Webmethods (WEBM) 10-Q 2002 Q1 Quarterly report

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 JUNE 30, 2001

OR

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

COMMISSION FILE NUMBER 001-15681

WEBMETHODS, INC.
(Exact Name of Registrant as Specified in its Charter)

DELAWARE	54-1807654
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
3930 PENDER DRIVE, FAIRFAX, VIRGINIA	22030
(Address of principal executive offices)	(Zip Code)

Registrant’s Telephone Number, Including Area Code: (703) 460-2500

      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 [ ]

      As of July 31, 2001, 49,426,083 shares of the registrant’s Common Stock, par value $.01 per share, were issued and outstanding.

WEBMETHODS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED JUNE 30, 2001
TABLE OF CONTENTS

Part I	Financial Information
Item 1	Financial Statements
	Condensed Consolidated Financial Statements
	Condensed Consolidated Balance Sheets as of
	June 30, 2001 (unaudited) and March 31, 2001
	Condensed Consolidated Statements of Operations (unaudited) -
	Three months ended June 30, 2001 and 2000
	Condensed Consolidated Statements of Cash Flows (unaudited) -
	Three months ended June 30, 2001 and 2000
	Notes to Condensed Consolidated Financial Statements (unaudited)
Item 2	Management’s Discussion and Analysis of Financial
	Condition and Results of Operations
Item 3	Quantitative and Qualitative Disclosures About Market Risk
Part II	Other Information
Item 2	Changes in Securities and Use of Proceeds
Item 6	Exhibits and Reports on Form 8-K
	(a) Exhibits
	(b) Reports on Form 8-K

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PART I 
FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

WEBMETHODS, INC.

CONSOLIDATED BALANCE SHEETS

			JUNE 30,			MARCH 31,
			2001			2001
			(unaudited)
			(in thousands, except share information)
ASSETS
Current assets:
	Cash and cash equivalents		$	74,296		$	109,713
	Marketable securities available for sale			104,219			96,676
	Accounts receivable, net of allowances of $4,759 and $4,342, respectively			50,952			58,757
	Prepaid expenses and other current assets			9,310			9,846
		Total current assets		238,777			274,992
Marketable securities available for sale				29,565			—
Property and equipment, net				19,354			17,364
Goodwill and acquired intangibles, net				58,026			68,535
Other assets				14,380			14,397
		Total assets	$	360,102		$	375,288
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Accounts payable		$	8,698		$	8,368
	Accrued expenses			12,049			13,008
	Accrued salaries and commissions			12,246			15,536
	Deferred revenue			41,243			45,585
	Current portion of capital lease obligations			2,571			1,773
		Total current liabilities		76,807			84,270
	Capital lease obligations, net of current portion and other			3,054			2,613
	Long term deferred revenue			24,171			22,796
		Total liabilities		104,032			109,679
Stockholders’ equity:
	Common stock, $0.01 par value; 500,000,000 shares authorized;    49,290,016 and 48,732,800 shares issued and outstanding			493			487
	Additional paid-in capital			502,766			499,825
	Deferred stock compensation and warrant charge			(30,644	)		(38,154	)
	Accumulated deficit			(217,093	)		(197,155	)
	Accumulated other comprehensive gain			548			606
		Total stockholders’ equity		256,070			265,609
		Total liabilities and stockholders’ equity	$	360,102		$	375,288

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

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WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(UNAUDITED)

