software products contain technology
that is licensed from, or provided by, third parties. Any
significant interruption in the supply or support of any of that
third-party software could adversely affect our sales, unless
and until we can replace the functionality provided by the
third-party software. Because some of 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. In other instances we
provide third-party software with our current software and offer
support for the third party software, and we depend on these
third-parties to deliver reliable products, provide underlying
product support and respond to emerging industry standards and
other technological changes. The failure of these third parties
to meet these criteria could harm our business.

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

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 in October 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 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 without 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, Hong Kong, the Peoples Republic of China, France,
Germany, Japan, South 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 amended complaint
alleges, among other things, 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, and that those commissions and
arrangements were not disclosed to the public after
webMethods initial public offering. The amended complaint
also alleges that false analysts reports were issued. The
amended complaint seeks unspecified damages on behalf of a
purported class of purchasers of webMethods common stock between
February 10,

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##### Table of Contents



2000 and December 6, 2000. This case has
been consolidated as part of In Re Initial Public Offering
Securities Litigation (SDNY). Our 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 its
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

webMethods common stock has been publicly
traded on the Nasdaq National Market under the symbol
WEBM since our initial public offering on
February 11, 2000. The high and low sales prices of
webMethods common stock as reported by the Nasdaq National
Market during the last two fiscal years are shown below:

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

As of June 2, 2003, there were approximately
420 holders of record of webMethods common stock. The number of
holders of record of webMethods common stock does not reflect
the number of beneficial holders whose shares are held by
depositories, brokers or other nominees. As of June 13,
2003, the closing price of webMethods common stock was
$9.74.

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, 2003.

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##### Table of Contents



Equity Compensation Plan Information

|                                                                 |  |                      |            |                      |  |                                |         |     |  |  |           |    
|---------------------------------------------------------------- |  | -------------------- | ---------- | -------------------- |  | ------------------------------ | ------- | --- |  |  | --------- | ---
|                                                                 |  | Number of securities |            |                      |  | Number of securities remaining
|                                                                 |  | to be issued upon    |            | Weighted-average     |  | available for future issuance 
|                                                                 |  | exercise of          |            | exercise price of    |  | under equity compensation     
|                                                                 |  | outstanding options, |            | outstanding options, |  | plans (excluding securities   
|Plan category                                                    |  | warrants and rights  |            | warrants and rights  |  | reflected in column(a))       
|                                                                 |  |                      |            |                      |  |                               
|                                                                 |  | (a)                  |            | (b)                  |  | (c)                           
|Equity compensation plans approved by security
    holders       |  |                      | 15,494,609 | (1)                  |  | $                              | 18.1983 | (1) |  |  | 1,899,271 | (1)
|Equity compensation plans not approved by
    securities holders |  |                      | 335,393    | (2)                  |  |                                | 32.0559 | (2) |  |  |          |    
|                                                                 |  |                      |            |                      |  |                                |         |     |  |  |           |    
|Total                                                            |  |                      | 15,830,002 |                      |  | $                              | 18.4919 |     |  |  | 1,899,271 |    
|                                                                 |  |                      |            |                      |  |                                |         |     |  |  |           |    



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Excludes webMethods Employee Stock Purchase
    Plan, under which, as of March 31, 2003, a total of
    3,750,000 shares have been reserved for issuance, 721,690 shares
    had been issued at an average purchase price of $14.0724 and
    3,028,310 shares remained available for future issuance. Also
    excludes 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, 2003.                                                                                                                                             
|   
|(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.

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.




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, 2003, 2002
and 2001 and the historical consolidated balance sheet data as
of March 31, 2003 and 2002 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, 2000 and 1999 and the historical
consolidated balance sheet data as of March 31, 2001, 2000
and 1999 are derived from consolidated financial statements of
webMethods not contained in this report. Historical results are
not necessarily indicative of future results.

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|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |        |        |        | 
|------------------------------------------------------------------------------------- | ---------------------------------------- | ------------------------------------------- | ------------------------ | ------- | ------ | ------- | ------- | ------- | ------- | ------- | -------- | ------- | ------- | ------- | ------- | ------ | ------ | ------ | ------- | ------ | ------ | ------ | 
|                                                                                      |                                          |                                            
|                                                                                      |                                          | Year Ended March 31,                       
|                                                                                      |                                          |                                            
|                                                                                      |                                          | 2003                                        |                          | 2002    |        | 2001    |         | 2000    |         | 1999   
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |        
|                                                                                      |                                          |                                            
|                                                                                      |                                          | (In thousands, except per share data)      
|Consolidated Statements of Operations
    Data:                                       |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|Revenue:                                                                              |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|                                                                                      | License                                  |                                             | $                        | 117,066 |        |         | $       | 121,803 |         |         | $        | 143,514 |         |         | $       | 42,822 |        |        | $       | 10,775 |       
|                                                                                      | Professional services                    |                                             |                          | 33,378  |        |         |         | 35,800  |         |         |          | 34,945  |         |         |         | 11,699 |        |        |         | 2,459  |       
|                                                                                      | Maintenance                              |                                             |                          | 46,310  |        |         |         | 38,393  |         |         |          | 23,498  |         |         |         | 5,624  |        |        |         | 1,036  |       
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|                                                                                      |                                          |                                             | Total revenue            |         |        | 196,754 |         |         |         | 195,996 |          |         |         | 201,957 |         |        |        | 60,145 |         |        |        | 14,270 | 
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|Cost of revenue:                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|                                                                                      | License                                  |                                             |                          | 1,937   |        |         |         | 2,335   |         |         |          | 5,189   |         |         |         | 2,612  |        |        |         | 799    |       
|                                                                                      | Professional services and maintenance:   |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |        |       
|                                                                                      |                                          | Stock based compensation                    |                          |         | 251    |         |         |         | 436     |         |          |         | 1,188   |         |         |        | 560    |        |         |        | 71     |       
|                                                                                      |                                          | Other professional services and maintenance |                          |         | 41,937 |         |         |         | 42,124  |         |          |         | 46,304  |         |         |        | 16,102 |        |         |        | 3,803  |       
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|                                                                                      |                                          |                                             | Total cost of revenue    |         |        | 44,125  |         |         |         | 44,895  |          |         |         | 52,681  |         |        |        | 19,274 |         |        |        | 4,673  | 
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|Gross profit                                                                          |                                          |                                             | 152,629                  |         |        |         | 151,101 |         |         |         | 149,276  |         |         |         | 40,871  |        |        |        | 9,597   |       
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|Operating expenses:                                                                   |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|                                                                                      | Sales and marketing:                     |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |        |       
|                                                                                      |                                          | Stock based compensation and warrant charge |                          |         | 3,761  |         |         |         | 2,865   |         |          |         | 4,813   |         |         |        | 1,471  |        |         |        | 267    |       
|                                                                                      |                                          | Other sales and marketing costs             |                          |         | 92,958 |         |         |         | 106,377 |         |          |         | 100,154 |         |         |        | 44,033 |        |         |        | 14,741 |       
|                                                                                      | Research and development:                |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |        |       
|                                                                                      |                                          | Stock based compensation                    |                          |         | 97     |         |         |         | 12,526  |         |          |         | 12,447  |         |         |        | 1,250  |        |         |        | 182    |       
|                                                                                      |                                          | Other research and development costs        |                          |         | 47,441 |         |         |         | 49,634  |         |          |         | 45,158  |         |         |        | 14,780 |        |         |        | 6,066  |       
|                                                                                      | General and administrative:              |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |        |       
|                                                                                      |                                          | Stock based compensation                    |                          |         | 47     |         |         |         | 433     |         |          |         | 1,640   |         |         |        | 307    |        |         |        | 57     |       
|                                                                                      |                                          | Other general and administrative costs      |                          |         | 17,831 |         |         |         | 19,372  |         |          |         | 20,837  |         |         |        | 9,753  |        |         |        | 3,171  |       
|                                                                                      | Restructuring costs                      |                                             |                          | 2,155   |        |         |         | 7,243   |         |         |          |        |         |         |         |       |        |        |         |       |       
|                                                                                      | Acquisition related expenses             |                                             |                          |        |        |         |         |        |         |         |          | 34,039  |         |         |         |       |        |        |         |       |       
|                                                                                      | Amortization of goodwill and intangibles |                                             |                          |        |        |         |         | 38,697  |         |         |          | 41,395  |         |         |         | 1,305  |        |        |         |       |       
|                                                                                      | In-process research and development      |                                             |                          |        |        |         |         |        |         |         |          | 34,910  |         |         |         | 2,737  |        |        |         |       |       
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|                                                                                      |                                          |                                             | Total operating expenses |         |        | 164,290 |         |         |         | 237,147 |          |         |         | 295,393 |         |        |        | 75,636 |         |        |        | 24,484 | 
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|Operating loss                                                                        |                                          |                                             | (11,661                  | )       |        |         | (86,046 | )       |         |         | (146,117 | )       |         |         | (34,765 | )      |        |        | (14,887 | )     
|Interest income, net                                                                  |                                          |                                             | 4,076                    |         |        |         | 8,537   |         |         |         | 14,503   |         |         |         | 3,315   |        |        |        | 415     |       
|Impairment of equity investments in private
    companies                             |                                          |                                             | (1,000                   | )       |        |         | (5,200  | )       |         |         |         |         |         |         |        |        |        |        |        |       
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|Net loss                                                                              |                                          |                                             | (8,585                   | )       |        |         | (82,709 | )       |         |         | (131,614 | )       |         |         | (31,450 | )      |        |        | (14,472 | )     
|Accretion and accrued dividends related to
    mandatorily redeemable preferred stock |                                          |                                             |                         |         |        |         |        |         |         |         |         |         |         |         | (10,223 | )      |        |        | (605    | )     
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|Net loss attributable to common shareholders                                          |                                          | $                                           | (8,585                   | )       |        | $       | (82,709 | )       |         | $       | (131,614 | )       |         | $       | (41,673 | )      |        | $      | (15,077 | )     
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|Basic and diluted net loss per share                                                  |                                          | $                                           | (0.17                    | )       |        | $       | (1.67   | )       |         | $       | (2.81    | )       |         | $       | (2.23   | )      |        | $      | (1.75   | )     
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       
|Shares used in computing basic and diluted net
    loss per common share              |                                          |                                             | 51,282                   |         |        |         | 49,493  |         |         |         | 46,860   |         |         |         | 18,717  |        |        |        | 8,633   |       
|                                                                                      |                                          |                                             |                          |         |        |         |         |         |         |         |          |         |         |         |         |        |        |        |         |       

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|                                                                                                 |  |                |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |        | 
|------------------------------------------------------------------------------------------------ |  | -------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- |  |  | - | ------ | 
|                                                                                                 |  |               
|                                                                                                 |  | March 31,     
|                                                                                                 |  |               
|                                                                                                 |  | 2003           |         | 2002 |  | 2001 |         | 2000 |  | 1999
|                                                                                                 |  |                |         |      |  |      |         |      |  |     
|                                                                                                 |  |               
|                                                                                                 |  | (In thousands)
|Consolidated Balance Sheet Data:                                                                 |  |                |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |        | 
|Cash, cash equivalents and short-term and
    long-term marketable securities available for sale |  | $              | 201,626 |      |  | $    | 211,842 |      |  | $    | 206,389 |  |  | $ | 196,972 |  |  | $ | 9,129  | 
|Working capital                                                                                  |  |                | 149,424 |      |  |      | 178,909 |      |  |      | 190,722 |  |  |   | 181,355 |  |  |   | 8,462  | 
|Total assets                                                                                     |  |                | 304,436 |      |  |      | 324,063 |      |  |      | 375,288 |  |  |   | 299,187 |  |  |   | 19,738 | 
|Long-term liabilities, net of current portion and
    other                                      |  |                | 7,267   |      |  |      | 21,653  |      |  |      | 25,409  |  |  |   | 6,208   |  |  |   | 465    | 
|Mandatorily redeemable preferred stock                                                           |  |                |        |      |  |      |        |      |  |      |        |  |  |   |        |  |  |   | 11,118 | 
|Total stockholders equity                                                                       |  |                | 218,559 |      |  |      | 215,544 |      |  |      | 265,609 |  |  |   | 252,169 |  |  |   | 345    | 






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

This annual report on Form 10-K 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. 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, sufficiency of working capital 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, strength of results from geographic
or specific vertical markets and allocation of resources to
those markets, 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, economic
conditions or the impact of recent changes in accounting
standards and (iv) assumptions underlying any of the
foregoing. In some instances, forward-looking statements can be
identified by the use of the words believes,
anticipates, plans, expects,
intends, may, will,
should, estimates, predicts,
continue, the negative thereof or similar
expressions. Although we believe that the expectations reflected
in the forward-looking statements are reasonable, our
expectations or the forward-looking statements could prove to be
incorrect, and actual results could differ materially from those
indicated by the forward-looking statements. Our future
financial condition and results of operations, as well as any
forward-looking statements, are subject to risks and
uncertainties, including (but not limited to) those discussed in
Item 1 of this report under the caption Factors That
May Affect Future Operating Results. Achieving the future
results or accomplishments described or projected in
forward-looking statements depends upon events or developments
that are often beyond our ability to control. All
forward-looking statements and all reasons why actual results
may differ that are included in this report are made as of the
date of this report, and webMethods disclaims any obligation to
publicly update or revise such forward-looking statements or
reasons why actual results may differ.

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.

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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 Year 2003 Overview

We decreased our net loss to $8.6 million in
our fiscal year ended March 31, 2003, from
$82.7 million in the previous year. Our net loss of
$8.6 million included a negative foreign currency impact of
approximately $700,000. During the fourth quarter of our fiscal
year ended March 31, 2003, we achieved profitability with
quarterly net income of $157,000.

While our total revenue increased slightly, to
$196.8 million for fiscal year 2003 from $196.0 for fiscal
year 2002, our ability to increase software license revenue, our
principal source of revenue, continued to be impacted by the
economic downturn and reduced information technology spending.
In fiscal year 2003, license revenue decreased by
$4.7 million to $117.1 million, which was a
significantly smaller decrease than in fiscal year 2002, when
license revenue decreased by $21.7 million to
$121.8 million. Many enterprises continue to be cautious,
and information technology (IT) purchases are subjected to
more rigorous internal reviews and approvals which often result
in longer sales cycles, the postponement of IT projects or
customers placing smaller orders.

We maintained our intense focus on expense
management throughout fiscal year 2003. This resulted in a 10%
reduction from fiscal year 2002 in total sales and marketing,
research and development and general and administrative
expenses, in all cases excluding stock based compensation and
warrant charge, as applicable. In October 2002, we reduced
our headcount by approximately 43, or 5%.

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 primarily on a
perpetual basis and to a lesser extent, on a renewable term
basis. As of March 31, 2003, we had over
925 customers, compared to over 800 customers 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, SAP AG and Siebel
Systems. 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 year 2003, 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.
During fiscal year 2003, we expanded our partnership with
Informatica to make Business Activity Monitoring more easily
attainable and announced our integration of the JBoss
application server directly into the webMethods Integration
Platform.

