Back to GetFilings.com

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

1

Table of Contents

	•	increase return on investment from existing enterprise software systems;
	•	increase operational efficiency by reducing internal costs and inefficiencies and streamlining operations;
	•	improve supply chain efficiencies through shortened cycle times, lower inventories and reduced error rates;
	•	accelerate time-to-market for new products and services by integrating internal applications into a platform and integrating and synchronizing this platform with end-to-end information flow between enterprise applications and customers, suppliers and business partners;
	•	strengthen relationships with their customers, suppliers and business partners due to new direct, secure connections across multiple computing platforms, applications and protocols; and
	•	create new revenue opportunities due to improved customer retention, improved customer service and the ability to deliver additional value-added services and customized product offerings.

      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

2

Table of Contents

      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

3

Table of Contents

     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:

	•	Comprehensive, Robust Solution: a comprehensive, end-to-end solution for extended enterprise integration, inside the enterprise and with business-to-business trading partners and customers over the Internet that does not require substantial custom programming;
	•	Dynamic Adaptability: a system designed to adapt quickly and efficiently to changing business operations, rules and processes, and to accommodate change without additional programming;
	•	Scalability: a system that easily accommodates a wide range of transaction and data flow volumes across locally and globally-distributed networks;
	•	Extensibility: flexibility to allow for the efficient incorporation of, and integration with, evolving technologies;
	•	Security: inherent state-of-the-art security and administrative capabilities designed for integration among an enterprise and its customers, suppliers and business partners; and
	•	Management and Monitoring: efficient, easy-to-use and centralized management and monitoring of the integration platform and all of its components.

      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

4

Table of Contents

      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

5

Table of Contents

      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

6

Table of Contents

      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.

7

Table of Contents

      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

8

Table of Contents

      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.

9

Table of Contents

      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

10

Table of Contents

      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:

	•	The Multi-Broker Option enables an unlimited number of Information Brokers to be configured to provide information sharing and automatic information delivery throughout the enterprise, including its network of customers, suppliers and business partners. Multiple Information Brokers collaborate to provide a single integrated system that efficiently delivers information among applications.
	•	The High Availability Option ensures uninterrupted availability without data loss through server outages.
	•	The Secure Socket Layer, or SSL, Option enables customers to send encrypted data with digital signature authentication.

      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:

	•	front-office and eCommerce applications, including those from Clarify, Inc., Siebel Systems, Inc. and InterWorld Corporation;
	•	back office enterprise applications, including those from PeopleSoft, Inc. and SAP;
	•	relational databases, including those from IBM (DB2), Informix Corporation, Microsoft Corporation (SQL Server), Oracle Corporation and Sybase, Inc.;
	•	custom applications developed using ActiveX, C, C++, CORBA, Java and XML Languages.

      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

11

Table of Contents

      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.

12

Table of Contents

      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.

13

Table of Contents

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

	•	architecture and application design services;
	•	application development;
	•	installation services;
	•	Testing and implementation services and maintenance services; and
	•	on-site support and coaching.

      We charge for these services on a time and materials basis and provide them through our professional services groups based in 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

14

Table of Contents

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.

15

Table of Contents

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

16

Table of Contents

      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

17

Table of Contents

      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:

18

Table of Contents

      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

19

Table of Contents

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.

20

Table of Contents

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 p