WEBMETHODS INC - 10-K Annual Report


x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 31, 2004

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

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 x No o

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

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

As of September 30, 2003, there were 52,057,159 shares of the registrant’s Common Stock outstanding. The aggregate market value of such shares held by non-affiliates of the registrant, based upon the closing sale price ($8.02) of such shares on the Nasdaq National Market for such date, was approximately $266,180,100. Shares of the registrant’s Common Stock held by each executive officer and director of the registrant, and by each entity publicly reporting that it owns 5% or more of the outstanding shares of the registrant’s Common Stock, have been excluded, as such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for any other purpose.

As of June 10, 2004, there were outstanding 52,870,429 shares of the registrant’s Common Stock.

Certain portions of the definitive Proxy Statement to be used in connection with the registrant’s 2004 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K to the extent stated. That Proxy Statement will be filed within 120 days of registrant’s fiscal year ended March 31, 2004.

This annual report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Examples of forward-looking statements include, but are not limited to, (i) projections of revenue, costs or expense, margins, income or loss, earnings or loss per share, capital expenditures, cash requirements or other financial items, sufficiency of working capital and projections regarding the market for webMethods’ software and services, (ii) statements of the plans, objectives or expectations of webMethods, Inc. or its management, including the development or enhancement of software, development and continuation of strategic partnerships and alliances, contributions to webMethods’ revenue by its business partners, implementation and effect of sales and marketing initiatives by webMethods, financial results of webMethods, Inc. and its subsidiaries, financial results within geographic or specific vertical markets and the allocation of resources to those markets, predictions of the timing and type of customer or market reaction to sales and marketing initiatives, the ability to control expenses, future hiring, webMethods’ business strategy and the execution on it and actions by customers and competitors, (iii) statements of future economic performance, economic conditions or the impact of recent or anticipated changes in accounting standards and (iv) assumptions underlying any of the foregoing. In some instances, forward-looking statements can be identified by the use of the words “believes,” “anticipates,” “plans,” “expects,” “intends,” “may,” “will,” “should,” “estimates,” “predicts,” “continue,” the negative thereof or similar expressions. Although we believe that the expectations reflected in the forward-looking statements are reasonable, our expectations or the forward-looking statements could prove to be incorrect, and actual results could differ materially from those indicated by the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to risks and uncertainties, including (but not limited to) those discussed in this Item 1 under the caption “Factors That May Affect Future Operating Results.” Achieving the future results or accomplishments described or projected in forward-looking statements depends upon events or developments that are often beyond our ability to control. All forward-looking statements and all reasons why actual results may differ that are included in this report are made as of the date of this report, and webMethods disclaims any obligation to publicly update or revise such forward-looking statements or reasons why actual results may differ.

We are a leading provider of software and services for end-to-end business integration solutions. We offer a set of software products that enable organizations to run, manage and optimize their business. Our software products and related services give organizations the ability, seamlessly and in real-time, to integrate disparate information resources, to connect customers, vendors and business partners with the organization and its employees, to view and manage the connected information resources, data, business processes and human workflows and to provide Web services at the enterprise level.

webMethods® completed three acquisitions in October 2003 to significantly expand our portfolio of products in the Service Oriented Architecture (SOA), Business Activity Monitoring (BAM) and portal spaces. Taken individually, the acquisitions were:


	•	The Mind Electric. webMethods acquired The Mind Electric, Inc., a privately-held provider of Web services and Service Oriented Architecture software that enables enterprise Service Oriented Architectures. The software products offered by webMethods that are derived from this acquisition are webMethods Fabric^TM and webMethods Glue®.

	•	The Dante Group. webMethods acquired The Dante Group, Inc., a privately-held provider of Business Activity Monitoring software. The software product offered by webMethods that is derived from this acquisition is webMethods Optimize^TM.


	•	DataChannel Portal. webMethods acquired certain assets of DataChannel (recently marketed as PortalMinder by Netegrity), a portal platform for creating secure, identity-driven portals within a scalable architecture. The software product offered by webMethods that is derived from this acquisition is webMethods Portal^TM.

With the addition of the products from these acquisitions, continued organic development from our product development team, and several key partnerships, webMethods offers a solution that represents the next generation of integration technology and provides our customers with a breadth of functionality that we believe is compelling. And while each one of the technologies represented in our solution is, in and of itself, significant and important to our customers, it is the combined breadth and strength of these technologies and the natural synergies among them that drive further value and return on investment for our customers.

The webMethods solution starts with the strength of our foundational integration capabilities. Introduced in the first quarter of webMethods’ fiscal year 2005, the webMethods Enterprise Services Platform^TM combines proven, mature enterprise application integration technology — incorporating the offering formerly known as the webMethods Integration Platform^TM — with the Service Oriented Architecture capabilities of webMethods Fabric^TM and webMethods’ highly-scalable and event-driven messaging capabilities. The result is an integration solution for linking business processes, enterprise and legacy application software products, databases, and Web services, both within and across business enterprises and government organizations. Further, the Service Oriented Architecture capabilities provided by webMethods Fabric enable customers to implement Web services-based integration on an enterprise scale. The webMethods Integration Platform now incorporated into the webMethods Enterprise Services Platform has enabled customers to achieve quantifiable return on their investment within a comparably brief timeframe by linking business processes and seamlessly integrating enterprise and legacy applications and databases.

To this strong foundation, webMethods brings value-added functions for end-to-end Business Process Management, integrated Business Activity Monitoring and greatly simplified Composite Application creation. These functions both complement and extend the functionality of the webMethods Enterprise Services Platform, allowing customers to leverage their integration efforts to realize broader value for their enterprise. It is the sum of these functions that enable customers to create an integrated, real-time view of their enterprise, establish real-time visibility into business processes and optimize existing business processes or create entirely new business processes as the pressures of competitive business dictate. We believe these capabilities result in enhanced adaptability and agility for our customers.

By deploying webMethods’ solutions, customers can reduce costs, create new revenue opportunities, strengthen relationships with their customers, vendors and business partners and establish real-time visibility and control of their business processes. webMethods’ solutions enable our customers to rapidly and cost-effectively meet the full range of their business integration requirements with a single, highly-scalable infrastructure. webMethods’ solutions enable our customers to create an integrated, real-time view of their customers, vendors and business partners, projects, orders, assets, business processes, human workflows, information system resources and data.