We believe our strong focus and track record of
ensuring that our software is successfully put into production
(production event) is a strong competitive advantage
and differentiator. During fiscal year 2003, our global customer
services group reported and documented over 340 separate
production events as compared to 178 such events in the prior
year. In many instances during fiscal year 2003, these customers
deployed our software within 17 weeks or less. Ensuring
that our customers successfully implement our software in a
timely manner enables them to achieve a greater return on their
investment and, in many cases, encourages them to purchase
additional software for other integration projects and serve as
a reference customer for us in our future sales efforts.

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We believe the software integration market will
continue to provide opportunity for long term growth. Our focus
on customer success and satisfaction has resulted in an
increasing number of referenceable customers and productions
events. Over 50% of our license revenue in fiscal year 2003 came
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.

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 of America. 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.
Judgments we make regarding these items, including collection
risk, can materially impact the timing of recognition of license
revenue, especially for perpetual software licenses.

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

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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. At March 31, 2003 and
2002, the allowance for doubtful accounts was $2,850,000 and
$3,685,000 respectively.


Goodwill and Intangibles
Assets

We record goodwill and intangible assets when we
acquire other companies. The allocation of acquisition cost to
intangible assets and goodwill involves the extensive use of
managements estimates and assumptions, and the result of
the allocation process can have a significant impact on our
future operating results. Financial Accounting Standards Board
No. 142, Goodwill and Other Intangible Assets
(SFAS 142), which was issued during fiscal year 2002 and
adopted by us on April 1, 2002, eliminated the amortization
of goodwill and indefinite lived intangible assets. Intangible
assets with finite lives are amortized over their useful lives
while goodwill and indefinite lived assets are not amortized
under SFAS 142, but are periodically tested for impairment.
In accordance with SFAS 142, all of our goodwill is
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. Goodwill is
tested for impairment using a two-step process. The first step
is to identify a potential impairment and the second step
measures the amount of the impairment loss, if any. Goodwill is
deemed to be impaired if the carrying amount of the asset
exceeds its estimated fair value. See Recently Issued
Accounting Pronouncements, for more information.

Foreign Currency Effects

The functional currency for our foreign
operations is the local currency. The financial statements of
foreign subsidiaries have been translated into United States
dollars. Asset and liability accounts have been translated using
the exchange rate in effect at the balance sheet date. Revenue
and expense accounts have been translated using the average
exchange rate for the period. The gains and losses associated
with the translation of the financial statements resulting from
the changes in exchange rates from period to period have been
reported in other comprehensive income or loss. To the extent
assets and liabilities of the foreign operations are realized or
the foreign operations are expected to pay back the intercompany
debt in the foreseeable future, amounts previously reported in
other comprehensive income or loss would be included in net
income or loss in the period in which the transaction occurs.
Transaction gains or losses, other than intercompany debt deemed
to be of a long-term nature, are included in net income or loss
in the period in which they occur.

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.

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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,
|                         |  | 2003             |         | Change     |  | 2002      |       | Change     |  | 2001     
|                         |  |                  |         |            |  |           |       |            |  |          
|                         |  |                 
|                         |  | ($ In thousands)
|Total revenue            |  |                  | 196,754 |            |  |           | 0.4   | %          |  |           | 195,996 |    |  |  | (3.0  | )% |  |  | 201,957  |   
|Gross profit             |  |                  | 152,629 |            |  |           | 1.0   | %          |  |           | 151,101 |    |  |  | 1.2   | %  |  |  | 149,276  |   
|% of total revenue       |  |                  | 77.6    | %          |  |           |       |            |  |           | 77.1    | %  |  |  |       |    |  |  | 73.9     | % 
|Total operating expenses |  |                  | 164,290 |            |  |           | (30.7 | )%         |  |           | 237,147 |    |  |  | (19.7 | )% |  |  | 295,393  |   
|% of total revenue       |  |                  | 83.5    | %          |  |           |       |            |  |           | 121.0   | %  |  |  |       |    |  |  | 146.3    | % 
|Operating loss           |  |                  | (11,661 | )          |  |           | (86.4 | )%         |  |           | (86,046 | )  |  |  | (41.1 | )% |  |  | (146,117 | ) 
|% of total revenue       |  |                  | (5.9    | )%         |  |           |       |            |  |           | (43.9   | )% |  |  |       |    |  |  | (72.4    | )%
|Net loss                 |  |                  | (8,585  | )          |  |           | (89.6 | )%         |  |           | (82,709 | )  |  |  | (37.2 | )% |  |  | (131,614 | ) 
|% of total revenue       |  |                  | (4.4    | )%         |  |           |       |            |  |           | (42.2   | )% |  |  |       |    |  |  | (65.2    | )%

During fiscal year 2003, our total revenue
increased slightly to $196.8 million from
$196.0 million in fiscal year 2002, and declined slightly
from $202.0 million in fiscal year 2001. Our revenue in
fiscal years 2002 and 2003 was impacted by the economic downturn
and reduced information technology spending, as well as the
economic consequences of terrorist acts and geopolitical
developments and uncertainties. We believe our ability to
maintain relatively stable total revenue in fiscal years 2002
and 2003 distinguishes us from many of our competitors who
sustained declines in total revenue during their 2002 and 2003
fiscal years.

Our net loss decreased substantially to
$8.6 million in fiscal year 2003 from $82.7 million in
fiscal year 2002 due, in part, to cessation of required goodwill
amortization, reductions in the amortization of deferred stock
compensation costs and decreases in other operating expenses.
Our net loss in fiscal year 2002 decreased substantially from
$131.6 million in fiscal year 2001 due, in part, to
nonrecurring in-process research and development and
acquisition-related expenses in fiscal year 2001 and decreased
expense for the amortization of goodwill and intangibles in
fiscal year 2002, offset by restructuring costs in fiscal year
2002.

Revenue

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

|                      |  |                  |         |            |  |           |      |            |  |           |         |  |  |  |       |    |  |   |         | 
|--------------------- |  | ---------------- | ------- | ---------- |  | --------- | ---- | ---------- |  | --------- | ------- |  |  |  | ----- | -- |  | - | ------- | 
|                      |  | March 31,        |         | Percentage |  | March 31, |      | Percentage |  | March 31,
|                      |  | 2003             |         | Change     |  | 2002      |      | Change     |  | 2001     
|                      |  |                  |         |            |  |           |      |            |  |          
|                      |  |                 
|                      |  | ($ In thousands)
|License               |  | $                | 117,066 |            |  |           | (3.9 | )%         |  | $         | 121,803 |  |  |  | (15.1 | )% |  | $ | 143,514 | 
|Professional services |  |                  | 33,378  |            |  |           | (6.8 | )%         |  |           | 35,800  |  |  |  | 2.4   | %  |  |   | 34,945  | 
|Maintenance           |  |                  | 46,310  |            |  |           | 20.6 | %          |  |           | 38,393  |  |  |  | 63.4  | %  |  |   | 23,498  | 
|                      |  |                  |         |            |  |           |      |            |  |           |         |  |  |  |       |    |  |   |         | 
|Total revenue         |  | $                | 196,754 |            |  |           | 0.4  | %          |  | $         | 195,996 |  |  |  | (3.0  | )% |  | $ | 201,957 | 
|                      |  |                  |         |            |  |           |      |            |  |           |         |  |  |  |       |    |  |   |         | 

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,
|              |  | 2003             |         | Change     |  | 2002      |      | Change     |  | 2001     
|              |  |                  |         |            |  |           |      |            |  |          
|              |  |                 
|              |  | ($ In thousands)
|Americas      |  | $                | 133,756 |            |  |           | (6.5 | )%         |  | $         | 143,003 |  |  |  | (20.6 | )% |  | $ | 180,192 | 
|Europe        |  |                  | 36,351  |            |  |           | 1.9  | %          |  |           | 35,666  |  |  |  | 100.4 | %  |  |   | 17,800  | 
|Asia Pacific  |  |                  | 26,647  |            |  |           | 53.8 | %          |  |           | 17,327  |  |  |  | 337.0 | %  |  |   | 3,965   | 
|              |  |                  |         |            |  |           |      |            |  |           |         |  |  |  |       |    |  |   |         | 
|Total revenue |  | $                | 196,754 |            |  |           | 0.4  | %          |  | $         | 195,996 |  |  |  | (3.0  | )% |  | $ | 201,957 | 
|              |  |                  |         |            |  |           |      |            |  |           |         |  |  |  |       |    |  |   |         | 

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While our total revenue increased slightly in
fiscal year 2003 from fiscal year 2002 and decreased 3% in
fiscal year 2002 from fiscal year 2001, our ability to increase
software license revenue, our principal source of revenue,
continued to be impacted by the economic downturn, reduced
information technology spending and the economic consequences of
terrorist acts and geopolitical developments and uncertainties,
particularly in North America. Those negative factors were
partially offset by the positive foreign currency impact in
certain international markets in fiscal year 2003. Many
enterprises continue to be cautious and subject IT purchases to
more rigorous internal reviews and approvals, which often result
in longer sales cycles, the postponement of IT projects or
customers placing smaller orders.

Professional services revenue decreased by 7%, to
$33.4 million, for fiscal year 2003 compared to
$35.8 million for fiscal year 2002, reflecting a decrease
in the number of our internal billable consultants and
subcontractors due to an increase in the self-sufficiency of our
customers to do their own implementations and an increase in
systems integrator-led customer implementations. In fiscal year
2002, professional services revenue increased 2%, to
$35.8 million, from $34.9 million in fiscal year 2001.

Maintenance revenue increased 21% and 63% in
fiscal years 2003 and 2002, 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. Additionally, more customers have moved to our 24x7
support plans given the mission critical nature of their
integration projects. As our customers increase the size of
their software deployments, these premium support agreements
become more critical to them.

In fiscal year 2003, revenue from the Americas
declined 6% to $133.8 million due primarily to the
reduction in information technology spending. Combined revenue
from Europe and Asia Pacific (international revenue)
increased $10.0 million to $63.0 million which
included a $5.2 million positive foreign currency impact.
International revenue accounted for 32% of our total revenue in
fiscal year 2003 as compared to 27% and 11% in 2002 and 2001,
respectively. International revenue increased in fiscal year
2003 principally due to our increased focus and continued
investments in the Asia Pacific region, an increased acceptance
of our software in this region, larger international deal sizes
and positive foreign currency impacts.

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,
|                                      |  | 2003              |      | 2002      |  | 2001     
|                                      |  |                   |      |           |  |          
|License                               |  |                   | 98.3 | %         |  |           | 98.1 | % |  |  | 96.4 | %
|Professional services and maintenance |  |                   | 47.4 | %         |  |           | 43.2 | % |  |  | 20.8 | %
|Total revenue                         |  |                   | 77.7 | %         |  |           | 77.3 | % |  |  | 74.5 | %

We improved our total gross profit, excluding
stock based compensation, to 78% in fiscal year 2003 from 77%
and 75% in fiscal years 2002 and 2001, 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 embedded in our software licensed from third
parties. Our gross profit on license revenue was 98% in fiscal
years 2003 and 2002 and was 96% and fiscal year 2001. The
improvement in license gross profit since 2001 is due primarily
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 47%, 43% and 21% in fiscal years 2003, 2002 and 2001,
respectively. Our gross profit, excluding stock based
compensation, in

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fiscal year 2001 was negatively impacted 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.


The improvement in total gross profit, excluding
stock based compensation, in fiscal year 2003 is primarily due
to the 21% increase in maintenance revenue and, to a lesser
extent, a decrease in the cost of professional services and
maintenance compared to fiscal year 2002. The increase in
maintenance revenue is due primarily to the increase in
customers purchasing our software and related maintenance
contracts.

The improvement in gross profit in fiscal year
2002, excluding stock based compensation 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 year 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.

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,
|                                              |  | 2003              |         | Change     |  | 2002      |        | Change     |  | 2001     
|                                              |  |                   |         |            |  |           |        |            |  |          
|                                              |  |                  
|                                              |  | ($ In thousands) 
|Operating Expenses:                           |  |                   |         |            |  |           |        |            |  |           |         |   |  |  |        |    |  |   |         |  
|Sales and marketing*                          |  | $                 | 92,958  |            |  |           | (12.6  | )%         |  | $         | 106,377 |   |  |  | 6.2    | %  |  | $ | 100,154 |  
|% of total revenue                            |  |                   | 47.2    | %          |  |           |        |            |  |           | 54.3    | % |  |  |        |    |  |   | 49.6    | %
|Research and development*                     |  |                   | 47,441  |            |  |           | (4.4   | )%         |  |           | 49,634  |   |  |  | 9.9    | %  |  |   | 45,158  |  
|% of total revenue                            |  |                   | 24.1    | %          |  |           |        |            |  |           | 25.3    | % |  |  |        |    |  |   | 22.4    | %
|General and administrative*                   |  |                   | 17,831  |            |  |           | (8.0   | )%         |  |           | 19,372  |   |  |  | (7.0   | )% |  |   | 20,837  |  
|% of total revenue                            |  |                   | 9.1     | %          |  |           |        |            |  |           | 9.9     | % |  |  |        |    |  |   | 10.3    | %
|Stock based compensation and warrant charge** |  |                   | 3,905   |            |  |           | (75.3  | )%         |  |           | 15,824  |   |  |  | (16.3  | )% |  |   | 18,900  |  
|% of total revenue                            |  |                   | 2.0     | %          |  |           |        |            |  |           | 8.1     | % |  |  |        |    |  |   | 9.4     | %
|Restructuring costs                           |  |                   | 2,155   |            |  |           | (70.2  | )%         |  |           | 7,243   |   |  |  | 100.0  | %  |  |   |        |  
|% of total revenue                            |  |                   | 1.1     | %          |  |           |        |            |  |           | 3.7     | % |  |  |        |    |  |   | 0.0     | %
|Acquisition related expenses                  |  |                   |        |            |  |           | 0.0    | %          |  |           |        |   |  |  | (100.0 | )% |  |   | 34,039  |  
|% of total revenue                            |  |                   | 0.0     | %          |  |           |        |            |  |           | 0.0     | % |  |  |        |    |  |   | 16.9    | %
|Amortization of goodwill and intangibles      |  |                   |        |            |  |           | (100.0 | )%         |  |           | 38,697  |   |  |  | (6.5   | )% |  |   | 41,395  |  
|% of total revenue                            |  |                   | 0.0     | %          |  |           |        |            |  |           | 19.7    | % |  |  |        |    |  |   | 20.5    | %
|In-process research and development           |  |                   |        |            |  |           | 0.0    | %          |  |           |        |   |  |  | (100.0 | )% |  |   | 34,910  |  
|% of total revenue                            |  |                   | 0.0     | %          |  |           |        |            |  |           | 0.0     | % |  |  |        |    |  |   | 17.3    | %
|Operating expense                             |  | $                 | 164,290 |            |  |           | (30.7  | )%         |  | $         | 237,147 |   |  |  | (19.7  | )% |  | $ | 295,393 |  
|% of total revenue                            |  |                   | 83.5    | %          |  |           |        |            |  |           | 121.0   | % |  |  |        |    |  |   | 146.3   | %



---



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

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

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collateral. Also included in our operating
expenses is the amortization of deferred stock compensation and
deferred warrant charge, restructuring charges, acquisition
related expenses, amortization of goodwill and intangibles and
in process research and development.


