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Webmethods Inc – ‘10-K’ for 3/31/01

On:  Friday, 6/29/01, at 4:35pm ET   ·   For:  3/31/01   ·   Accession #:  950133-1-501723   ·   File #:  1-15681

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Table of Contents

UNITED STATES

FORM 10-K

(Mark One)

	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 31, 2001
	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number

webMethods, Inc.

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

      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       No 

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

      The aggregate market value of webMethods Common Stock held by non-affiliates of the registrant as of May 31, 2001, based upon the closing price of webMethods Common Stock on the Nasdaq National Market for such date, was $858,707,762.

      As of June 22, 2001, there were outstanding 49,240,023 shares of webMethods Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

      Certain portions of the definitive Proxy Statement to be used in connection with webMethods’ annual meeting of stockholders, to be held on August 23, 2001, and to be mailed to stockholders on or about July 16, 2001, are incorporated by reference into Part III of this Form 10-K.

Table of Contents

WEBMETHODS, INC.

FORM 10-K

TABLE OF CONTENTS

Table of Contents

PART I

      Some of the information contained in, or incorporated by reference into, this report constitute forward-looking statements. These statements relate to future events or future financial performance and involve known and unknown risks, uncertainties and other factors. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” “intends,” “may,” “will,” “should,” “estimates,” “predicts,” “continue” and similar expressions are intended to identify forward-looking statements. The important factors discussed below under the caption “Factors that May Affect Future Operating Results,” among others, could cause actual results to differ materially from those indicated by forward-looking statements made herein and presented elsewhere by management from time to time. We do not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Item 1.  BUSINESS

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

OVERVIEW

      webMethods was organized in Delaware in 1996. We completed our initial public offering in February 2000. Our executive offices are located at 3930 Pender Drive, Fairfax, Virginia 22030 and we have offices across the United States, Europe and Asia. Our telephone number is (703) 460-2500.

      We are a leading provider of infrastructure software and services for comprehensive end-to-end integration solutions that enable our customers to achieve comprehensive automation of business processes by integrating their systems in real time. Our customers use our software, webMethods Enterprise, webMethods B2B, and webMethods Mainframe Integration Server, to integrate business processes among different systems within their enterprise and to work more closely with their customers, suppliers and other business partners through the real-time exchange of information and transactions. We achieve this comprehensive, real-time integration with the webMethods Extended Enterprise Solution Suite (formerly webMethods B2Bi Solutions Suite) software, the first end-to-end solution that operates inside, outside and across corporate firewalls. With the combined functionality of webMethods Enterprise, webMethods B2B, and webMethods Mainframe Integration Server, webMethods Extended Enterprise Solution Suite enables a company not only to integrate its portfolio of existing enterprise applications, but also to extend these applications to its customers, suppliers and other business partners. As a result, a company can exchange information in real time, enabling its business to operate faster and more efficiently and to use intranets and the Internet to conduct electronic transactions internally and with customers, suppliers and business partners. In addition, our software is incorporated into the operation of a number of major industry-backed exchanges.

      webMethods Extended Enterprise Solution Suite permits our customers to rapidly and cost effectively deploy new real-time business-to-business (B2B) e-commerce applications by both integrating their existing internal enterprise systems and by integrating these systems with those of their business partners. For example, webMethods Enterprise can improve supply chain management by automating, without costly custom programming, various internal business processes such as procurement, order processing, inventory management, shipping and fulfillment systems and enterprise resource planning systems. webMethods B2B can improve supply chain management by integrating the processes of our customer with similar processes of its customers, suppliers and business partners. webMethods Mainframe Integration Server enables integration with existing mainframe systems used in Global 2000 organizations. By using webMethods Enterprise software, webMethods Mainframe Integration Server and webMethods

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      We market our software globally through a direct sales force and a number of resellers and systems integrators. A key element of our sales and marketing strategy is to leverage relationships with our customers and business partners. We believe that by providing solutions to leading buyers, suppliers, portals and enterprise software and hardware companies pursuing enterprise application integration, or EAI, solutions, business-to-business e-commerce opportunities or comprehensive end-to-end-solutions, our software sales will increase substantially as our technologies become more widely deployed in the marketplace. Our installed base of customers has helped fuel demand for our products by introducing the customers, suppliers and other business partners of our customers to our products.

      webMethods Extended Enterprise Solution Suite, webMethods B2B, webMethods Enterprise and webMethods Mainframe Integration Server, have been licensed to customers in a variety of industries including manufacturing, telecommunications, financial services, shipping and logistics, chemicals and insurance. As of March 31, 2001, we had over 625 customers, including Cisco Systems, Citibank, Compaq Computer, Dell Computer, Dun & Bradstreet, Eastman Chemical, Federal Express, Ford Motor Company, W.W. Grainger, Hewlett-Packard, Lexmark, Lucent, Motorola and Starbucks. In addition, we have established strategic relationships with major industry-backed exchanges, such as Covisint, Aeroxchange, Quadrem, Converge and ForestExpress, to utilize our software to integrate their trading partners. We also have strategic relationships with enterprise application vendors, such as i2 Technologies, J.D. Edwards and SAP AG, that incorporate our technology into their software or resell our software. We have business relationships with other leading independent software vendors and system integrators, including Accenture, Ariba, BEA Systems, Commerce One, Deloitte Consulting, Electronic Data Systems (EDS), IBM Global Services, KPMG Consulting, Oracle, Siebel Systems and others.

Industry Background

     Proliferation and variety of internal applications

      Over the past decade, enterprise computing environments have undergone a significant transformation. This transformation has been driven by accelerating organizational demands for flexibility, efficiency, and speed in order to more effectively respond to a rapidly changing business environment and increasingly global marketplace. In parallel, there has been a shift from in-house, custom development of mission-critical applications to the purchase of these applications and related services from third-party vendors. Packaged applications have spread throughout the enterprise to address many highly strategic business functions, including resource planning, management of supply and distribution networks, customer relationship management, sales force automation, business decision support and e-commerce. In this new corporate environment, a single business process can require access to data and information from many

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      Companies have invested an enormous amount of financial and technical resources in developing and deploying a broad range of packaged and custom applications. To take full advantage of these investments, it has become critical for companies to efficiently integrate these applications. META Group estimates that the average Fortune 1000 company maintains 49 distinct enterprise applications and spends from one-quarter to one-third of its total information technology budget on integration-related efforts. The complexity of this integration challenge has historically required time-consuming, expensive, custom-developed in-house solutions or third-party specialized consulting and system integration services. More recently, the market for third-party EAI software has emerged to provide this integration capability as a packaged solution. Driven by the increasingly business-critical need for integration, the e-business integration software and service market is projected by IDC to reach a total size of $54 billion by 2005.

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

      The competitive environment for businesses has intensified dramatically in recent years, causing companies to seek new ways to generate sustainable competitive advantages. As competition has increased and markets have become more dynamic, companies have begun to recognize that they must coordinate more closely with their customers, suppliers and business partners.

      Against this backdrop, the explosive emergence of the Internet has further changed the nature and pace of business operations and competition. The Internet has emerged as a crucial medium for electronic commerce. The widespread adoption of the Internet as a business communications platform has created a foundation for business-to-business e-commerce that has already enabled organizations to tap new revenue streams, streamline cumbersome processes, lower costs and improve productivity. Companies are now able to conduct business electronically through an Internet-enabled real-time network of customers, suppliers and partners. As a result, the ability to conduct business electronically has become a critical strategic objective. Companies need to integrate all aspects of their enterprises, including back-office operations and processing, front-office applications, such as sales, marketing and customer service, and supplier management systems, such as planning, sourcing, purchasing, fulfillment and inventory control. For example, a company can now give its suppliers and partners real-time electronic access to its scheduling, billing and inventory information, thereby enhancing communication, reducing operating costs and creating a networked organization that takes advantage of supplier and partner strengths in ways not previously possible. To compete successfully, a company needs an integration platform that allows it to adapt quickly to changing market conditions, accelerate time to market, enhance relationships with customers, suppliers and partners, and reduce operating costs.

      Traditional enterprise applications alone, however, do not readily support business processes beyond the borders of an enterprise. As a result, companies relying only on their enterprise applications have not been able to easily integrate their business processes with those of their customers, suppliers and other business partners to achieve productivity gains.

      We believe the next wave of business innovation will focus on greater collaboration among businesses and the sharing of business processes among members of a business community. Businesses are seeking a comprehensive integration solution that allows them to utilize their existing portfolio of enterprise applications to exchange information and transact business with customers, suppliers and other business partners over the Internet.