We had more than 1,100 customers as of March 31, 2004, including many major business enterprises included in the top 2,000 business enterprises worldwide (the “Global 2000”) and government organizations. Our customers include leaders in manufacturing, process industries (such as chemicals, oil and gas, life sciences, metals, paper and plastics), financial services, telecommunications, consumer goods manufacturing and retail, utilities and transportation and logistics. We license our software primarily through our direct sales force. In Japan and the Asia Pacific region and, to a lesser extent, in Europe, we also license our software through resellers. We pursue joint promotional and selling efforts with strategic partners who provide enterprise application software products, many of whom embed our software directly into their application products. We also pursue joint promotional and selling efforts through strategic alliances with major systems integrators. Through these joint efforts with our strategic partners, we leverage our direct sales force, and, indirectly, the sales forces of our partners, to reach a broader range of

Our goal is to continue extending our technology and product leadership in business integration and Service Oriented Architecture solutions. Our strategy is based on driving the success of our customers and partners, making our software ubiquitous among the Global 2000 and government organizations by expanding and maximizing our strategic software vendor partnerships, leveraging our sales force and technical services team by expanding our strategic alliances with major systems integrators and providing a compelling business integration and Service Oriented Architecture solution.

We believe that there are three major trends shaping our industry, and those trends are the basis for our strategy.

Integration is routinely rated as the top strategic priority for most Global 2000 companies and government organizations due to the benefits available from the integration of information resources. The reason is clear. Computers are being applied to ever more aspects of customers’ businesses. But with the widespread proliferation of packaged application software, custom applications, databases, Web services, and various other computing technologies, as well as proliferation of these same information resources and technologies throughout an organization’s chain of vendors, customers, affiliates and business partners, the ability to integrate these disparate systems and applications has become a strategic part of an organization’s information systems infrastructure. In addition, the need for integration software is driven by the widespread adoption of enterprise resource planning (ERP), supply chain management (SCM), financial management, and customer relationship management (CRM) software application products, whose strategic value to the customer is largely dependent on integration with other information systems and software products within the organization. Organizations that have purchased such software or systems often seek to streamline internal processes and enable communication and collaboration internally and with their customers, vendors and partners to increase productivity, create new revenue opportunities, reduce costs and strengthen relationships with their customers, vendors and business partners.

Second, in parallel with the continued demand for integration software, there has been an increase in the need for more sophisticated integration technology.

Integration systems today require the ability not only to integrate the numerous disparate information resource types (databases, legacy mainframe applications, packaged application software, custom applications, trading partners, people and Web services), but also to manage the business processes that govern the interactions between these resources. This Business Process Management capability is the foundation that allows an organization or enterprise to manage its business with its information systems. In many cases, the deployment of Business Process Management capability has revealed that many critical business processes involve activities that people must perform manually. Consequently, customers are pressuring integration vendors to provide fully-integrated manual workflow capabilities that allow users to define business processes that include manual steps and to manage the complete business process with their integration technology. Customers are also increasingly demanding software toolsets that allow for the rapid creation of user interfaces to support these human workflow steps.

More recently, integration technology has further evolved to include technologies that enable enterprises to access and analyze real-time data flowing through the integrated information systems associated with business transactions and to govern the interactions between the many information resources that comprise the enterprise information technology environment. This Business Activity Monitoring capability enables enterprises to realize real-time visibility into their business operations and provides them with the ability to effect more timely changes to their business operations resulting in the ability to optimize those operations to best meet the needs of the enterprise.

The ability of integration technology solutions to define business processes and Business Activity Monitoring schemas in a minimal amount of time and with a minimum of custom software coding is increasingly becoming an expectation of prospective customers. This demand for ease-of-use has caused a fundamental shift in demand for integration technology away from complex software programming techniques to a more intuitive, highly-graphical configuration approach. It has also driven the demand for integrated software tools that allow users to solve a wide variety of integration requirements without having to learn multiple software products or writing custom software code. A natural extension of this expectation is the ability to deliver personalized Composite Applications — applications that integrate functionality from multiple related, but stove-pipe, information systems — using a common presentation, delivery and collaboration framework.

The third significant trend in our industry is the growing acceptance among customers and prospects of Service Oriented Architecture and Web services as the preferred basis for implementing business integration, business process optimization and Composite Application functionality.

Service Oriented Architecture is an approach to software architecture and deployment that allows enterprises to more easily assemble, integrate, and modify software applications and business processes in response to market requirements. Service Oriented Architecture offers flexibility in the way information systems can be configured, and has the potential to lower implementation costs of multiple new software applications by increasing reusability. While not a novel concept in itself, Service Oriented Architecture is becoming more broadly accepted among customers and prospects given the growing acceptance and adoption of Web services methodology and is now generally viewed among customers and prospects as the best-practice approach for integration infrastructure software.

Complementing Service Oriented Architecture is the expanding interest in Web services. The appeal of Web services is the prospect of enforcing cross-platform standardization of the low-level integration points across a wide range of computing resources, thereby allowing a user or computing resource to seamlessly access functionality or business processes provided by other software products operating within the enterprise. The expected benefit is lower services costs associated with integration. Although a number of companies outside the integration software industry promote their offerings as a solution for Web services-based integration, many industry analysts agree that this functionality will be most capably delivered by established integration software companies, given their experience in seamlessly and securely linking enterprise and legacy applications and databases using standards-based technologies and protocols, and managing the operation of that infrastructure.

We believe that the webMethods solution offers a compelling suite of capabilities to integrate information resources and provide Web services at the enterprise level to make Global 2000 companies and government organizations more agile. With webMethods’ solution, customers are able to more rapidly deploy information technology capabilities as they pursue competitive advantages, seek to secure more value from their existing information technology resources and strive to take advantage of standards-based technologies in their information technology infrastructure.