During fiscal year 2001 and the first quarter of
fiscal year 2002 (the quarter ended June 30, 2001), we
increased personnel and infrastructure costs as we experienced
significant growth in revenue and demand for our software and
services and anticipated that growth to continue. We then
reassessed the demand for our software and services and, in
early July 2001, 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
$5.5 million since the restructuring. The remaining
restructuring charges of $1.7 million related to rent on
the excess facilities, and will be paid over the remaining
rental period extending through March 2008. During our
third quarter of fiscal year 2003 (the quarter ended
December 31, 2002), we reduced headcount by 43 employees to
889, a 5% decrease. In connection with this reduction we
recorded a restructuring charge of $2.2 million, of which
$2.1 million has been paid and $56,000 will be paid during
fiscal year 2004.

Operating expenses, excluding stock based
compensation and warrant charge, amortization of goodwill and
intangibles and restructuring charge, totaled
$158.2 million in fiscal year 2003, a decrease of 10% from
fiscal year 2002 due to our intense focus on expense management.
Operating expenses, excluding stock based compensation and
warrant charge, amortization of goodwill and intangibles,
in-process research and development, acquisition related
expenses and restructuring costs, totaled $175.4 million in
fiscal year 2002, as compared to $166.1 million in fiscal
year 2001. The 6% increase in those operating expenses from
fiscal year 2001 to fiscal year 2002 was primarily due to higher
headcount-related expenses in the first quarter of fiscal year
2002. Following the restructuring in fiscal year 2002, we
increasingly focused on expense management and reduced our
quarterly fiscal year 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.

Sales and marketing expense, excluding stock
based compensation and warrant charge, was 47%, 54% and 50% of
total revenue in fiscal years 2003, 2002 and 2001, respectively.
In fiscal year 2003, sales and marketing expense, excluding
stock based compensation and warrant charge, decreased to
$93.0 million from $106.4 million in fiscal year 2002.
This decrease was primarily due to a decrease in the employee
compensation and benefit expense arising from decreased average
headcount, and decreases in sales assistance fees paid to
partners, marketing program costs, recruiting expenses and
commission expense. In fiscal year 2002, sales and marketing
expense, excluding stock based compensation and warrant charge
increased to $106.4 million from $100.2 million in
fiscal year 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, which was partially
offset by a decrease in marketing program costs, travel and
commissions expense.

Research and development expense, excluding stock
based compensation, was 24%, 25% and 22% of total revenue in
fiscal years 2003, 2002 and 2001, respectively. During fiscal
year 2003, we shipped webMethods Manager, a new product, and a
new version of our integration platform, webMethods 6. In
fiscal year 2003, research and development expense, excluding
stock based compensation, decreased $2.2 million primarily
due to reduced employee compensation and benefits expenses
related to decreased average headcount, reduced travel expenses
and the reduction in the use of outside contractors. During
fiscal year 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 year 2002, research and development expense, excluding
stock based compensation, increased $4.5 million primarily
due to employee compensation and

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benefit expenses related to increased average
headcount. This increase was offset by a reduction in
third-party development expenses.


General and administrative expense, excluding
stock based compensation, as a percentage of total revenue was
9% for the fiscal year ended 2003 and 10% for the fiscal years
ended 2002 and 2001, respectively. In fiscal year 2003, general
and administrative expenses, excluding stock based compensation,
decreased $1.5 million from fiscal year 2002 to
$17.8 million. This decrease is primarily due to a decrease
in bad debt expense, partially offset by an increase in
insurance expense. In fiscal year 2002, general and
administrative expense, excluding stock based compensation,
decreased $1.5 million from fiscal year 2001 to
$19.4 million. This decrease is primarily due to a
reduction 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.

Stock based compensation and warrant charge was
$4.2 million, $16.3 million and $20.1 million in
fiscal years 2003, 2002 and 2001, respectively, of which
$251,000, $436,000, and $1.2 million 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
    fiscal years ended March 31, 2000 and 1999, we recorded
    aggregate unearned compensation of $15.5 million,
    representing the difference between the deemed fair value of our
    common stock at the date of grant and the exercise price of such
    options.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | (ii) As a result of the acquisitions of
    Translink Software, Inc., Premier Software Technology, Inc. and
    Alier, Inc. we recorded a deferred stock compensation charge of
    $27.9 million related to restricted stock issued to
    stockholders of the acquired companies.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| | (iii) In connection with the 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 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. In March 2003, we
    amended our OEM/Reseller agreement with i2. We extended the term
    of the agreement by one year to March 2006 and also reduced the
    number of required webMethods on-site resources from 10 to 1
    which resulted in a corresponding reduction of $1.3 million
    in fees due under the agreement. Additionally, we made changes
    relating to the sharing of revenue related to maintenance.

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 year 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 year 2001. Amortization of goodwill and acquired
intangibles was $38.7 million in fiscal year 2002 and
$41.4 million in 2001. The estimated useful life of the
goodwill and the acquired intangibles was 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 ceased
beginning April 1, 2002 upon our adoption of SFAS 142
(see Recently Issued Accounting Pronouncements for
more information).

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There was no in-process research and development
charge for the fiscal years ended March 31, 2003 and
March 31, 2002. We incurred an in-process research and
development charge of $34.9 million for the year ended
March 31, 2001. The $34.9 million charge during fiscal
year ended 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 was 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.

Interest income, net

Net interest income decreased by approximately
$4.5 million or 52% to $4.1 million for fiscal year
2003 from $8.5 million for fiscal year 2002. Net interest
income decreased by approximately $6.0 million or 41% to
$8.5 million for fiscal year 2002 from $14.5 million
for fiscal year 2001. These decreases for both periods were
primarily attributable to lower interest rates on corporate
paper, bonds and money market funds compared to those in the
same period in the prior year.

Impairment of equity investment in private
companies

We recognized an other-than-temporary decline in
value of $1.0 million in one private company investment and
$5.2 million in four private company equity investments for
fiscal years 2003 and 2002, respectively. There was no
impairment of these investments for fiscal year 2001.

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.

As of March 31, 2003, we had net operating
loss carry-forwards of approximately $235.0 million. These
net operating loss carry-forwards are available to reduce future
taxable income and begin to expire in fiscal year 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, 2003, 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. 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. Historical results may not be indicative of future
results.

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|                                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |        |        |        | 
|--------------------------------------------------------- | ---------------------------------------- | ------------------------------------------- | ------------------------ | -------- | ------ | --------- | ------ | -------- | ------ | -------- | ------ | -------- | ------ | --------- | ------ | -------- | ------ | ------ | ------- | ------ | ------ | ------ | ------- | ------ | ------ | ------ | ------- | ------ | ------ | ------ | ------- | ------ | ------ | ------ | 
|                                                          |                                          |                                            
|                                                          |                                          | Three Months Ended                         
|                                                          |                                          |                                            
|                                                          |                                          | Mar. 31,                                    |                          | Dec. 31, |        | Sept. 30, |        | June 30, |        | Mar. 31, |        | Dec. 31, |        | Sept. 30, |        | June 30,
|                                                          |                                          | 2003                                        |                          | 2002     |        | 2002      |        | 2002     |        | 2002     |        | 2001     |        | 2001      |        | 2001    
|                                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |         
|                                                          |                                          |                                            
|                                                          |                                          | (In thousands)                             
|Revenue:                                                  |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          | License                                  |                                             | $                        | 27,982   |        |           | $      | 33,940   |        |          | $      | 26,475   |        |           | $      | 28,669   |        |        | $       | 32,823 |        |        | $       | 30,434 |        |        | $       | 21,742 |        |        | $       | 36,804 |       
|                                                          | Professional services                    |                                             |                          | 8,641    |        |           |        | 7,951    |        |          |        | 8,584    |        |           |        | 8,202    |        |        |         | 7,856  |        |        |         | 8,852  |        |        |         | 9,401  |        |        |         | 9,691  |       
|                                                          | Maintenance                              |                                             |                          | 12,478   |        |           |        | 11,919   |        |          |        | 11,103   |        |           |        | 10,810   |        |        |         | 10,069 |        |        |         | 9,828  |        |        |         | 9,594  |        |        |         | 8,902  |       
|                                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          |                                          |                                             | Total revenue            |          |        | 49,101    |        |          |        | 53,810   |        |          |        | 46,162    |        |          |        | 47,681 |         |        |        | 50,748 |         |        |        | 49,114 |         |        |        | 40,737 |         |        |        | 55,397 | 
|                                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|Cost of revenue:                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          | License                                  |                                             |                          | 512      |        |           |        | 765      |        |          |        | 525      |        |           |        | 135      |        |        |         | 370    |        |        |         | 613    |        |        |         | 651    |        |        |         | 701    |       
|                                                          | Professional services and maintenance:   |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |        |       
|                                                          |                                          | Stock based compensation                    |                          |          | 34     |           |        |          | 65     |          |        |          | 76     |           |        |          | 76     |        |         |        | 68     |        |         |        | 47     |        |         |        | 129    |        |         |        | 192    |       
|                                                          |                                          | Other professional services and maintenance |                          |          | 10,593 |           |        |          | 10,409 |          |        |          | 10,668 |           |        |          | 10,267 |        |         |        | 9,707  |        |         |        | 10,050 |        |         |        | 9,968  |        |         |        | 12,399 |       
|                                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          |                                          |                                             | Total cost of revenue    |          |        | 11,139    |        |          |        | 11,239   |        |          |        | 11,269    |        |          |        | 10,478 |         |        |        | 10,145 |         |        |        | 10,710 |         |        |        | 10,748 |         |        |        | 13,292 | 
|                                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|Gross profit                                              |                                          |                                             | 37,962                   |          |        |           | 42,571 |          |        |          | 34,893 |          |        |           | 37,203 |          |        |        | 40,603  |        |        |        | 38,404  |        |        |        | 29,989  |        |        |        | 42,105  |       
|                                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|Operating expenses:                                       |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          | Sales and marketing:                     |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |        |       
|                                                          |                                          | Stock based compensation and warrant charge |                          |          | 912    |           |        |          | 896    |          |        |          | 983    |           |        |          | 970    |        |         |        | 788    |        |         |        | 411    |        |         |        | 434    |        |         |        | 1,232  |       
|                                                          |                                          | Other sales and marketing                   |                          |          | 21,747 |           |        |          | 24,309 |          |        |          | 22,592 |           |        |          | 24,310 |        |         |        | 26,005 |        |         |        | 26,063 |        |         |        | 24,109 |        |         |        | 30,200 |       
|                                                          | Research and development:                |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |        |       
|                                                          |                                          | Stock based compensation                    |                          |          | 12     |           |        |          | 26     |          |        |          | 40     |           |        |          | 19     |        |         |        | 449    |        |         |        | 1,872  |        |         |        | 6,715  |        |         |        | 3,490  |       
|                                                          |                                          | Other research and development              |                          |          | 11,282 |           |        |          | 12,059 |          |        |          | 11,821 |           |        |          | 12,279 |        |         |        | 12,006 |        |         |        | 12,219 |        |         |        | 12,110 |        |         |        | 13,299 |       
|                                                          | General and administrative:              |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |        |       
|                                                          |                                          | Stock based compensation                    |                          |          | 3      |           |        |          |       |          |        |          | 23     |           |        |          | 21     |        |         |        | 267    |        |         |        | 27     |        |         |        | 52     |        |         |        | 87     |       
|                                                          |                                          | Other general and administrative            |                          |          | 4,780  |           |        |          | 4,758  |          |        |          | 4,228  |           |        |          | 4,065  |        |         |        | 4,184  |        |         |        | 4,573  |        |         |        | 4,711  |        |         |        | 5,904  |       
|                                                          | Restructuring costs                      |                                             |                          | (82      | )      |           |        | 2,237    |        |          |        |         |        |           |        |         |        |        |         |       |        |        |         |       |        |        |         | 7,243  |        |        |         |       |       
|                                                          | Amortization of goodwill and intangibles |                                             |                          |         |        |           |        |         |        |          |        |         |        |           |        |         |        |        |         | 8,797  |        |        |         | 8,876  |        |        |         | 10,516 |        |        |         | 10,508 |       
|                                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|                                                          |                                          |                                             | Total operating expenses |          |        | 38,654    |        |          |        | 44,285   |        |          |        | 39,687    |        |          |        | 41,664 |         |        |        | 52,496 |         |        |        | 54,041 |         |        |        | 65,890 |         |        |        | 64,720 | 
|                                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|Operating loss                                            |                                          |                                             | (692                     | )        |        |           | (1,714 | )        |        |          | (4,794 | )        |        |           | (4,461 | )        |        |        | (11,893 | )      |        |        | (15,637 | )      |        |        | (35,901 | )      |        |        | (22,615 | )     
|Interest income, net                                      |                                          |                                             | 849                      |          |        |           | 975    |          |        |          | 913    |          |        |           | 1,339  |          |        |        | 1,348   |        |        |        | 1,782   |        |        |        | 2,730   |        |        |        | 2,677   |       
|Impairment of equity investments in private
    companies |                                          |                                             |                         |          |        |           |       |          |        |          | (1,000 | )        |        |           |       |          |        |        | (5,200  | )      |        |        |        |        |        |        |        |        |        |        |        |       
|                                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       
|Net income/(loss)                                         |                                          | $                                           | 157                      |          |        | $         | (739   | )        |        | $        | (4,881 | )        |        | $         | (3,122 | )        |        | $      | (15,745 | )      |        | $      | (13,855 | )      |        | $      | (33,171 | )      |        | $      | (19,938 | )     
|                                                          |                                          |                                             |                          |          |        |           |        |          |        |          |        |          |        |           |        |          |        |        |         |        |        |        |         |        |        |        |         |        |        |        |         |       

