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FORM S-1

WEBMETHODS, INC.

Delaware

3877 Fairfax Ridge Road, Fourth Floor

Mr. Phillip Merrick

Copies to:

     Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this Registration Statement.

     If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  [   ]

     If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. 
[   ]        

     If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. 
[   ] 

     If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. 
[   ] 

     If delivery of the prospectus is expected to be made pursuant to Rule 434, check the following box.  [   ]

CALCULATION OF REGISTRATION FEE

     The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to Section 8(a), may determine.

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The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any state where the offer or sale is not permitted.

PROSPECTUS (Subject to Completion)
Issued November 19, 1999

                               Shares

[WEBMETHODS LOGO]

COMMON STOCK

webMethods, Inc. is offering            shares of common stock. This is our initial public offering and no public market currently exists for our shares. We anticipate that the initial public offering price will be between $          and $      per share.

We have applied to list our common stock on the Nasdaq National Market under the symbol “WEBM.”

Investing in our common stock involves risks. See “Risk Factors” beginning on page 3.

The Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities, or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

webMethods has granted the underwriters the right to purchase up to an additional  shares to cover over-allotments. Morgan Stanley & Co. Incorporated expects to deliver the shares of common stock to purchasers on           , 2000.

MORGAN STANLEY DEAN WITTER

	MERRILL LYNCH & CO.

	DAIN RAUSCHER WESSELS

	FRIEDMAN BILLINGS RAMSEY

          , 2000

INSIDE FRONT COVER PAGE OF PROSPECTUS

Graphic:

      The diagram on the left side of the page has the words “ABC Company using webMethods B2B” in the hub. Emanating from the hub are six arrows with arrowheads in both directions, and circles representing business partners at the far end of each arrow. Each of the business partners has one of the following labels:

           Buyer using SAP R/3

      Additionally, 4 of the arrows have words running parallel with the arrows, including

           RosettaNet

      Under this hub is a subtitle reading: “webMethods B2B Enables Directly Integrated Business Communities.” There is also a box to the lower left, which includes a heading, “Example webMethods B2B Customers.” Under the heading, the names “Dell,” “Dun & Bradstreet,” “DHL” and “Hewlett Packard” are listed.

      The diagram on the right side of the page has the words “B2B Marketplace using webMethods B2B” in the hub. The hub is surrounded by six blue circles representing suppliers and seven red circles representing customers. Arrows with points in both directions connect four of the suppliers and four of the customers to a circle drawn around the hub, in the manner of a traffic circle.

      Under the hub is a subtitle reading “webMethods B2B enables B2B Marketplaces.” There is a box to the lower left that contains the heading “Example webMethods B2B Marketplace Customers.” Listed underneath are mySAP.com, Grainger.com, MRO.com and VerticalNet.

      An arrow with points at both ends is drawn between the two hubs, and is designated Portal Connection. There are faint “topographical” lines in the background behind the two hubs, with the word “Internet” superimposed over. At the bottom center of the page, there is a block of copy that extends across the page between the two example customer boxes and under the two diagrams. This copy reads, “webMethods B2B provides companies with integrated direct links to buyers and suppliers, connects them to major B2B Marketplaces and enables real-time, interactive communication through the Internet regardless of existing technology infrastructure.”

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      Our principal executive offices are located at 3877 Fairfax Ridge Road, Fourth Floor, Fairfax, Virginia 22030 and our telephone number is (703) 460-2500. Our Web site address is www.webMethods.com. The information contained in our Web site is not incorporated by reference into this prospectus.

      You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell shares of common stock and seeking offers to buy shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of the common stock.

      Until           , 2000, (25 days after the date of this prospectus) all dealers that buy, sell or trade our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

      In this prospectus, “webMethods,” “we,” “us” and “our” refer to webMethods, Inc. and its subsidiaries and not to the underwriters. Unless otherwise indicated, all information contained in this prospectus:

	•	assumes that the underwriters’ over-allotment option will not be exercised;
	•	except as noted in the consolidated financial statements, gives effect to the conversion of all outstanding shares of mandatorily redeemable, convertible preferred stock and accrued dividends into           shares of common stock at a ratio of twenty shares of common stock for each share of mandatorily redeemable, convertible preferred stock outstanding and by issuing           shares of common stock valued at $       per share for the accrued dividends on the mandatorily redeemable, convertible preferred stock effective upon the closing of this offering; and
	•	except as noted in the consolidated financial statements, reflects a           for           stock split of the common stock to be effected immediately prior to the effectiveness of this offering.

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PROSPECTUS SUMMARY

      You should read the following summary together with the more detailed information regarding webMethods and the common stock being sold in this offering and our financial statements and notes thereto appearing elsewhere in this prospectus.

WEBMETHODS

      We are a leading provider of infrastructure software and services that allow companies to achieve business-to-business integration, or B2Bi. B2Bi software is a new category of software that enables companies to work more closely with their customers, suppliers and business partners through the real-time exchange of information and transactions. Our software solution, webMethods B2B, permits our customers to rapidly and cost effectively deploy new, real-time business-to-business e-commerce applications over the Internet by integrating their existing enterprise applications with those of their customers, suppliers and other business partners. Our customers can use our software to achieve varying levels of integration, from integration with a single business partner to full integration across an entire trading network. We believe that our solution provides companies with a number of benefits, including increased revenue opportunities, tighter relationships with customers, suppliers and other business partners, improved supply chain efficiencies and increased return on investment on existing technology.

      Our software supports a broad range of current and emerging business-to-business, or B2B, communication standards, which allows the benefits of a company’s internally focused enterprise applications to be extended to its business partners regardless of existing technology infrastructure. In addition, because our software operates with many disparate systems and supports a range of B2B communication standards, it can be implemented across a network of business partners, without long and expensive implementation cycles and without the need for consensus among business partners regarding communication standards.

      A key element of our sales and marketing strategy is to leverage the relationships that we have developed with our customers and business partners. We believe that providing solutions to B2B e-commerce leaders will increase customer awareness, stimulating demand. As of October 31, 1999, we had over 100 customers including Dell, DHL, Dun & Bradstreet, W.W. Grainger, Hewlett Packard, Lexmark and Occidental Chemical. In addition, we have established strategic relationships with leading B2B e-commerce marketplaces such as mySAP.com, the Ariba Network, Clarus Supplier Universe, Grainger.com, OrderZone.com, VerticalNet and Intelisys.