					THREE MONTHS ENDED JUNE 30,
					2001			2000
					(in thousands, except share and per share data)
Revenue:
	License				$	36,804		$	23,986
	Professional services					9,691			7,743
	Maintenance					8,902			3,336
				Total revenue		55,397			35,065
Cost of revenue:
	License					701			1,002
	Professional services and maintenance:
			Stock based compensation			192			217
			Other professional services and maintenance			12,399			10,105
				Total cost of revenue		13,292			11,324
Gross profit						42,105			23,741
Operating expenses:
	Sales and marketing:
			Stock based compensation and warrant charge			1,232			1,027
			Other sales and marketing costs			30,200			19,474
	Research and development:
			Stock based compensation			3,490			2,752
			Other research and development costs			13,299			7,661
	General and administrative:
			Stock based compensation			87			862
			Other general and administrative costs			5,904			4,105
	Amortization of goodwill and intangibles					10,508			9,680
	In-process research and development					—			2,311
				Total operating expenses		64,720			47,872
Operating loss						(22,615	)		(24,131	)
Interest income, net						2,677			3,212
		Net loss			$	(19,938	)	$	(20,919	)
Basic and diluted net loss per share					$	(0.41	)	$	(0.46	)
Shares used in computing basic and diluted net loss per share						48,839,735			45,907,352
Comprehensive loss:
		Net loss			$	(19,938	)	$	(20,919	)
		Other comprehensive loss:
				Unrealized loss on securities available for sale		(104	)		(14	)
				Foreign currency cumulative translation adjustment		46			58
				Total comprehensive loss	$	(19,996	)	$	(20,875	)

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

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WEBMETHODS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

			THREE MONTHS ENDED JUNE 30,
			2001			2000
			(in thousands)
Cash flows from operating activities:
	Net loss		$	(19,938	)	$	(20,919	)
	Adjustments to reconcile net loss to net     cash used in operating activities:
		Depreciation and amortization		1,833			556
		Provision for allowance for doubtful accounts		1,320			367
		Provision for warranty		—			88
		Amortization of deferred stock compensation     related to employee stock options and     non-employee stock warrants		5,001			4,858
		Amortization of goodwill and intangibles		10,508			9,680
		Write off of in-process research and development		—			2,311
Increase (decrease) in cash resulting from    changes in assets and liabilities:
		Accounts receivable		6,055			(11,642	)
		Prepaid expenses and other current assets		934			(4,290	)
		Other assets		(463	)		(1,096	)
		Accounts payable		486			(347	)
		Accrued expenses		(978	)		2,173
		Accrued salaries and commissions		(843	)		22
		Accrued ESPP		(2,331	)		(688	)
		Deferred revenue		(2,763	)		12,809
Net cash used in operating activities				(1,179	)		(6,118	)
Cash flows from investing activities:
	Purchases of property and equipment			(1,908	)		(954	)
	Net purchases of marketable securities available     for sale			(37,210	)		(22,476	)
	Purchase of investments in private companies			—			(7,000	)
	Acquisition of business, net of cash acquired			—			(4,741	)
Net cash used in investing activities				(39,118	)		(35,171	)
Cash flows from financing activities:
	Payments on capital leases			(717	)		(70	)
	Repayments under notes and lines of credit			—			(723	)
	Proceeds from exercise of stock options and     stock issued under the ESPP			5,454			3,768
Net cash provided by financing activities				4,737			2,975
Effect of exchange rate on cash				143			(46	)
Net decrease in cash and cash equivalents				(35,417	)		(38,360	)
Cash and cash equivalents at beginning of period				109,713			171,716
Cash and cash equivalents at end of period			$	74,296		$	133,356

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

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WEBMETHODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

      The accompanying unaudited interim condensed consolidated financial statements of webMethods, Inc. and its subsidiaries (collectively, the “Company”) reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods presented in conformity with generally accepted accounting principles for the interim financial information. Such adjustments are of a normal recurring nature. Intercompany balances and transactions have been eliminated in consolidation.

      The results of the interim periods presented are not necessarily indicative of the results for the year or any current or future period.

2. RECENT ACCOUNTING PRONOUNCEMENTS

      In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will rather be tested at least annually for impairment. Under the provisions of SFAS No. 142, any impairment loss identified upon adoption of this standard is recognized as a cumulative effect of a change in accounting principle. Any impairment loss incurred subsequent to initial adoption of SFAS No. 142 is recorded as a charge to current period earnings. In the event the Company acquires goodwill subsequent to June 30, 2001 it will not be amortized. The Company will adopt SFAS No. 142 in fiscal 2003 and, at that time, will stop amortizing goodwill that resulted from business combinations completed prior to the adoption of SFAS No. 141. The Company is currently evaluating the provisions of SFAS No. 142 and has not yet determined the effect that adoption of this standard will have on its consolidated financial statements.

3. SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

			THREE MONTHS ENDED
			JUNE 30,
			2001			2000
			(in thousands)
Cash paid during the period for interest			$	122		$	46
Non-cash investing and financing activities
	Equipment purchased under capital lease		$	1,934		$	190
	Change in net unrealized loss of marketable securities		$	(104	)	$	(14	)
Translink Acquisition:
	Fair value of assets acquired, net of cash acquired			—		$	82,209
		Less:
	Liabilities assumed			—			(593	)
	Common stock issued in connection with the acquisition			—			(79,678	)
				—			1,938
	Write off of in-process research and development			—			2,311
	Cash paid for acquisition, net of cash acquired		$	—		$	4,249
Premier Acquisition:
	Fair value of assets acquired, net of cash acquired			—			13,947
		Less:
	Liabilities assumed			—			(462	)
	Common stock issued in connection with the acquisition			—			(12,993	)
	Cash paid for acquisition, net of cash acquired		$	—		$	492

5

WEBMETHODS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

4. SEGMENT INFORMATION

      The Company markets its products in the United States and in foreign countries. Information regarding geographic areas for the three months ended June 30, 2001 and 2000 are as follows:

		THREE MONTHS ENDED
		JUNE 30,
REVENUES		2001		2000
		(in thousands)
North America		$	40,366	$	33,817
Europe			10,810		1,248
Asia Pacific			4,221		—
	Total	$	55,397	$	35,065

		AS OF		AS OF
		JUNE 30,		MARCH 31,
LONG LIVED ASSETS		2001		2001
		(in thousands)
North America		$	119,113	$	97,853
Europe			1,319		1,236
Asia Pacific			893		1,207
	Total	$	121,325	$	100,296

5. OPTION EXCHANGE PROGRAM

      In April 2001, the Company implemented an option exchange program whereby employees were offered the opportunity to exchange stock options with split-adjusted exercise prices of $40.00 and above for new options to purchase an equal number of shares. The new options will be granted at least six months and one day following the date the options were accepted for exchange but no later than December 31, 2001. The exercise price of the new options will be the closing market price of the Company’s common stock on the Nasdaq Stock Market on the grant date of the new options. A total of 7,489,000 options were surrendered for exchange under this program.

6. SUBSEQUENT EVENTS

      In July 2001, the Company announced a reduction in force and will take a restructuring charge in the quarter ending September 30, 2001. This restructuring charge will consist primarily of charges related to headcount reductions and consolidation of facilities. The plan will result in headcount reductions of approximately 15%, and the Company expects to consolidate certain of its main facilities and close excess field offices.

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ITEM 2:  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

      The following discussion of the Company’s financial condition and results of operations should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in the Company’s Annual Report on Form 10-K for the year ended March 31, 2001 (File No. 001-15681). The information contained herein is not a comprehensive discussion and analysis of the financial condition and results of operations, but rather updates the disclosures made in the Company’s Annual Report on Form 10-K.

      Certain information contained herein should be considered “forward-looking information,” which is subject to a number of substantial risks and uncertainties. Statements contained herein that are not statements of historical fact may be deemed to be forward-looking information. Without limiting the foregoing, words such as “anticipates,” “believes,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “should,” “will,” and “would” and other forms of these words or similar words are intended to identify forward-looking information. Such forward-looking statements are made only as of the date of this report. The Company’s actual results could differ materially from those contained in forward-looking statements. Important factors known to the Company that could cause such material differences are discussed under the caption “Factors that May Affect Future Operating Results” in the Business section of the Company’s abovementioned Form 10-K. The Company undertakes no obligations to publicly update or revise any forward-looking information, whether as a result of new information, future events or otherwise.

OVERVIEW

Background

      We are a leading provider of infrastructure software and services for comprehensive end-to-end integration solutions that enable our customers to achieve comprehensive automation of business processes by integrating their systems in real time. Our customers use our software, webMethods Enterprise, webMethods B2B, and webMethods Mainframe Integration Server, to integrate business processes among different systems within their enterprise and to work more closely with their customers, suppliers and other business partners through the real-time exchange of information and transactions. webMethods Extended Enterprise Solution Suite permits our customers to rapidly and cost effectively deploy new real-time business-to-business (B2B) e-commerce applications by better integrating their existing internal enterprise systems and by integrating those systems with those of their business partners.

      webMethods was founded in June 1996. In August 2000, webMethods acquired Active Software, Inc. (“Active”) in a transaction which was accounted for as a pooling of interests. Active was founded in September 1995. We have grown from 94 employees as of March 31, 1998 to 1,067 employees as of June 30, 2001.

