WEBMETHODS INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004

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

Commission File Number

1-15681

webMethods, Inc.

(Exact name of Registrant as Specified in its Charter)


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

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

Registrant’s telephone number, including area code: (703) 460-2500

Securities registered pursuant to Section 12(b) of the Act: None

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

Preferred Stock Purchase Rights

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

As of February 10, 2005, there were outstanding 53,317,777 shares of the registrant’s Common Stock.

WEBMETHODS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004

TABLE OF CONTENTS


Part I	Financial Information
Item 1	Financial Statements	1
	Condensed Consolidated Financial Statements	1
	Condensed Consolidated Balance Sheets (unaudited) as of September 30, 2004 and March 31, 2004	1
	Condensed Consolidated Statements of Operations and Comprehensive Loss (unaudited) — Three and six months ended September 30, 2004 and 2003	2
	Condensed Consolidated Statements of Cash Flows (unaudited) — Six months ended September 30, 2004 and 2003	3
	Notes to Condensed Consolidated Financial Statements (unaudited)	4
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3	Quantitative and Qualitative Disclosures About Market Risk	28
Item 4	Controls and Procedures	29
Part II	Other Information
Item 1	Legal Proceedings	31
Item 4	Submission of Matters to a Vote of Security Holders	31
Item 6	Exhibits	32

PART I

FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

WEBMETHODS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)


				September 30,			March 31,
				2004			2004

							As restated
				(In thousands)
ASSETS
Current assets:
	Cash and cash equivalents			$	63,582		$	75,462
	Marketable securities available for sale				72,926			44,328
	Accounts receivable, net of allowance of $1,809 and $2,103				45,208			46,741
	Prepaid expenses and other current assets				7,797			6,235

			Total current assets		189,513			172,766
Marketable securities available for sale					6,366			36,157
Property and equipment, net					7,448			8,106
Goodwill					46,704			46,704
Intangible assets, net					9,589			10,787
Other assets					7,028			9,130

			Total assets	$	266,648		$	283,650


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Accounts payable			$	8,968		$	10,919
	Accrued expenses				15,345			17,084
	Accrued salaries and commissions				11,647			11,560
	Deferred revenue				37,387			36,018
	Short-term borrowings				1,693			2,584
	Current portion of capital lease obligations				583			909

		Total current liabilities			75,623			79,074
	Capital lease obligations, net of current portion				152			373
	Other long term liabilities				799			1,000
	Long term deferred revenue				5,269			6,066

			Total liabilities		81,843			86,513

Commitments and contingencies
Stockholders’ equity:
	Common stock, $0.01 par value; 500,000,000 shares authorized; 53,101,682 and 52,746,722 shares issued and outstanding				531			527
	Additional paid-in capital				523,333			521,455
	Deferred stock compensation and warrant charge				(4,302	)		(5,625	)
	Accumulated deficit				(336,416	)		(321,473	)
	Accumulated other comprehensive income				1,659			2,253

			Total stockholders’ equity		184,805			197,137

			Total liabilities and stockholders’ equity	$	266,648		$	283,650

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

WEBMETHODS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)


				Three Months Ended						Six Months Ended
				September 30,						September 30,

				2004			2003			2004			2003

							As restated						As restated
				(In thousands, except per share amounts)
Revenue:
	License			$	23,851		$	20,850		$	38,657		$	42,024
	Professional services				12,077			10,460			24,601			19,333
	Maintenance				14,838			12,766			29,445			25,317

			Total revenue		50,766			44,076			92,703			86,674

Cost of revenue:
	Amortization of intangibles				599			—			1,198			—
	License				245			555			865			1,022
	Professional services and maintenance:
		Stock based compensation			—			22			—			44
		Other professional services and maintenance			14,280			12,403			28,553			24,062

			Total cost of revenue		15,124			12,980			30,616			25,128

Gross profit					35,642			31,096			62,087			61,546

Operating expenses:
	Sales and marketing:
		Stock based compensation and warrant charge			661			721			1,322			1,417
		Other sales and marketing costs			19,926			21,467			41,040			43,917
	Research and development:
		Stock based compensation			—			10			—			10
		Other research and development costs			10,820			10,857			21,870			22,058
	General and administrative:
		Stock based compensation			—			3			—			6
		Other general and administrative costs			4,868			4,524			9,941			8,947
	Restructuring and related charges				2,756			—			2,756			—