THE OFFERING

      The foregoing information is based on shares outstanding as of September 30, 1999. This information:

	•	excludes an aggregate of 7,000,000 shares of common stock reserved for issuance under our stock plans, of which 3,558,323 shares were subject to outstanding options, at a weighted average exercise price of $1.68 per share;
	•	excludes 4,000 shares of common stock issuable upon the exercise of an outstanding warrant, at an exercise price of $1.66 per share; and
	•	includes $2.5 million of our of common stock or           shares to be sold to The Goldman Sachs Group, Inc. in a private transaction concurrent with the closing of this offering at a price per share equal to $     , the assumed initial public offering price less one-half of the underwriting discount and commission.

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SUMMARY CONSOLIDATED FINANCIAL DATA

      The pro forma information in the consolidated balance sheet data above gives effect to our sale of 68,770 shares of mandatorily redeemable, convertible Series E preferred stock in November 1999 for net proceeds of approximately $16.9 million.

      The pro forma as adjusted information in the consolidated balance sheet data above gives effect to the conversion of all outstanding shares of mandatorily redeemable, convertible preferred stock and accrued dividends into           shares of common stock effective upon the closing of this offering, the receipt of $2.5 million from The Goldman Sachs Group, Inc. at a price per share equal to $          , the assumed initial public offering price per share less one-half of the underwriting discount and commission in exchange for           shares of common stock to be issued in a private transaction concurrent with the closing of this offering, and the sale of           shares of our common stock in this offering, at an assumed initial public offering price of $     per share, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

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RISK FACTORS

      This offering and an investment in our common stock involve a high degree of risk. You should carefully consider the following risk factors and the other information in this prospectus, including our consolidated financial statements and the related notes, before investing in our common stock. Our business, operating results or financial condition could be seriously harmed by any of the following risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment.

Risks Related To Our Business

      We are an early stage company, so we have only a limited operating history with which you can evaluate our business and prospects.

      We commenced operations in June 1996 and first shipped webMethods B2B in June 1998. Accordingly, we have only a limited operating history with which you can evaluate our business and our prospects. In addition, our prospects must be considered in light of the risks encountered by companies in the early stages of development in new and rapidly evolving markets, especially the business-to-business integration software market. Some of the risks we face include our ability to:

	•	attract and retain a broad customer base;
	•	negotiate and maintain favorable strategic relationships; and
	•	plan and manage our growth effectively.

If we fail to manage these risks successfully, our business could be harmed.

      We expect to incur losses in the future.

      We have never been profitable. We have incurred net losses in every fiscal period since we began operations. For the fiscal year ended March 31, 1999, our net loss was $3.3 million. For the six months ended September 30, 1999, our net loss was $5.0 million. As of September 30, 1999, our accumulated deficit was approximately $11.1 million. We expect to substantially increase our sales and marketing, research and development and general and administrative expenses. As a result, we will need to generate significant additional revenues to achieve and maintain profitability in the future. We are not certain when we will become profitable, if ever. Even if we do achieve profitability, we may not sustain or increase profitability on a quarterly or annual basis. Failure to achieve or maintain profitability will materially and adversely affect the market price of our common stock.

      Our quarterly financial results are subject to significant fluctuations because of many factors, any of which could harm our business and our stock price.

      Our quarterly revenue and results of operations are difficult to predict. We have experienced, and expect to continue to experience, fluctuations in revenue and operating results from quarter-to-quarter. As a result, we believe that quarter-to-quarter comparisons of our revenue and operating results are not necessarily meaningful, and that such comparisons may not be accurate indicators of future performance. The reasons for these fluctuations include, but are not limited to:

	•	our ability to retain existing customers and to attract new customers;
	•	the length of our sales cycle, which makes it difficult to forecast the quarter in which our sales will occur;
	•	the amount and timing of operating costs relating to expansion of our business, operations and infrastructure;
	•	the number and timing of new hires;
	•	our mix of license and professional services revenue;
	•	our utilization rate for our professional services personnel;

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	•	the success of our strategic relationships;
	•	changes in our pricing policies or our competitors’ pricing policies;
	•	the announcement and introduction of new products or product enhancements by us or our competitors; and
	•	our mix of domestic and international sales.

      We plan to significantly increase our operating expenses to expand our sales and marketing operations and fund greater levels of research and development. Our operating expenses, which include sales and marketing, research and development and general and administrative expenses, are based on our expectations of future revenues and are relatively fixed in the short term. If revenue falls below our expectations in a quarter and we are not able to quickly reduce our spending in response, our operating results for that quarter could be harmed. It is likely that in some future quarter our operating results may be below the expectations of public market analysts and investors and, as a result, the price of our common stock may fall.

      Variations in our sales cycle could cause our quarterly operating results to fluctuate.

      The period between our initial contact with a potential customer and the purchase of our software and services is often long and subject to delays associated with the budgeting, approval, and competitive evaluation processes which frequently accompany significant capital expenditures. A lengthy sales cycle may have an impact on the timing of our revenue, which in turn could cause our quarterly operating results to fluctuate. We believe that a customer’s decision to purchase our software and services is discretionary, involves a significant commitment of resources, and is influenced by customer budgetary cycles. 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.

      We expect to depend on webMethods B2B for all of our revenue for the foreseeable future and if it does not achieve broad market acceptance, our business and results of operation could suffer.

      We currently derive all of our revenue from licensing our webMethods B2B software and providing related professional services, maintenance and support. We expect that we will continue to depend on webMethods B2B for our revenue for the foreseeable future. Consequently, a decline in the price of, or demand for, webMethods B2B, or its failure to achieve broad market acceptance, could seriously harm our business and results of operations.

      webMethods B2B is based in large part on XML, which has not yet achieved broad market acceptance and if broad market acceptance for XML does not develop, our business could be harmed.

      webMethods B2B is currently based in large part upon XML, or eXtensible Markup Language, an emerging standard for sharing data over the Internet. While we anticipate that XML will achieve broad market acceptance in the near future, it is possible that a competing standard perceived to be superior could replace XML, in which case the market may not accept an XML-based product. If a new standard were perceived to be superior, our software might not be compatible with the new standard or we might not be able to develop a product using this standard in a timely manner. Consequently, a failure of XML-based products to achieve broad market acceptance or the introduction of a competing standard perceived to be superior in the market could harm our business.