      Based on the growth of the Internet and the expectations for growth in e-commerce, we believe the market opportunity for integration software and services is substantial. Research has been conducted to project the size of the integration software market. This research is based on interviews and surveys of industry associations and companies and measures only revenue to be received from Internet commerce sites. According to Forrester Research, revenue generated from business-to-business e-commerce will exceed $2.7 trillion by 2003, representing a far larger market opportunity than business-to-consumer

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     Current approaches to enterprise application integration are inadequate

      We believe that traditional integration and EAI solutions fail to fully capitalize on the benefits of Internet technologies and do not adequately address the challenges of business-to-business integration. These solutions are often inflexible and rigid, lack key functionality, such as security and integration management and monitoring, and do not offer the speed of implementation and time-to-market benefits required in today’s business environment. As a result, we believe that there is a significant opportunity for a vendor who can provide a platform that enables seamless, real-time and efficient integration across the extended enterprise of business-to-business trading partners. This platform needs to provide the following key capabilities:

      The variety of computing environments and the inability to share information across those environments have been a major impediment to business-to-business integration. For example, the co-existence of mainframe-based legacy systems and enterprise applications within a single business often makes it difficult to share information internally. More importantly, many organizations’ applications, particularly their enterprise resource planning, or ERP, systems, were not designed to communicate outside of a single enterprise, making business-to-business communication difficult.

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

      EAI software and other middleware technologies alone also fail to fully deliver comprehensive integration. These packages integrate systems within a single company, but typically cannot provide the open and scalable inter-company integration that is critical for comprehensive integration. Traditional EAI solutions rely on proprietary, custom architectures and software, which must be implemented by all parties to enable any inter-company usage. It is difficult to convince multiple parties in a trading network to implement the same products or technologies. In addition, EAI solutions experience operating difficulties

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

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

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

The webMethods Solution

      Our solution provides the foundation for a new class of comprehensive end-to-end software integration solutions for companies and industry trading exchanges that can be delivered with shorter, more cost-effective implementation cycles, the ability to scale to large numbers of business partners, and greater security and transactional integrity. webMethods Extended Enterprise Solution Suite is the first end-to-end solution that operates inside, outside and across corporate firewalls. We believe that webMethods Enterprise, webMethods Mainframe Integration Server and webMethods B2B, whether used alone or together as part of a comprehensive end-to-end solution, provide significant benefits to our customers.

      Our EAI solution involves developing, marketing and supporting comprehensive integration software products that enable our customers to more quickly expand and capitalize upon greater business opportunities. webMethods Enterprise software connects a wide range of enterprise applications and systems and provides a comprehensive software platform for integrating these applications with minimal custom programming.

      Increased Operational Efficiency. webMethods Extended Enterprise Solution Suite is critical to the success of customers because it integrates the “last mile” of business processes that may span many partners, companies or divisions inside a company. webMethods Enterprise enables companies to increase their operational efficiency by streamlining operations and providing up-to-date, accurate information in real-time across a complete range of enterprise applications. For example, a company may have an enterprise resource planning system such as SAP, a customer relationship management system such as Siebel as well as custom-developed applications for managing inventory or production. By integrating these systems in real time, we enable customers to ensure that there is consistent, up-to-date information in all systems at all times. This eliminates problems that arise from data inconsistency that can impact quality of

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      webMethods Mainframe Integration Server provides a unique capability not found in competing products which enables companies to easily integrate with existing legacy mainframe systems. Because approximately 70% of the world’s structured data resides in mainframe systems, this is a critical differentiator for webMethods and has enabled us to be successful with large Global 2000 organizations. webMethods Mainframe Integration Server provides a non-invasive approach to mainframe integration meaning it does not require extensive programming or changes to the mainframe systems.

      webMethods B2B provides companies with integrated direct links to buyers and suppliers, connects them to major B2B exchanges and enables real-time, interactive communication through the Internet regardless of existing technology infrastructure. The webMethods B2B software provides support for a broad range of current and emerging business-to-business communication standards, including eXtensible Markup Language, or XML, traditional EDI, Open Buying on the Internet, or OBI, and XML-based e-commerce frameworks, such as RosettaNet, cXML, Commerce One’s xCBL and Microsoft BizTalk. With webMethods B2B, the benefits provided by internally focused enterprise applications can be extended beyond a single company to its customers, suppliers and business partners. We also offer our customers the ability to choose varying levels of business partner integration, from minimal integration with a single business partner to full integration across an entire trading network. In addition, because webMethods B2B operates with many disparate systems and supports many different business-to-business communication standards, it can be implemented by multiple business partners without long and expensive implementation cycles or the need for consensus among business partners regarding communication standards. We believe the webMethods Extended Enterprise Solution Suite provides the following compelling and strategic business benefits to our customers:

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

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

      Improved Supply Chain Efficiencies. Achieving a close degree of collaboration with suppliers allows many companies to realize cost efficiencies by outsourcing a significant share of their manufacturing. With or without an outsourcing strategy, companies can use our software to achieve significant cost savings and

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

The webMethods Growth Strategy

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

      Leverage Customers and Partners as Distribution Channels. We believe that because we provide solutions to some of the leading e-commerce buyers, suppliers, business-to-business exchanges and enterprise software and hardware companies, our product sales benefit from a multiplier effect as our customers expose more of their business partners to our solution. As of March 31, 2001, we had over 625 customers including Cisco Systems, Citibank, Compaq Computer, Dell Computer, Dun & Bradstreet, Eastman Chemical, Federal Express, Ford Motor Company, W.W. Grainger, Hewlett Packard, Lexmark, Lucent, Motorola and Starbucks. We also have strategic relationships with major industry-backed exchanges, such as Covisint, Aeroxchange, Quadrem, Converge, and ForestExpress, to utilize our software to operate their trading networks. The members of, and investors in, those exchanges are Global 2000 companies that place significant weight on the technical decisions of the exchange and may purchase additional licenses or licenses for other webMethods products as a result of use of our products on the trading networks.

      We also have strong relationships with leading enterprise application software providers, including i2 Technologies, J.D. Edwards and SAP AG, who tightly integrate and distribute webMethods products with their software. For example, our relationship with SAP provides SAP’s customers with the SAP Business Connector, an OEM version of webMethods B2B used to integrate SAP applications. SAP and webMethods jointly target these customers to sell the full webMethods Extended Enterprise Solution Suite, which supports integration of non-SAP applications. In addition, SAP can resell certain webMethods products to both SAP and non-SAP customers, as well as receive referral fees for leads provided to webMethods. As another example, i2 Technologies has selected webMethods as their preferred integration platform, and has licensed webMethods software to tightly integrate with their applications. i2 sales representatives can sell both the integrated software as well as the full range of webMethods products. We believe these relationships, and similar relationships with J.D. Edwards, Broadvision and others, are unique in nature and provide a competitive advantage for webMethods. We also have relationships with other leading enterprise application software providers, including Ariba, BEA Systems, Commerce One, Hewlett-Packard, Oracle and Siebel Systems.

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      In addition, we have expanded and strengthened our partnerships with major system integrators in order to provide services and sales leverage to our software product-based business model. We have established a series of formal partnerships with system integrators, such as Accenture, American Management Systems, Inc., Computer Services Corporation, Deloitte Consulting, Electronic Data Systems, IBM Global Services and KPMG Consulting, Each of these partners has established a formal webMethods practice, thus increasing dramatically the number of webMethods–trained resources available through our system integrator partners. As a result of this expanded knowledge base, as well as joint implementation successes, these partnerships and alliances have resulted in a virtual extension of our direct sales force. In addition, through joint promotional and selling efforts with these partners, we are able to reach a broader range of customers than would be possible through our sales force alone. These relationships also enable us to focus on being the provider of business-to-business integration software and leveraging our unique capabilities and technologies while providing our customers with a comprehensive solution and enabling us to scale our business more quickly, effectively and inexpensively.

      Extend Technology and Product Leadership and Provide a Complete Integration Solution. We believe that we have developed the broadest and most comprehensive integration software currently available, supporting more application-to-application, business-to-business and mainframe integration protocols and data format standards than any competing product. We provide one of the most extensive libraries of integration adapters to enable our customers to achieve the highest levels of productivity when integrating systems within their enterprise or with their business partners. We have been a pioneer in the application of XML and Java technologies for all areas of integration and e-commerce. We intend to continue investing in research and development and to remain actively involved with industry standards bodies to ensure that our products incorporate developing technology and industry standards. We also intend to increase the performance, functionality and ease of use of our software by integrating new technologies and supporting a wider range of enterprise applications. In the future, we may acquire technology or businesses that enhance or complement our technology.