The strength of the webMethods solution derives from both the strength of our individual solutions and the synergies enabled by our combination of Service Oriented Architecture, business integration, Business Process Management, Business Activity Monitoring and Composite Application Framework functionality. Historically, companies may have selected different products from different vendors to achieve these various capabilities, only to suffer from lack of integration between the different selected products. By combining these best-of-breed capabilities into one infrastructure, we offer customers the ability to lower their total cost of ownership and to streamline the overall implementation process.

At the foundation of webMethods’ solution is the webMethods Enterprise Services Platform, a set of software capabilities that enable customers to implement a powerful, reliable Service Oriented Architecture. webMethods calls this an Enterprise Service Oriented Architecture (ESOA). ESOA goes


	•	Proven business integration functionality — inherited from our previous flagship offering, the webMethods Integration Platform — which allows companies to not only integrate existing applications and establish electronic communications with trading partners, but to incorporate these resources seamlessly into the Enterprise Service Oriented Architecture. The webMethods Integration Server, which unites enterprise application integration and business-to-business functionality under a common architecture, is the basis for this capability. As a foundation for business integration and Composite Application development, the webMethods Integration Server allows the customer’s information technology resources to be published, managed and orchestrated as Web services in a Service Oriented Architecture. With so much investment tied up in existing information technology systems, this is the most expedient and cost-effective path to populating a Service Oriented Architecture with the Web services that higher-level software tools, portals, and other service-based applications can leverage. The move to Web services also benefits downstream business integration initiatives through reusability and the reduced cost and complexity resulting from standardization.

	•	A robust, scalable, high performance event-driven messaging capability that allows the webMethods Enterprise Services Platform to support real-time, message-oriented interactions in addition to the Web services request/reply style of interaction. Enabled by the webMethods Broker, event-driven processing naturally complements Web services by providing the real-time capabilities that are needed for Business Activity Monitoring and other applications. The webMethods Broker^TM offers reliable message delivery and a scalable publish/subscribe architecture that is capable of processing thousands of messages per second. The webMethods Broker is also the basis of webMethods JMS+^TM, a Java Message Service-compliant messaging solution that is offered as a standalone product.

	•	Enables implementation of an enterprise-caliber service-oriented infrastructure. Delivered by webMethods Fabric, the webMethods Enterprise Services Platform enables enterprises to go from small, static, brittle, ad hoc networks of unmanaged Web services to larger, dynamic, robust, coordinated networks of managed Web services. webMethods Fabric can be deployed as an intermediary or in conjunction with either the Web service producer or Web service consumer or both. webMethods Fabric coordinates the use of Web services in a Service Oriented Architecture regardless of what technology was used to create those services including, but not limited to, webMethods software, J2EE application servers, .NET-based applications, other packaged applications or mainframe environments. With this flexible deployment architecture, customers can reduce network latency and create a more secure and robust environment for deploying a Service Oriented Architecture. These include capabilities such as Web services monitoring and management, service discovery, dynamic binding, failover and load-balancing, and intelligent message processing.

	•	An extensive library of adapters so that the webMethods Enterprise Services Platform can integrate the numerous proprietary interfaces presented by a broad variety of enterprise applications (e.g., supply chain management software from i2 Technologies, inter-enterprise software solutions from SAP AG, sales, marketing and customer relationship management software from Siebel Systems, customer relationship management and enterprise management software from PeopleSoft). The webMethods Enterprise Services Platform can also be extended by customers and partners through the use of webMethods software toolkits that allow them to develop interfaces to integrate custom applications or other software with the webMethods Enterprise Services Platform.

	•	Support for a wide range of electronic commerce protocols that enable our customers to automate and integrate their commercial transactions generated by their information technology resources with the information systems of their customers and business partners. Examples of these types of transactions include purchasing and procurement, supply chain management, collaborative product


		design and vendor-managed inventory. Our software supports a broad range of capabilities to support these and other initiatives of an enterprise to integrate its information resources with those of its customers and business partners. These protocols include XML, traditional and Internet EDI, Commerce One’s xCBL, RosettaNet, Chem eStandards and ebXML.

	•	A high-performance Java Web services platform with webMethods Glue. webMethods Glue eliminates the traditional complexity of Web services development. Targeted at the Java developer, webMethods Glue provides the fastest and easiest way to turn ordinary Java objects into Web services with very little incremental effort. By using webMethods Glue, developers can publish any Java object as a Web service using just a few lines of code, while remote Web services can be invoked as if they were local Java objects.

	•	Capabilities targeted at J2EE and .NET developers to make it easier for users of those technologies to connect their application into the Enterprise Service Oriented Architecture.

webMethods’ Business Process Management solution facilitates business process management, first, by providing capabilities for orchestrating both automated and manual processes; second, by promoting the creation of business-oriented services that can be reused across different processes; and, third, by providing a level of abstraction from the underlying systems that makes the task of orchestrating business processes accessible to the non-technical user. The webMethods Business Process Management tools also provide an intuitive design and development environment for incorporating manual workflows and custom user-interfaces into business process flows, allowing the webMethods solution to manage automated and manual tasks. The webMethods Business Process Management solution provides two core capabilities: an easy-to-use graphical tool for modeling business processes and orchestrating services, and a codeless design environment that allows organizations to create workflow solutions, including associated user interfaces, to monitor and manage manual processes.

webMethods’ Business Activity Monitoring solution enables customers to achieve new levels of agility by monitoring their business operations on their information systems in real-time, identifying opportunities and diagnosing problems as they occur, and responding instantly to changes in business activity. The webMethods Business Activity Monitoring solution, webMethods Optimize, combines real-time awareness about business events with the ability to correlate information surrounding these events into meaningful feedback along the decision chain. This solution provides further value when the customer extends this correlation capability to the point of recommending responses or even predicting failures before they occur. With webMethods Optimize, companies are able to improve the speed and effectiveness of their decision-making by gaining complete real-time visibility into their business processes. webMethods offers a set of service offerings to support our customers’ implementation of our Business Activity Monitoring solution. These include the webMethods BAM Workshop, a facilitated on-site session which helps companies identify the business processes most appropriate for an initial Business Activity Monitoring implementation; a Business Process Report Card detailing the “as is” state of a business process with regard to its ability to meet its business commitments and identified Key Performance Indicators (KPI’s); and a BAM Assessment providing an in-depth analysis of a company’s key business processes with regard to their applicability and associated return on investment for Business Activity Monitoring.