      Our customer base is concentrated and loss of a major customer could harm our business.

      In the fiscal year ended March 31, 1999, two customers accounted for an aggregate of approximately 23% of our total revenue, one for approximately 13% and the other for approximately 10%. During the six months ended September 30, 1999, two customers accounted for approximately 45% of our total revenue, one for approximately 35%, and one for approximately 10%. We may continue to derive a significant portion of our revenue from a relatively small number of customers in the future. If a major customer decided not to renew its license to use our products, our business, operating results and financial condition could be harmed.

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      If our strategic relationships terminate, our business could suffer.

      We have established strategic relationships with B2B e-commerce marketplaces, resellers, enterprise application software providers, system integrators and other technology leaders. These relationships expose our software to many potential customers to which we may not otherwise have access. In addition, these relationships provide us with insights into new technology and with third-party service providers that our customers can use for implementation assistance. If our relationships with any of these organizations were terminated, we might lose important opportunities, including sales and marketing opportunities, and our business may suffer.

      If our relationship with SAP AG terminates, our business could be adversely affected.

      In March 1999, we entered into a development partner agreement with SAP AG. Our relationship with SAP AG provides us with an important endorsement of our software, will expose the capabilities of a restricted version of our webMethods B2B software to the SAP AG customer base and gives us the opportunity to license the fully featured version of our webMethods B2B software to its customer base. If our relationship with SAP AG terminates or weakens, our revenues may decline and our business could be adversely affected. Under the development partner agreement, we granted SAP AG a perpetual license to include a restricted version of webMethods B2B in its software. We cannot be certain that SAP AG’s interest in promoting our software to its customers will be consistent with our own. As a result, we cannot be certain that we will continue to have access to SAP AG’s customer base or that SAP AG customers will license additional software from us.

      SAP AG has become a significant customer, accounting for approximately 35% of our revenues for the six months ended September 30, 1999 as a result of the development partner agreement. Under the agreement, SAP AG agreed to pay a quarterly fixed fee. This fee is, and may continue to be, a significant portion of our revenue if we are not able to expand our revenue base. SAP AG must pay this fee even if the agreement is terminated. In addition, we may receive revenue as a result of SAP AG customers that upgrade to an unrestricted version of webMethods B2B. If SAP AG chooses not to renew the license agreement in order to receive access to the latest version of our software at the expiration of the development license agreement, our revenue may decline and our business could be adversely affected.

      Our business model depends on our customers renewing their licenses.

      Although most enterprise software providers offer perpetual licenses with a single payment received at the time of the license grant, we typically license our webMethods B2B software on a two-year renewable basis. We first shipped webMethods B2B in June 1998 and, to date, none of our initial two-year licenses has reached its renewal date. If a significant portion of our customers were to elect not to renew their licenses for our software or were to seek perpetual licenses in the future, we would lose a recurring revenue stream on which we base our business model and our business, operating results and financial condition could be harmed.

      We need to expand our sales and distribution capabilities.

      We need to substantially expand our direct and indirect sales and distribution efforts, both domestically and internationally, in order to increase market awareness and sales of our webMethods B2B software and the related services we offer. We have recently expanded our direct sales force and plan to hire additional sales personnel. webMethods B2B requires a sophisticated sales effort targeted at multiple departments within an organization. Competition for qualified sales and marketing personnel is intense, and we might not be able to hire and retain adequate numbers of such personnel to maintain our growth. New hires will require training and take time to achieve full productivity. Our competitors have attempted to hire our employees away from us and we expect that they will continue such attempts in the future. We also plan to expand our relationships with system integrators, enterprise software vendors and other third-party resellers to further develop our indirect sales channel. As we continue to develop our indirect sales channel, we will need to manage potential conflicts between our direct sales force and third-party reselling efforts.

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      Our business will suffer if we do not expand our professional services organization or if we are unable to establish and maintain relationships with third-party implementation providers.

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

      The business-to-business e-commerce industry is highly competitive and we may not be able to compete effectively.

      The market for B2B e-commerce solutions is rapidly changing and intensely competitive. We expect competition to intensify as the number of entrants and new technologies increases. We may not be able to compete successfully against current or future competitors. The competitive pressures facing us may harm our business, operating results and financial condition.

      Our current and potential competitors include, among others, large software vendors, companies and trading networks that develop their own business-to-business integration e-commerce solutions, electronic data interchange, or EDI, vendors, vendors of proprietary enterprise application integration, or EAI, solutions and application server vendors who have added XML capabilities to their products. In addition, our customers and companies with whom we currently have strategic relationships may become competitors in the future. Many of our competitors and potential competitors have more experience developing Internet-based software, larger technical staffs, larger customer bases, more established distribution channels, greater brand recognition and greater financial, marketing and other resources than we do. Our competitors may be able to develop products and services that are superior to our software and services, that achieve greater customer acceptance or that have significantly improved functionality as compared to our existing software and future products and services. In addition, negotiating and maintaining favorable customer and strategic relationships is critical to our business. Our competitors may be able to negotiate strategic relationships on more favorable terms than we are able to negotiate. Many of our competitors may also have well-established relationships with our existing and prospective customers. Increased competition may result in reduced margins, loss of sales or decreased market share which in turn could harm our business, operating results and financial condition.

      We have experienced significant growth in our business in recent periods and failure to manage this growth could harm our business.

      Our ability to successfully offer software and services and implement our business plan in a rapidly evolving market requires an effective planning and management process. We have increased, and plan to continue to increase, the scope of our operations at a rapid rate. The number of people we employ has grown and will continue to grow substantially. As of March 31, 1999, we had a total of 65 employees. As of October 31, 1999, we had a total of 150 employees. Future expansion efforts could be expensive and may strain our managerial and other resources. To manage future growth effectively, we must maintain and enhance our financial and accounting systems and controls, integrate new personnel and manage expanded operations. If we do not manage growth properly, it could harm our business, operating results and financial condition.

      If our software contains defects, we could lose customers and revenue.

      Software as complex as ours often contains known and undetected errors or performance problems. Many serious defects are frequently found during the period immediately following introduction of new software or

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      If we cannot develop our software in a timely and effective manner, our operating results could suffer.