Revenue

      We enter into arrangements, which may include the sale of licenses of our integration software, professional services and maintenance or various combinations of each element. We recognize revenue based on Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended, and modified by SOP 98-9, “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions.” SOP 98-9 modified SOP 97-2 by requiring revenue to be recognized using the “residual method” if certain conditions are met. Revenue is recognized based on the residual method when an agreement has been signed by both parties, the fees are fixed or determinable, collection of the fees is probable, delivery of the product has occurred and no other significant obligations remain. Historically we have not experienced significant returns or offered exchanges of our products.

      For multi-element arrangements, each element of the arrangement is analyzed and we allocate a portion of the total fee under the arrangement to the undelivered elements, such as professional services, training and maintenance. Revenue allocated to the undelivered elements is deferred using vendor-specific objective evidence of fair value of the elements and the remaining portion of the fee is allocated to the delivered elements (generally the software license), under the residual method. Vendor specific-objective evidence of fair value is based on the price the customer is required to pay when the element is sold separately (i.e. hourly time and material rates charged for consulting services when sold separately from a software license and the optional renewal rates charged by us for maintenance arrangements).

      For electronic delivery, the product is considered to have been delivered when the access code to download the software from our website and activation key, as applicable, have been provided to the customer. If an element of the license agreement has not been delivered, revenue for the element is deferred based on its vendor-specific objective evidence of fair value. If vendor-specific objective evidence of fair value does not exist, all revenue is deferred until sufficient objective evidence exists or all elements have been delivered. If the fee due from the customer is not fixed or determinable, revenue is recognized as payments become due. If collectibility is not considered probable, revenue is recognized when the fee is collected.

      License Revenue: Amounts allocated to license revenue under the residual method are recognized at the time of delivery of the software when vendor-specific objective evidence of fair value exists for the undelivered elements, if any, and all the other revenue recognition criteria discussed above have been met.

      Professional Services Revenue: Revenue from professional services is comprised of consulting, implementation services and training. Consulting services are generally sold on a time-and-materials basis and include services such as installation and building non-complex interfaces to allow the software to operate in customized environments. Services are generally separable from the other elements under the arrangement since the performance of the services is not essential to the functionality (i.e. the services do not involve significant production, modification or customization of the software or building complex interfaces) of any other element of the transaction. Revenue for professional services and training is recognized when the services are performed.

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

Costs of Revenue

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

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Operating Expenses

      Our operating expenses are classified as sales and marketing, research and development and general and administrative. Each category includes related expenses for compensation, employee benefits, professional fees, travel, communications and allocated facilities, recruitment and overhead costs. Our sales and marketing expenses include expenses which are specific to the sales and marketing activities, such as commissions, trade shows, public relations, promotional costs and marketing collateral. Also included in our operating expenses is the amortization of deferred stock compensation and deferred warrant charge.

RECENT DEVELOPMENTS

      In July 2001, we announced a reduction in force and will take a restructuring charge in the quarter ending September 30, 2001. This restructuring charge will consist primarily of charges related to headcount reductions and consolidation of facilities. The plan will result in headcount reductions of approximately 15%, and we expect to consolidate some of our main facilities and close excess field offices.

RESULTS OF OPERATIONS

Revenue

      Total revenue increased by approximately $20.3 million, or 58.0%, to $55.4 million for the three months ended June 30, 2001 from $35.1 million for the three months ended June 30, 2000.

      License. License revenue increased by approximately $12.8 million, or 53.4%, to $36.8 million for the three months ended June 30, 2001 from $24.0 million for the three months ended June 30, 2000. License revenue as a percentage of total revenue was 66.4% and 68.4% for the quarters ended June 30, 2001 and 2000, respectively. The absolute dollar increase was primarily attributable to an increase in sales to new and existing customers resulting from increased sales force headcount, new products, features and enhancements, a growing acceptance of our integration software, new and expanded relationships with many systems integration and enterprise application vendors and an increased presence internationally.