      We recognize that solving the integration challenges facing our customers is critical to the continued success of their businesses. Our approach is designed to help them meet those challenges by offering a comprehensive integration solution that is capable of integrating all key information system resources of our customers, as well as those of their business partners. We expect to continually add to the depth and breadth of the entire webMethods integration platform, always with the ultimate objective of making integration faster and easier for our customers. For application-to-application integration, the webMethods integration platform incorporates a high-speed information broker, intelligent adapters and management facilities necessary to provide a robust platform for integrating applications that require extremely high-speed exchange or synchronization of data. In addition, we have developed a methodology that enables our customers to develop a focused integration strategy and implementation plan. This methodology is accompanied by pre-built standard integration processes that can be readily customized and deployed.

      In November 2000, we began offering as a service webMethods Partner Connect (formerly B2B.com), the first platform for rapid trading partner integration, and webMethods for Trading Networks, a new product with enhanced functionality allowing organizations to grow and manage large diverse trading networks.

      Our key technical personnel have been recognized as innovators in integration, middleware and networking technologies. We believe that the recognition by industry analysts and the media of our technical achievements is important in increasing market awareness and generating business referral opportunities. In addition, we understand that our customers’ success is paramount and we partner with a variety of third parties whose capabilities both complement and augment our own in order to assist our customers in rapidly delivering successful business results.

      Leverage Professional Services Capabilities. We have established strong relationships with our customers by designing and developing successful integration solutions for them. In order to continue this, we plan to continue to expand our direct professional services capabilities by increasing the number of professional services consultants and adding additional service locations. In addition, we intend to offer

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      Expand Global Sales Efforts. We are aggressively pursuing a global, multi-channel distribution strategy that leverages both our direct sales force and our relationships with resellers, systems integrators and international distributors. We currently have more than 30 offices around the world, including more than 20 offices in North America and sales and support offices in Australia, England, France, Germany, Hong Kong, Japan, Korea, Mexico, the Netherlands, Singapore and Taiwan. We expect to continue expanding our international presence by establishing additional overseas offices in Europe, Asia and Australia and expanding our indirect sales channels in Europe and Asia. In addition, we plan to increase our customer and partner base through aggressive sales and marketing campaigns and by conducting joint marketing efforts with some of our customers and partners. As of March 31, 2001, we had 399 employees dedicated to sales and marketing.

      Continue to Emphasize Renewable License Model. While most software providers only license their software on a perpetual basis, we offer renewable term licenses to our customers as our preferred licensing model. At the end of the license term, customers can either renew for another term with a new license fee due or terminate their license. We believe that, because of the critical nature of the services performed by our software, a majority of the licenses will be renewed, which will provide future license revenues upon renewal of the licenses.

      Facilitate broad acceptance and deployment of webMethods’ Extended Enterprise Solution Suite. Our objective is to establish the webMethods Extended Enterprise Solution Suite as the integration software of choice across multiple industries. To facilitate this broad acceptance, we have designed our platform to be open, extensible and broadly applicable to many different markets. For example, we have licensed webMethods Enterprise or webMethods B2B to leading enterprises in the financial services, technology, telecommunications, government, utilities, retail, manufacturing and transportation industry sectors.

PRODUCTS AND SERVICES

      webMethods Extended Enterprise Solution Suite contains features that help integrate internal applications, business partners, exchanges, buyers and suppliers into online trading networks. Our software helps companies directly integrate with their business partners while also participating in business-to-business exchanges. Our software supports a broad range of current and emerging standards for business-to-business communications, including XML, traditional EDI, OBI and XML-based e-commerce frameworks such as Commerce XML, xCBL and FpML. In addition, webMethods B2B provides support for and interoperability with EDI applications as well as leading enterprise applications and systems.

Product Architecture and Technology

      webMethods Extended Enterprise Solution Suite offers a complete platform for automating business processes that span any system, application, division or company. It provides a complete end-to-end solution for integration inside the enterprise as well as with trading partners and customers over the Internet. webMethods Extended Enterprise Solution Suite has been designed to allow our customers to achieve internal integration as well as integration with business partners in less time, at lower cost and with fewer alterations to their existing applications than current alternatives.

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      Scalability, Performance and Reliability. The webMethods integration platform has been designed to handle thousands of simultaneous integration connections and service a high volume of transactions among those many connections. Using a clustered multi-server, multi-threaded architecture, the software’s performance is optimized for multi-processor systems, and supports high-volume server-side processing of business documents. For e-commerce implementations, a customer and their business partners that are both running webMethods B2B can take advantage of guaranteed delivery features that ensure that critical messages or business documents get delivered from one partner to another.

      Reusable Integration Services Architecture. The webMethods integration platform is built around a reusable architecture for application-to-application, business-to-business and mainframe integration services, which models business processes and operations such as purchase order submission and order tracking. The webMethods integration platform includes graphical development tools permitting integration services to be reused and combined across multiple trading partner relationships.

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

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

      Our product offerings are summarized below.

  webMethods Enterprise Products

      We market the webMethods Enterprise platform as a part of the webMethods Extended Enterprise Solution Suite as well as a on a standalone basis. Our integration methodology provides a framework for accelerating integration projects implemented by our customers and system integrator partners.

      webMethods Enterprise consists of a number of products that work together to provide our customers with a comprehensive enterprise integration or EAI solution. These products include the webMethods Enterprise Business Integrator for graphically modeling integration projects; the Information Broker, which provides the underlying technology for integrating different sources of data in real time; Intelligent Adapters, which provide dynamic connectivity to applications and systems; and Graphical Management and Monitoring Tools, which make the integration platform easy to deploy, manage and maintain.

      webMethods Business Integrator. The webMethods Business Integrator is a visual modeling tool that automates the design, development and deployment of end-to-end business processes. Once the design for integration is complete, the webMethods Business Integrator automatically generates the underlying code and runtime system, enabling customers to focus on business process issues, not technical complexities. The webMethods Business Integrator implements the webMethods Enterprise integration methodology and eliminates much of the custom programming involved in integrating complex systems.

      webMethods Enterprise Information Broker. The Information Broker is the central component of the webMethods Enterprise platform. The Information Broker resides on a server and mediates requests to and from applications, providing essential queuing, filtering, routing and storage of information in a secure

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      Information Broker Options. Our customers may choose the following Information Broker options, which increase functionality and enhance the ability of webMethods Enterprise to support mission-critical eBusiness integration projects:

      webMethods Enterprise Intelligent Adapters. Intelligent Adapters connect individual software applications to the webMethods Enterprise platform. Our partners and we have developed a large number of Intelligent Adapters that work with many enterprise applications and systems, including:

      Our breadth of Intelligent Adapters enables easier and faster integration of additional applications to an eBusiness integration solution or project. The wide range of Intelligent Adapters available from webMethods and our partners give webMethods Enterprise a scope of integration not available from other integration solution providers. We believe that our webMethods Enterprise Intelligent Adapters are also more configurable and adaptable than approaches available from other vendors. webMethods Enterprise

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      webMethods Enterprise Adapter Development Kit. The webMethods Enterprise Adapter Development Kit enables customers, partners and independent software vendors to create their own custom adapters for the webMethods Enterprise platform, which further extends the capabilities of the webMethods Enterprise platform. Virtually any application can be integrated through the use of custom adapters created with the Adapter Development Kit, thereby ensuring that customers can successfully integrate their current applications, as well as applications which may be developed or acquired in the future.

  webMethods B2B Products

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

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

      The webMethods B2B Integration Server can perform all communications using standard Hypertext Transport Protocol, or HTTP, as the data transport protocol. For this reason, communications sent through the webMethods B2B Integration Server are not rejected by corporate firewalls that generally exclude communications sent using proprietary protocols. We have invested significant resources so that our server software is able to utilize HTTP without compromising security, reliability or performance.

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

      webMethods for Trading Networks is a graphical tool that enables Global 2000 companies to build, manage and analyze high-volume, real-time trading networks. These networks allow companies to automate and streamline their business processes, eliminate unnecessary manual procedures and reduce costs associated with processing errors. Working in conjunction with the webMethods B2B system, webMethods for Trading Networks delivers a dynamic infrastructure with highly configurable business analysis and operational control. webMethods for Trading Networks accelerates integration, streamlines business processes and increases visibility across the entire trading network-providing real-time business views into trading partner interactions.