			Total operating expenses		39,031			37,582			76,929			76,355

Operating loss					(3,389	)		(6,486	)		(14,842	)		(14,809	)
Interest income					532			721			1,085			1,728
Interest expense					(29	)		(17	)		(56	)		(107	)
Other (expense) income					(116	)		(5	)		(4	)		24
Impairment of equity investment in private company					(1,057	)		—			(1,057	)		—

	Loss before income taxes			$	(4,059	)	$	(5,787	)	$	(14,874	)	$	(13,164	)
Provision for income taxes					65			—			69			—

	Net loss			$	(4,124	)	$	(5,787	)	$	(14,943	)	$	(13,164	)

Basic and diluted net loss per share				$	(0.08	)	$	(0.11	)	$	(0.28	)	$	(0.25	)

Shares used in computing basic and diluted net loss per share					53,088,527			52,038,339			52,958,538			51,922,154

Comprehensive loss:
	Net loss			$	(4,124	)	$	(5,787	)	$	(14,943	)	$	(13,164	)
	Other comprehensive income (loss):
		Unrealized income (loss) on securities available for sale			111			(32	)		(318	)		(90	)
		Foreign currency cumulative translation adjustment			354			799			(276	)		944

			Total comprehensive loss	$	(3,659	)	$	(5,020	)	$	(15,537	)	$	(12,310	)

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

WEBMETHODS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


			Six Months Ended
			September 30,

			2004			2003

						As restated
			(In thousands)
Cash flows from operating activities:
	Net loss		$	(14,943	)	$	(13,164	)
	Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation and amortization		3,243			4,320
		Provision for doubtful accounts		241			—
		Amortization of deferred stock compensation related to employee and non-employee stock options and non-employee stock warrants		1,322			1,477
		Amortization of acquired intangibles		1,198			—
		Impairment of equity investment in private company		1,057			—
		Conversion of interest income into equity in private company		—			(257	)
	Increase (decrease) in cash resulting from changes in assets and liabilities:
		Accounts receivable		952			2,345
		Prepaid expenses and other current assets		(1,598	)		(1,210	)
		Other assets		980			41
		Accounts payable		(1,866	)		(217	)
		Accrued expenses and other liabilities		(1,851	)		(686	)
		Accrued salaries and commissions		149			(622	)
		Deferred revenue		911			(4,720	)

Net cash used in operating activities				(10,205	)		(12,693	)

Cash flows from investing activities:
	Purchases of property and equipment			(2,660	)		(1,597	)
	Net maturities of marketable securities available for sale			874			8,712
	Repayment of investment in private company			—			1,000

Net cash (used in)/provided by investing activities				(1,786	)		8,115

Cash flows from financing activities:
	Short-term borrowings			3,533			3,189
	Payments on short-term borrowings			(4,284	)		—
	Payments on capital leases			(547	)		(2,085	)
	Proceeds from exercise of stock options and stock issued under the ESPP			1,882			1,636

Net cash provided by financing activities				584			2,740

Effect of exchange rate on cash and cash equivalents				(473	)		1,211

Net decrease in cash and cash equivalents				(11,880	)		(627	)
Cash and cash equivalents at beginning of period				75,462			79,702

Cash and cash equivalents at end of period			$	63,582		$	79,075

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

WEBMETHODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)


1.	Basis of Presentation

The accompanying consolidated financial statements of webMethods, Inc. and its subsidiaries (collectively, the “Company”) have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). This Quarterly Report on Form 10-Q should be read in conjunction with the Company’s Amendment No. 2 to Form 10-K for the year ended March 31, 2004. Certain information and footnote disclosures which are normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to SEC rules and regulations. The information reflects all normal and recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the financial position of the Company, and its results of operations for the interim periods set forth herein. The results for the three months and six months ended September 30, 2004 are not necessarily indicative of the results to be expected for the full year or any future period. Certain amounts previously reported have been reclassified to conform with current year presentation.