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|                                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |      |      |       | 
|--------------------------------------------------------- | ---------------------------------------- | ------------------------------------------- | ------------------------ | -------- | ---- | --------- | ---- | -------- | ---- | -------- | ----- | -------- | ---- | --------- | ---- | -------- | ---- | ----- | ----- | ---- | ---- | ----- | ----- | ---- | ---- | ----- | ----- | ---- | ---- | ----- | ----- | ---- | ---- | ----- | 
|                                                          |                                          |                                            
|                                                          |                                          | As a Percentage of Total Revenue           
|                                                          |                                          |                                            
|                                                          |                                          | Mar. 31,                                    |                          | Dec. 31, |      | Sept. 30, |      | June 30, |      | Mar. 31, |       | Dec. 31, |      | Sept. 30, |      | June 30,
|                                                          |                                          | 2003                                        |                          | 2002     |      | 2002      |      | 2002     |      | 2002     |       | 2001     |      | 2001      |      | 2001    
|                                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |         
|Revenue:                                                  |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     
|                                                          | License                                  |                                             |                          | 57.0     | %    |           |      | 63.1     | %    |          |       | 57.4     | %    |           |      | 60.1     | %    |       |       | 64.7 | %    |       |       | 62.0 | %    |       |       | 53.4 | %    |       |       | 66.4 | %   
|                                                          | Professional services                    |                                             |                          | 17.6     |      |           |      | 14.8     |      |          |       | 18.6     |      |           |      | 17.2     |      |       |       | 15.5 |      |       |       | 18.0 |      |       |       | 23.0 |      |       |       | 17.5 |     
|                                                          | Maintenance                              |                                             |                          | 25.4     |      |           |      | 22.1     |      |          |       | 24.0     |      |           |      | 22.7     |      |       |       | 19.8 |      |       |       | 20.0 |      |       |       | 23.6 |      |       |       | 16.1 |     
|                                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     
|                                                          |                                          |                                             | Total revenue            |          |      | 100.0     |      |          |      | 100.0    |       |          |      | 100.0     |      |          |      | 100.0 |       |      |      | 100.0 |       |      |      | 100.0 |       |      |      | 100.0 |       |      |      | 100.0 | 
|                                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     
|Cost of revenue:                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     
|                                                          | License                                  |                                             |                          | 1.0      |      |           |      | 1.4      |      |          |       | 1.1      |      |           |      | 0.3      |      |       |       | 0.7  |      |       |       | 1.2  |      |       |       | 1.6  |      |       |       | 1.3  |     
|                                                          | Professional services and maintenance:   |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |      |     
|                                                          |                                          | Stock based compensation                    |                          |          | 0.1  |           |      |          | 0.1  |          |       |          | 0.2  |           |      |          | 0.2  |       |       |      | 0.1  |       |       |      | 0.1  |       |       |      | 0.3  |       |       |      | 0.3  |      
|                                                          |                                          | Other professional services and maintenance |                          |          | 21.6 |           |      |          | 19.4 |          |       |          | 23.1 |           |      |          | 21.5 |       |       |      | 19.2 |       |       |      | 20.5 |       |       |      | 24.5 |       |       |      | 22.4 |      
|                                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     
|                                                          |                                          |                                             | Total cost of revenue    |          |      | 22.7      |      |          |      | 20.9     |       |          |      | 24.4      |      |          |      | 22.0  |       |      |      | 20.0  |       |      |      | 21.8  |       |      |      | 26.4  |       |      |      | 24.0  | 
|                                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     
|Gross profit                                              |                                          |                                             | 77.3                     |          |      |           | 79.1 |          |      |          | 75.6  |          |      |           | 78.0 |          |      |       | 80.0  |      |      |       | 78.2  |      |      |       | 73.6  |      |      |       | 76.0  |     
|                                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     
|Operating expenses:                                       |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     
|                                                          | Sales and marketing:                     |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |      |     
|                                                          |                                          | Stock based compensation and warrant charge |                          |          | 1.9  |           |      |          | 1.7  |          |       |          | 2.1  |           |      |          | 2.0  |       |       |      | 1.6  |       |       |      | 0.8  |       |       |      | 1.1  |       |       |      | 2.2  |      
|                                                          |                                          | Other sales and marketing                   |                          |          | 44.3 |           |      |          | 45.2 |          |       |          | 48.9 |           |      |          | 51.0 |       |       |      | 51.2 |       |       |      | 53.1 |       |       |      | 59.2 |       |       |      | 54.5 |      
|                                                          | Research and development:                |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |      |     
|                                                          |                                          | Stock based compensation                    |                          |          |     |           |      |          |     |          |       |          | 0.1  |           |      |          |     |       |       |      | 0.9  |       |       |      | 3.8  |       |       |      | 16.5 |       |       |      | 6.3  |      
|                                                          |                                          | Other research and development              |                          |          | 23.0 |           |      |          | 22.4 |          |       |          | 25.6 |           |      |          | 25.8 |       |       |      | 23.7 |       |       |      | 24.8 |       |       |      | 29.7 |       |       |      | 24.0 |      
|                                                          | General and administrative:              |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |      |     
|                                                          |                                          | Stock based compensation                    |                          |          |     |           |      |          |     |          |       |          |     |           |      |          |     |       |       |      | 0.5  |       |       |      | 0.1  |       |       |      | 0.1  |       |       |      | 0.1  |      
|                                                          |                                          | Other general and administrative            |                          |          | 9.7  |           |      |          | 8.8  |          |       |          | 9.3  |           |      |          | 8.6  |       |       |      | 8.2  |       |       |      | 9.3  |       |       |      | 11.6 |       |       |      | 10.7 |      
|                                                          | Restructuring costs                      |                                             |                          | (0.2     | )    |           |      | 4.2      |      |          |       |         |      |           |      |         |      |       |       |     |      |       |       |     |      |       |       | 17.7 |      |       |       |     |     
|                                                          | Amortization of goodwill and intangibles |                                             |                          |         |      |           |      |         |      |          |       |         |      |           |      |         |      |       |       | 17.3 |      |       |       | 18.1 |      |       |       | 25.8 |      |       |       | 19.0 |     
|                                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     
|                                                          |                                          |                                             | Total operating expenses |          |      | 78.7      |      |          |      | 82.3     |       |          |      | 86.0      |      |          |      | 87.4  |       |      |      | 103.4 |       |      |      | 110.0 |       |      |      | 161.7 |       |      |      | 116.8 | 
|                                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     
|Operating loss                                            |                                          |                                             | (1.4                     | )        |      |           | (3.2 | )        |      |          | (10.4 | )        |      |           | (9.4 | )        |      |       | (23.4 | )    |      |       | (31.8 | )    |      |       | (88.1 | )    |      |       | (40.8 | )   
|Interest income, net                                      |                                          |                                             | 1.7                      |          |      |           | 1.8  |          |      |          | 2.0   |          |      |           | 2.8  |          |      |       | 2.6   |      |      |       | 3.6   |      |      |       | 6.7   |      |      |       | 4.8   |     
|Impairment of equity investments in private
    companies |                                          |                                             |                         |          |      |           |     |          |      |          | (2.2  | )        |      |           |     |          |      |       | (10.2 | )    |      |       |      |      |      |       |      |      |      |       |      |     
|                                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     
|Net income/(loss)                                         |                                          |                                             | 0.3                      | %        |      |           | (1.4 | )%       |      |          | (10.6 | )%       |      |           | (6.6 | )%       |      |       | (31.0 | )%   |      |       | (28.2 | )%   |      |       | (81.4 | )%   |      |       | (36.0 | )%  
|                                                          |                                          |                                             |                          |          |      |           |      |          |      |          |       |          |      |           |      |          |      |       |       |      |      |       |       |      |      |       |       |      |      |       |       |     

LIQUIDITY AND CAPITAL RESOURCES

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, 2003 showed a 5% decrease in our cash and
investments and a 16% decrease in our working capital from the
prior year. The decrease in working capital is primarily due to
cash used in operations and the reinvestment of certain
marketable securities which were previously short term in nature
but have now been reinvested for longer terms, offset by
decreases in accounts payable and accrual balances at
March 31, 2003 as compared to March 31, 2002.

Net cash used in operating activities was
$12.8 million, $4.1 million, and $16.7 million in
fiscal years 2003, 2002 and 2001, respectively. The increase in
cash used in operating activities during fiscal year 2003,
compared to fiscal year 2002 was due primarily to larger
decreases in accounts payable, accrued expenses, accrued
salaries and commissions and deferred revenue balances offset by
a smaller decrease in the accounts receivable balance.

Net cash used in investing activities was
$11.7 million, $21.2 million and $65.1 million in
fiscal years 2003, 2002 and 2001, respectively. Cash used in
investing activities in fiscal years 2003 and 2002 primarily
reflects purchases of property and equipment and net purchases
of marketable securities, offset in fiscal 2002 by proceeds
from the repayment of an investment in a private company. Net
cash used in investing activities in fiscal year 2001 included
$14.1 million relating to purchases of Intelliframe
technology and the Translink acquisition. Capital expenditures
were $3.0 million, $5.9 million, and

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$10.7 million in fiscal years 2003, 2002 and
2001, 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
$4.4 million, $14.4 million and $19.9 million in
fiscal years 2003, 2002 and 2001, respectively. These cash flows
primarily reflect net cash proceeds from exercises of stock
options and net cash proceeds from Employee Stock Purchase Plan
common stock issuances offset by payments on capital leases. Net
cash proceeds from exercises of stock options were
$2.6 million, $10.5 million and $11.4 million in
fiscal years 2003, 2002 and 2001 respectively. Net cash proceeds
from ESPP common stock issuances were $3.0 million,
$5.0 million and $6.1 million in fiscal years 2003,
2002 and 2001 respectively. Payments on capital leases were
$4.9 million, $3.1 million and $685,000 in fiscal
years 2003, 2002 and 2001, respectively.

We have a line of credit to borrow up to a
maximum principal amount of $20,000,000 with a maturity date of
October 10, 2003, which we expect to renew. Any borrowings
under this line bear interest at the banks prime rate per
annum. As of March 31, 2003, we had not borrowed against
this line of credit. In connection with the line of credit, we
have a letter of credit totaling $355,000 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 twelve 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 will 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. The Company adopted SFAS No. 142 on
April 1, 2002 and, at that time, stopped amortizing
goodwill that resulted from business combinations completed
prior to the adoption.

In October 2001, the Financial Accounting
Standards Board issued SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets, which
supersedes 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. The Company adopted SFAS
No. 144, effective April 1, 2002. There was no
impairment charge recorded for the fiscal year ended
March 31, 2003.

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 we have

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historically accounted for reimbursements of
out-of-pocket expenses in the manner provided for under EITF
Topic No. D-103, the adoption of the provisions of EITF
Topic No. D-103 did not have an impact on our consolidated
financial position, results of operations and cash flows.


In June 2002, the Financial Accounting Standards
Board issued SFAS No. 146 Accounting for Costs
Associated with Exit or Disposal Activities. This standard
is effective for exit or disposal activities that are initiated
after December 31, 2002. The adoption of this standard did
not have a material effect on our financial position, results of
operations and cash flows.

In November 2002, the Financial Accounting
Standards Board issued Interpretation No. 45 (FIN
No. 45), Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guaranteed of
Indebtedness of Others. FIN 45 requires that the we
recognize the fair value for guarantee and indemnification
arrangements issued or modified after December 31, 2002, if
these arrangements are within the scope of the Interpretation.
In addition, we must continue to monitor the conditions that are
subject to the guarantees and indemnifications, as required
under previously existing generally accepted accounting
principles, in order to identify if a loss has occurred. If we
determine it is probable that a loss has occurred then any such
estimable loss would be recognized under those guarantees and
indemnifications. Some of the software licenses granted by us
contain provisions that indemnify licensees of our software from
damages and costs resulting from claims alleging that the our
software infringes the intellectual property rights of a
third-party. We have historically received only a limited number
of requests for indemnification under these provisions and have
not been required to make material payments pursuant to these
provisions. Accordingly, we have not recorded a liability
related to these indemnification provisions. We do not have any
guarantees or indemnification arrangements other than the
indemnification clause in some of its software licenses. We do
not believe that FIN 45 will have a material impact on our
financial position, results of operations and cash flows.

In November 2002, the EITF reached a consensus on
EITF No. 00-21, Revenue Arrangements with Multiple
Deliverables. EITF No. 00-21 addresses certain
aspects of the accounting by a vendor for arrangements under
which the vendor will perform multiple revenue-generating
activities. EITF No. 00-21 will be effective for interim
periods beginning after June 15, 2003. We are currently
evaluating the impact of the adoption on our financial position,
results of operations and cash flows.

In December 2002, the Financial Accounting
Standards Board issued (SFAS 148), Accounting for
Stock Based Compensation-Transition and Disclosure-an Amendment
to FAS 123. SFAS 148 provides two additional
transition methods for entities that adopt the preferable method
of accounting for stock based compensation. Further, the
statement requires disclosure of comparable information for all
companies regardless of whether, when, or how an entity adopts
the preferable, fair value based method of accounting. These
disclosures are now required for interim periods in addition to
the traditional annual disclosure. The amendments to SFAS
No. 123, which provides for additional transition methods,
are effective for periods beginning after December 15,
2002, although earlier application is permitted. The amendments
to the disclosure requirements are required for financial
reports containing condensed financial statements for interim
periods beginning after December 15, 2002. The Company has
accounted for stock-based employee compensation using the
intrinsic method under APB 25 and has adopted the amendment
to disclose the provisions of SFAS 148.

In January 2003, the Financial Accounting
Standards Board issued Interpretation No. 46 (FIN
No. 46), Consolidation of Variable Interest Entities,
an Interpretation of ARB No. 51, which relates to the
identification of, and financial reporting for,
variable-interest entities (VIEs). FIN No. 46 has
far-reaching effects and applies to new entities that are
created after January 31, 2003, as well as to existing VIEs
no later than the beginning of the first interim or annual
reporting period that starts after July 1, 2003. We do not
believe that FIN 46 will have a material impact on our
financial position, results of operations and cash flows.

In May 2003, the Financial Accounting Standards
Board issued SFAS No. 150 (SFAS 150), Accounting
for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity. SFAS 150 requires that
certain instruments with certain characteristics be classified
as liabilities as

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opposed to equity. This statement is effective
for financial instruments entered into or modified after
May 30, 2003, and otherwise is effective July 1, 2003.
We do not believe that the adoption of this standard will have a
material impact on our financial position, results of operations
and cash flows.





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, and U.S. government
agency securities. 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, 2003, 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, United Kingdom, 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 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-24 of this
report.






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

None.

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##### Table of Contents






PART III

The following information contained in the
definitive Proxy Statement of webMethods in connection with our
2003 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
webMethods 2003 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 2003
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 webMethods 2003 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 webMethods 2003 Annual Meeting of
Stockholders, and is incorporated into this report by reference.




Item 14.  CONTROLS AND
PROCEDURES

As of March 31, 2003, webMethods
management, including our Chief Executive Officer and Chief
Financial Officer, have conducted an evaluation of the
effectiveness of disclosure controls and procedures pursuant to
Exchange Act Rule 13a-14. Based on that evaluation, the
Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures are
effective to ensure that information we are required to disclose
in reports that we file or submit under the Securities Exchange
Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified in Securities and
Exchange Commission rules and forms. There have been no
significant changes in internal controls, or in factors that
could significantly affect internal controls, subsequent to the
date the Chief Executive Officer and Chief Financial Officer
completed their evaluation.