From the services and resources that are made available through the webMethods infrastructure, the webMethods Composite Application Framework enables customers to assemble a new breed of application. With minimal development, these composite business applications are able to deliver personalized access to other application software, data and business processes from across the enterprise. Instead of developing

traditional client/server or Web applications using monolithic (and sometimes proprietary) technologies, the webMethods Composite Application Framework enables a process of assembly, using the inventory of Web services available within the webMethods-enabled Enterprise Service Oriented Architecture. As the key component of the webMethods Composite Application Framework, webMethods Portal^TM provides the primary delivery mechanism for user interaction with these composite applications. webMethods Portal allows people — both inside and outside the customer — to be provided with personalized access to the information, business processes, and applications that are relevant to their job function or relationship to the organization. By promoting contextual views of business situations, the webMethods Composite Application Framework can enable webMethods’ customers to achieve significant gains in business efficiency, customer satisfaction, and decision-making capabilities.

We believe our focused business strategy enables us to be a leading provider of business integration and Service Oriented Architecture solutions. Our strategy is based on investing our efforts in our customers and business partners to ensure their success with our solutions, developing and delivering what we believe to be the next generation of integration technology, and then extending our customers’ investments in business integration and Web services enablement with business-focused, value-added capabilities for Business Process Management, Business Activity Monitoring and Composite Application construction. By executing on our strategy, we believe we are helping to ensure the success of our customers and business partners with our solutions. The key elements of our strategy include the following:

Focus on Customer Success. A core part of our strategy is a tremendous focus on customers to ensure their success with our solutions and referenceability. We invest in resources and programs to improve our customers’ success rates with our solutions by reducing their time to deploy our software, minimizing their runtime costs and assisting them in maximizing their return on investment for their integration projects. We attempt to accomplish this by working closely with customers to understand their business needs, timelines and associated project risks, and then supporting them to ensure they achieve their goals. Our satisfied customers often assist with references and site visits for prospective customers.

Expand and Maximize Our Strategic Software Vendor Partnerships. We have relationships with enterprise application software vendors, including American Management Systems (AMS), Hewlett-Packard Company, Informatica, i2 Technologies, Microsoft, PeopleSoft and Siebel Systems, some of whom embed a limited-use implementation of webMethods software into their solution and may then sell both the integrated solution as well as other webMethods products. As a result, any customer of our partner who licenses its product in which our software is embedded receives a license-limited version of webMethods software. We believe these customers will be good candidates to purchase additional webMethods integration software.

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

Concentrate on Major Systems Integrators. We continue to expand and strengthen our alliances with major system integrators to provide services and sales leverage to our software product-based business model. We have established a series of formal alliance relationships with major system integrators, such as Accenture, American Management Systems (AMS), Atos Origin, BearingPoint, Cap Gemini Ernst & Young Group (CGE&Y), Computer Sciences Corporation (CSC), Deloitte, Electronic Data Systems Corporation (EDS) and Tata Consulting Services (TCS). Many of these partners have established a formal webMethods practice, thus increasing dramatically the number of webMethods-trained resources available through our system integrator partners.

As a result of this expanded knowledge-base, as well as implementation successes on which the systems integrator partner and webMethods have worked jointly, these alliances have resulted in a virtual extension of our direct sales force. This results in the third-party introduction and subsequent endorsement

Extend Technology and Product Leadership to Provide the Most Compelling Integration Solution. We believe that we have developed one of the broadest and most comprehensive business integration solutions currently available, supporting more application-to-application, business-to-business, mainframe integration and Web services protocols and data format standards than any competing product. We have integrated workflow technology to allow our customers and their business partners to automate not only the unattended business process but also those critical business functions where a person plays a key role. The products we introduced in the December 2003 quarter further extended our portfolio to include innovative Service Oriented Architecture technology, business activity monitoring technology and a portal capability. We believe that while each one of our products individually brings value and shows technical leadership, it is the combination of these capabilities in one solution that differentiates us from our competition.

Continue to Demonstrate Leadership in Web Services and Service Oriented Architecture. webMethods was an early pioneer in Web services, demonstrated by our role in the application of extensible markup language (XML), Web Interface Definition Language (WIDL) and Java technologies for all areas of integration and e-commerce. We believe that we have successfully built upon our heritage and positioned webMethods as a leader in Web services and Service Oriented Architecture. The webMethods Enterprise Services Platform combines the extensive integration capabilities of the webMethods Integration Platform with the Service Oriented Architecture capabilities of webMethods Fabric, resulting in a platform for delivering Web services technology which we believe is unparalleled in the industry. This solution is standards-based and vendor neutral, and bridges J2EE and .NET technologies. The webMethods Enterprise Services Platform unifies proven integration technology with innovative Web services and Service Oriented Architecture capabilities to help our customers apply Web services to solving integration problems throughout their enterprise. As further validation of our leadership in Web services, webMethods currently serves on the Board of Directors of the Web Services Interoperability organization (WS-I).

Extend the Value of Integration to the Business Users at Our Customers and Prospects. Integration solves very important problems for our customers, but the role of integration has historically been viewed as technical in nature and the principal domain of information technology personnel. Through our solutions for Business Process Management and Business Activity Monitoring, webMethods can demonstrate and deliver value that directly touches the business users within the enterprise. BPM provides businesses the ability to capture business processes and integrate necessary human interaction directly into those processes. BAM provides real-time visibility into those processes, providing business users with the ability to not only track key performance indicators (KPIs), but actually predict when those KPIs might trend out of the range for acceptable values. Taken together, BPM and BAM create a continuous cycle of visibility and control, with BAM providing the feedback necessary to tune these processes through the integrated BPM functions to maximize process efficiencies.

We believe that our capabilities in BPM and BAM help to differentiate webMethods, and provide us with important new selling opportunities. These capabilities elevate the value of webMethods into the heart of the processes critical to the health of our customers’ enterprises, and give the webMethods sales force the opportunity to help our customers and prospects address specific business issues that help them create differentiation in their respective markets. We expect that our sales force will be able to leverage this message to generate new customers, including those prospects that may be using a competitive product. Our BPM and BAM capabilities also enable our existing customers to extend the value of their existing integration investment with webMethods, creating upsell opportunities within our customer base.