      Professional Services. Professional services revenue increased by approximately $1.9 million, or 25.2%, to $9.7 million for the three months ended June 30, 2001 from $7.7 million for the three months ended June 30, 2000. Professional services revenue as a percentage of total revenue was 17.5% and 22.1% for the quarters ended June 30, 2001 and 2000, respectively. The absolute dollar increase was attributable to the increased licensing activity described above, which has resulted in increased customer implementation activity and follow-on professional services. The decrease in professional service revenue as a percentage of total revenue was due primarily to our increased use of systems integration partners to provide professional services to our customers.

      Maintenance. Maintenance revenue increased by approximately $5.6 million, or 166.8%, to $8.9 million for the three months ended June 30, 2001 from $3.3 million for the three months ended June 30, 2000. Maintenance revenue as a percentage of total revenue was 16.1% and 9.5% for the quarters ended June 30, 2001 and 2000, respectively. These increases are due primarily to our increased license activity as described above since most license contracts include post contract maintenance and support which is recognized as revenue on a ratable basis over the term of the maintenance agreement.

Cost of Revenue

      License. Cost of license revenue decreased by approximately $301,000, or 30.0%, to $701,000 for the three months ended June 30, 2001 from $1.0 million for the three months ended June 30, 2000. Cost of license revenue as a percentage of total revenue was 1.3% and 2.9% for the quarters ended June 30, 2001 and 2000, respectively. This decrease in the cost of license revenue was primarily due to decreased sales of our product which incorporates third party technology for which we pay royalties, and to a lesser extent, the amortization of prepaid third party software licensing fees. Gross profit margin on license revenue increased to 98.1% for the three months ended June 30, 2001 compared to 95.8% for the three months ended June 30, 2000. The improvement in gross margin was attributable to a smaller proportion of our products sold that incorporated third party technology for which we pay royalties.

      Professional Services and Maintenance. Cost of professional services and maintenance, excluding stock based compensation, increased by approximately $2.3 million, or 22.7%, to $12.4 million for the three months ended June 30, 2001 from $10.1 million for the three months ended June 30, 2000. Cost of professional services and

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maintenance revenue, excluding stock based compensation, as a percentage of total revenue was 22.4% and 28.8% for the quarters ended June 30, 2001 and 2000, respectively. The absolute dollar increase was primarily attributable to increases in the number of professional service and technical support personnel and, to a lesser extent, increases in subcontractor and travel expenses. Gross profit margin on professional services and maintenance, excluding stock based compensation, increased to 33.3% of professional services and maintenance revenue for the three months ended June 30, 2001 compared to 8.8% for the three months ended June 30, 2000. The increase in gross profit margin was due primarily to the increase in maintenance revenue, which has a lower cost associated with it, as well as increase in the rates charged on professional services.

Gross Profit

      Gross profit increased by approximately $18.4 million, or 77.4%, to $42.1 million for the three months ended June 30, 2001 from $23.7 million for the three months ended June 30, 2000. The increase was attributable to the growth in our customer base, which contributed to increased revenue from software licenses, professional services and maintenance, and, to a lesser extent, a decrease in third party royalties as a percentage of license revenue and a decrease in professional services revenue as a percentage of total revenue. The gross profit margin was 76.0% for the quarter ended June 30, 2001, up from 67.7% for the quarter ended June 30, 2000.

Operating Expenses

      Sales and Marketing. Sales and marketing expenses, excluding stock based compensation, increased by approximately $10.7 million, or 55.1%, to $30.2 million for the three months ended June 30, 2001 from $19.5 million for the three months ended June 30, 2000. Sales and marketing expense, excluding stock based compensation, as a percentage of total revenue was 54.5% and 55.5% for the quarters ended June 30, 2001 and 2000, respectively. The absolute dollar increase in sales and marketing expenses was primarily attributable to an increase in the number of sales and marketing employees, commissions, international expansion and, to a lesser extent, increases in external commissions and marketing programs which include trade shows, public relations, promotional costs and marketing collateral.