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      webMethods Partner Connect (formerly B2B.com) is a web-based solution that enables Global 2000 companies and major business-to-business trading exchanges to rapidly deploy trading networks of any size. For companies seeking to aggressively build out their business-to-business trading networks, webMethods Partner Connect makes it possible to accelerate the implementation process of thousands of partners by up to 50 percent. Through webMethods Partner Connect, Global 2000 companies and business-to-business exchanges can provide their trading partners access to all the resources and expertise they need to rapidly deploy, support and extend their trading exchange or corporate hub. webMethods Partner Connect provides all of the components necessary to help companies quickly deploy a trading network. webMethods Partner Connect implements a complete Implementation Methodology which presents each trading partner with best practice templates and a graphically driven, rapid implementation path to help accelerate the entire process. webMethods Partner Connect supports software downloads, license management, version control and software configuration capabilities that reduce the manual steps required to integrate partners. webMethods Partner Connect also provides Trading Partner Management by providing comprehensive tracking, administration and reporting of trading partners and their initiatives. In June 2001, webMethods Partner Connect was also enhanced to include an Enablement Center facility which allows a developer of a trading network to test its partner connections using webMethods Partner Connect before its trading network is completed, thereby ensuring the most efficient path to return on investment.

      webMethods B2B for RosettaNet provides support for the RosettaNet framework and all released RosettaNet partner interchange processes. RosettaNet is a popular business-to-business standard in the electronic components industry. In addition to providing complete support for this leading supply chain integration standard, webMethods B2B for RosettaNet processes transactional data and offers scalable trading partner profiles and business rule management.

Professional Services and Customer Care

      As part of a complete solution, we offer comprehensive professional services that complement our software, including strategic planning, project management and systems integration, as well as consulting services and training relating to our software products. As of March 31, 2001, our professional services and customer care group consisted of 219 employees.

      Professional Services. A majority of our customers make use of our professional services to help them design and develop a successful business solution. Experienced consultants work with customers to design a solution based on the customers’ existing applications and required functionality and then ensure that the selected solution is successfully implemented, from installation to ongoing maintenance. Our consultants have participated in or led a number of important integration projects for our customers and partners. In addition, webMethods has on-site professional services and development resources working with major application vendors to deliver OEM integration with partners such as i2 Technologies, J.D. Edwards and SAP AG.

      To supplement internal professional services capabilities, we have established strategic relationships with several consulting firms, including Accenture, Deloitte Consulting, EDS, IBM Global Services and KPMG Consulting. These system integrators provide us with a substantial body of expertise relating to enterprise applications and the creation of business-to-business e-commerce networks, as well as the flexibility to handle both large and small projects and deliver complete solutions. These systems integrators also give us feedback on our software and implementation that can be incorporated into product enhancements. We believe these relationships benefit our business by exposing our software to the substantial customer base of each of these systems integrators. While we generally partner with system integrators to provide services such as project implementation and management to our customers, our professional services organization also directly supports our customers by providing services related to integration mentoring, integration process design and custom adapter development.

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

      We charge for these services on a time and materials basis and provide them through our professional services groups based in the Fairfax, Virginia; Atlanta, Georgia; Dallas, Texas; Denver, Colorado; Santa Clara, California; Chicago, Illinois; San Francisco, California; Sunnyvale, California; Australia; England; France; Germany; Hong Kong; Korea; Japan; Mexico, the Netherlands; Singapore and Taiwan facilities. We plan to increase the number of our professional services consultants and add additional service locations.

      Customer Care. We believe that offering a superior level of customer service is essential for our long-term success. Because customer service is a standard feature of our licenses, almost all of our customers utilize our customer support. We offer our customers a choice of several levels of customer support, all of which provide dependable and timely resolution of customer technical inquiries. The most comprehensive option offers support 24 hours a day, seven days a week. We are committed to resolving customer inquiries in a rapid and cost-effective manner. In addition, customers can access the online customer newsgroup to benefit from the experiences of other companies in using our software.

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

CUSTOMERS

      As of March 31, 2001, we had licensed our software to over 625 customers. In the fiscal years ended March 31, 2001, March 31, 2000 and March 31, 1999 no individual customers accounted for more than 10% of our total revenues. Many of our customers are Global 2000 companies and the companies that serve them and represent a broad spectrum of enterprises within diverse industry sectors, including manufacturing, telecommunications, financial services, shipping and logistics, chemicals, insurance, and business-to-business exchanges.

STRATEGIC RELATIONSHIPS

      To increase our leadership in the market, we have formed strategic alliances with business-to-business e-commerce exchanges, enterprise application vendors, business-to-business e-commerce technology leaders and system integrators. These relationships enable us to capitalize on the growing market for e-commerce solutions by embedding and integrating our software into the products and services provided by our

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SALES AND MARKETING

      We sell our software through our direct sales force, enterprise application vendors who package our software with their product suite, resellers and third-party systems integrators. While the majority of our sales are made by our direct sales force or through resellers, a number of our sales are the direct result of leads generated by strategic relationships with systems integrators. The sales cycle for our software typically ranges from 60 to 180 days.

      As of March 31, 2001, our sales and marketing group consisted of 399 professionals located in our headquarters in Fairfax, Virginia, and offices in California; Colorado; New York; Texas; Georgia; Ohio; Illinois; Massachusetts; Australia; Canada; England; France; Germany; Hong Kong; Japan; Korea; Mexico; the Netherlands; Singapore; and Taiwan. Information on revenues derived from North America, Europe and Asia-Pacific countries, as well as long-lived assets located in those geographic areas, is included in Note 18 of the Notes to Consolidated Financial Statements included in Item 8 of this report. We expect to continue expanding our sales and marketing group through targeted recruitment of qualified individuals.

      Our system integrator partners and service, distribution and marketing partners have capabilities that complement and augment our own integration solution and extend our market reach. In particular, our system integrator partners often contribute industry-specific and application-specific expertise as well as large scale project management capabilities that enable us to address a broad range of markets. Many of our service, distribution and marketing partners package or incorporate our products with their products or solutions, enabling us to create combined offerings with our partners that address specific problems, focus on specific markets and provide more complete and tailored offerings. Relationships with our partners may be structured to include the ability for our partners to resell our products directly or to embed products directly into our partners’ products, or as referred relationships, where a customer is referred by our partner to license our products directly from us.

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

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RESEARCH AND DEVELOPMENT

      We believe that strong product development capabilities are essential to our strategy of continuing to enhance and expand the capabilities of our products in order to continue to provide our customers with a comprehensive integration platform. We have invested significant time and resources in creating a structured process for undertaking all product development. This process involves several functional groups at all levels within our organization and is designed to provide a framework for defining and addressing the activities required to bring product concepts and development projects to market successfully. In addition, we have recruited key engineers and software developers with experience in the application integration, networking and Internet software markets.

      We have made substantial investments in research and development, primarily through internal development. We believe that we have demonstrated significant innovations in our application of Java and XML technologies to the problems of integration. While we evaluate externally developed technologies for integration into our products, most enhancements have been, and are expected to continue to be, developed internally. The majority of our research and development activity consists of developing new versions of and enhancements to our products to better serve the needs of our customers.

      As of March 31, 2001, we had 283 employees dedicated to research and development. Our research and development expenditures in fiscal years 1999, 2000 and 2001 were approximately $6.1 million, $14.8 million and $45.2 million, respectively. We expect to continue committing significant resources to research and development in the future.

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

COMPETITION

      The market for integration software is rapidly changing and intensely competitive and is likely to become more competitive as the number of entrants and new technologies increases. While none of our competitors or potential competitors currently produces a solution that is identical to webMethods Extended Enterprise Solutions Suite, we are subject to current or potential competition in the integration software market from large software vendors; business-to-business exchanges that develop their own business-to-business integration solutions; certain EDI vendors; and vendors of proprietary EAI and application server products, who have added XML capabilities to their products. We also compete with various providers of application integration solutions, including CrossWorlds, SeeBeyond Technology Corp., TIBCO Software, Inc. and Vitria Technology, Inc. In addition, a number of other companies are offering products and services that address specific aspects of application integration, including IBM, Microsoft and BEA Systems, Inc. We also face competition for some aspects of our product and service offerings in the integration software market from major system integrators, both independently and in conjunction with in-house corporate information technology departments, which have traditionally been the prevalent resource for application integration. We expect additional competition from other established and emerging companies. In addition, customers and other companies with whom we have strategic relationships may become competitors in the future. Furthermore, our competitors may combine with each other, or other companies may enter our markets by acquiring or entering into strategic relationships with our competitors. For more information regarding our competition, see “Factors that May Affect Future Operating

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

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

INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS

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

      The unauthorized reproduction or other misappropriation of our proprietary technology could enable third parties to benefit from the technology developed by us without paying for it. In addition, the steps we have taken to protect our proprietary rights and intellectual property may not be adequate to deter misappropriation. We may not be able to detect unauthorized use of our proprietary information or take appropriate steps to enforce our intellectual property rights effectively. Despite efforts by us to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use software or technology that we consider proprietary and third parties may attempt to develop similar technology independently. In addition, other parties may breach confidentiality agreements or other protective contracts into which we have entered, and we may not be able to enforce our rights effectively in the event of these breaches. Furthermore, we expect that we will increase our international operations in the future, and the laws of many foreign countries do not protect our intellectual property rights to the same extent as 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.”