As of March 31, 2004, we had more than 1,100 customers. Many of our customers are Global 2000 companies and represent a broad spectrum of vertical markets. We also have a number of government organizations as customers. Our customers include leaders in manufacturing, process industries

In each of the fiscal years ended March 31, 2004, 2003 and 2002, no individual customer accounted for more than 10% of our total revenue.

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

Our direct sales organization consists of sales representatives and pre-sales consultants supported by personnel with experience within the industries we serve. At March 31, 2004, our sales and marketing personnel serving North America were located in our headquarters in Fairfax, Virginia, and in approximately 25 other offices in the United States and Canada. At that date, our sales and marketing personnel in Europe were located in nine countries, and our sales and marketing personnel in Asia Pacific were located in Australia, Japan and six other countries. Information on revenue we derived from our Americas, Europe, Japan and Asia Pacific operations, as well as long lived assets located in those geographic areas, is included in Note 18 of the Notes to Consolidated Financial Statements of webMethods, Inc. included elsewhere in this report. We expect to continue expanding our sales and marketing group through targeted recruitment of qualified individuals.

We continued to focus on key vertical markets with specialized teams during our fiscal year ended March 31, 2004. Those teams focus on customers, prospective customers and business partners in vertical markets such as manufacturing, process industries (such as chemicals, oil and gas, life sciences, metals, paper and plastics), financial services, telecommunications, government, consumer goods manufacturing and retail, utilities and transportation and logistics.

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

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

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

We believe that our strategic relationships represent a significant advantage over our competition. As described above in “webMethods’ Strategy,” we utilize our strategic partnerships with enterprise application software vendors, such as American Management Systems (AMS), Hewlett-Packard Company, Informatica, i2 Technologies, Microsoft, PeopleSoft and Siebel Systems, to provide a differentiator when selling to a prospective customer that owns or plans to purchase one or more products from these companies in which a license-limited version of our software is embedded or utilized. We believe that this provides us with an incumbency advantage for many of the new business opportunities in which we compete. We also utilize our strategic partnerships with software vendors, such as Informatica, JBoss Group and Defywire Inc., to provide real-time visibility, analytic and reporting capabilities to data flowing through the webMethods Integration Platform, a J2EE-based application server and the capability of delivering real-time information over wireless networks to cellular phones, PDA’s and laptops. We also expect to continue to benefit from these relationships through their promotion of our products. We are also building a base of independent software vendors, original manufacturers and device manufacturers embedding webMethods Glue to provide Web services-enabled solutions.

We believe that our multiple strategic alliances with major systems integrators also constitute a significant advantage over some competitors. As described above in “webMethods’ Strategy,” we work very closely with many major systems integrators, including Accenture, AMS, Atos Origin, Bearing Point, CGE&Y, CSC, Deloitte, EDS and TCS, to support our customers’ integration needs. We invest in partner education to assist our partners in staying knowledgeable of the latest integration technology and proficient with webMethods’ product functionality. We believe that our investment in these relationships is important because they augment our direct sales force by promoting our products as the most appropriate solution for their clients and increase our implementation capabilities.

In Japan and the Asia Pacific region and, to a lesser extend in Europe, we license our software through resellers and distributors, who may also sell our consulting and implementation services. We have relationships with a number of resellers or distributors with expertise in certain industry sectors or countries in which we do not currently have a significant number of direct sales personnel.

We believe our partners influenced, directly or indirectly, a significant portion of our license revenue during fiscal years ended March 31, 2004 and March 31, 2003, and we expect this to continue in future periods. During our fiscal year 2004, we expanded our relationship with PeopleSoft as its partner for certain embedded integration technology, and we implemented joint selling and integrated global customer support. In April 2004, we formed a partnership with Microsoft Corporation based upon the availability of the webMethods for Microsoft Package^TM that enables enterprise customers to benefit from the integration of webMethods and Microsoft Video Studio .NET technologies.

As part of the effort to expand support for customers in Asia Pacific, webMethods partnered with Hewlett-Packard Company and established an integration competency center in Hong Kong to offer resources and expertise that enable customers to develop and test applications before deploying them in production environments.

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

We offer our customers a variety of software support and maintenance options designed to meet their varied needs. Our most sophisticated enterprise customers may choose options that include 24-hour coverage, seven days per week. We have established a “follow-the sun” support model with integrated,

major support centers in Virginia and California in the United States and in Australia, Japan and the Netherlands. Our resellers and distributors generally provide initial software support to their customers, and we provide support on more complicated support issues. Our customers and business partners can also receive support from our webMethods Advantage^TM support limited access extranet, which includes extensive discussion groups and technical advisory papers and provides online access to our customer service management system so that our customers and business partners can submit and monitor the status of any technical issues.

Many of our customers purchase consulting services from us to support their full range of integration initiatives. We may provide all of these services directly or we may augment the efforts of a systems integration partner in performing these services. We offer these professional services both during the initial deployment of our products and thereafter to address our customers’ needs through the entire project lifecycle. We provide professional services ranging from initial software infrastructure architectural planning to the complete deployment of our products. We also offer training courses and other education products at our facilities, as well as on-site at our customers’ and partners’ facilities. All of these offerings have been expanded to include the products and capabilities derived from the acquisitions we completed in October 2003 and the new products delivered by our product development staff in fiscal year 2004.

We believe our strong focus and track record of ensuring that our software is successfully put into production (“production event”) is a strong competitive advantage and differentiator. During fiscal year 2004, our global customer services group reported and documented more than 497 separate production events as compared to 340 such events in fiscal year 2003 and 178 such events in fiscal year 2002. Ensuring that our customers successfully implement our software in a timely manner enables them to achieve a greater return on their investment and, in many cases, encourages them to purchase additional software for other business integration projects and serve as a reference customer for us in our future sales efforts.