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PART IV




Item 16.  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,
    2003 and 2002                                                             |  |      | F-2 | 
|Consolidated Statements of Operations and
    Comprehensive Loss for the years ended March 31, 2003, 2002
    and 2001 |  |      | F-3 | 
|Consolidated Statements of Changes in
    Stockholders Equity for the years ended March 31,
    2003, 2002 and 2001   |  |      | F-4 | 
|Consolidated Statements of Cash Flows for the
    years ended March 31, 2003, 2002 and 2001                            |  |      | F-5 | 
|Notes to Consolidated Financial Statements                                                                             |  |      | F-6 | 



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

|                                                                      |  |  |      | 
|--------------------------------------------------------------------- |  |  | ---- | 
|Schedule II  Valuation and
    Qualifying Accounts                   |  |  | F-25 | 
|Report of Independent Accountants on Financial
    Statement Schedule |  |  | F-26 | 



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

|        |      |             |  |     |  |                                                                                                                                               
|------- | ---- | ----------- |  | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|        |      |            
|Exhibit |      |            
|Number  |      | Description
|        |      |            
|        | 2.1  |             |  | (1) |  | Agreement and Plan of Merger dated as of
    May 20, 2000, by and among webMethods, Inc., Wolf
    Acquisition, Inc. and Active Software, Inc.
|        | 3.1  |             |  | (2) |  | Fifth Amended and Restated Certificate of
    Incorporation of webMethods, Inc., as amended                                                   
|        | 3.2  |             |  | (3) |  | Amended and Restated Bylaws of webMethods, Inc.                                                                                               
|        | 4.1  |             |  | (3) |  | Specimen certificate for shares of webMethods,
    Inc. Common Stock                                                                          
|        | 4.2  |             |  | (4) |  | Rights Agreement dated as of October 18,
    2001 between webMethods, Inc. and American Stock
    Transfer & Trust Company                    
|        | 10.1 |             |  | (3) |  | Second Amended and Restated Investor Rights
    Agreement                                                                                     
|        | 10.2 |             |  | (5) |  | webMethods, Inc. Amended and Restated Stock
    Option Plan, as amended                                                                       
|        | 10.3 |             |  | (3) |  | Employee Stock Purchase Plan                                                                                                                  
|        | 10.4 |             |  | (3) |  | Indemnification Agreement entered into between
    webMethods, Inc. and each of its directors                                                 
|        | 21.1 |             |  | *   |  | Subsidiaries of webMethods, Inc.                                                                                                              
|        | 23.1 |             |  | *   |  | Consent of PricewaterhouseCoopers LLP                                                                                                         
|        | 24   |             |  |     |  | Power of Attorney (included on signature page of
    this report)                                                                             
|        | 99.1 |             |  | *   |  | Rule 13a-14(a) Certification of Chief
    Executive Officer                                                                                   
|        | 99.2 |             |  | *   |  | Rule 13a-14(a) Certification of Chief
    Financial Officer                                                                                   
|        | 99.3 |             |  | *   |  | Section 1350 Certification of Chief
    Executive Officer                                                                                     
|        | 99.4 |             |  | *   |  | Section 1350 Certification of Chief
    Financial Officer                                                                                     

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---

|    |                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------
|(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).                  
|   
|(5) | Incorporated by reference to webMethods
    Form 10-K for the year ended March 31, 2002 (File
    No. 1-15681).     
|   
|*   | Filed herewith.                                                                                                      

(b) Reports on Form 8-K. The
following reports on Form 8-K have been filed by
webMethods, Inc. since the beginning of its fiscal quarter on
January 1, 2003:

|               |  |          |       |               |  |  |                                     | 
|-------------- |  | -------- | ----- | ------------- |  |  | ----------------------------------- | 
|Date of Report |  | Item No. |       | Item Reported
|               |  |          |       |              
|April 3, 2003  |  |          | 7, 12 |               |  |  | Press release dated April 3, 2003.  | 
|April 29, 2003 |  |          | 7, 12 |               |  |  | Press release dated April 29, 2003. | 

(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.

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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 18th of June, 2003.



| |                 
| | ----------------
| | 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 18, 2003
|/s/ MARY DRIDIMary Dridi               |  | Chief Financial Officer and Treasurer             |  | June 18, 2003
|/s/ BETSY S. ATKINSBetsy S. Atkins     |  | Director                                          |  | June 18, 2003
|/s/ GARY J. FERNANDESGary J. Fernandes |  | Director                                          |  | June 18, 2003
|/s/ JAMES P. GAUERJames P. Gauer       |  | Director                                          |  | June 18, 2003
|/s/ R. JAMES GREENR. James Green       |  | Director                                          |  | June 18, 2003
|/s/ JERRY JASINOWSKIJerry Jasinowski   |  | Director                                          |  | June 18, 2003
|/s/ JACK L. LEWISJack L. Lewis         |  | Director                                          |  | June 18, 2003
|/s/ GENE RIECHERSGene Riechers         |  | Director                                          |  | June 18, 2003
|/s/ ROBERT T. VASANRobert T. Vasan     |  | Director                                          |  | June 18, 2003

44



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##### Table of Contents



REPORT OF INDEPENDENT ACCOUNTANTS

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

In our opinion, the accompanying consolidated
balance sheets and the related consolidated statements of
operations and comprehensive loss, changes in stockholders
equity and cash flows present fairly, in all material respects,
the financial position of webMethods, Inc. and its subsidiaries
at March 31, 2003 and 2002, and the results of their
operations and their cash flows for each of the three years in
the period ended March 31, 2003 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.

As discussed in Note 1, effective on
April 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 142, and accordingly, changed its
method of accounting for goodwill and other intangible assets.

/s/ PRICEWATERHOUSECOOPERS LLP

McLean, Virginia

April 23, 2003


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##### Table of Contents



WEBMETHODS, INC.

CONSOLIDATED BALANCE SHEETS

|                                         |                                                                                                                               |                                            |        |          |         |  |        |          |         | 
|---------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------ | -------- | ------- |  | ------ | -------- | ------- | 
|                                         |                                                                                                                               |                                           
|                                         |                                                                                                                               | Year Ended March 31,                      
|                                         |                                                                                                                               |                                           
|                                         |                                                                                                                               | 2003                                       |        | 2002    
|                                         |                                                                                                                               |                                            |        |         
|                                         |                                                                                                                               |                                           
|                                         |                                                                                                                               | (In thousands, except                     
|                                         |                                                                                                                               | share data)                               
|ASSETS                                   |                                                                                                                               |                                            |        |          |         |  |        |         
|Current assets:                          |                                                                                                                               |                                            |        |          |         |  |        |         
|                                         | Cash and cash equivalents                                                                                                     |                                            | $      | 79,702   |         |  | $      | 98,497   |        
|                                         | Marketable securities available for sale                                                                                      |                                            |        | 97,079   |         |  |        | 113,345  |        
|                                         | Accounts receivable, net of allowance of $2,850
    and $3,685.                                                               |                                            |        | 43,691   |         |  |        | 46,417   |        
|                                         | Prepaid expenses and other current assets                                                                                     |                                            |        | 7,562    |         |  |        | 7,516    |        
|                                         |                                                                                                                               |                                            |        |          |         |  |        |         
|                                         |                                                                                                                               | Total current assets                       |        |          | 228,034 |  |        |          | 265,775 | 
|Marketable securities available for sale |                                                                                                                               |                                            | 24,845 |          |         |  |       |         
|Property and equipment, net              |                                                                                                                               |                                            | 12,068 |          |         |  | 17,181 |         
|Goodwill                                 |                                                                                                                               |                                            | 29,838 |          |         |  | 29,838 |         
|Other assets                             |                                                                                                                               |                                            | 9,651  |          |         |  | 11,269 |         
|                                         |                                                                                                                               |                                            |        |          |         |  |        |         
|                                         |                                                                                                                               | Total assets                               |        | $        | 304,436 |  |        | $        | 324,063 | 
|                                         |                                                                                                                               |                                            |        |          |         |  |        |         
|LIABILITIES AND STOCKHOLDERS EQUITY     |                                                                                                                               |                                            |        |          |         |  |        |         
|Current liabilities:                     |                                                                                                                               |                                            |        |          |         |  |        |         
|                                         | Accounts payable                                                                                                              |                                            | $      | 9,768    |         |  | $      | 15,105   |        
|                                         | Accrued expenses                                                                                                              |                                            |        | 14,802   |         |  |        | 16,170   |        
|                                         | Accrued salaries and commissions                                                                                              |                                            |        | 11,648   |         |  |        | 15,594   |        
|                                         | Deferred revenue                                                                                                              |                                            |        | 39,649   |         |  |        | 37,298   |        
|                                         | Current portion of capital lease obligations                                                                                  |                                            |        | 2,743    |         |  |        | 2,699    |        
|                                         |                                                                                                                               |                                            |        |          |         |  |        |         
|                                         |                                                                                                                               | Total current liabilities                  |        |          | 78,610  |  |        |          | 86,866  | 
|                                         | Capital lease obligations, net of current portion
    and other                                                               |                                            |        | 567      |         |  |        | 1,765    |        
|                                         | Long term deferred revenue                                                                                                    |                                            |        | 6,700    |         |  |        | 19,888   |        
|                                         |                                                                                                                               |                                            |        |          |         |  |        |         
|                                         |                                                                                                                               | Total liabilities                          |        |          | 85,877  |  |        |          | 108,519 | 
|                                         |                                                                                                                               |                                            |        |          |         |  |        |         
|Commitments and contingencies            |                                                                                                                               |                                            |        |          |         |  |        |         
|Stockholders equity:                    |                                                                                                                               |                                            |        |          |         |  |        |         
|                                         | Common stock, $0.01 par value; 500,000,000 shares
    authorized; 51,766,572 and 50,477,383 shares issued and
    outstanding |                                            |        | 518      |         |  |        | 505      |        
|                                         | Additional paid-in capital                                                                                                    |                                            |        | 515,828  |         |  |        | 510,281  |        
|                                         | Deferred stock compensation and warrant charge                                                                                |                                            |        | (9,450   | )       |  |        | (14,875  | )      
|                                         | Accumulated deficit                                                                                                           |                                            |        | (288,449 | )       |  |        | (279,864 | )      
|                                         | Accumulated other comprehensive income (loss)                                                                                 |                                            |        | 112      |         |  |        | (503     | )      
|                                         |                                                                                                                               |                                            |        |          |         |  |        |         
|                                         |                                                                                                                               | Total stockholders equity                 |        |          | 218,559 |  |        |          | 215,544 | 
|                                         |                                                                                                                               |                                            |        |          |         |  |        |         
|                                         |                                                                                                                               | Total liabilities and stockholders equity |        | $        | 304,436 |  |        | $        | 324,063 | 
|                                         |                                                                                                                               |                                            |        |          |         |  |        |         

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

F-2



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##### Table of Contents



WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE LOSS

|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |          |         |          |  
|------------------------------------------------------------------------ | ---------------------------------------- | ----------------------------------------------------------- | ------------------------ | ------- | ------ | ------- | ---------- | ------- | ------- | ------- | ---------- | -------- | ------- | -------- | -
|                                                                         |                                          |                                                            
|                                                                         |                                          | Year Ended March 31,                                       
|                                                                         |                                          |                                                            
|                                                                         |                                          | 2003                                                        |                          | 2002    |        | 2001   
|                                                                         |                                          |                                                             |                          |         |        |        
|                                                                         |                                          |                                                            
|                                                                         |                                          | (In thousands, except share and per share data)            
|Revenue:                                                                 |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|                                                                         | License                                  |                                                             | $                        | 117,066 |        |         | $          | 121,803 |         |         | $          | 143,514  |        
|                                                                         | Professional services                    |                                                             |                          | 33,378  |        |         |            | 35,800  |         |         |            | 34,945   |        
|                                                                         | Maintenance                              |                                                             |                          | 46,310  |        |         |            | 38,393  |         |         |            | 23,498   |        
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|                                                                         |                                          |                                                             | Total revenue            |         |        | 196,754 |            |         |         | 195,996 |            |          |         | 201,957  |  
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|Cost of revenue:                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|                                                                         | License                                  |                                                             |                          | 1,937   |        |         |            | 2,335   |         |         |            | 5,189    |        
|                                                                         | Professional services and maintenance:   |                                                             |                          |         |        |         |            |         |         |         |            |          |        
|                                                                         |                                          | Stock based compensation                                    |                          |         | 251    |         |            |         | 436     |         |            |          | 1,188   |         
|                                                                         |                                          | Other professional services and maintenance                 |                          |         | 41,937 |         |            |         | 42,124  |         |            |          | 46,304  |         
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|                                                                         |                                          |                                                             | Total cost of revenue    |         |        | 44,125  |            |         |         | 44,895  |            |          |         | 52,681   |  
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|Gross profit                                                             |                                          |                                                             | 152,629                  |         |        |         | 151,101    |         |         |         | 149,276    |         
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|Operating expenses:                                                      |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|                                                                         | Sales and marketing:                     |                                                             |                          |         |        |         |            |         |         |         |            |          |        
|                                                                         |                                          | Stock based compensation and warrant charge                 |                          |         | 3,761  |         |            |         | 2,865   |         |            |          | 4,813   |         
|                                                                         |                                          | Other sales and marketing costs                             |                          |         | 92,958 |         |            |         | 106,377 |         |            |          | 100,154 |         
|                                                                         | Research and development:                |                                                             |                          |         |        |         |            |         |         |         |            |          |        
|                                                                         |                                          | Stock based compensation                                    |                          |         | 97     |         |            |         | 12,526  |         |            |          | 12,447  |         
|                                                                         |                                          | Other research and development costs                        |                          |         | 47,441 |         |            |         | 49,634  |         |            |          | 45,158  |         
|                                                                         | General and administrative:              |                                                             |                          |         |        |         |            |         |         |         |            |          |        
|                                                                         |                                          | Stock based compensation                                    |                          |         | 47     |         |            |         | 433     |         |            |          | 1,640   |         
|                                                                         |                                          | Other general and administrative costs                      |                          |         | 17,831 |         |            |         | 19,372  |         |            |          | 20,837  |         
|                                                                         | Restructuring costs                      |                                                             |                          | 2,155   |        |         |            | 7,243   |         |         |            |         |        
|                                                                         | Acquisition related expenses             |                                                             |                          |        |        |         |            |        |         |         |            | 34,039   |        
|                                                                         | Amortization of goodwill and intangibles |                                                             |                          |        |        |         |            | 38,697  |         |         |            | 41,395   |        
|                                                                         | In-process research and development      |                                                             |                          |        |        |         |            |        |         |         |            | 34,910   |        
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|                                                                         |                                          |                                                             | Total operating expenses |         |        | 164,290 |            |         |         | 237,147 |            |          |         | 295,393  |  
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|Operating loss                                                           |                                          |                                                             | (11,661                  | )       |        |         | (86,046    | )       |         |         | (146,117   | )       
|Interest income, net                                                     |                                          |                                                             | 4,076                    |         |        |         | 8,537      |         |         |         | 14,503     |         
|Impairment of equity investment in private
    companies                 |                                          |                                                             | (1,000                   | )       |        |         | (5,200     | )       |         |         |           |         
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|                                                                         | Net loss                                 |                                                             | $                        | (8,585  | )      |         | $          | (82,709 | )       |         | $          | (131,614 | )      
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|Basic and diluted net loss per share                                     |                                          | $                                                           | (0.17                    | )       |        | $       | (1.67      | )       |         | $       | (2.81      | )       
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|Shares used in computing basic and diluted net
    loss per common share |                                          |                                                             | 51,281,729               |         |        |         | 49,492,654 |         |         |         | 46,860,324 |         
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|Comprehensive loss:                                                      |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|                                                                         | Net loss                                 |                                                             | $                        | (8,585  | )      |         | $          | (82,709 | )       |         | $          | (131,614 | )      
|                                                                         | Other comprehensive income (loss):       |                                                             |                          |         |        |         |            |         |         |         |            |          |        
|                                                                         |                                          | Unrealized (loss) gain on securities
    available for sale |                          |         | (135   | )       |            |         | (692    | )       |            |          | 919     |         
|                                                                         |                                          | Foreign currency cumulative translation adjustment          |                          |         | 750    |         |            |         | (417    | )       |            |          | (184    | )       
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         
|                                                                         |                                          |                                                             | Total comprehensive loss |         | $      | (7,970  | )          |         | $       | (83,818 | )          |          | $       | (130,879 | )
|                                                                         |                                          |                                                             |                          |         |        |         |            |         |         |         |            |         