      We do not currently own any issued patents. We currently hold a trademark registration in the United States for the webMethods names. We also have a pending application for the trademark registration of the B2B Integration Server name in the United States and have pending applications for the registration of the webMethods name in the European Union, Japan and Australia. In addition, we have four pending patent applications for technology related to our products. It is possible that the patents, copyrights or

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      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. Although we attempt to avoid infringing known proprietary rights of third parties in our product development efforts, we expect that we may be subject to legal proceedings and claims for alleged infringement by us or our licensees of third party proprietary rights, such as patents, trademarks or copyrights, by us or our licensees from time to time in the ordinary course of business. While we are not aware that any of our products, patents, trademarks, copyrights or other proprietary rights infringe the proprietary rights of third parties, any infringement claims, with or without merit, brought by such third parties could be time-consuming and expensive to defend, or require us to enter into royalty or license agreements, which are not advantageous to us. In addition, parties making these claims may be able to obtain an injunction, which could prevent us from selling our products in the United States or abroad. Any of these results could harm our business. 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. For more information regarding our proprietary rights, see “Factors that May Affect Future Operating Results — Third party claims that we infringe upon their intellectual property rights could be costly to defend or settle.”

      In addition, we license technology that is incorporated into our products from third parties, and any significant interruption in the supply or support of any licensed software could adversely affect our sales, unless and until we can replace the functionality provided by this licensed software. 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.”

EMPLOYEES

      As of March 31, 2001, we employed 1,018 full-time employees. These included 399 in sales and marketing, 219 in professional services and customer care, 283 in research and development and 117 in administration and finance. Our future success will depend in part on our ability to attract, retain and motivate highly qualified technical and management personnel, for whom competition is intense. From time to time, we have employed, and will continue to employ, independent contractors and consultants to support research and development, marketing and sales, and business development. Our employees are not represented by a collective bargaining agreement and we have never experienced a strike or similar work stoppage. We consider relations with our employees to be good.

EXECUTIVE OFFICERS OF WEBMETHODS

      Our executive officers and their ages and positions as of May 31, 2001 are as follows:

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      Phillip Merrick, the 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 BS in Computer Science from the University of Melbourne in Australia.

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

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

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

FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

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

      We believe that quarter-to-quarter comparisons of our financial results are not necessarily meaningful indicators of our future operating results and should not be relied on as an indication of our future performance. If our quarterly operating results fail to meet the expectations of analysts, the trading price of shares of our common 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 amount and timing of operating costs relating to expansion of our business, operations and infrastructure and the number and timing of new hires. We plan to continue to increase our operating expenses to expand our sales and marketing operations and fund greater levels of research and development. Our operating expenses, which include sales and marketing, research and development and general and administrative expenses, are based on our expectations of future revenues and are relatively fixed in the short term. If revenue falls below our expectations in a quarter and we are not able to quickly reduce our spending in response, our operating results for that quarter could be harmed. It is possible that in some future quarter our operating results may be below the expectations of public market analysts and investors and, as a result, the price of our common stock may fall. In addition, the stock market, particularly the stock prices of Internet-related companies, has been very volatile. This volatility is often

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

      Due to customer demand, economic conditions or seasonal factors, we may experience a lower growth rate for, or no growth in, sales of our software products and services. For example, the growth rate for the sale of our products and services during summer months may be slower than at other times during year, particularly in European markets. We also may have slower or no growth due to patterns in the capital budgeting and purchasing cycles of our current and prospective customers. These periods of slower or no growth may lead to 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 products and services could cause our operating results to vary significantly from quarter to quarter, which could result in volatility in the stock price of the company.

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, and R. James Green, our Chief Technology Officer and Executive Vice President, 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.

We rely on system integrators and other strategic relationships to implement and promote our software products and, if these relationships terminate, we may lose important deals and marketing opportunities.

      We have established strategic relationships with business-to-business exchanges, resellers, enterprise application software providers, hardware platform and software applications developers, service providers, system integrators and other technology leaders. These relationships expose our software to many potential customers to which we may not otherwise have access. In addition, these relationships provide us with insights into new technology and with third-party service providers that our customers can use for implementation assistance. If our relationships with any of these organizations were terminated or if we failed to work effectively with our partners or to grow our base of these types of partners, we might lose important opportunities, including sales and marketing opportunities, and our business may suffer. In general, our partners are not required to market or promote our products and generally are not restricted from working with competing software companies. Accordingly, our success will depend on their willingness and ability to devote sufficient resources and efforts to marketing our software products rather than the products of others. If these relationships are not successful, we will have to devote substantially more resources to the distribution, sales and marketing, implementation and support of our products than we would otherwise, and our efforts may not be as effective as those of our partners, which would harm our business.

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

      We cannot be certain that we can attract or retain a sufficient number of highly qualified professional services personnel. Customers that license our software typically engage our professional services staff or third party consultants to assist with support, training, consulting and implementation. We believe that growth in our software sales depends on our ability to provide our customers with these services and to attract and educate third-party consultants to provide similar services. As a result, we plan to increase the number of our professional services personnel and third party consultants to meet these needs. New professional services personnel and service providers will require training and education and take time to reach full productivity. Competition for qualified personnel and service providers is intense, particularly because we are in a new market and only a limited number of individuals have acquired the skills needed to provide the services our customers require. Our business may be harmed if we are unable to expand our professional services organization and establish and maintain relationships with third-party implementation providers.

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

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

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 products or develop new products 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 business-to-business 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 products 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 revenues may decline and we may lose important sales and marketing opportunities if our relationship with some of our strategic partners changes or terminates.

      We currently have several strategic partners, such as SAP AG, J. D. Edwards, EDS and i2 Technologies, that we believe provide us with important sales and marketing opportunities. In addition, these relationships may include additional business opportunities, such as the SAP AG development partner agreement, under which we are the supplier of enterprise application integration technology for the

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If our customers do not renew their licenses, we may lose a recurring revenue stream, which could harm our operating results.

      Although most enterprise software providers offer perpetual licenses with a single payment received at the time of the license grant, we offer renewable term licenses to our customers as our preferred licensing model. We first shipped webMethods B2B in June 1998 and we first began licensing webMethods Enterprise on a renewable basis in August 2000. To date, only a few of our more significant licenses have reached their respective renewal dates. If a significant portion of our customers were to elect not to renew their licenses for our software or were to seek perpetual licenses in the future, we would lose a recurring revenue stream that is a factor in our business model, 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 expand our sales and distribution capabilities.

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

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

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

The integration software market is highly competitive, and we may not be able to compete effectively.

      The market for integration software solutions is rapidly changing and intensely competitive. There are a variety of methods available for integration software. 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 products. If integration products such as our software products 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

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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 Internet-based applications and standards, as well as general technology trends such as changes in or introductions of operating systems, will require us to adapt our software products to remain competitive. Our products could become obsolete and unmarketable if we are unable to adapt to new technologies or standards. Software as complex as ours often contains known and undetected errors or performance problems. Many serious defects are frequently found during the period immediately following introduction of new software or enhancements to existing software. Internal quality assurance testing and customer testing may reveal product performance issues or desirable feature enhancements that could lead us to postpone the release of new versions of our software. The reallocation of resources associated with any postponement could cause delays in the development and release of future enhancements to our currently available software. Although we attempt to resolve all errors that we believe would be considered serious by our customers, our software is not error-free. Undetected errors or performance problems may be discovered in the future, and known errors that we consider minor may be considered serious by our customers. This could result in lost revenue or delays in customer deployment and would be detrimental to our reputation, which could harm our business, operating results and financial condition. If our software products experience 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.

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

      We commenced operations in June 1996 and first shipped webMethods B2B in June 1998. Active Software, with which we completed a merger in August 2000, was incorporated in September 1995 and commercially released its first software product in August 1996. We have been operating as a combined company since August 2000. If we do not generate sufficient cash resources from our business to fund operations, our growth could be limited unless we are able to obtain additional capital through public or private equity or debt financings. If we are unable to grow as planned, our chances of achieving and maintaining profitability could be reduced, which, in turn, could have a material adverse effect on the

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

      Our ability to successfully offer software and services and implement our business plan in a rapidly evolving market requires an effective planning and management process. Our growth could be limited if we or our partners are unable to provide to our customers in a timely manner the implementation services sometimes required for the successful installation and use of our products. In addition, our management team may not be able to achieve the rapid execution necessary to fully exploit the market for our products and services. We have increased, and plan to continue to increase, the scope of our operations at a rapid rate. Our total revenues have grown to approximately $202.0 million for the year ended March 31, 2001, from $60.1 million for the year ended March 31, 2000. The number of people we employ has grown and will continue to grow substantially. As of March 31, 2000, we had a total of 522 employees. As of March 31, 2001, we had a total of 1,018 employees. Future expansion efforts could be expensive and may strain our managerial and other resources. To manage future growth effectively, we must maintain and enhance our financial and accounting systems and controls, integrate new personnel, manage expanded operations and our relationships with our customers, suppliers and partners. If we do not manage growth properly, it could harm our business, operating results and financial condition.

