MICROMUSE INC, S-1/A, 1998-01-20

MICROMUSE INC
S-1/A, 1998-01-20
PREPACKAGED SOFTWARE

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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 20, 1998.

REGISTRATION NO. 333-42177
================================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------

AMENDMENT NO. 1

FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

MICROMUSE INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S> <C> <C>
DELAWARE 7372 94-3288385
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>

139 TOWNSEND STREET
SAN FRANCISCO, CALIFORNIA 94107
(415) 538-9090
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

CHRISTOPHER J. DAWES
CHIEF EXECUTIVE OFFICER AND PRESIDENT
MICROMUSE INC.
139 TOWNSEND STREET
SAN FRANCISCO, CALIFORNIA 94107
(415) 538-9090
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)

COPIES TO:

<TABLE>
<S> <C>
STEVEN M. SPURLOCK, ESQ. MARK A. BERTELSEN, ESQ.
MARK P. LONG, ESQ. JAMES N. STRAWBRIDGE, ESQ.
RICHARD R. HESP, ESQ. JON C. GONZALES, ESQ.
GUNDERSON DETTMER STOUGH WILSON SONSINI GOODRICH & ROSATI
VILLENEUVE FRANKLIN & HACHIGIAN, LLP PROFESSIONAL CORPORATION
155 CONSTITUTION DRIVE 650 PAGE MILL ROAD
MENLO PARK, CALIFORNIA 94025 PALO ALTO, CALIFORNIA 94304
(650) 321-2400 (650) 493-9300
</TABLE>

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, as amended, 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,
please check the following box. [ ]

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 THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SUCH SECTION 8(A), MAY DETERMINE.
================================================================================
<PAGE> 2

INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO THE REGISTRATION OR QUALIFICATION UNDER THE SECURITIES
LAWS OF ANY SUCH JURISDICTION.

SUBJECT TO COMPLETION, DATED JANUARY 20, 1998

LOGO

- --------------------------------------------------------------------------------

3,000,000 SHARES

COMMON STOCK
- --------------------------------------------------------------------------------

Of the 3,000,000 shares (the "Shares") of Common Stock, par value $0.01 per
share ("Common Stock"), of Micromuse Inc. (the "Company") offered hereby (the
"Offering"), 2,900,000 shares are being offered by the Company and 100,000
shares are being offered by certain stockholders of the Company (the "Selling
Stockholders"). The Company will not receive any proceeds from the sale of
shares of Common Stock by the Selling Stockholders. See "Principal and Selling
Stockholders" and "Underwriting." Prior to this Offering, there has been no
public market for the Common Stock. It is currently estimated that the initial
public offering price will be between $8.00 and $10.00 per share. See
"Underwriting" for a discussion of the factors to be considered in determining
the initial public offering price. The Company has applied to have the Common
Stock approved for listing on the Nasdaq National Market under the symbol
"MUSE."

FOR INFORMATION CONCERNING CERTAIN RISK FACTORS WHICH SHOULD BE CONSIDERED BY
PROSPECTIVE INVESTORS, SEE "RISK FACTORS" COMMENCING ON PAGE 5.

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
PROCEEDS TO
PRICE TO UNDERWRITING PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDERS
<S> <C> <C> <C> <C>
Per Share $ $ $ $
Total(3) $ $ $ $
</TABLE>

(1) See "Underwriting" for information relating to indemnification and
compensation of the Underwriters and other matters.

(2) Before deducting expenses of the Offering of approximately $1,100,000, all
of which are payable by the Company.

(3) The Company and the Selling Stockholders have granted to the Underwriters an
option, exercisable within 30 days of the date hereof, to purchase up to
450,000 additional shares of Common Stock solely to cover over-allotments,
if any. If all such shares are purchased, the total Price to Public,
Underwriting Discount, Proceeds to Company and Proceeds to Selling
Stockholders will be increased to $ , $ , $ and
$ , respectively. See "Underwriting."