      Because of the complexity of our software, internal quality assurance testing and customer testing may reveal product performance issues or desirable feature enhancements that could lead us to postpone the release of new versions of our software. In addition, the reallocation of resources associated with any postponement could cause delays in the development and release of future enhancements to our currently available software. We may not be able to successfully complete the development of currently planned or future enhancements in a timely and efficient manner. Any such failure or delay could harm our operating results.

      Our executive officers and certain key personnel are critical to our business and these officers and key personnel may not remain with us in the future.

      Our future success depends upon the continued service of our executive officers and other key personnel and none of our officers or key employees is bound by an employment agreement for any specific term. If we lose the services of one or more of our executive officers or key employees, or if one or more of them decide to join a competitor or otherwise compete directly or indirectly with us, our business, operating results and financial condition could be harmed. In particular, Phillip Merrick, our Chairman of the Board, President and Chief Executive Officer, would be particularly difficult to replace.

      If we cannot meet our future capital requirements, our business will be harmed.

      We currently anticipate that the net proceeds from this offering, together with our existing working capital immediately prior to this offering, will be sufficient to meet our anticipated working capital and capital expenditure requirements through at least the next twelve months. The time period for which we believe our capital is sufficient is an estimate; the actual time period may differ materially as a result of a number of factors, risks and uncertainties. We may need to raise additional funds in the future through public or private debt or equity financings in order to:

	•	take advantage of opportunities, including more rapid international expansion or acquisitions of complementary businesses or technologies;
	•	develop new products or services; or
	•	respond to competitive pressures.

      Additional financing we may need in the future may not be available on terms favorable to us, if at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of opportunities, develop new products or services or otherwise respond to unanticipated competitive pressures. In such case, our business, operating results and financial condition could be harmed.

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

      We intend to expand our international sales efforts in the future. We have very limited experience in marketing, selling and supporting our software and services abroad. Expansion of our international operations will require a significant amount of attention from our management and substantial financial resources. If we are unable to grow our international operations successfully and in a timely manner, our business and operating results could be harmed. In addition, doing business internationally involves additional risks, particularly:

	•	unexpected changes in regulatory requirements, taxes, trade laws and tariffs;
	•	restrictions on repatriation of earnings;

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	•	differing intellectual property rights;
	•	differing labor regulations;
	•	changes in a specific country’s or region’s political or economic conditions;
	•	greater difficulty in staffing and managing foreign operations; and
	•	fluctuating currency exchange rates.

      If we are unable to protect our intellectual property, our business may suffer.

      Our success depends, in part, upon our proprietary technology and other intellectual property rights. To date, we have relied primarily on a combination of copyright, trade secret, trademark and patent laws, and nondisclosure and other contractual restrictions on copying and distribution to protect our proprietary technology. We have two pending patent applications for technology related to our software, but we cannot assure you that these applications will be successful. A small number of our agreements with our customers and systems integrators contain provisions regarding the rights of third parties to obtain the source code for our software, which may limit our ability to protect our intellectual property rights in the future. Litigation to enforce our intellectual property rights or protect our trade secrets could result in substantial costs and may not be successful. Any inability to protect our intellectual property rights could seriously harm our business, operating results and financial condition. In addition, the laws of certain foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States. Our means of protecting our intellectual property rights in the United States or abroad may not be adequate to fully protect our intellectual property rights.

      Third parties may claim that we infringe upon their intellectual property rights.

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

      In addition, we have agreed, and may agree in the future, to indemnify certain of our customers against claims that our software infringes upon the intellectual property rights of others. We could incur substantial costs in defending ourselves and our customers against infringement claims. In the event of a claim of infringement, we and our customers may be required to obtain one or more licenses from third parties. We, or our customers, may be unable to obtain necessary licenses from third parties at a reasonable cost, or at all. Defense of any lawsuit or failure to obtain any such required licenses could harm our business, operating results and financial condition.

      Potential Year 2000 problems with our internal systems or the software that we sell could cause our business to be harmed.

      Many currently installed computer systems, software products and other control devices are unable to accept four digit entries signifying years to distinguish 21st century dates from 20th century dates. As a result, many companies’ computer systems, software products and control devices may need to be upgraded or replaced in order to operate properly in the Year 2000 and beyond.

      We have designed and tested our software to be Year 2000 compliant and to continue operating even if we experience date-related problems. However, our software may contain undetected errors or defects associated with Year 2000 date functions. If any such errors or defects do exist, we may incur material costs to

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      In addition, our customers’ and their business partners’ hardware operating systems and other software applications must operate effectively for them to use our software effectively. If these systems or applications are not Year 2000 compliant, our customers and their business partners may not be able to use our software. We cannot predict the extent to which our customers’ and their business partners’ systems and applications are Year 2000 compliant. If these systems are not Year 2000 compliant, our business, operating results and financial condition could be harmed.

Risks Relating To Our Industry

      Our market is subject to rapid technological change and our future success will depend on our ability to meet the changing needs of our industry.

      Our market is characterized by rapidly changing technology, evolving industry standards and frequent new product announcements. To be successful, we must adapt to our rapidly changing market by continually improving the performance, features and reliability of our software and services. We could incur substantial costs to modify our software, services or infrastructure in order to adapt to these changes. Our business could be harmed if we incur significant costs without adequate results, or if we are unable to adapt rapidly to these changes.

      Continued adoption of the Internet as a method of conducting business is necessary for our future growth.

      The market for Internet-based, business-to-business integration software is relatively new and is evolving rapidly. Our future revenues and any future profits depend upon the widespread acceptance and use of the Internet as an effective medium for business-to-business commerce. The failure of the Internet to continue to develop as a commercial or business medium could harm our business, operating results and financial condition. The acceptance and use of the Internet for business-to-business commerce could be limited by a number of factors, such as the growth and use of the Internet in general, the relative ease of conducting business on the Internet, the efficiencies and improvements that conducting commerce on the Internet provides, concerns about transaction security and taxation of transactions on the Internet.

      We depend on the speed and reliability of the Internet and our customers’ internal networks.