We may still face challenges that may prevent us from successfully completing the integration of our recent acquisitions.

      The integration of acquired businesses into our existing business is a complex, time-consuming and expensive process. We have acquired several businesses in the past year and still face certain challenges that, if not met successfully, may prevent us from successfully completing the integration of these businesses into our company. We may still encounter difficulties, costs and delays involved in integrating operations, including: the inability to market successfully an integrated line of products and services to our customers; the inability to retain key employees over a long period of time; and the diversion of management’s attention and financial resources from other ongoing business concerns. If we do not successfully complete the integration of these acquired businesses into our company, or if we are unable to achieve the perceived benefits of these acquisitions as rapidly as, or to the extent, anticipated by financial or industry analysts, the market price of our common stock may decline.

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

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

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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 products 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 products 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 pending patent applications for technology related to our software, but we cannot assure you that these applications will be successful. A small number of our agreements with 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 products and obtain and use information that we regard as proprietary. In addition, other parties may breach confidentiality agreements or other protective contracts we have entered into, and we may not be able to enforce our rights in the event of these breaches. Furthermore, we expect to continue increasing our international operations in the future, and the laws of certain foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States. Our means of protecting our intellectual property rights in the United States or abroad may not be adequate to fully protect our intellectual property rights. Litigation to enforce our intellectual property rights or protect our trade secrets could result in substantial costs and may not be successful. Any inability to protect our intellectual property rights could seriously harm our business, operating results and financial condition.

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

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

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Because our products 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 such as Internet commerce. Errors, defects or other performance problems could result in financial or other damages to our customers. Customers could seek damages for losses from us, which, if successful, could have a material adverse effect on our business, operating results or financial condition. In addition, the failure of our products to perform to customer expectations could give rise to warranty claims. Although our license agreements typically contain provisions designed to limit our exposure to product liability claims, existing or future laws or unfavorable judicial decisions could negate these limitation of liability provisions. We have not experienced any product liability claims to date. However, a product liability claim brought against us, even if not successful, could be time consuming and costly to defend and could harm our reputation. In addition, although we carry general liability insurance, our current insurance coverage would likely be insufficient to protect us from all liability that may be imposed under these types of claims.

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 products to companies in these markets, we may need to expand or enhance our products to adapt to these industry-specific technologies, which could be costly and require the diversion of engineering resources.

Item 2.  PROPERTIES

      Our principal administrative, sales, marketing and research and development facilities are 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 also maintain offices for sales and support personnel in New York, New York; Northern New Jersey; San Francisco, Sunnyvale, Berkeley, El Segundo, and San Diego, California; Alpharetta, Georgia; Plano, Texas; Columbus, Ohio; Chicago, Illinois; Englewood, Colorado; Boston, Massachusetts; Hilversum, The Netherlands; Frankfurt, Germany; Paris, France; Tokyo, Japan; Seoul, Korea; Taipei, Taiwan; Hong Kong; Singapore; Sydney and Melbourne, Australia; Montreal and Toronto, Canada; Atixopan, Mexico; and Reading, United Kingdom.

Item 3.  LEGAL PROCEEDINGS

      We are involved from time to time in routine litigation that arises in the ordinary course of our business, but are not currently involved in any litigation that we believe could reasonably be expected to have a material adverse effect on us.

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.

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PART II

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

      As of March 30, 2001, there were approximately 500 holders of record of webMethods’ common stock. The number of holders of record our common stock is not representative of the number of beneficial holders because many shares are held by depositories, brokers or other nominees.

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

      During our fiscal year ended March 31, 2001, we sold certain securities that were not registered under the Securities Act of 1933, as amended, at the time of issuance, as described below. On February 16, 2000, we sold a total of 518,135 shares of our common stock to a total of four investors for $33.78, or an aggregate of $17,502,600, in a private placement concurrent with our initial public offering. We also sold unregistered securities prior to our IPO in February 2000, as described in information in Item 15 of webMethods’ Registration Statement on Form S-1 (File No. 333-91039), which is incorporated by reference.

      On February 5, 2001, we issued to Computer Network Technology Corporation 273,542 shares of our common stock with a fair value of 23.3 million, in addition to a cash payment, in exchange for all of the issued and outstanding securities of IntelliFrame Corporation, a wholly-owned subsidiary of Computer Network Technology Corporation.

      In connection with an expanded partnering and reseller relationship between i2 Technologies, Inc. and webMethods, on March 2, 2001, we issued to i2 Technologies a warrant to purchase up to 750,000 shares of our common stock at an exercise price of $40.88 per share, subject to certain adjustments. This warrant and the underlying right to purchase shares expires upon the earlier to occur of March 2, 2005 or ninety (90) days after the expiration of the reseller agreement between i2 Technologies and webMethods. On June 1, 2001, we signed an amended warrant with i2 Technologies that reduced the number of shares that i2 Technologies is able to purchase to 710,000 and reduces the exercise price per share from $40.88 to $28.70. We believe that the fair value of the amended warrant did not exceed the fair value of the original warrant at the date of amendment.

      None of the foregoing transactions involved any underwriters, underwriting discounts or commissions, or any public offering, and the registrant believes that each transaction was exempt from the registration requirements of the Securities Act of 1933, as amended, by virtue of Section 4(2) thereof, Regulation D promulgated thereunder or Rule 701 promulgated under Section 3(b) thereof, pursuant to compensatory benefit plans and contracts relating to compensation as provided under such Rule 701. The recipients in such transactions represented their intention to acquire the securities for investment only and not with a

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Item 6.  SELECTED FINANCIAL DATA

      The following selected historical consolidated financial data for webMethods should be read in conjunction with the consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations of webMethods, which are included elsewhere in this report. The historical consolidated statement of operations data for the years ended March 31, 2001, 2000 and 1999 and the historical consolidated balance sheet data as of March 31, 2001 and 2000 are derived from the consolidated financial statements of webMethods, which have been audited by PricewaterhouseCoopers LLP, independent accountants for webMethods, and are included elsewhere in this report. The historical consolidated statement of operations data for the years ended March 31, 1999, 1998 and 1997 and the historical consolidated balance sheet data as of March 31, 1998 and 1997 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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      The following discussion and analysis of the financial condition and results of operations of webMethods should be read in conjunction with the “Selected Consolidated Financial Data” contained in Item 6, and webMethods’ consolidated financial statements and related notes contained in Item 8. This discussion and analysis contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Words such as “anticipates,” “expects,” “intends,” “believes,” “plans,” “seeks,” “estimates” and similar expressions identify such forward-looking statements. These forward-looking statements are subject to risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under “Factors that May Affect Future Operating Results” in Item 1 and elsewhere in this report.

OVERVIEW

Background

      We are a leading provider of infrastructure software and services for comprehensive end-to-end integration solutions that enable our customers to achieve comprehensive automation of business processes by integrating their systems in real time. Our customers use our software, webMethods B2B, webMethods Enterprise, and webMethods Mainframe Integration Server to integrate business processes among different systems within the enterprise through the real-time exchange of information and to work more closely with their customers, suppliers and other business partners through the real-time exchange of information and transactions.

      webMethods was founded in June 1996. In August 2000, webMethods acquired Active Software, Inc. (“Active”) in a transaction which was accounted for as a pooling of interests. Active was founded in September 1995. We have grown from 94 employees as of March 31, 1998 to 1,018 employees as of March 31, 2001. We shipped the first version of webMethods B2B in June 1998 and have released seven subsequent versions of webMethods B2B, the most recent of which we began shipping in April 2001. The first version of webMethods Enterprise Server was shipped in August 1996, and eleven subsequent versions of the webMethods Enterprise Server have been released since, the most recent of which began shipping in March 2001. The first shipment of the webMethod’s Mainframe Integration Server was in August 2000 and two subsequent versions have been released with the most recent being in December 2000.

Business Merger

      On August 15, 2000 webMethods completed a merger with Active, a provider of software products for businesses that allow users to integrate incompatible software applications across their extended enterprises of customers, suppliers and partners, which was a publicly held software company based in Santa Clara, California. 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 has been accounted for as a pooling of interests, and accordingly the financial statements have been retroactively restated as if the merger had occurred as of the beginning of the earliest period presented. Active had a calendar fiscal year end. In connection with the retroactive restatement, the financial statements of Active were recast to a March 31 year end to conform to webMethods presentation.