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

We focus our ongoing product development efforts on a combination of enhancing, broadening and deepening the functionality of our core products and services to address new software alliances, industries, marketplaces and geographic markets as well as new product development to meet emerging opportunities based on new technologies. During our fiscal year ended March 31, 2004, we released the latest version of our flagship integration platform, webMethods 6.1, and a new product, webMethods JMS+ for event-driven, high speed JMS messaging. During the period between the acquisitions in October 2003 and the end of fiscal year 2004, we also released new production versions of all of the products derived from the three acquisitions: webMethods Fabric, webMethods Glue, webMethods Portal and webMethods Optimize. Significant work to integrate and unify the acquired products with our core integration platform was either completed or was well underway at the completion of fiscal year 2004.

Our product development staff has developed our products utilizing project teams focused on independent components of the software under development. We maintain product release planning procedures to ensure integration, testing and version control among the different project development teams. We maintain our primary development centers in Fairfax, Virginia and Sunnyvale, California and have special development teams in Denver, Colorado, Seattle, Washington and Westborough, Massachusetts. The development teams represented by the acquisitions in October 2003 have been integrated into the development methodology and product lifecycle management process used by webMethods.

The market for our software and services is extremely competitive and subject to rapid change. We offer a suite of capabilities for business integration, Business Process Management, Business Activity Monitoring, Composite Application delivery, and Service Oriented Architecture infrastructure that

represents the next generation of integration technology and provides our customers with a breadth of functionality that we believe is compelling. We are not aware of any competitor that can demonstrate the breadth of capabilities that we can with our in-depth expertise in trading partner integration and management, our long history of Web services experience, our deep knowledge of legacy IBM mainframe integration and our broad expertise in Enterprise Application Integration (EAI). We compete primarily with providers of integration software products, including International Business Machines Corporation (IBM) and TIBCO Software, Inc. We also compete with BEA Systems, Inc., Microsoft Corporation, SeeBeyond Technology Corporation, SAP AG, Sterling Commerce Inc. and a wide-range of companies that are emerging in this category. We expect additional competition primarily from other emerging companies. In addition, we may face pricing pressures from our current competitors and new market entrants in the future. We believe that the competitive factors affecting the market for our software and services are numerous and the specific importance of any one of these factors varies significantly for each specific customer environment. These competitive factors include product functionality and features; performance and price; ease and cost of product implementation; vendor and product reputation; quality of customer support services; financial strength; customer training and documentation; and quality of professional services offerings. Although we believe that our software and services currently compete favorably with respect to such factors, we may not be able to maintain our competitive position against current and potential competitors.

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

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

For example, we take measures to avoid disclosure of our trade secrets, including, but not limited to, requiring all employees and certain consultants, customers, prospective customers, and others with which we have business relationships to execute confidentiality agreements that prohibit the unauthorized use and disclosure of our trade secrets and other proprietary materials and information. Further, we enter into license agreements with our customers, business partners, resellers and distributors that limit the unauthorized access to, use and distribution of our software, documentation and other proprietary information. Our license agreements with our customers, business partners, resellers and distributors impose restrictions on the use of our technology, including prohibiting the reverse engineering or de-compiling of our software, impose restrictions on the licensee’s ability to utilize the software and provide for specific remedies in the event of a breach of these restrictions. We also restrict access to our source code. While some of our license agreements require us to place the source code for our software in escrow for the benefit of the licensee, these agreements generally provide these licensees with a limited, non-exclusive license to use this code in the event we cease to do business without a successor or there is a bankruptcy proceeding by or against webMethods; certain agreements may provide that the licensee can use the escrowed source code if we fail to provide the necessary software maintenance and support.

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

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

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

We may not be able to detect unauthorized use of our proprietary information or take appropriate steps to enforce our intellectual property rights effectively, and the use by others of our proprietary rights could materially harm our business. Policing the unauthorized use of our products and other proprietary rights is difficult and expensive, particularly given the global nature and reach of the Internet. In the event we increase our international operations in the future, effective protection of intellectual property rights may be unavailable or limited in certain countries because the laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States. For more information regarding our proprietary rights, see “Factors That May Affect Future Operating Results — If we are unable to protect our intellectual property, we may lose a valuable asset, experience reduced market share, or incur costly litigation to protect our rights.”

Despite our efforts to protect our proprietary rights, parties may breach confidentiality agreements or other protective licenses and contracts into which we have entered, and we may not be able to enforce our rights effectively in the event of these breaches. There can be no assurance that we will be able to prevent unauthorized attempts to copy or reverse engineer aspects of our software or to obtain and use information that we regard as proprietary. Further, unauthorized parties may attempt to copy or otherwise obtain and use software or technology that we consider proprietary, and third parties may attempt to develop similar technology independently. It is possible that our competitors will adopt similar product or service names, impeding our ability to protect our intellectual property and possibly leading to customer confusion. The unauthorized reproduction or other misappropriation of our proprietary technology could enable third parties to benefit from the technology developed by us without paying for it.

The software industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement and the violation of other intellectual property rights. We believe that software developers in our market will increasingly be subject to infringement claims as the number of products in different software industry segments overlap. Although we attempt to avoid infringing known proprietary rights of third parties in our product development efforts, a third party has

claimed that the use of our software in certain situations infringed on its intellectual property rights. Third parties may in the future claim that we have infringed on their intellectual property rights (including those intellectual property rights currently existing or developed in the future) or the use our software in certain situations infringes on their intellectual property rights. We may increasingly be subject to infringement claims as the number of products and competitors in our industry grows and functionalities of products overlap. Furthermore, former employers of our current and future employees may assert that their employees have improperly disclosed confidential or proprietary information to us.

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

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

For more information regarding our proprietary rights, see “Factors That May Affect Future Operating Results — Third-party claims that we infringe upon their intellectual property rights may be costly to defend or settle and could damage our business.”