      The recent growth in Internet traffic has caused frequent periods of decreased performance. If Internet usage continues to grow rapidly, its infrastructure may not be able to support these demands and its performance and reliability may decline. If outages or delays on the Internet occur frequently or increase in frequency, business-to-business e-commerce could grow more slowly or decline, which may reduce the demand for our software. The ability of our webMethods B2B software to satisfy our customers’ needs is ultimately limited by and depends upon the speed and reliability of both the Internet and our customers’ internal networks. Consequently, the emergence and growth of the market for our software depends upon improvements being made to the entire Internet as well as to our individual customers’ networking infrastructures to alleviate overloading and congestion. If these improvements are not made, the ability of our customers to utilize our solution will be hindered, and our business, operating results and financial condition may suffer.

      Increased security risks of online commerce may deter future use of our software and services.

      A fundamental requirement to conduct Internet-based, business-to-business e-commerce is the secure transmission of confidential information over public networks. Advances in computer capabilities, new discoveries in the field of cryptography, or other developments may result in a compromise or breach of the security features contained in our software or the algorithms used by our customers and their business partners to protect content and transactions on Internet e-commerce marketplaces or proprietary information in our customers’ and their business partners’ databases. Anyone who is able to circumvent security measures could

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      Internet-related laws could adversely affect our business.

      Regulation of the Internet is largely unsettled. The adoption of laws or regulations that increase the costs or administrative burdens of doing business using the Internet could cause companies to seek an alternative means of transacting business. If the adoption of new Internet laws or regulations causes companies to seek alternative methods for conducting business, the demand for our software could decrease and our business could be adversely affected.

Risks Relating To This Offering

      Because certain existing stockholders own a large percentage of our voting stock, other stockholders’ voting power may be limited.

      Following consummation of this offering, it is anticipated that our officers, directors and their affiliates will beneficially own or control approximately           % of our common stock. In combination with entities owning 5% or more of our outstanding shares of common stock, this group controls           shares of common stock, or           % of the outstanding shares of our stock. As a result, if such persons act together, they will have the ability to control all matters submitted to our stockholders for approval, including the election and removal of directors and the approval of any merger, consolidation or sale of all or substantially all of our assets. These stockholders may make decisions that are adverse to your interests. See our discussion under the caption “Principal Stockholders” for more information about ownership of our outstanding shares.

      Future sales of our common stock may depress our stock price.

                shares of our common stock can be sold in the public market 180 days after the offering. If substantial amounts of our common stock were to be sold in the public market following this offering, the market price of our common stock could fall. In addition, such sales could create the perception to the public of difficulties or problems with our software and services. As a result, these sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. For a more detailed discussion of shares eligible for sale after the offering, see “Shares Eligible for Future Sale.”

      We have broad discretion to use the offering proceeds, and the investment of these proceeds may not yield a favorable return.

      The net proceeds of this offering are not allocated for specific purposes. Thus, our management has broad discretion over how these proceeds are used and could spend most of these proceeds in ways with which our stockholders may not agree. The proceeds may be invested in ways that do not yield favorable returns. See “Use of Proceeds” for more information about how we plan to use our proceeds from this offering.

      Our securities have no prior market, and our stock price may decline after the offering.

      Before this offering, there has not been a public market for our common stock. An active public market for our common stock may not develop or be sustained after this offering. The initial public offering price has been determined by negotiations between representatives of the underwriters and us. The trading prices of many technology companies’ stocks are at or near historical highs and reflect price to earnings ratios substantially above historic levels. We cannot be certain that these trading prices or price to earnings ratios will be sustained. The trading market price of our common stock may decline below our initial public offering price.

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      Internet-related stock prices are especially volatile and this volatility may depress our stock price.

      The stock market, and specifically the stock prices of Internet-related companies, has been very volatile. This volatility is often not related to the operating performance of the companies. This broad market volatility and industry volatility may reduce the price of our common stock, without regard to our operating performance. Due to this volatility, the market price of our common stock could significantly decrease.

      Fluctuations in our common stock’s price may affect our visibility and credibility in the business-to-business e-commerce solutions market. In the event of broad fluctuations in the market price of our common stock, you may be unable to resell your shares at or above the offering price.

      Securities class action litigation has often been brought against companies that experience volatility in the market price of their securities. Litigation brought against us could result in substantial costs to us in defending against a lawsuit and management’s attention could be diverted from our business.

      As a new investor, you will experience immediate and substantial dilution in the value of the common stock.

      If you purchase shares of our common stock in this offering, you will incur immediate and substantial dilution in pro forma net tangible book value. If the holders of outstanding options and warrants exercise those options and warrants, you will incur further dilution. See “Dilution” for a calculation of the amount of dilution you will incur.

      We have implemented certain anti-takeover provisions.

      Provisions of our certificate of incorporation and our bylaws, as well as Delaware law, could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. See “Description of Capital Stock — Anti-Takeover Effects of Provisions of our Certificate of Incorporation and Delaware Law” for a description of these provisions.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

      Some of the statements under “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and elsewhere in this prospectus constitute forward-looking statements. These statements involve known and unknown risks, uncertainties, and other factors that may cause our or our industry’s actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by such forward-looking statements. Such factors include, among other things, those listed under “Risk Factors” and elsewhere in this prospectus.

      This prospectus contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. In evaluating these statements, you should specifically consider various factors, including the risks outlined under “Risk Factors.” These factors may cause our actual results to differ materially from any forward-looking statement.

      Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of such statements. We are under no duty to update any of the forward-looking statements after the date of this prospectus to conform such statements to actual results.

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USE OF PROCEEDS

      We estimate that our net proceeds from the sale of the       shares of common stock we are offering will be approximately $          , assuming an initial public offering price of $     per share and after deducting underwriting discounts and commissions and estimated offering expenses of $          payable by us. If the over-allotment option is exercised in full, we estimate that the net proceeds will be approximately $          . The primary purposes of this offering are to obtain additional equity capital, create a public market for our common stock and facilitate future access to public markets.

      We intend to use the net proceeds we receive from the offering for working capital and general corporate purposes. Although we may use a portion of the net proceeds to acquire technology or businesses that are complementary to our business, we have no current plans in this regard. Pending their use, we plan to invest the net proceeds in short-term, interest-bearing, investment grade securities.

DIVIDEND POLICY

      We have not paid or declared any cash dividends on our common stock since our inception and do not intend to pay any cash dividends on our common stock in the foreseeable future. We currently intend to retain all future earnings, if any, for use in the operation of our business. The terms of our loan agreement prohibit us from paying dividends without the consent of the lender.