Business Acquisitions

      In April 2000, we acquired Premier Software Technologies, Inc. (Premier), a provider of integration products and services for e-commerce. In connection with this transaction, 63,929 shares of our common stock were issued and cash of $500,000 was paid 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 our common stock.

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      In April 2000, we acquired TransLink Software, Inc. (TransLink), a provider of high performance mainframe integration solutions for e-commerce. In connection with this transaction, 419,683 shares of our common stock were issued and cash of $4.5 million was paid. In addition, the outstanding options to purchase TransLink capital stock were converted into options to purchase an aggregate of 22,682 shares of our common stock.

Acquisition of Technology

      In February 2001, we acquired Intelliframe Corporation, a wholly owned subsidiary of Computer Network Technology Corporation (“Intelliframe”). Through the acquisition, we acquired Intelliframe, certain workflow technology and Intelliframe’s Boston based research and development team. The total purchase price for the acquisition was $32.1 million consisting of a cash payment of $8.8 million and the issuance of 273,542 shares of our common stock with a fair value of $23.3 million on the date of issuance.

      The Intelliframe workflow technology was purchased with the intent 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 include the completion of all planning, designing and testing activities that are necessary to meet its design requirements, including functions, features and technical performance requirements. No other significant assets were purchased. Accordingly management has determined the product into which the acquired technology is to be incorporated has not met technological feasibility and as such substantially all of the purchase price was charged to in-process research and development during the quarter ended March 31, 2001.

Revenue

      We enter into arrangements, which may include the sale of licenses of our integration 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 and no other significant obligations remain. Historically we have not experienced significant returns or offered exchanges of our products.

      For multi-element arrangements, each element of the arrangement is analyzed and we allocate a portion of the total fee under the arrangement to the undelivered elements, such as professional services, training and maintenance. 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), 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 us for maintenance arrangements).

      For electronic delivery, the product is considered to have been delivered when the access code to download the software from our website and activation key, as applicable, have 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 revenue 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.

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      Professional Services Revenue: Revenue from professional services is 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. Revenue for professional services and training is recognized when the services are performed.

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

Costs of Revenue

      Our cost of license revenue primarily includes royalties related to third parties’ software embedded in our products or sold to our customers. Our cost of professional services and maintenance revenue includes compensation and related expenses for our professional services and technical support organizations, costs of third-party consultants we use to provide professional services to customers and an allocation of overhead and recruitment costs.

Operating Expenses

      Our operating expenses are 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 include expenses which are specific to the sales and marketing activities, such as commissions, trade shows, public relations, promotional costs and marketing collateral. Also included in our operating expenses is the amortization of deferred stock compensation and deferred warrant charge.

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RESULTS OF OPERATIONS

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

Year Ended March 31, 2001 compared to Year Ended March 31, 2000

Revenue

      Total revenue increased by approximately $141.9 million, or 236%, to $202.0 million for the year ended March 31, 2001 from $60.1 million for the year ended March 31, 2000.

      License. License revenue increased by approximately $100.7 million, or 235%, to $143.5 million for the year ended March 31, 2001 from $42.8 million for the year ended March 31, 2000. License revenue as a percentage of total revenue is 71.1% and 71.2% for the year ended March 31, 2001 and 2000, respectively. The absolute dollar increase is primarily attributable to an increase in sales to new and existing customers resulting from increased sales force headcount, new products, features and enhancements, a growing acceptance of our integration software, new and expanded relationships with many systems integrators and enterprise application vendors and an increased presence internationally.

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      Professional Services. Professional services revenue increased by approximately $23.3 million, or 199%, to $35.0 million for the year ended March 31, 2001 from $11.7 million for the year ended March 31, 2000. Professional services revenue as a percentage of total revenue is 17.3% and 19.5% for the year ended March 31, 2001 and 2000, respectively. The absolute dollar increase is attributable to the increased licensing activity described above, which has resulted in increased customer implementation activity and follow-on professional services.

      Maintenance. Maintenance revenue increased by approximately $17.9 million, or 320%, to $23.5 million for the year ended March 31, 2001 from $5.6 million for the year ended March 31, 2000. Maintenance revenue as a percentage of total revenue is 11.6% and 9.3% for the year ended March 31, 2001 and 2000, respectively. This increase is due primarily to the increased license activity as described above since most license contracts include post contract maintenance and support which is recognized as revenue on a ratable basis over the term of the maintenance agreement.

Cost of revenue

      License. Cost of license revenue increased by approximately $2.6 million, or 100%, to $5.2 million for the year ended March 31, 2001 from $2.6 million for the year ended March 31, 2000. Cost of license revenue as a percentage of total revenue is 2.6% and 4.3% for the year ended March 31, 2001 and 2000, respectively. The growth in cost of license revenue on an absolute dollars basis was attributable to an increase in revenue from licenses for which we pay royalties related to third party software embedded in our products or sold to our customers. Gross profit margin on license revenue increased to 96% for the year ended March 31, 2001 compared to 94% for the year ended March 31, 2000. The improvement in gross margin was attributable to a smaller proportion of our products sold, incorporating third party technology for which we pay royalties. We anticipate that the cost of license revenue will increase in absolute dollars as we license additional products, although cost of license revenue may vary as a percentage of license revenue from period to period.

      Professional Services and Maintenance. Cost of professional services and maintenance revenue, excluding stock based compensation, increased by approximately $30.2 million, or 188% to $46.3 million for the year ended March 31, 2001 from $16.1 million for the year ended March 31, 2000. Cost of professional services and maintenance revenue as a percentage of total revenue is 22.9% and 26.8% for the years ended March 31, 2001 and 2000, respectively. This increase on an absolute dollar basis was primarily attributable to increases in the number of professional service and technical support personnel, which increased to 219 people as of March 31, 2001 from 114 people as of March 31, 2000, and to a lesser extent an increase in subcontractor and travel expenses. Gross profit margin on professional services and maintenance excluding stock based compensation, increased to 21% of professional services and maintenance revenue, for the year ended March 31, 2001 compared to 7% for the year ended March 31, 2000. The increase in gross profit margin is due primarily to the increase in maintenance revenue which has a lower cost associated with it as well as an increase in the rates charged on professional services.

Gross profit

      Gross profit increased by approximately $108.4 million, or 265%, to $149.3 million for the year ended March 31, 2001 from $40.9 million for the year ended March 31, 2000. The increase is attributable to the growth in our customer base, which contributed to increased revenue from software licenses, professional services and maintenance, and, to a lesser extent, a decrease in third party royalties as a percentage of license revenue and a decrease in professional services revenue as a percentage of total revenue. The gross profit margin was 74% for the year ended March 31, 2001, up from 68% for the year ended March 31, 2000.

Operating expenses

      Sales and Marketing. Sales and marketing expenses, excluding stock based compensation, increased by approximately $56.2 million, or 128%, to $100.2 million, for the year ended March 31, 2001 from

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      Research and Development. Research and development expenses, excluding stock based compensation, increased by approximately $30.4 million, or 205%, to $45.2 million for the year ended March 31, 2001 from $14.8 million for the year ended March 31, 2000. Research and development expense as a percentage of total revenue is 22.4% and 24.6% for the years ended March 31, 2001 and 2000, respectively. The absolute dollar increase in research and development expenses is attributable to increases in the number of software development, pre-commercial release quality assurance and documentation personnel, and, to a lesser extent, third-party development costs.

      General and Administrative. General and administrative expenses, excluding stock based compensation, increased by approximately $11.0 million, or 112%, to $20.8 million for the year ended March 31, 2001 from $9.8 million for the year ended March 31, 2000. General and administrative expense as a percentage of total revenue is 10.3% and 16.2% for the years ended March 31, 2001 and 2000, respectively. The absolute dollar increase in general and administrative expenses is attributable to external legal, accounting and other professional fees, provision for allowance for doubtful accounts, increases in the number of accounting, finance and human resources personnel and implementation of systems infrastructure.

      Acquisition Related Expenses. In connection with the acquisition of Active, we expensed $34.0 million in acquisition related expenses. These expenses included investment banking, regulatory, legal and accounting fees.

      Amortization of Goodwill and Acquired Intangibles. Amortization of goodwill and acquired intangibles was $41.4 million for the year ended March 31, 2001 and $1.3 million for the year ended March 31, 2000. The estimated useful life of the goodwill and the acquired intangibles is 3 years for trained and acquired assembled workforce, one year for license agreements, 2 years for non-compete agreements, 3 years for goodwill and 4 years for favorable lease terms. The goodwill and acquired intangibles relate to the acquisitions of Alier during the year ended March 31, 2000, and Premier and Translink during the year ended March 31, 2001.