2.	Restatements

On February 3, 2005, the Company issued a press release and thereafter filed a Form 8-K announcing that the Company was restating its financial statements for fiscal year 2004 (ended March 31, 2004), as well as quarterly financial statements for each of the three interim quarterly reports in that fiscal year and for the three months ended June 30, 2004. That announcement related primarily to the recently completed independent investigation conducted by the Company’s Audit Committee into certain transactions of the Company’s Japanese subsidiary.

As a result of the investigation, the Company’s Audit Committee concluded that improper activities of certain employees of the Japanese subsidiary caused the Company to misstate revenue and expenses for the year ended March 31, 2004 and certain quarters therein and the three months ended June 30, 2004, as well as misstate accounts receivable, deferred revenue, debt and certain other items attributable to the operations of the Japanese subsidiary. The Audit Committee’s investigation found that the improper activities included, among other things, engaging in improper licensing and professional services transactions and misrepresenting the transactions to the Company’s management; causing the Japanese subsidiary to engage in undisclosed and unauthorized borrowings; failing to record expenses and recording improper expenses; and creating false documents in support of improper transactions. The Audit Committee also determined that those employees of the Japanese subsidiary acted to conceal their improper activities from webMethods’ management.

The adjustments to the Company’s financial statements in the restatements fall into five general categories: (i) adjustments to license, professional services and maintenance revenue relating to improper activities of certain employees of the Japanese subsidiary; (ii) adjustments to deferred revenue with respect to certain of those revenue items that should have been deferred and recognized as revenue in subsequent periods; (iii) adjustments to properly record expenses of the Japanese subsidiary in the appropriate period; (iv) adjustments to debt (excluding the reclassificatoin of interest expense, which was nominal) and accounts receivable as a result of certain unauthorized borrowings by the Japanese subsidiary that were improperly recorded by it as collections of receivables; and (v) elimination of a provision for tax expense based upon estimates of the taxable income of the Company’s Japanese subsidiary.

As a result of the foregoing, the Company’s consolidated financial statements for the three- and six-month periods ended September 30, 2003 and the Company’s Consolidated Balance Sheet at March 31, 2004 have been restated from amounts previously reported. The accompanying consolidated financial data presents the Company’s restated Condensed Consolidated Statements of Operations for the three and six

WEBMETHODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

2. Restatements — (Continued)

months ended September 30, 2003 and restated balance sheet items as of March 31, 2004 on a comparative basis showing the amounts as originally reported and as restated.

Summary of the Significant Effects of the Restatement on the Consolidated Statements of Operations


			Three Months Ended September 30, 2003									Six Months Ended September 30, 2003

			As previously									As previously
			reported			Adjustments			As restated			reported			Adjustments			As restated

			(In thousands, except per share amounts)
Revenue:
	License		$	22,025		$	(1,175	)	$	20,850		$	43,827		$	(1,803	)	$	42,024
	Professional services			10,578			(118	)		10,460			19,451			(118	)		19,333
	Maintenance			12,786			(20	)		12,766			25,336			(19	)		25,317

		Total revenue		45,389			(1,313	)		44,076			88,614			(1,940	)		86,674
Cost of revenue				12,980			—			12,980			25,128			—			25,128

Gross profit				32,409			(1,313	)		31,096			63,486			(1,940	)		61,546
Operating expenses				37,582			—			37,582			76,355			—			76,355

Operating loss				(5,173	)		(1,313	)		(6,486	)		(12,869	)		(1,940	)		(14,809	)
Interest and other income, net				699			—			699			1,634			11			1,645

Net loss			$	(4,474	)	$	(1,313	)	$	(5,787	)	$	(11,235	)	$	(1,929	)	$	(13,164	)

Basic and diluted net loss per share			$	(0.09	)	$	(0.02	)	$	(0.11	)	$	(0.22	)	$	(0.03	)	$	(0.25	)

Summary of the Significant Effects of the Restatement on the Consolidated Balance Sheet


	March 31, 2004

	As previously
	reported		Adjustments			As restated

	(In thousands)
Accounts receivable, net	$	47,050	$	(309	)	$	46,741