      Research and Development. Research and development expenses, excluding stock based compensation, increased by approximately $5.6 million, or 73.6%, to $13.3 million for the three months ended June 30, 2001 from $7.7 million for the three months ended June 30, 2000. Research and development expense, excluding stock based compensation, as a percentage of total revenue is 24.0% and 21.8% for the quarters ended June 30, 2001 and 2000, respectively. The absolute dollar increase in research and development expenses was primarily attributable to increases in the number of software development, pre-commercial release quality assurance and documentation personnel, and, to a lesser extent, third-party development costs.

      General and Administrative. General and administrative expenses, excluding stock based compensation, increased by approximately $1.8 million, or 43.8%, to $5.9 million for the three months ended June 30, 2001 from $4.1 million for the three months ended June 30, 2000. General and administrative expense, excluding stock based compensation, as a percentage of total revenue is 10.7% and 11.7% for the quarters ended June 30, 2001 and 2000, respectively. The absolute dollar increase in general and administrative expenses was primarily attributable to external legal, accounting and other professional fees, provision for allowance for doubtful accounts, increases in the number of accounting, finance and human resources personnel and implementation of systems infrastructure.

      Stock Based Compensation and Warrant Charge. In connection with the grant of stock options to employees and non-employee directors during the years ended March 31, 2000 and 1999, we recorded aggregate unearned compensation of $15.5 million, representing the difference between the deemed fair value of our common stock at the date of grant and the exercise price of such options. As a result of the acquisitions of companies in February and April 2000 we recorded a deferred stock compensation charge of $27.9 million related to restricted stock issued to stockholders of the acquired companies. In connection with the Active merger, 50% of Active's remaining options vested upon consummation of the merger which resulted in an acceleration of amortization of deferred stock compensation.

      In connection with an OEM/Reseller agreement with i2 Technologies (i2), we issued a warrant, as amended, to i2 to purchase 710,000 shares of our common stock at an exercise price of $28.70 per share. The fair value of the original warrant based on the Black-Scholes valuation model was $23.6 million on the date of issuance which has been recorded as a deferred warrant charge. As part of the agreement, i2 will pay us OEM fees of $10,000,000 over the term of the agreement which will be recorded as a reduction to the deferred warrant charge and will not be recorded as revenue.

      The deferred stock compensation and deferred warrant charge is presented as a reduction of stockholders’ equity and is amortized over the vesting period of the applicable equity arrangement and is shown by expense category. Of the total deferred stock compensation and warrant charge recorded for options, restricted stock and warrants, approximately $5.0 million was amortized during the quarter ended June 30, 2001, compared to $4.9 million during the quarter ended June 30, 2000.

      Amortization of Goodwill and Acquired Intangibles. Amortization of goodwill and acquired intangibles was $10.5 million for the quarter ended June 30, 2001 and $9.7 million for the quarter ended June 30, 2000. The estimated useful life of the goodwill and the acquired intangibles is 3 years for trained and acquired assembled workforce, one year for license agreements, 2 years for non-compete agreements, 3 years for goodwill and 4 years for favorable lease terms. The goodwill and acquired intangibles relate to the acquisitions of companies in February and April 2000.

      In-process research and development. In-process research and development was expensed upon consummation of an acquisition in April 2000 as acquired technology had not reached technological feasibility and, in the opinion of management, has no alternative future use. For the three months ended June 30, 2000, $2.3 million was expensed related to in-process research and development.

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Interest Income, Net

      Interest income, net decreased by approximately $535,000, or 16.7%, to $2.7 million for the three months ended June 30, 2001 from $3.2 million for the three months ended June 30, 2000. This decrease was primarily attributable to lower interest rates on corporate paper, bonds and money market funds available in the quarter ended June 30, 2001 compared to those in the quarter ended June 30, 2000.

LIQUIDITY AND CAPITAL RESOURCES

      We have financed our operations through an initial public offering of our common stock which was completed on February 10, 2000, private sales of mandatorily redeemable, convertible preferred stock, prior to March 31, 2000, and, to a lesser extent, through bank loans and equipment leases. As of June 30, 2001, we had approximately $74.3 million in cash and cash equivalents, approximately $104.2 million in short-term investments, approximately $29.6 million in long-term investments and approximately $162.0 million in working capital.