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

      Stock Based Compensation and Warrant Charge. In connection with the grant of stock options to employees and non-employee directors during the years ended March 31, 2000 and 1999, we recorded aggregate unearned compensation of $15.5 million, representing the difference between the deemed fair value of our common stock at the date of grant and the exercise price of such options. As a result of the acquisitions of Alier, Premier and Translink we recorded a deferred compensation charge of $27.9 million related to restricted stock issued to Alier, Premier and Translink stockholders. In connection with the

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      In March 2001, we entered into an OEM/Reseller agreement with i2 and issued i2 a warrant to purchase 750,000 shares of our 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 $23.6 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 $10,000,000 over the term of the agreement which will be recorded as a reduction to the deferred warrant charge and will not be recorded as revenue. In March 2001 we received $4.0 million of OEM fees from i2 which was recorded as a reduction to the deferred warrant charge.

      The deferred stock compensation and deferred 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. Of the total deferred stock compensation and warrant charge recorded for options, restricted stock and warrants, approximately $20.1 million was amortized during the year ended March 31, 2001, compared to $3.6 million during the year ended March 31, 2000.

Interest income, net

      Interest income, net increased by approximately $11.2 million, or 339%, to $14.5 million for the year ended March 31, 2001 from $3.3 million for the year ended March 31, 2000. This increase is primarily attributable to increases in interest income that resulted from the approximately $169.4 million in net cash proceeds resulting from issuance of common stock in our initial public offering and the concurrent private placement in February 2000.

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

Revenue

      Total revenue increased by approximately $45.8 million, or 320%, to $60.1 million for the year ended March 31, 2000 from $14.3 million for the year ended March 31, 1999.

      License. License revenue increased by approximately $32.0 million, or 296%, to $42.8 million for the year ended March 31, 2000 from $10.8 million for the year ended March 31, 1999. License revenue as a percentage of total revenue is 71.2% and 75.5% for the years ended March 31, 2000 and March 31, 1999 respectively. This absolute dollar increase is primarily attributable to an increase in sales to new and existing customers resulting from increased sales force headcount and a growing acceptance of our integration software.

      Professional Services. Professional services revenue increased by approximately $9.2 million, or 368%, to $11.7 million for the year ended March 31, 2000 from $2.5 million for the year ended March 31, 1999. Professional services revenue as a percentage of total revenue is 19.5% and 17.2% for the years ended March 31, 2000 and March 31, 1999 respectively. This absolute dollar increase is attributable to the increased licensing activity described above, which has resulted in increased customer implementation activity and follow-on professional services.

      Maintenance. Maintenance revenue increased by approximately $4.6 million, or 460%, to $5.6 million for the year ended March 31, 2000 from $1.0 million for the year ended March 31, 1999. Maintenance revenue as a percentage of total revenue is 9.3% and 7.3% for the years ended March 31, 2000 and March 31, 1999 respectively. This absolute dollar increase is attributable to the increased licensing activity described above. Because a majority of the license contracts include post-contract maintenance and support, an increased level of license revenue as well as renewal maintenance on perpetual licenses results in an increased amount of maintenance revenue recognized ratably over the term of the maintenance agreement.

Cost of revenue

      License. Cost of license revenue increased by approximately $1.8 million, or 227%, to $2.6 million for the year ended March 31, 2000 from $799,000 for the year ended March 31, 1999. Cost of license

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      Professional Services and Maintenance. Cost of professional services and maintenance, exclusive of stock based compensation, increased by approximately $12.3 million, or 324% to $16.1 million for the year ended March 31, 2000 from $3.8 million for the year ended March 31, 1999. Cost of professional services and maintenance revenue as a percentage of total revenue is 26.8% and 26.6% for the years ended March 31, 2000 and March 31, 1999 respectively. This absolute dollar increase is primarily attributable to increases in the number of professional service and technical support personnel, which increased to 114 people as of March 31, 2000 from 26 people as of March 31, 1999. In addition, subcontractor, travel, and recruiting expenses contributed to the increase in cost of professional services and maintenance for the year ended March 31, 2000. Gross profit margin on professional services and maintenance, exclusive of stock based compensation, increased to 7% of professional services and maintenance revenue in the year ended March 31, 2000 compared to (9%) for the year ended March 31, 1999.

Gross profit

      Gross profit increased by approximately $31.3 million, or 326%, to $40.9 million for the year ended March 31, 2000 from $9.6 million for the year ended March 31, 1999. The increase is attributable to the growth in our customer base, which contributed to increased revenue from software licenses, professional services and maintenance. The gross profit margin was 68% for the year ended March 31, 2000 up from 67% for the year ended March 31, 1999.

Operating expenses

      Sales and Marketing. Sales and marketing expenses, exclusive of stock based compensation, increased by approximately $29.2 million, or 197%, to $44.0 million for the year ended March 31, 2000 from $14.8 million for the year ended March 31, 1999. This expense as a percentage of total revenue is 73.2% and 103.3% for the year ended March 31, 2000 and March 31, 2001 respectively. The absolute dollar increase in sales and marketing expenses is primarily attributable to an increase in the number of sales and marketing employees, international expansion and, to a lesser extent, increases in marketing programs.

      Research and Development. Research and development expenses, exclusive of stock based compensation, increased by approximately $8.7 million, or 143%, to $14.8 million for the year ended March 31, 2000 from $6.1 million for the year ended March 31, 1999. This expense as a percentage of total revenue is 24.6% and 42.5% for the year ended March 31, 2000 and March 31, 2001 respectively. The absolute dollar increase in research and development expenses is attributable to increases in the number of software development, pre-commercial release quality assurance and documentation personnel and in third-party development costs.

      General and Administrative. General and administrative expenses, exclusive of stock based compensation, increased by approximately $6.6 million, or 206%, to $9.8 million for the year ended March 31, 2000 from $3.2 million for the year ended March 31, 1999. This expense as a percentage of total revenue is 16.2% and 22.2% for the year ended March 31, 2000 and March 31, 2001 respectively. This absolute dollar increase is primarily attributable to increases in the number of accounting and finance, human resources, and office administration personnel. In addition, professional service fees, corporate insurance and other general corporate costs increased to support organizational growth.

      Amortization of Goodwill and Acquired Intangibles. Amortization of goodwill and acquired intangibles was $1.3 million during the year ended March 31, 2000. The estimated useful life of the goodwill and the acquired intangibles is 3 years for trained and acquired assembled workforce, one year for

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      In-process Research and Development. In-process research and development was $2.7 million during the year ended March 31, 2000. This amount represents a one-time charge of $2.7 million recorded upon the acquisition of Alier in February 2000. This charge relates to the in-process research and development that was expensed upon consummation of the acquisition as technology acquired had not reached technological feasibility, and in the opinion of management, had no alternative future use.

      Amortization of Deferred Stock Compensation. Certain options granted during the year ended March 31, 2000 have been treated as compensatory because the estimated fair value for accounting purposes was greater than the exercise price as determined by our Board of Directors on the date of grant. The total deferred stock compensation associated with these options as of March 31, 2000 amounted to approximately $11.1 million, net of amortization. In connection with the acquisition of Alier, restricted stock was issued to two of the Alier stockholders, which has been treated as deferred stock compensation. These restrictions vest over a 2-year period. Of the total deferred stock compensation, approximately $3.6 million was amortized during the year ended March 31, 2000 compared to $577,000 during the year ended March 31, 1999. These remaining amounts are being amortized over the respective vesting periods of these equity arrangements, generally 48 months for the options and 24 months for the restricted stock.

Interest income, net

      Interest income, net increased by approximately $2.9 million, or 699%, to $3.3 million for the year ended March 31, 2000 from $415,000 for the year ended March 31, 1999. This increase is primarily attributable to increases in interest income that resulted from the approximately $169.4 million in net cash proceeds resulting from issuance of common stock in our initial public offering and the concurrent private placement in February 2000.

Quarterly results of operations

      The following tables set forth consolidated statement of operations data for us for each of the eight quarters ended March 31, 2001, as well as that data expressed as a percentage of the total revenue for the quarters presented. This information has been derived from our unaudited consolidated financial statements, which have been retroactively restated to give effect to the pooling of interests in connection with the merger between webMethods and Active. The unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements contained in Item 8 of this report and include all adjustments, consisting only of normal recurring adjustments that we consider necessary for a fair presentation of such information. You should read this information in conjunction with our annual audited consolidated financial statements and related notes appearing in Item 8 of this report. You should not draw any conclusions about our future results from the results of operations for any quarter.