In addition, we license technology from third parties that is incorporated into our software, and we bundle technology from third parties with our software. We also incorporate into our software certain “open source” software code or software tools, the use of which in commercial software products, such as ours, may be prohibited or restricted now or in the future. Any significant interruption in the supply or support of any technology we license from third parties, or our inability to continue to use “open source” software in our products, could adversely affect our business, unless and until we can replace the functionality provided by the licensed technology or “open source” software. Our use of licensed technology or “open source” software could cause our products to infringe the intellectual property rights of others, causing costly litigation and the loss of significant rights.

webMethods, Inc. was organized in Delaware in 1996. We completed our initial public offering in February 2000. In August 2000, webMethods, Inc. acquired Active Software, Inc., a publicly-held software company that developed and delivered enterprise application integration software. In February 2001, we acquired IntelliFrame Corporation, its workflow technology and its research and development team. In October 2003, we acquired The Mind Electric, Inc., The Dante Group, Inc. and certain assets of Datachannel. References to “webMethods,” “we,” “us” or “our” include webMethods, Inc. and its subsidiaries unless a statement specifically refers to webMethods, Inc. Our executive offices are located at 3930 Pender Drive, Fairfax, Virginia 22030, and our main telephone number is (703) 460-2500. We operate in a single segment of software and related services.

Our internet address is www.webMethods.com. Our Investor Relations page of our web site provides a link to a service giving access to our securities filings as soon as reasonably practical after we electronically file with the Securities and Exchange Commission (SEC) our annual reports, quarterly reports, current reports and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and as soon as reasonably practical after any of our directors or executive officers electronically file with the Securities and Exchange Commission any reports pursuant to Section 16 of the Securities Exchange Act of 1934. We do not charge for access to and viewing of those filings. Other information on our Investor Relations page and our web site is not part of this Form 10-K or any other webMethods securities filing unless specifically incorporated. In addition, our reports, proxy statements and other information are filed with the SEC through the SEC’s Electronic Data Gathering, Analysis and Retrieval system and are publicly available through the SEC’s site on the World Wide Web, at www.sec.gov. All statements made in any of our securities filings, including all forward-looking statements or information, are made as of the date of that document in which the statement is included, and we do not assume or undertake any obligation to update any of those statements or documents unless we are required to do so by law.

As of March 31, 2004, we employed approximately 860 full-time employees. These included approximately 300 in sales and marketing, 200 in professional services and technical support, approximately 240 in research and development and approximately 120 in other administrative areas, including accounting, finance, human resources, facilities and information technology. Our future success will depend in part on our ability to attract, retain and motivate highly qualified technical and management personnel, for whom competition is intense. From time to time, we have employed, and will continue to employ, independent contractors and consultants to support research and development, marketing and sales, and business development. Our employees are not represented by a collective bargaining agreement and we have never experienced a strike or similar work stoppage. We consider relations with our employees to be good.

Our executive officers and their ages and positions as of May 31, 2004 are as follows:

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 B.S. 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 January 2001. Mr. Mitchell served as Vice President of Worldwide Sales from September 1999 to December 1999. From 1995 to 1997, Mr. Mitchell

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

Richard Chiarello joined webMethods in April 2004 as Executive Vice President, Worldwide Operations. From October 2002 to 2004, he served as Senior Vice President, Worldwide Sales, of Siebel Systems, Inc., where he managed all aspects of the company’s worldwide sales operations. From December 1998 to September 2002, he served as President of ATL LLC Consulting, a private sales consulting company founded by Mr. Chiarello to serve clients in the information technology industry. He also served as President and Chief Operating Officer of AMC Computer Corporation, a hardware and professional services company, from October 2000 to June 2001. From December 1985 to December 1998, Mr. Chiarello held several sales, marketing and executive management positions at Computer Associates International, Inc., the most recent of which was Executive Vice President and General Manager, Worldwide Sales and Channels. Prior to joining Computer Associates International, Inc., Mr. Chiarello served in a variety of sales positions with IBM Corporation from 1977 to 1985. Mr. Chiarello holds a B.A. from Queens College in New York and has completed executive management training in the IBM Management Training program and with Babson Business School, Boston, Massachusetts.

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

Douglas W. McNitt joined webMethods in October 2000 as General Counsel, became an Executive Vice President in January 2002, and became Secretary in May 2003. Mr. McNitt served in various capacities, including Senior Counsel and Assistant General Counsel for America Online, Inc. during his service there from December 1997 to September 2000. From May 1996 to December 1997, he was an associate with the law firm of Tucker, Flyer & Lewis, a professional corporation, and was an associate with the law firm of McDermott, Will & Emery from April 1994 to May 1996. Mr. McNitt holds a B.A. from Stanford University and a J.D. from Notre Dame Law School.

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

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

Unanticipated fluctuations in our quarterly revenue or operating results, or failure to return to and maintain profitability, could significantly affect the price of webMethods common stock.

We believe that quarter-to-quarter or year-to-year comparisons of our financial results are not necessarily meaningful indicators of our future revenue or operating results and should not be relied on as

an indication of our future performance. If our quarterly or annual revenue or operating results fail to meet the guidance we provide publicly or the expectations of investors or analysts, that could have a material adverse effect on the market price of webMethods common stock. Our quarterly operating results have varied substantially in the past and may vary substantially in the future depending upon a number of factors, including the changes in demand for our products and services, the timing and terms of large transactions with customers, competitive pressures, our ability to execute on our business plans, the amount and timing of operating costs, the timing and amount of revenue from acquired technology and businesses, delays in the availability of new products or new releases of existing products and changes that we may make in our business, operations and infrastructure. In addition, economic conditions and other events beyond our control, such as economic uncertainties, geopolitical developments or uncertainties, travel limitations, infectious outbreaks like SARS, terrorist acts and other major, unanticipated events may have significant negative impact on our quarterly operating results and delay our ability to return to and maintain profitability on a basis determined in accordance with accounting principles generally accepted in the United States (GAAP). Further, the expensing of stock options in the future, the costs of compliance with the Sarbanes-Oxley Act and other legal and compliance requirements could add significant costs that may impede or delay our ability to return to and maintain profitability on a GAAP basis. If our quarterly revenue or operating results are adversely impacted, that could have a material adverse effect on the market price of webMethods common stock.