SIMULTANEOUS PRIVATE TRANSACTION

      Concurrent with the closing of this offering, we plan to sell $2.5 million of our common stock to The Goldman Sachs Group, Inc. in a private transaction at a price per share equal to the initial public offering price less one-half of the underwriting discount and commission.

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CAPITALIZATION

      The following table sets forth the following information:

	•	our actual capitalization as of September 30, 1999;
	•	our pro forma capitalization after giving effect to our sale of 68,770 shares of mandatorily redeemable, convertible preferred stock in November  1999, with net proceeds of approximately $16.9 million; and
	•	our pro forma as adjusted capitalization after giving effect to the conversion of all outstanding shares of mandatorily redeemable, convertible preferred stock into           shares of common stock at a ratio of twenty shares of common stock for each share of mandatorily redeemable, convertible preferred stock outstanding and by issuing shares of common stock valued at $          per share for the accrued dividends, on the mandatorily redeemable, convertible preferred stock, upon the closing of this offering, the receipt of $2.5 million from The Goldman Sachs Group, Inc. in exchange for            shares of common stock to be issued in a private transaction concurrent with the closing of this offering at a price per share equal to $           , the assumed initial public offering price less one-half of the underwriting discount and commission, and the sale of shares of common stock at an assumed initial public offering price of $     per share in this offering, less the underwriting discounts and commissions and estimated offering expenses payable by us.

      This table excludes the following shares:

	•	3,558,323 shares of common stock subject to outstanding options under our stock option plans, and 3,053,651 additional shares of common stock available for issuance under this stock option plan; and
	•	4,000 shares of common stock issuable upon the exercise of an outstanding warrant.

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      You should read this table in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Notes to Consolidated Financial Statements. See “Management — Incentive Stock Plans,” and “Description of Capital Stock.”

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DILUTION

      Our pro forma net tangible book value as of September 30, 1999, after giving effect to (1) our sale of 68,770 shares of our mandatorily redeemable, convertible preferred stock in November 1999 for aggregate proceeds of approximately $16.9 million, (2) the conversion of all outstanding shares of mandatorily redeemable, convertible preferred stock and accrued dividends into            shares of common stock at a ratio of twenty shares of common stock for each share of mandatorily redeemable, convertible preferred stock outstanding and by issuing shares of common stock valued at            per share for the accrued dividends, upon the closing of this offering and (3) receipt of $2.5 million from The Goldman Sach Group, Inc. in connection with the sale of         shares of common stock in a private transaction concurrent with the closing of this offering at a price per share equal to $          , the assumed initial public offering price less one-half of the underwriting discount and commission, was approximately $          , or approximately $     per share. Pro forma net tangible book value per share represents the amount of our stockholders’ equity, less intangible assets, divided by            shares of common stock outstanding after giving effect to the conversion of all outstanding shares of mandatorily redeemable, convertible preferred stock and accrued dividends into shares of common stock upon completion of this offering.

      Dilution per share to new investors represents the difference between the amount per share paid by purchasers of our common stock in this offering and the pro forma net tangible book value per share of common stock immediately after completion of this offering. After giving effect to the sale by us of            shares of common stock in this offering at an assumed initial offering price of $     per share, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma net tangible book value as of September 30, 1999, would have been $          , or $     per share. This represents an immediate increase in net tangible book value of $     per share to existing stockholders and an immediate dilution in net tangible book value of $     per share to purchasers of common stock in this offering, as illustrated in the following table:

      The following table sets forth, on a pro forma basis as of September 30, 1999, the number of shares of common stock purchased from us, the total consideration paid or to be paid, and the average price per share paid or to be paid by existing stockholders and by new investors at an assumed initial offering price of $     per share, before deducting the estimated offering underwriting discounts and commissions and the estimated offering expenses payable by us:

      If the underwriters’ over-allotment option is exercised in full, the number of shares held by new investors will increase to            shares, or      %, of the total number of shares of common stock outstanding after this offering.

      As of September 30, 1999, there were options outstanding to purchase a total of 3,558,323 shares of common stock under our stock option plan at a weighted average exercise price of $1.68 per share. After September 30, 1999, we granted options to purchase an additional            shares of our common stock at a weighted average exercise price of $     per share. In addition, as of October 31, 1999, there was a warrant outstanding to purchase 4,000 shares of common stock at an exercise price of $1.66 per share. To the extent outstanding options are exercised, there will be further dilution to new investors. See note 11 of notes to the consolidated financial statements.

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SELECTED CONSOLIDATED FINANCIAL DATA

      The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes to the consolidated financial statements and Management Discussion and Analysis of Financial Condition and Results of Operations, which are included elsewhere in this prospectus. The consolidated statement of operations data for the period from inception (June 12, 1996) through March 31, 1997 and for the years ended March 31, 1998 and 1999 and the consolidated balance sheet data at March 31, 1998 and 1999 are derived from our consolidated financial statements, which have been audited by PricewaterhouseCoopers LLP, independent auditors, and are included elsewhere in this prospectus. The consolidated balance sheet data as of March 31, 1997 are derived from consolidated financial statements not contained in this prospectus. The consolidated financial data for the six month periods ended September 30, 1998 and 1999 and at September 30, 1999 are derived from our unaudited consolidated financial statements included elsewhere in this prospectus. We have prepared this unaudited information on the same basis as the audited consolidated financial statements and have included all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for such periods. Historical results are not necessarily indicative of future results and operating results for the six month period ended September 30, 1999 are not necessarily indicative of the results that may be expected for the entire year ended March 31, 2000.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

      The following discussion and analysis of the financial condition and results of operations of webMethods should be read in conjunction with “Selected Consolidated Financial Data” and webMethods’ consolidated financial statements and related notes appearing elsewhere in this prospectus. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

      We are a leading provider of infrastructure software and services for achieving business-to-business integration, or B2Bi. Our software, webMethods B2B, enables companies to work more closely with their customers, suppliers and other business partners through the real-time exchange of information and transactions over the Internet.

      webMethods was founded in June 1996. We have grown from 17 employees as of March 31, 1998 to 150 employees as of October 31, 1999. During the period from our inception in June 1996 to March 31, 1997, we had insignificant revenues and were primarily engaged in developing our software and recruiting and hiring personnel. We shipped the first version of webMethods B2B in June 1998. We have released four subsequent versions of webMethods B2B, the most recent of which we began shipping in September 1999.