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

F-3



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##### Table of Contents



WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS EQUITY

for the years ended March 31, 2001, 2002
and 2003


|                                                                                                       |  |              |        |            |  |              |     |             |  |               |         |             |  |       |         |   |  |   |          |   |  |   |        |   |  |   |          |  
|------------------------------------------------------------------------------------------------------ |  | ------------ | ------ | ---------- |  | ------------ | --- | ----------- |  | ------------- | ------- | ----------- |  | ----- | ------- | - |  | - | -------- | - |  | - | ------ | - |  | - | -------- | -
|                                                                                                       |  |              |        |            |  |              |     | Deferred    |  |               |         |             |  |      
|                                                                                                       |  |              |        |            |  |              |     | Stock       |  |               |         | Accumulated |  |      
|                                                                                                       |  |              |        |            |  | Compensation |     |             |  | Other         |         |            
|                                                                                                       |  | Common Stock |        | Additional |  | and          |     |             |  | Comprehensive |         |            
|                                                                                                       |  |              |        | Paid-in    |  | Warrant      |     | Accumulated |  | Income        |         |            
|                                                                                                       |  | Shares       |        | Amount     |  | Capital      |     | Charge      |  | Deficit       |         | (Loss)      |  | Total
|                                                                                                       |  |              |        |            |  |              |     |             |  |               |         |             |  |      
|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 income                                                                             |  |              |       |            |  |              |    |             |  |               |        |             |  |       |        |   |  |   |         |   |  |   | 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  |  
|Stock options exercised, net                                                                           |  |              | 907    |            |  |              | 9   |             |  |               | 2,608   |             |  |       |        |   |  |   |         |   |  |   |       |   |  |   | 2,617    |  
|ESPP common stock issuances                                                                            |  |              | 383    |            |  |              | 4   |             |  |               | 2,957   |             |  |       |        |   |  |   |         |   |  |   |       |   |  |   | 2,961    |  
|Adjustment of deferred compensation related to
    forfeitures                                         |  |              |       |            |  |              |    |             |  |               | (303    | )           |  |       | 303     |   |  |   |         |   |  |   |       |   |  |   |         |  
|Amortization of deferred warrant charge                                                                |  |              |       |            |  |              |    |             |  |               |        |             |  |       | 3,402   |   |  |   |         |   |  |   |       |   |  |   | 3,402    |  
|Amortization of deferred stock compensation
    related to restricted stock                            |  |              |       |            |  |              |    |             |  |               |        |             |  |       | 470     |   |  |   |         |   |  |   |       |   |  |   | 470      |  
|Compensation charge related to stock option
    grants to non-employees                                |  |              |       |            |  |              |    |             |  |               | 285     |             |  |       |        |   |  |   |         |   |  |   |       |   |  |   | 285      |  
|Cash collection from i2 applied to deferred
    warrant charge                                         |  |              |       |            |  |              |    |             |  |               |        |             |  |       | 1,250   |   |  |   |         |   |  |   |       |   |  |   | 1,250    |  
|Other comprehensive income                                                                             |  |              |       |            |  |              |    |             |  |               |        |             |  |       |        |   |  |   |         |   |  |   | 615    |   |  |   | 615      |  
|Net loss                                                                                               |  |              |       |            |  |              |    |             |  |               |        |             |  |       |        |   |  |   | (8,585   | ) |  |   |       |   |  |   | (8,585   | )
|                                                                                                       |  |              |        |            |  |              |     |             |  |               |         |             |  |       |         |   |  |   |          |   |  |   |        |   |  |   |          |  
|Balance, March 31, 2003                                                                                |  |              | 51,767 |            |  | $            | 518 |             |  | $             | 515,828 |             |  | $     | (9,450  | ) |  | $ | (288,449 | ) |  | $ | 112    |   |  | $ | 218,559  |  
|                                                                                                       |  |              |        |            |  |              |     |             |  |               |         |             |  |       |         |   |  |   |          |   |  |   |        |   |  |   |          |  

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

F-4



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##### Table of Contents



WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                             |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |          |         |  
|------------------------------------------------------------ | --------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------- | ------ | ------- | ---- | ------- | ------- | ------- | - | ------- | -------- | ------- | -
|                                                             |                                                                                   |                                                                                                                                                              
|                                                             |                                                                                   | Year Ended March 31,                                                                                                                                         
|                                                             |                                                                                   |                                                                                                                                                              
|                                                             |                                                                                   | 2003                                                                                                                                                          |         | 2002   |         | 2001
|                                                             |                                                                                   |                                                                                                                                                               |         |        |         |     
|                                                             |                                                                                   |                                                                                                                                                              
|                                                             |                                                                                   | (In thousands)                                                                                                                                               
|Cash flows from operating activities:                        |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         
|                                                             | Net loss                                                                          |                                                                                                                                                               | $       | (8,585 | )       |      | $       | (82,709 | )       |   | $       | (131,614 | )      
|                                                             | Adjustments to reconcile net loss to net cash
    used in operating activities:   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |          |        
|                                                             |                                                                                   | Depreciation and amortization                                                                                                                                 |         |        | 10,044  |      |         |         | 8,453   |   |         |          | 4,181   |  
|                                                             |                                                                                   | Provision for doubtful accounts                                                                                                                               |         |        | 384     |      |         |         | 2,840   |   |         |          | 4,808   |  
|                                                             |                                                                                   | Provision for warranty                                                                                                                                        |         |        |        |      |         |         |        |   |         |          | 88      |  
|                                                             |                                                                                   | Impairment of equity investments                                                                                                                              |         |        | 1,000   |      |         |         | 5,200   |   |         |          |        |  
|                                                             |                                                                                   | Loss on disposal of equipment                                                                                                                                 |         |        |        |      |         |         | 574     |   |         |          | 46      |  
|                                                             |                                                                                   | Amortization of deferred stock compensation and
    compensation for accelerated vesting related to employee stock
    options and non-employee stock warrant |         |        | 4,156   |      |         |         | 16,260  |   |         |          | 20,088  |  
|                                                             |                                                                                   | Amortization of goodwill and acquired intangibles                                                                                                             |         |        |        |      |         |         | 38,697  |   |         |          | 41,395  |  
|                                                             |                                                                                   | Write off of in-process research and development                                                                                                              |         |        |        |      |         |         |        |   |         |          | 34,910  |  
|                                                             | Increase (decrease) in cash resulting from
    changes in assets and liabilities: |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |          |        
|                                                             |                                                                                   | Accounts receivable                                                                                                                                           |         |        | 4,477   |      |         |         | 9,373   |   |         |          | (45,459 | )
|                                                             |                                                                                   | Prepaid expenses and other current assets                                                                                                                     |         |        | 181     |      |         |         | 2,720   |   |         |          | (3,250  | )
|                                                             |                                                                                   | Other non-current assets                                                                                                                                      |         |        | 551     |      |         |         | (4,569  | ) |         |          | (1,937  | )
|                                                             |                                                                                   | Accounts payable                                                                                                                                              |         |        | (6,065  | )    |         |         | 6,596   |   |         |          | 5,320   |  
|                                                             |                                                                                   | Accrued expenses                                                                                                                                              |         |        | (1,698  | )    |         |         | 3,386   |   |         |          | 4,787   |  
|                                                             |                                                                                   | Accrued salaries and commissions                                                                                                                              |         |        | (4,689  | )    |         |         | 176     |   |         |          | 7,573   |  
|                                                             |                                                                                   | Deferred revenue                                                                                                                                              |         |        | (12,562 | )    |         |         | (11,124 | ) |         |          | 42,369  |  
|                                                             |                                                                                   | Other non-current liabilities                                                                                                                                 |         |        |        |      |         |         |        |   |         |          | 34      |  
|                                                             |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         
|Net cash used in operating activities                        |                                                                                   |                                                                                                                                                               | (12,806 | )      |         |      | (4,127  | )       |         |   | (16,661 | )       
|                                                             |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         
|Cash flows from investing activities:                        |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         
|                                                             | Purchases of property and equipment                                               |                                                                                                                                                               |         | (2,967 | )       |      |         | (5,859  | )       |   |         | (10,720  | )      
|                                                             | Net purchases of marketable securities available
    for sale                     |                                                                                                                                                               |         | (8,717 | )       |      |         | (17,360 | )       |   |         | (33,269  | )      
|                                                             | (Purchases) repayments of investments in private
    companies                    |                                                                                                                                                               |         |       |         |      |         | 2,000   |         |   |         | (7,000   | )      
|                                                             | Purchase of Intelliframe workflow technology and
    related expenses             |                                                                                                                                                               |         |       |         |      |         |        |         |   |         | (9,324   | )      
|                                                             | Acquisition of businesses, net of cash acquired                                   |                                                                                                                                                               |         |       |         |      |         |        |         |   |         | (4,741   | )      
|                                                             |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         
|Net cash used in investing activities                        |                                                                                   |                                                                                                                                                               | (11,684 | )      |         |      | (21,219 | )       |         |   | (65,054 | )       
|                                                             |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         
|Cash flows from financing activities:                        |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         
|                                                             | Borrowings under capital leases                                                   |                                                                                                                                                               |         | 2,500  |         |      |         |        |         |   |         |         |        
|                                                             | Repayments under notes payable and lines of credit                                |                                                                                                                                                               |         |       |         |      |         |        |         |   |         | (1,029   | )      
|                                                             | Payments on capital leases                                                        |                                                                                                                                                               |         | (4,932 | )       |      |         | (3,135  | )       |   |         | (685     | )      
|                                                             | Proceeds from exercise of stock options and
    warrants                          |                                                                                                                                                               |         | 2,617  |         |      |         | 10,512  |         |   |         | 11,445   |        
|                                                             | Proceeds from ESPP common stock issuances                                         |                                                                                                                                                               |         | 2,961  |         |      |         | 4,981   |         |   |         | 6,145    |        
|                                                             | Proceeds from OEM fees applied to deferred
    warrant charge                     |                                                                                                                                                               |         | 1,250  |         |      |         | 2,000   |         |   |         | 4,000    |        
|                                                             |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         
|Net cash provided by financing activities                    |                                                                                   |                                                                                                                                                               | 4,396   |        |         |      | 14,358  |         |         |   | 19,876  |         
|                                                             |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         
|Effect of the exchange rate on cash and cash
    equivalents |                                                                                   |                                                                                                                                                               | 1,299   |        |         |      | (228    | )       |         |   | (164    | )       
|                                                             |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         
|Net decrease in cash and cash equivalents                    |                                                                                   |                                                                                                                                                               | (18,795 | )      |         |      | (11,216 | )       |         |   | (62,003 | )       
|Cash and cash equivalents at beginning of period             |                                                                                   |                                                                                                                                                               | 98,497  |        |         |      | 109,713 |         |         |   | 171,716 |         
|                                                             |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         
|Cash and cash equivalents at end of period                   |                                                                                   | $                                                                                                                                                             | 79,702  |        |         | $    | 98,497  |         |         | $ | 109,713 |         
|                                                             |                                                                                   |                                                                                                                                                               |         |        |         |      |         |         |         |   |         |         

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

F-5



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##### Table of Contents



WEBMETHODS, INC.






NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


1.     Organization

webMethods, Inc. (the Company) is a leading
provider of 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. On February 10,
2000, the Company completed its initial public offering of
4,715,000 of its $.01 par value common stock, priced at $35.00
per share. Gross proceeds aggregated approximately
$165 million. 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.

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.

Allowance
for doubtful accounts

The Company maintains 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, inquires,
and other financial information from our customers.

F-6



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##### Table of Contents



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, 2003 and 2002, is
$1,800,000 and $2,800,000, 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 year 2003, the Company recorded an
other than temporary write down of $1,000,000 related to the
impairment of one private equity investment. During fiscal year
2002, the Company recorded an other than temporary write down of
$5,200,000 related to the impairment of four private equity
investments. The Company did not record an other than temporary
write down in fiscal year 2001.

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.

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##### Table of Contents



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. Prior to April 1, 2002, identifiable
intangible assets related to the acquisition of favorable lease
terms were amortized on a straight-line basis over four years.
Goodwill and assembled workforce were amortized on a
straight-line basis over three years. Non-compete agreements
were amortized on a straight-line basis over one year.

On April 1, 2002, the Company adopted
Statement of Financial Accounting Standards No. 142 (SFAS
No. 142) Goodwill and Other Intangible Assets,
which eliminated the amortization of goodwill and other
intangibles with indefinite lives unless the intangible asset is
deemed to be impaired. In accordance with SFAS 142, all of
our goodwill is associated with our corporate reporting unit, as
we do not have multiple reporting units. In accordance with the
SFAS No. 142, goodwill is tested for impairment using a
two-step process. The first step is to identify a potential
impairment and the second step measures the amount of the
impairment loss, if any. Goodwill is deemed to be impaired if
the carrying amount of the asset exceeds its estimated fair
value. The Company performed an impairment test of its goodwill
and determined that no impairment of remaining goodwill existed
at adoption and at March 31, 2003.

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, 2003 and March 31, 2002.

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



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##### Table of Contents



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 software licenses, 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



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##### Table of Contents



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.

The following table summarizes the Companys
results on a pro forma basis as if it had recorded compensation
expense based upon the fair value at the grant date for awards
consistent with the methodology prescribed in SFAS 123,
Accounting for Stock-Based Compensation, for fiscal
years 2003, 2002 and 2001:

|                                                              |  |                      |         |      |  |      |         |   |  |   |          |  
|------------------------------------------------------------- |  | -------------------- | ------- | ---- |  | ---- | ------- | - |  | - | -------- | -
|                                                              |  |                     
|                                                              |  | Year Ended March 31,
|                                                              |  |                     
|                                                              |  | 2003                 |         | 2002 |  | 2001
|                                                              |  |                      |         |      |  |     
|Net loss attributable to common shareholders, as
    reported |  | $                    | (8,585  | )    |  | $    | (82,709 | ) |  | $ | (131,614 | )
|Net loss attributable to common shareholders, pro
    forma   |  |                      | (63,735 | )    |  |      | (97,433 | ) |  |   | (259,735 | )
|Basic and diluted net loss per common share, as
    reported  |  |                      | (.17    | )    |  |      | (1.67   | ) |  |   | (2.81    | )
|Basic and diluted net loss per common share, pro
    forma    |  |                      | (1.24   | )    |  |      | (1.97   | ) |  |   | (5.54    | )

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 2.93%, 4.40% and 4.90% for the years ended
March 31, 2003, 2002 and 2001, respectively; expected volatility
of 97%, 125% and 122% for the years ended March 31, 2003, 2002
and 2001, 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, 2003, 2002 and 2001 was $8.93, $15.65 and $84.02,
respectively.

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.

F-10



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

2.     Summary of
significant accounting policies 
(Continued)

Segment
reporting

The Company operates as a single segment and will
evaluate additional segment disclosure requirements as it
expands its operations. See Note 19 or 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 will 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.
The Company adopted SFAS No. 142 on April 1, 2002 and,
at that time, stopped amortizing goodwill that resulted from
business combinations completed prior to the adoption.