We generally close a substantial number of license transactions in the last month of each quarter, which makes it more difficult to gauge the level of license revenue we will have in any quarter until near to, or after, its conclusion. We expect to continue devoting resources to our sales and marketing operations and our research and development activities. Our operating expenses, which include sales and marketing, research and development and general and administrative expenses, are based on our expectations of future revenue and are relatively fixed in the short term. If revenue falls below our expectations in a quarter or our operating costs increase in a quarter and we are not able to quickly reduce our spending in response, our operating results for that quarter could be significantly below the guidance we provide publicly or expectations of investors or analysts. It is possible that our revenue or operating results in the future may be below the guidance we provide publicly and the expectations of investors or analysts and, as a result, the market price of webMethods common stock may fall significantly. In addition, the stock market, particularly the stock prices of independent infrastructure software companies, has been very volatile. This volatility is often not related to the operating performance of the companies. From our initial public offering in February 2000 until June 1, 2004, the closing price of webMethods’ stock on the Nasdaq National Market has ranged from a high of $336.25 to a low of $4.32.

Growth of our sales may slow from time to time, causing our quarterly operating results to fluctuate and possibly resulting in significant volatility in the market price of webMethods common stock.

Due to customer demand, economic conditions, the timing and terms of large transactions with customers, competitive pressures, our ability to execute on our business plan, seasonal factors or major, unanticipated events, we may experience a lower growth rate for, no growth in, or a decline in quarterly or annual revenue from sales of our software and services in some or all of the geographic regions in which we operate. For example, the growth rate for revenue from sales of our software and services during summer months may be lower than at other times during the year, particularly in European markets, and may be impacted by the annual nature of our sales compensation plans.

We also may experience declines in expected revenue due to patterns in the capital budgeting and purchasing cycles of our current and prospective customers, changes in demand for our software and services, the timing and amount of revenue from acquired technology and business, economic uncertainties, geopolitical developments or uncertainties, travel limitations, infectious outbreaks like SARS, terrorist acts or other major unanticipated events. These periods of slower or no growth may lead to lower revenue, which could cause fluctuations in our quarterly operating results. In addition, variations in sales cycles may have an impact on the timing of our revenue, which in turn could cause our quarterly operating results to fluctuate. To successfully sell our software and services, we generally must educate our potential customers

regarding their use and benefits, which can require significant time and resources. Any misperception by us in the needs of our customers and prospective customers, or any delay in sales of our software and services could cause our revenue and operating results to vary significantly from quarter to quarter, which could result in significant volatility in the market price of webMethods common stock.

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

We commenced operations in September 1996. Active Software, with which we completed a merger in August 2000, was incorporated in September 1995. We have been operating as a combined company since August 2000. In addition, we have acquired several businesses and technologies with limited operating histories. During much of our history, we have sustained losses from operations. For a number of reasons described in other factors listed here, we may not be able to achieve our anticipated revenue growth, and control costs of operations, to achieve our forecasts of operating results, including returning to and maintaining profitability on a GAAP basis. That situation could have a material adverse effect on the market price of webMethods common stock. If we do not generate sufficient revenue to achieve and maintain income from operations, our growth could be limited unless we are willing to incur operating losses that may be substantial and are able to fund those operating losses from our available assets or, if necessary, from the sale of additional capital through public or private equity or debt financings. If we are unable to grow as planned, our chances of returning to and maintaining profitability and the anticipated or forecasted results of operations could be reduced, which, in turn, could have a material adverse effect on the market price of webMethods common stock.

Our target markets are highly competitive, and we may not be able to compete effectively.

The markets for business integration solutions, Service Oriented Architecture capabilities, Business Activity Monitoring and Business Process Management solutions and Composite Application framework capabilities are rapidly changing and intensely competitive. There are a variety of methods available to integrate software applications, monitor and optimize business processes and workflows, provide Service- Oriented Architectures, enable Web services and provide customers the capabilities to run, manage and optimize their enterprise. 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 our Service Oriented Architecture technology, our Enterprise Services Platform solution, our Business Process Management solution, our Business Activity Monitoring solution, our Composite Application Framework or other solutions we offer or have announced. If our technology, software and solutions are not widely adopted by our target markets or if we are not able to compete successfully against current or future competitors, our business, operating results and financial condition may be harmed. Our current and potential competitors include, among others, large software vend


Delaware (State or Other Jurisdiction of Incorporation or Organization)		54-1807654 (I.R.S. Employer Identification No.)

3930 Pender Drive, Fairfax, Virginia (Address of Principal Executive Offices)		22030 (Zip Code)



Part I
Item 1.	Business	1
	Overview	1
	Industry Background	3
	The webMethods Solution	4
	webMethods’ Strategy	7
	Customers	8
	Sales and Marketing	9
	Partners and Strategic Relationships	10
	Global Customer Services	10
	Product Development	11
	Competition	11
	Intellectual Property and Other Proprietary Rights	12
	Corporate Information	14
	Available Information	15
	Employees	15
	Executive Officers of webMethods	15
	Factors That May Affect Future Operating Results	16
Item 2.	Properties	24
Item 3.	Legal Proceedings	25
Item 4.	Submission of Matters to a Vote of Security Holders	25
Part II
Item 5.	Market for Registrant’s Common Stock and Related Stockholder Matters	25
Item 6.	Selected Financial Data	27
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
	Overview	28
	Results of Operations	32
	Liquidity and Capital Resources	40
	Recently Issued Accounting Pronouncements	41
Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	42
Item 8.	Financial Statements and Supplementary Data	42
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures	43
Item 9A.	Controls and Procedures	43
Part III
Item 10.	Directors and Executive Officers of the Registrant	44
Item 11.	Executive Compensation	44
Item 12.	Security Ownership of Certain Beneficial Owners and Management	44
Item 13.	Certain Relationships and Related Transactions	44
Item 14.	Principal Accountant Fees and Services	44
Part IV
Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	45
Signatures		47
EX-21.1
EX-23.1
EX-31.1
EX-31.2
EX-32.1
EX-32.2

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents


Name	Age		Position

Phillip Merrick		41	Chairman of the Board and Chief Executive Officer
David Mitchell		39	President and Chief Operating Officer
Richard Chiarello		51	Executive Vice President, Worldwide Operations
Mary Dridi		43	Chief Financial Officer, Executive Vice President and Treasurer
Douglas W. McNitt		39	General Counsel, Executive Vice President and Secretary
Kristin A. Weller		33	Executive Vice President, Product Development