      Our revenue is derived from sales of licenses of our webMethods B2B software, professional services, and maintenance and support. We generally license our software on a two-year renewable basis, which includes maintenance and support for the term of the renewable license. Periodically, we license our software over a different renewable term or on a perpetual basis. License fees are generally billed upon shipment. Maintenance is included in renewable licenses for the term of the license. Maintenance on perpetual licenses is generally billed annually in advance. We offer implementation and other professional services on a time and materials basis and training on a fixed fee basis. We began our international direct sales efforts in July 1999. We expect that our revenue from international licenses will grow as we expand our sales efforts abroad.

      Revenue from the sale of software licenses is recognized upon shipment of our software, provided that the fee is fixed and determinable, persuasive evidence of an arrangement exists and collection of the resulting receivable is considered probable. Historically, we have not experienced significant returns or exchanges of our software. We recognize software license revenue over the term of the license if the license requires us to deliver unspecified software during its term or if the license contains extended payment terms. Maintenance revenue is recognized ratably over the maintenance period. The portion of revenue from our two-year renewable licenses that is allocated to maintenance and support is recognized over the term of the license. Payments received in advance of revenue recognition are recorded as deferred revenue. Professional services revenue is recognized as the service is performed. Our revenue recognition practices are in accordance with Statement of Position, or SOP, 97-2, as modified by SOP 98-9, which was issued in December 1998. We adopted the provisions of SOP 98-9 for the year ended March 31, 1999.

      Our cost of license revenue primarily includes royalties to third parties for software used in our software and a provision for warranty obligations. Our cost of professional services and maintenance and service revenue includes salaries and related expenses for our professional services and technical support organizations, costs of third-party consultants we use to provide professional services to our customers and an allocation of overhead and recruitment costs.

      Although revenue has consistently increased from quarter to quarter, we have incurred significant costs to develop our technology and products and to recruit and train personnel for our research and development, sales, marketing, professional services and administration departments. As a result, we have incurred significant losses since inception, and as of September 30, 1999, had an accumulated deficit of $11.1 million. We believe our success depends on rapidly increasing our customer base, further developing our webMethods B2B software and introducing new product enhancements into the marketplace. We intend to continue to

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      We had 150 full-time employees as of October 31, 1999 and intend to hire a significant number of employees in the future. This expansion places significant demands on our management and operational resources. To manage this rapid growth and increase demand, we must invest in and implement scalable operational systems, procedures and controls. We must also be able to recruit qualified candidates to manage our expanding operations. We expect future expansion to continue to challenge our ability to hire, train, manage and retain our employees.

Results of Operations

      The following table sets forth consolidated statement of operations data for each of the periods indicated as a percentage of total revenue. During the period from June 12, 1996 (date of inception) to March 31, 1997 we were a development stage company with revenues of $12,000 and a net loss of $284,000. We have not included percentage data for the period ended March 31, 1997 because the information is not meaningful. For the same reason, we have not included a comparison of the period ended March 31, 1997 to the year ended March 31, 1998.

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Six Months Ended September 30, 1998 and 1999

      Revenue

      Total revenue increased by approximately $5.9 million, or 589%, to $6.9 million for the six months ended September 30, 1999 from $1.0 million for the six months ended September 30, 1998. In March 1999, we agreed to license our webMethods B2B software to SAP AG to include in their software and to provide SAP AG with development services. For this license and these services, SAP AG agreed to pay us a fixed license and development fee payable in quarterly installments beginning with the quarter ended June 30, 1999. As a result, SAP AG accounted for approximately 35% of our revenues during the six months ended September 30, 1999. In addition, during the six months ended September 30, 1999, Sterling Commerce accounted for an aggregate of approximately 10% of total revenue and, in the six months ended September 30, 1998, Intelisys accounted for approximately 19% of total revenue.

      License. License revenue increased by approximately $4.0 million, or 463%, to $4.9 million for the six months ended September 30, 1999 from $866,000 for the six months ended September 30, 1998. This increase is primarily attributable to an increase in sales to new and existing customers resulting from increased sales force headcount and a growing acceptance of our webMethods B2B software. License revenue from our relationship with SAP AG, which commenced in March 1999, accounted for approximately $1.8 million, or 38%, of the total license revenue for the six months ended September 30, 1999.

      Professional Services. Professional services revenue increased by approximately $1.2 million, or 1,158%, to $1.3 million for the six months ended September 30, 1999 from $103,000 for the six months ended September 30, 1998. This increase is attributable to the increased licensing activity described above, which has resulted in increased customer implementation activity and follow-on professional services. Professional services revenue attributable to the new SAP AG relationship was approximately $315,000, or 24% of total professional service revenue for the six months ended September 30, 1999.

      Maintenance. Maintenance revenue increased by approximately $687,000, or 2,216%, to $718,000 for the six months ended September 30, 1999 from $31,000 for the six months ended September 30, 1998. This increase is attributable to the increased licensing activity described above. As the majority of our license contracts include post-contract maintenance and support, an increased level of license revenue results in an increased amount of maintenance revenue recognized ratably over the term of the maintenance agreement. Maintenance revenue attributable to the new SAP AG relationship was approximately $277,000, or 39%, of total maintenance revenue for the six months ended September 30, 1999.

      Cost of Revenue

      License. Cost of license revenue increased by approximately $384,000, or 1,829%, to $405,000 for the six months ended September 30, 1999 from $21,000 for the six months ended September 30, 1998. This increase in the cost of licenses is due to license fees paid to third party software developers for software included in our software and provisions for warranty obligations. In addition, during the six months ended September 30, 1999, we wrote off $236,000 of prepaid third party software licensing fees because we developed the capabilities internally.

      Professional Services and Maintenance. Cost of professional services and maintenance increased by approximately 1,753% to $1.3 million for the six months ended September 30, 1999 from $72,000 for the six months ended September 30, 1998. This increase is primarily attributable to increases in the number of professional service and technical support personnel, which increased to 17 people as of September 30, 1999 from two people as of September 30, 1998.