The following table summarizes the impact of the
adoption of SFAS No. 142 on net loss and net loss per share
and the impact had SFAS No. 142 been in effect for all
periods presented (in thousands, except share and per share
amounts):

|                                          |  |                      |            |      |  |      |            |   |  |   |            |  
|----------------------------------------- |  | -------------------- | ---------- | ---- |  | ---- | ---------- | - |  | - | ---------- | -
|                                          |  |                     
|                                          |  | Year Ended March 31,
|                                          |  |                     
|                                          |  | 2003                 |            | 2002 |  | 2001
|                                          |  |                      |            |      |  |     
|Net loss                                  |  | $                    | (8,585     | )    |  | $    | (82,709    | ) |  | $ | (131,614   | )
|Adjustments:                              |  |                      |            |      |  |      |            |   |  |   |            |  
|Amortization of goodwill                  |  |                      |           |      |  |      | 35,590     |   |  |   | 31,947     |  
|                                          |  |                      |            |      |  |      |            |   |  |   |            |  
|Adjusted net loss                         |  | $                    | (8,585     | )    |  | $    | (47,119    | ) |  | $ | (99,667    | )
|Weighted average shares-basic and diluted |  |                      | 51,281,729 |      |  |      | 49,492,654 |   |  |   | 46,860,324 |  
|                                          |  |                      |            |      |  |      |            |   |  |   |            |  
|Adjusted basic and diluted EPS            |  | $                    | (0.17      | )    |  | $    | (0.95      | ) |  | $ | (2.13      | )
|Reported basic and diluted EPS            |  | $                    | (0.17      | )    |  | $    | (1.67      | ) |  | $ | (2.81      | )

In October 2001, the Financial Accounting
Standards Board 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 was
effective April 1, 2002 for the Company. There was no
impairment charge recorded for the fiscal year ended
March 31, 2003.

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

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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



2.     Summary of significant
accounting policies  (Continued)


for under EITF Topic No. D-103, the adoption of
the provisions of EITF Topic No. D-103 did not have an
impact on its consolidated financial position, results of
operations or cash flows.

In June 2002, the Financial Accounting Standards
Board issued SFAS No. 146 Accounting for Costs
Associated with Exit or Disposal Activities. This standard
is effective for exit or disposal activities that are initiated
after December 31, 2002. The adoption of this standard did
not have a material effect on the Companys financial
position, results of operations and cash flows.

In November 2002, the FASB issued Interpretation
No. 45 (FIN No. 45), Guarantors Accounting
and Disclosure Requirements for Guarantees, Including Indirect
Guaranteed of Indebtedness of Others. FIN 45 requires that
the Company recognize the fair value for guarantee and
indemnification arrangements issued or modified after
December 31, 2002, if these arrangements are within the
scope of the Interpretation. In addition, the Company must
continue to monitor the conditions that are subject to the
guarantees and indemnifications, as required under previously
existing generally accepted accounting principles, in order to
identify if a loss has occurred. If the Company determines it is
probable that a loss has occurred then any such estimable loss
would be recognized under those guarantees and indemnifications.
Some of the software licenses granted by the Company contain
provisions that indemnify licensees of the Companys
software from damages and costs resulting from claims alleging
that the Companys software infringes the intellectual
property rights of a third-party. The Company has historically
received only a limited number of requests for indemnification
under these provisions and have not been required to make
material payments pursuant to these provisions. Accordingly, the
Company has not recorded a liability related to these
indemnification provisions. The Company does not have any
guarantees or indemnification arrangements other than the
indemnification clause in some of its software licenses. The
adoption of this standard did not have a material effect on the
Companys financial position, results of operations and
cash flows.

In November 2002, the EITF reached a consensus on
EITF No. 00-21, Revenue Arrangements with Multiple
Deliverables. EITF No. 00-21 addresses certain aspects of
the accounting by a vendor for arrangements under which the
vendor will perform multiple revenue-generating activities. EITF
No. 00-21 will be effective for interim periods beginning
after June 15, 2003. The Company is currently evaluating
the impact of the adoption on its financial position,
results of operations and cash flows.

In December 2002, the Financial Accounting
Standards Board issued (SFAS 148), Accounting for Stock
Based Compensation-Transition and Disclosure-an Amendment to FAS
123. SFAS 148 provides two additional transition methods
for entities that adopt the preferable method of accounting for
stock based compensation. Further, the statement requires
disclosure of comparable information for all companies
regardless of whether, when, or how an entity adopts the
preferable, fair value based method of accounting. These
disclosures are now required for interim periods in addition to
the traditional annual disclosure. The amendments to SFAS
No. 123, which provides for additional transition methods,
are effective for periods beginning after December 15,
2002, although earlier application is permitted. The amendments
to the disclosure requirements are required for financial
reports containing condensed financial statements for interim
periods beginning after December 15, 2002. The Company has
accounted for stock-based employee compensation using the
intrinsic method under APB 25 and has adopted the amendment to
disclose the provisions of SFAS 148.

In January 2003, the FASB issued Interpretation
No. 46 (FIN No. 46), Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51, which
relates to the identification of, and financial reporting for,
variable-interest entities (VIEs). FIN No. 46 has
far-reaching effects and applies to new entities that are
created after January 31, 2003, as well as to existing VIEs
no later than the beginning of

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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



2.     Summary of significant
accounting policies  (Continued)


the first interim or annual reporting period that
starts after July 1, 2003. The Company does not believe
that FIN 46 will have a material impact on its financial
position, results of operations and cash flows.

In May 2003, the Financial Accounting Standards
Board issued SFAS No. 150 (SFAS 150), Accounting for
Certain Financial Instruments with Characteristics of Both
Liabilities and Equity. SFAS 150 requires that certain
instruments with certain characteristics be classified as
liabilities as opposed to equity. This statement is effective
for financial instruments entered into or modified after
May 30, 2003, and otherwise is effective July 1, 2003.
The Company does not believe that the adoption of this standard
will have a material impact on its financial position, results
of operations and cash flows.

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, 2003, 2002 and 2001,
the Company has paid the firm approximately $764,000,
$1,223,000, and $2,194,000 respectively. As of March 31,
2003 and 2002, the aggregate amounts in trade accounts payable
for these services was approximately $65,000 and $173,000,
respectively.

4.     Investments in
private companies

In April 2000, the Company made an investment in
a third-party totaling $2,000,000 of which $1,000,000 was equity
and $1,000,000 was convertible debt. The Company and this
third-party share a common Board member. In March 2002, the
Company recorded an other-than-temporary decline in value of
$200,000 in the equity investment. As of March 31, 2003 and
2002, the carrying value of the investment in this third-party
was $1,800,000 and the Companys equity position, excluding
conversion of the debt, was less than 4%. The Company incurred
royalty expense of $1,168,000 to this investment in the year
ended March 31, 2003. The Company did not incur royalty
expense to this third-party in the years ended 2002 and 2001,
respectively.

In September 2002, the Company recorded an
other-than-temporary decline in value of $1.0 million in
another one of the equity investments the Company made in a
private company during 2000.

5.     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.

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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

6.     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, 2003 |         | March 31, 2002
|                                     |  |                |         |               
|                                     |  | Cost           |         | Fair Value     |  | Cost |         | Fair Value
|                                     |  |                |         |                |  |      |         |           
|                                     |  |                |         |               
|                                     |  | (In thousands) |         | (In thousands)
|Due in one year or less              |  | $              | 96,799  |                |  | $    | 97,079  |            |  | $ | 112,912 |  |  | $ | 113,345 | 
|Due after one year through two years |  |                | 24,825  |                |  |      | 24,845  |            |  |   |        |  |  |   |        | 
|                                     |  |                |         |                |  |      |         |            |  |   |         |  |  |   |         | 
|                                     |  | $              | 121,624 |                |  | $    | 121,924 |            |  | $ | 112,912 |  |  | $ | 113,345 | 
|                                     |  |                |         |                |  |      |         |            |  |   |         |  |  |   |         | 

The gross unrealized holding gains were $300,000
and $433,000 for the years ended March 31, 2003 and 2002,
respectively. The unrealized holding gains have been included,
in accumulated other comprehensive loss, which is a separate
component of stockholders equity.

7.     Property and
equipment

Property and equipment consisted of the following:

|                                          |  |                |         |      |  |   |         |  
|----------------------------------------- |  | -------------- | ------- | ---- |  | - | ------- | -
|                                          |  |               
|                                          |  | March 31,     
|                                          |  |               
|                                          |  | 2003           |         | 2002
|                                          |  |                |         |     
|                                          |  |               
|                                          |  | (In thousands)
|Equipment                                 |  | $              | 22,226  |      |  | $ | 18,968  |  
|Software                                  |  |                | 7,694   |      |  |   | 6,518   |  
|Furniture                                 |  |                | 4,033   |      |  |   | 3,763   |  
|Leasehold improvements                    |  |                | 2,912   |      |  |   | 2,489   |  
|                                          |  |                |         |      |  |   |         |  
|                                          |  |                | 36,865  |      |  |   | 31,738  |  
|Accumulated depreciation and amortization |  |                | (24,797 | )    |  |   | (14,557 | )
|                                          |  |                |         |      |  |   |         |  
|                                          |  | $              | 12,068  |      |  | $ | 17,181  |  
|                                          |  |                |         |      |  |   |         |  

During the year ended March 31, 2003 and
2002, the Company acquired certain equipment and software under
capital leases. Assets under capital leases included in
equipment as of March 31, 2003 and 2002 are $9,171,000 and
$7,856,000, respectively. Assets under capital lease included in
software were $515,000 as of March 31, 2003 and 2002.
Assets under capital lease included in furniture as of
March 31, 2003 and 2002 are $65,000 and $0, respectively.
Related to these capital leases and included in the accumulated
depreciation and amortization is $6,871,000 and $3,474,000 at
March 31, 2003 and 2002, respectively.

8.     Income
taxes

The Company has recorded no provision for income
taxes for the years ended March 31, 2003, March 31,
2002 and March 31, 2001, as the Company has incurred
operating losses since its inception. Net operating loss
carryforwards (NOLs) as of March 31, 2003 are approximately
$234,984,000 which begins to expire in 2010. Approximately
$5,500,000 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.

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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



8.     Income taxes 
(Continued)


The tax effect of each temporary difference is as
follows:

|                                      |  |                |         |      |  |   |         |  
|------------------------------------- |  | -------------- | ------- | ---- |  | - | ------- | -
|                                      |  |               
|                                      |  | March 31,     
|                                      |  |               
|                                      |  | 2003           |         | 2002
|                                      |  |                |         |     
|                                      |  |               
|                                      |  | (In thousands)
|Net operating loss carryforwards      |  | $              | 86,740  |      |  | $ | 79,417  |  
|Accrued expenses                      |  |                | 46      |      |  |   | 4,106   |  
|Deferred revenue                      |  |                | 1,856   |      |  |   | 3,234   |  
|Accounts receivable                   |  |                | 751     |      |  |   | 1,009   |  
|Impairment loss in equity investments |  |                | 2,350   |      |  |   | 2,009   |  
|Property and equipment                |  |                | 568     |      |  |   | (365    | )
|Stock option compensation             |  |                | 6,394   |      |  |   | 5,680   |  
|Acquired intangibles                  |  |                | (9,050  | )    |  |   | (9,222  | )
|Research and development credit       |  |                | 6,287   |      |  |   | 4,493   |  
|Other                                 |  |                | 291     |      |  |   | 162     |  
|Valuation allowance                   |  |                | (96,233 | )    |  |   | (90,523 | )
|                                      |  |                |         |      |  |   |         |  
|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 $5,710,000,
which can be attributed primarily to accrued deferred tax
liabilities and additional operating losses.

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,
|                                                             |                    |          
|                                                             |                    | 2003      |       | 2002 |   | 2001
|                                                             |                    |           |       |      |   |     
|U.S. Federal statutory rate                                  |                    |           | 34.0  | %    |   |      | 34.0  | % |   |  | 34.0  | %
|State and local taxes, net of Federal income tax
    benefit |                    |           | (2.5  | )    |   |      | 1.4   |   |   |  | 2.6   |  
|Non-deductible items                                         |                    |           | (2.1  | )    |   |      | (18.8 | ) |   |  |      |  
|Change in valuation allowance                                |                    |           | (34.0 | )    |   |      | (6.6  | ) |   |  | (13.9 | )
|Amortization of nondeductible goodwill                       |                    |           |      |      |   |      | (14.6 | ) |   |  | (5.9  | )
|Change in general business credit                            |                    |           | 21.1  |      |   |      | 5.3   |   |   |  |      |  
|Acquisition costs                                            |                    |           |      |      |   |      |      |   |   |  | (8.9  | )
|Foreign rate differential                                    |                    |           | (16.5 | )    |   |      | (0.3  | ) |   |  |      |  
|Purchase price adjustment                                    |                    |           |      |      |   |      |      |   |   |  | (7.1  | )
|Other                                                        |                    |           |      |      |   |      | (0.4  | ) |   |  | (0.8  | )
|                                                             |                    |           |       |      |   |      |       |   |   |  |       |  
|                                                             | Effective tax rate |           |       |     | % |      |       |  | % |  |       |  | %
|                                                             |                    |           |       |      |   |      |       |   |   |  |       |  

9.     Notes payable
and lines of credit

As of March 31, 2003, the Company had a line
of credit agreement with a bank to borrow up to a maximum
principal amount of $20,000,000 with a maturity date of
October 10, 2003 and an interest rate

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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

9.     Notes payable
and lines of credit  (Continued)

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, 2003, 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 $355,000 related to an office lease.

10.     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. This arrangement includes a
restrictive covenant that requires the Company to maintain a
minimum of $2,500,000 of cash and marketable securities. During
the fiscal year ending 2003, the Company obtained another
equipment line of credit with another 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 at an interest rate of 5.95%. Principal and
interest is payable under each lease in 24 monthly
installments. At expiration of the lease term, the Company will
have the option to purchase the equipment at fair market value.

The Company leases office space in various
locations under operating leases expiring through fiscal year
2011. In December 1999, the Company entered into a five-year
lease agreement for office space for the Companys
headquarters in Fairfax, Virginia. Total rent expense was
approximately $9,492,000, $11,783,000 and $8,148,000 for the
years ended March 31, 2003, 2002 and 2001, respectively.