      Net cash used in operating activities was approximately $1.2 million for the three months ended June 30, 2001, and approximately $6.1 million for the three months ended June 30, 2000. Net cash used from operating activities in each period reflects net losses offset in part by amortization of goodwill and intangibles and a decrease in accounts receivable as of June 30, 2001.

      Net cash used in investing activities was approximately $39.1 million for the three months ended June 30, 2001, and approximately $35.2 million for the three months ended June 30, 2000. Cash used in investing activities primarily reflects purchases of marketable securities available for sale in each period. Capital expenditures were approximately $1.9 million for the three months ended June 30, 2001 and $954,000 for the three months ended June 30, 2000. Capital expenditures consisted primarily of purchases of operating resources to manage operations, including computer hardware and software, office furniture and equipment and leasehold improvements. Since inception we have generally funded capital expenditures either through capital leases, the use of working capital, or bank loans.

      Net cash from financing activities was approximately $4.7 million for the three months ended June 30, 2001, and approximately $3.0 million for the three months ended June 30, 2000. These cash flows in the three months ended June 30, 2001 primarily reflect net cash proceeds from issuance of shares of our common stock through the employee stock purchase plan and the proceeds from the exercise of stock options. As of June 30, 2001, we had a line of credit to borrow up to a maximum principal amount of $10,000,000 with a maturity date of July 10, 2002. Borrowings under this line of credit are limited to 80% of eligible accounts receivable. Interest is payable on the unpaid principal balance at the bank’s prime rate. As of June 30, 2001 and 2000, we had not borrowed against this line of credit. In connection with the line of credit, we obtained a letter of credit totaling $750,000 outstanding as of June 30, 2000, which was subsequently reduced to $475,000 outstanding as of June 30, 2001. This letter of credit expires in May 2002 and relates to an office lease.

      We believe that our existing working capital and our line of credit will be sufficient to meet our working capital and operating resource expenditure requirements for at least the next twelve months. Thereafter, we may find it necessary to obtain additional equity or debt financing. In the event additional financing is required, we may not be able to raise it on acceptable terms or at all.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

      In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method and addresses the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired outside of a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but will rather be tested at least annually for impairment. Under the provisions of SFAS No. 142, any impairment loss identified upon adoption of this standard is recognized as a cumulative effect of a change in accounting principle. Any impairment loss incurred subsequent to initial adoption of SFAS No. 142 is recorded as a charge to current period earnings. In the event the Company acquires goodwill subsequent to June 30, 2001 it will not be amortized. The Company will adopt SFAS No. 142 in fiscal in 2003 and, at that time, will stop amortizing goodwill that resulted from business combinations completed prior to the adoption of SFAS No. 141. The Company is currently evaluating the provisions of SFAS No. 142 and has not yet determined the effect that adoption of this standard will have on its consolidated financial statements.

ITEM 3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to a variety of risks, including changes in interest rates affecting the return on our investments and foreign currency fluctuations. We have established policies and procedures to manage our exposure to fluctuations in interest rates and foreign currency exchange rates.

Interest rate risk. We maintain our funds in money market and certificate of deposit accounts at financial institutions. Our exposure to market risk due to fluctuations in interest rates relates primarily to our interest earnings on our cash deposits. These securities are subject to interest rate risk in as much as their fair value may fall if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from the levels prevailing as of March 31, 2001, the fair value of the portfolio would not decline by a material amount. We do not use derivative financial instruments to mitigate risks. However, we do have an investment policy that would allow us to invest in short-term and long-term investments such as money market instruments and corporate debt securities. Our policy attempts to reduce such risks by typically limiting the maturity date of such securities to no more than twenty-four months with a maximum average maturity to our whole portfolio of such investments at twelve months, placing our investments with high credit quality issuers and limiting the amount of credit exposure with any one issuer.