      Gross Profit

      Gross profit increased by approximately $4.2 million, or 468%, to $5.1 million for the six months ended September 30, 1999 from $907,000 for the six months ended September 30, 1998. The increase is attributable to the growth in our customer base, which contributed to increased revenue from software licenses, professional services and maintenance. The gross profit margin was 74.7% for the six months ended September 30, 1999, down from 90.7% for the six months ended September 30, 1998. The reduction in the

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      Operating Expenses

      Sales and Marketing. Sales and marketing expenses increased by approximately $4.7 million, or 325%, to $6.1 million for the six months ended September 30, 1999 from $1.4 million for the six months ended September 30, 1998. The increase in sales and marketing expenses is attributable to an increase in the number of sales and marketing employees and increases in marketing programs. We believe that these expenses will continue to increase in absolute dollar amounts in future periods as we expect to continue to expand our sales and marketing efforts.

      Research and Development. Research and development expenses increased by approximately $1.6 million, or 260%, to $2.2 million for the six months ended September 30, 1999 from $618,000 for the six months ended September 30, 1998. The increase in research and development expenses is attributable to increases in the number of software development, quality assurance and documentation personnel and in third-party development costs. To date, all research and development expenses have been expensed in the period incurred. We believe that continued investment in research and development is critical to attaining our strategic objectives, and, as a result, we expect research and development expenses to increase significantly in future periods.

      General and Administrative. General and administrative expenses increased by approximately $1.8 million, or 563%, to $2.1 million for the six months ended September 30, 1999 from $314,000 for the six months ended September 30, 1998. This increase is primarily attributable to the increases in the number of accounting and finance, human resources, and office administration personnel. In addition, professional service fees, corporate insurance and other general corporate costs increased to support organizational growth. We expect general and administrative costs to continue to increase in absolute dollars, as we expect to add personnel to support our expanding operations, incur additional costs related to the growth of our business, and assume the responsibilities of a public company.

      Interest Income, Net

      Interest income, net increased by approximately $299,000, or 1,574%, to $318,000 for the six months ended September 30, 1999 from $19,000 for the six months ended September 30, 1998. This increase is attributable to increases in interest income that resulted from the approximately $11.7 million in net cash proceeds we generated from the issuance of mandatorily redeemable, convertible preferred stock in May and June, 1999.

Fiscal Years Ended March 31, 1998 and 1999

      Revenue

      Total revenue increased by approximately $4.3 million, or 2,588%, to $4.5 million in fiscal 1999, from $166,000 in fiscal 1998 as we first shipped webMethods B2B at the end of the first quarter of fiscal 1999. During fiscal 1999, two customers accounted for an aggregate of approximately 23% of total revenue. Telstra accounted for approximately 13% and Object Design accounted for approximately 10% of our total revenue. In fiscal 1998, Ericsson, Cisco Systems, JP Morgan and AnswerThink accounted for an aggregate of approximately 63% of total revenue.

      License. License revenue increased by approximately $3.6 million, or 3,644%, to $3.7 million in fiscal 1999 from $99,000 in fiscal 1998. This increase is primarily attributable to the initial shipment of webMethods

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      Professional Services. Professional services revenue increased approximately $525,000, or 921%, to $582,000 in fiscal 1999 from $57,000 in fiscal 1998. This increase is attributable to the increased license activity described above which resulted in customer implementation activity and follow-on professional services.

      Maintenance. Maintenance revenue increased by approximately $163,000, or 1,630%, to $173,000 in fiscal 1999 from $10,000 in fiscal 1998. This increase is attributable to the increased licensing activity described above.

      Cost of Revenue

      License. Cost of license revenue increased to $172,000 in fiscal 1999 from $0 in fiscal 1998. This increase in the cost of licenses is due to license fees paid to third party software developers for software included in our software and provisions for warranty obligations.

      Professional Services and Maintenance. Cost of professional services and maintenance increased to $482,000 in fiscal 1999 from $0 in fiscal 1998. This increase is primarily attributable to increases in the number of professional service and technical support personnel, which increased to five people at March 31, 1999 from none at March 31, 1998.

      Gross Profit

      Gross profit increased by approximately $3.6 million, or 2,194%, to $3.8 million in fiscal 1999 from $166,000 in fiscal 1998. The increase is attributable to the growth in our customer base, which contributed to increased revenue from software licenses, professional services and maintenance. The gross profit margin was 85.3% for the year ended March 31, 1999, down from 100% for the year ended March 31, 1998. The reduction in the gross profit margin is attributable to the increased proportion of professional services revenue, which generates a lower margin than license revenue, during the year ended March 31, 1999.

      Operating Expenses

      Sales and Marketing. Sales and marketing expenses increased by approximately $3.9 million, or 553%, to $4.6 million in fiscal 1999 from $697,000 in fiscal 1998. The increase in the total amount of sales and marketing expenses is attributable to an increase in the number of sales and marketing employees and increases in marketing programs.

      Research and Development. Research and development expenses increased by approximately $1.1 million, or 191%, to $1.7 million in fiscal 1999 from $569,000 in fiscal 1998. The increase in the total amount of research and development expenses is attributable to increases in the number of software developers and quality assurance and documentation personnel.

      General and Administrative. General and administrative expenses increased by approximately $745,000, or 260%, to $1.0 million in fiscal 1999 from $287,000 in fiscal 1998. This increase is primarily attributable to increases in the number of administrative and professional services personnel and other general corporate expenses as we grew from 17 employees as of March 31, 1998 to 65 employees as of March 31, 1999.

      Interest Income, Net

      Interest income, net increased by approximately $110,000, or 458%, to $134,000 in fiscal 1999 from $24,000 in fiscal 1998. This increase is attributable to increases in interest income, which resulted from approximately $6.4 million in net cash proceeds we generated from the issuance of mandatorily redeemable, convertible preferred stock in September 1998.

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Quarterly Results of Operations

      The following tables set forth consolidated statement of operations data for each of the six quarters ended September 30, 1999, as well as that data expressed as a percentage of our total revenue for the quarter presented. This information has been derived from our unaudited consolidated financial statements. The unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements contained in this prospectus and include all adjustments, consisting only of normal recurring adjustments that we consider necessary for a fair presentation of such information. You should read this information in conjunction with our annual audited consolidated financial statements and related notes appearing elsewhere in this prospectus. You should not draw any conclusions about our future results from the results of operations for any quarter.

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