F-16



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

10.     Lease
commitments  (Continued)

Future minimum lease payments under the
Companys capital and operating leases are as follows:

|                                                               |            |                |        |         |  |   |        |       | 
|-------------------------------------------------------------- | ---------- | -------------- | ------ | ------- |  | - | ------ | ----- | 
|                                                               |            | Operating      |        | Capital
|                                                               |            |                |        |        
|                                                               |            |               
|                                                               |            | (In thousands)
|Years ending March 31,                                         |            |                |        |         |  |   |        |      
|                                                               | 2004       |                | $      | 11,360  |  |   | $      | 2,883 | 
|                                                               | 2005       |                |        | 9,722   |  |   |        | 329   | 
|                                                               | 2006       |                |        | 7,548   |  |   |        | 10    | 
|                                                               | 2007       |                |        | 7,648   |  |   |        |      | 
|                                                               | 2008       |                |        | 2,372   |  |   |        |      | 
|                                                               | Thereafter |                |        | 817     |  |   |        |      | 
|                                                               |            |                |        |         |  |   |        |      
|                                                               |            | $              | 39,467 |         |  |   | 3,222  |      
|                                                               |            |                |        |         |  |   |        |      
|Less amounts representing interest                             |            |                |        |         |  |   | (149   | )    
|                                                               |            |                |        |         |  |   |        |      
|                                                               |            |                |        |         |  |   | 3,073  |      
|Less current portion                                           |            |                |        |         |  |   | (2,743 | )    
|                                                               |            |                |        |         |  |   |        |      
|Capital lease obligation, net of current portion               |            |                |        |         |  |   | 330    |      
|Other long term liabilities                                    |            |                |        |         |  |   | 237    |      
|                                                               |            |                |        |         |  |   |        |      
|Capital lease obligation, net of current portion
    and other |            |                |        |         |  | $ | 567    |      
|                                                               |            |                |        |         |  |   |        |      

11.     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, 2003.

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.

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 $1,250,000 and $2,000,000,
of OEM fees from i2 during the years ended March 31, 2003
and 2002, respectively. These fees were recorded as a reduction
to the deferred warrant charge. The Company recorded $3,402,000
of amortization of the deferred warrant charge to sales and
marketing expense for both the year ending March 31, 2003
and for the year ending March 31, 2002. In April 2001, the
Company signed an amended warrant agreement which reduced the
number of shares of common stock i2 can purchase from 750,000 to

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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



11.     Stockholders
equity  (Continued)


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, 2003, 710,000 warrants remain outstanding with a
remaining life of approximately two years.

In March 2003, the OEM/ Reseller agreement was
modified to reduce the amount of OEM fees owed to webMethods
related to this agreement from $10,000,000 payable over four
years to $8,750,000 payable over five years. In addition, the
number of resources committed by webMethods to i2 has been
reduced as well as an elimination of the fee previously due to
i2 on certain maintenance arrangements. Due to this change in
the agreement, the amortization of the remaining unamortized
deferred warrant charge has been changed from 4 years to
5 years to coincide with the new payment schedule.

12.     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, for the year ended March 31,
2001, the financial statements have been retroactively restated
as if the merger had occurred as of the beginning of the year.
The Company incurred transaction costs of $34,039,000 directly
related to the merger.

13.     Business
acquisitions

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.

F-18



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



13.     Business
acquisitions  (Continued)


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
and 2001 respectively, the Company recorded $11,640,000 and
$12,998,000 of amortization of deferred stock compensation which
is based on the vesting period of related restricted stock.
During the year ended March 31, 2003, the Company did not
record any amortization of deferred stock compensation to
restricted stock. Pro forma information for these acquisitions
is not considered necessary as differences between actual and
pro forma information are not material.

14.     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.

15.     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 and again on April 1, 2003 by 2,462,195 shares of
common stock, 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, 2003, options to purchase 15,830,002 shares were
outstanding.

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.

F-19



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



15.     Stock based
compensation  (Continued)


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, 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 |      
|                            | Granted   |         |            | 3,606,974      |   |                  |        | 4.32   |  |   |        | 17.82  |  |   |       | 8.93  | 
|                            | Exercised |         |            | (906,603       | ) |                  |        | 0.11   |  |   |        | 14.36  |  |   |       | 3.20  | 
|                            | Cancelled |         |            | (2,448,580     | ) |                  |        | 0.11   |  |   |        | 151.09 |  |   |       | 17.70 | 
|                            |           |         |            |                |   |                  |        |         |  |  
|Outstanding, March 31, 2003 |           |         | 15,830,002 |                |   | $                | 0.11  |         |  | $ | 161.29 |        |  | $ | 18.49 |      
|                            |           |         |            |                |   |                  |        |         |  |  

Information regarding stock options outstanding
as of March 31, 2003 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   |           |  |                 |  | $                | 4.32   |             |  |                     |  |  | 1,079,789  |  |  |  | 5.95 |  |  | $ | 1.98   |  |  |  | 982,519   |  |  | $ | 1.89   | 
|                | 4.76   |           |  |                 |  |                  | 6.05   |             |  |                     |  |  | 370,357    |  |  |  | 6.77 |  |  |   | 5.99   |  |  |  | 305,790   |  |  |   | 6.05   | 
|                | 6.32   |           |  |                 |  |                  | 7.44   |             |  |                     |  |  | 1,608,478  |  |  |  | 9.41 |  |  |   | 7.31   |  |  |  | 146,709   |  |  |   | 7.18   | 
|                | 7.47   |           |  |                 |  |                  | 10.98  |             |  |                     |  |  | 1,707,759  |  |  |  | 8.93 |  |  |   | 8.66   |  |  |  | 368,967   |  |  |   | 8.40   | 
|                | 11.02  |           |  |                 |  |                  | 13.99  |             |  |                     |  |  | 893,224    |  |  |  | 7.93 |  |  |   | 12.14  |  |  |  | 436,300   |  |  |   | 12.29  | 
|                | 14.27  |           |  |                 |  |                  | 14.36  |             |  |                     |  |  | 6,271,337  |  |  |  | 8.63 |  |  |   | 14.36  |  |  |  | 3,680,695 |  |  |   | 14.36  | 
|                | 14.70  |           |  |                 |  |                  | 22.80  |             |  |                     |  |  | 1,613,774  |  |  |  | 8.34 |  |  |   | 19.54  |  |  |  | 689,385   |  |  |   | 20.16  | 
|                | 22.94  |           |  |                 |  |                  | 88.87  |             |  |                     |  |  | 1,809,833  |  |  |  | 7.75 |  |  |   | 43.73  |  |  |  | 1,014,663 |  |  |   | 45.30  | 
|                | 88.88  |           |  |                 |  |                  | 115.75 |             |  |                     |  |  | 471,921    |  |  |  | 7.13 |  |  |   | 105.29 |  |  |  | 310,560   |  |  |   | 105.66 | 
|                | 161.29 |           |  |                 |  |                  | 161.29 |             |  |                     |  |  | 3,530      |  |  |  | 6.81 |  |  |   | 161.29 |  |  |  | 3,530     |  |  |   | 161.29 | 
|                |        |           |  |                  |  |                  |        |             |  |                     |  |  |            |  |  |  |      |  |  |   |        |  |  |  |           |  |  |   |        | 
|$               | 0.11   |           |  |                 |  | $                | 161.29 |             |  |                     |  |  | 15,830,002 |  |  |  | 8.30 |  |  | $ | 18.49  |  |  |  | 7,939,118 |  |  | $ | 20.07  | 
|                |        |           |  |                  |  |                  |        |             |  |                     |  |  |            |  |  |  |      |  |  |   |        |  |  |  |           |  |  |   |        | 

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 $754,000, $1,218,000 and $6,807,000 was
amortized during the years ended March 31, 2003, 2002 and
2001 respectively, related to these options.

F-20



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



15.     Stock based
compensation  (Continued)


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.

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 3,750,000 shares of common stock have been made
available for issuance under the ESPP as of March 31, 2003.
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. This plan terminated on October 31, 2001.

F-21



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



15.     Stock based
compensation  (Continued)


The following table summarizes shares of common
stock available for issuance and shares purchased as of
March 31, 2003 (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               |  |  | 2661  |  
|                                        |  |  |       |  
|Additional authorized shares            |  |  | 750   |  
|Purchases                               |  |  | (383  | )
|                                        |  |  |       |  
|Balance at March 31, 2003               |  |  | 3,028 |  
|                                        |  |  |       |  

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.

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, 2003, 2002
and 2001.

F-22



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)

17.     Supplemental
disclosures of cash flow information:

|                                             |                                                                    |                      |     |       |  |      |     |       |  |   |       |         |   | 
|-------------------------------------------- | ------------------------------------------------------------------ | -------------------- | --- | ----- |  | ---- | --- | ----- |  | - | ----- | ------- | - | 
|                                             |                                                                    |                     
|                                             |                                                                    | Year Ended March 31,
|                                             |                                                                    |                     
|                                             |                                                                    | 2003                 |     | 2002  |  | 2001
|                                             |                                                                    |                      |     |       |  |     
|                                             |                                                                    |                     
|                                             |                                                                    | (In thousands)      
|Cash paid during the period for interest     |                                                                    | $                    | 673 |       |  | $    | 511 |       |  | $ | 156   |        
|                                             |                                                                    |                      |     |       |  |      |     |       |  |   |       |        
|Non-cash investing and financing activities: |                                                                    |                      |     |       |  |      |     |       |  |   |       |        
|                                             | Equipment purchased under capital lease                            |                      | $   | 1,665 |  |      | $   | 3,061 |  |   | $     | 4,350   |  
|                                             | Change in net unrealized gain or loss on
    marketable securities |                      |     | 135   |  |      |     | 692   |  |   |       | (1,125  | )
|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
also reduced the number of facilities by closing excess field
offices and consolidating several California facilities into two
locations.

During the quarter ended December 31, 2002,
the Company recorded a restructuring charge of $2.2 million
due to a further headcount reduction of approximately 43
employees or 5% of the workforce.

As of March 31, 2003 and March 31,
2002, respectively, $1.8 million and $3.0 million of
restructuring charges remained unpaid. This portion primarily
relates to rent on the excess facilities and will be paid over
the remaining rental periods.

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

F-23



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##### Table of Contents



WEBMETHODS, INC.


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 
(Continued)



19.     Segment
information  (Continued)


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,
|                  |       |                     
|                  |       | 2003                 |         | 2002    |  | 2001
|                  |       |                      |         |         |  |     
|                  |       |                     
|                  |       | (In thousands)      
|Revenues          |       |                      |         |         |  |      |         |         |  |   |         |        
|Americas          |       | $                    | 133,756 |         |  | $    | 143,003 |         |  | $ | 180,192 |        
|Europe            |       |                      | 36,351  |         |  |      | 35,666  |         |  |   | 17,800  |        
|Asia Pacific      |       |                      | 26,647  |         |  |      | 17,327  |         |  |   | 3,965   |        
|                  |       |                      |         |         |  |      |         |         |  |   |         |        
|                  | Total |                      | $       | 196,754 |  |      | $       | 195,996 |  |   | $       | 201,957 | 
|                  |       |                      |         |         |  |      |         |         |  |   |         |        
|Long Lived Assets |       |                      |         |         |  |      |         |         |  |   |         |        
|Americas          |       | $                    | 47,852  |         |  | $    | 55,360  |         |  | $ | 97,853  |        
|Europe            |       |                      | 2,228   |         |  |      | 1,555   |         |  |   | 1,236   |        
|Asia Pacific      |       |                      | 1,476   |         |  |      | 1,373   |         |  |   | 1,207   |        
|                  |       |                      |         |         |  |      |         |         |  |   |         |        
|                  | Total |                      | $       | 51,556  |  |      | $       | 58,288  |  |   | $       | 100,296 | 
|                  |       |                      |         |         |  |      |         |         |  |   |         |        

F-24



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##### Table of Contents



SCHEDULE II  VALUATION AND QUALIFYING
ACCOUNTS

For the years ended March 31, 2001, 2002 and
2003.

|                                |  |                |       |            |  |            |       |            |  |   |       |  |  |   |       | 
|------------------------------- |  | -------------- | ----- | ---------- |  | ---------- | ----- | ---------- |  | - | ----- |  |  | - | ----- | 
|                                |  | Balance at     |       |            |  |            |       | Balance at
|                                |  | Beginning of   |       |            |  |            |       | End of    
|                                |  | Period         |       | Provisions |  | Deductions |       | Period    
|                                |  |                |       |            |  |            |       |           
|                                |  |               
|                                |  | (In thousands)
|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 | 
|Year ended March 31, 2003       |  |                |       |            |  |            |       |            |  |   |       |  |  |   |       | 
|Allowance for doubtful accounts |  |                | 3,685 |            |  |            | 280   |            |  |   | 1,115 |  |  |   | 2,850 | 

F-25



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##### Table of Contents



Report of Independent Accountants on

Financial Statement Schedule


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

Our audit of the consolidated financial
statements referred to in our report dated April 23, 2003,
appearing in this Form 10-K of webMethods, Inc. for the
year ended March 31, 2003 also included an audit of the
financial statement schedule listed in Item 16(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 23, 2003

F-26



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##### Table of Contents



EXHIBIT INDEX

|        |      |             |  |     |  |                                                                                                                                               
|------- | ---- | ----------- |  | --- |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|        |      |            
|Exhibit |      |            
|Number  |      | Description
|        |      |            
|        | 2.1  |             |  | (1) |  | Agreement and Plan of Merger dated as of
    May 20, 2000, by and among webMethods, Inc., Wolf
    Acquisition, Inc. and Active Software, Inc.
|        | 3.1  |             |  | (2) |  | Fifth Amended and Restated Certificate of
    Incorporation of webMethods, Inc., as amended                                                   
|        | 3.2  |             |  | (3) |  | Amended and Restated Bylaws of webMethods, Inc.                                                                                               
|        | 4.1  |             |  | (3) |  | Specimen certificate for shares of webMethods,
    Inc. Common Stock                                                                          
|        | 4.2  |             |  | (4) |  | Rights Agreement dated as of October 18,
    2001 between webMethods, Inc. and American Stock
    Transfer & Trust Company                    
|        | 10.1 |             |  | (3) |  | Second Amended and Restated Investor Rights
    Agreement                                                                                     
|        | 10.2 |             |  | (5) |  | webMethods, Inc. Amended and Restated Stock
    Option Plan, as amended                                                                       
|        | 10.3 |             |  | (3) |  | Employee Stock Purchase Plan                                                                                                                  
|        | 10.4 |             |  | (3) |  | Indemnification Agreement entered into between
    webMethods, Inc. and each of its directors                                                 
|        | 21.1 |             |  | *   |  | Subsidiaries of webMethods, Inc.                                                                                                              
|        | 23.1 |             |  | *   |  | Consent of PricewaterhouseCoopers LLP                                                                                                         
|        | 24   |             |  |     |  | Power of Attorney (included on signature page of
    this report)                                                                             
|        | 99.1 |             |  | *   |  | Rule 13a-14(a) Certification of Chief
    Executive Officer                                                                                   
|        | 99.2 |             |  | *   |  | Rule 13a-14(a) Certification of Chief
    Financial Officer                                                                                   
|        | 99.3 |             |  | *   |  | Section 1350 Certification of Chief
    Executive Officer                                                                                     
|        | 99.4 |             |  | *   |  | Section 1350 Certification of Chief
    Financial Officer                                                                                     



---

|    |                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------
|(1) | Incorporated by reference to webMethods
    Registration Statement on Form S-4, as amended (File
    No. 333-39572).
|   
|(2) | Incorporated by reference to webMethods
    Form 10-K for the year ended March 31, 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).                  
|   
|(5) | Incorporated by reference to webMethods
    Form 10-K for the year ended March 31, 2002 (File
    No. 1-15681).     
|   
|*   | Filed herewith.                                                                                                      

47