Foreign currency exchange rate risk. Our exposure to market risk due to fluctuations in foreign currency exchange rates relates primarily to the intercompany balances with our subsidiaries located in Australia, England, France, Germany, Japan, the Netherlands and Singapore. Although we transact business in various foreign countries, settlement amounts are usually based on U.S. currency. Transaction gains or losses have not been significant in the past, and there is no hedging activity on foreign currencies. We would not experience a material foreign exchange loss based on a hypothetical 10% adverse change in the price of the euro, Great Britain pound, French franc, deutschmark, guilder, Singapore dollar, Australian dollar, or yen against the U.S. dollar. Consequently, we do not expect that a reduction in the value of such accounts denominated in foreign currencies resulting from even a sudden or significant fluctuation in foreign exchange rates would have a direct material impact on our financial position, results of operations or cash flows.

Notwithstanding the foregoing, analysis of the direct effects of interest rate and foreign currency exchange rate fluctuations on the value of certain of our investments and accounts, the indirect effects of fluctuations in foreign currency could have a material adverse effect on our business, financial condition and results of operations. For example, international demand for our products is affected by foreign currency exchange rates. In addition, interest rate fluctuations may affect the buying patterns of our customers. Furthermore, interest rate and currency exchange rate fluctuations have broad influence on the general condition of the U.S. foreign and global economics, which could materially adversely affect our business, financial condition results of operations and cash flows.

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PART II
OTHER INFORMATION

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

      On February 10, 2000, in connection with our initial public offering, a Registration Statement on Form S-1 (No. 333-91309) was declared effective by the Securities and Exchange Commission, pursuant to which 4,715,000 share of our common stock were offered and sold for our account at a price of $35.00 per share, generating aggregate gross proceeds of $165 million for the account of the Company. The managing underwriters were Morgan Stanley Dean Witter, Merrill Lynch & Co., Dain Rauscher Wessels and Freidman Billings Ramsey. After deduction approximately $11.6 million in underwriting discounts and $1.5 million in other related expenses, the net proceeds of the offering were approximately $151.9 million. As of June 30, 2001, $151.9 million of the net proceeds were invested in cash and cash equivalents, short-term and long-term investments. We intend to use such proceeds for capital expenditures and for general corporate purposes, including working capital to fund anticipated operating losses.

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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

      (a) Exhibits.

Exhibit
Number	Description
2.1(1)	Agreement and Plan of Merger dated as of May 20, 2000, by and among webMethods, Inc., Wolf Acquisition, Inc. and Active Software, Inc.
3.1(2)	Fifth Amended and Restated Certificate of Incorporation of webMethods, Inc., as amended
3.2(3)	Amended and Restated Bylaws of webMethods, Inc.
4.1(3)	Specimen certificate for shares of webMethods Common Stock
10.1(3)	Second Amended and Restated Investor Rights Agreement
10.2(4)	webMethods, Inc. Amended and Restated Stock Option Plan
10.3(3)	Employee Stock Purchase Plan
10.4(3)	Indemnification Agreement entered into between webMethods, Inc. and each of its directors

(1)	Incorporated by reference to webMethods’ Registration Statement on Form S-4, as amended (File No. 333-39572).
(2)	Incorporated by reference to webMethods’ Annual Report on Form 10-K for the year ended March 31, 2001 (File No. 001-15681).
(3)	Incorporated by reference to webMethods’ Registration Statement on Form S-1, as amended (File No. 333-91309).
(4)	Incorporated by reference to webMethods’ definitive Proxy Statement filed with the Securities and Exchange Commission on July 21, 2000 (File No. 001-15681)

      (b) Reports on Form 8-K.webMethods, Inc. filed the following report on Form 8-K since the beginning of its fiscal quarter on April 1, 2001:

Date of Report	Item No.		Item Reported
June 1, 2001		5	Announcement of amendment and restatement of warrant issued to i2 Technologies

SIGNATURES

      Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	WEBMETHODS, INC.
Date: August 13, 2001
	By: /s/ PHILLIP MERRICK
	Phillip Merrick
	Chairman of the Board and
	Chief Executive Officer
Date: August 13, 2001
	By: /s/ MARY DRIDI
	Mary Dridi
	Chief Financial Officer
	(Principal Financial Officer)