The shares of Common Stock offered hereby are offered, subject to prior sale, by
the Underwriters on a firm commitment basis when, and as if delivered and
accepted by them, and subject to approval of certain legal matters by counsel
for the Underwriters and certain other conditions. The Underwriters reserve the
right to withdraw, cancel or modify such offer and to reject orders in whole or
in part. Delivery of shares of Common Stock offered hereby to the Underwriters
is expected to be made in New York, New York, on or about , 1998.

DEUTSCHE MORGAN GRENFELL

NATIONSBANC MONTGOMERY SECURITIES

SALOMON SMITH BARNEY
The date of this Prospectus is , 1998.
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[PHOTOGRAPH FOR INSIDE COVER TO BE INSERTED HERE]

Except as otherwise noted, all information in this Prospectus, including
share and per share information, (i) assumes no exercise of the Underwriters'
over-allotment option, (ii) assumes the exercise of a warrant to purchase
1,500,000 shares of Series A Convertible Preferred Stock at an exercise price of
$2.00 per share and (iii) except in the Consolidated Financial Statements and
Notes thereto, excludes 897,605 shares of Common Stock held as treasury stock
and reflects the conversion of all outstanding shares of Preferred Stock of the
Company into an aggregate of 5,988,336 shares of Common Stock and the filing of
a Restated Certificate of Incorporation upon the closing of the Offering. See
"Description of Capital Stock" and "Underwriting."

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING BY ENTERING STABILIZING BIDS, EFFECTING SYNDICATE COVERING
TRANSACTIONS OR IMPOSING PENALTY BIDS OR OTHERWISE. SUCH ACTIVITIES, IF
COMMENCED, MAY BE DISCONTINUED AT ANY TIME. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."

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PROSPECTUS SUMMARY

The following summary should be read in conjunction with, and is qualified
in its entirety by, the more detailed information and Consolidated Financial
Statements and Notes thereto appearing elsewhere in this Prospectus.

THE COMPANY

Micromuse develops, markets and supports a family of scalable, highly
configurable, rapidly deployable software solutions that enable Service Level
Management -- the effective monitoring and management of multiple elements
underlying an Information Technology infrastructure, including network devices,
computing systems and applications, and the mapping of these elements to the
business services they impact. The Company's Netcool product suite collects,
normalizes and consolidates high volumes of event information from heterogeneous
network management environments into an active database which de-duplicates and
correlates the resulting data in real time, and then rapidly distributes
graphical views of the information to operators and administrators responsible
for monitoring service levels. Netcool's unique architecture allows for the
rapid, programmerless association of devices and specific attributes of those
devices to the business services they impact. This readily enables
administrators to create and modify their service views during systems
operations to monitor particular business services, rapidly identify which users
are affected by which network faults, pinpoint sources of network problems,
automate operator responses, facilitate problem resolution and report on the
results. The Company markets and distributes to customers through its own sales
force, OEMs, value added resellers and systems integrators. The Company has
distribution agreements with Bay Networks, Cisco Systems, N.E.T., and Vanstar.
As of December 31, 1997, the Company had over 100 customers operating in and
serving a variety of industries. Customers include America Online, British
Telecommunications, Cable and Wireless, Cellular One, First Data Resources,
Genuity, GE Information Services, GTE Internetworking, Merrill Lynch,
MindSpring, Morgan Stanley, Netcom, Pacific Bell, PSINet, Siemens, and
WorldCom/MFS/UUNet.

THE OFFERING

<TABLE>
<S> <C>
Common Stock offered................................ 3,000,000 shares (including 2,900,000 shares by the Company
and 100,000 shares by the Selling Stockholders)
Common Stock to be outstanding after the Offering... 14,700,956 shares(1)
Use of proceeds..................................... For working capital and other general corporate purposes.
Proposed Nasdaq National Market symbol.............. MUSE
</TABLE>

SUMMARY CONSOLIDATED FINANCIAL DATA

(In thousands)

<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED SEPTEMBER 30, DECEMBER 31,
---------------------------- ---------------
1995 1996 1997 1996 1997
------ ------ ------ ---- ------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
License...................................................... $1,077 $3,374 $6,968 $802 $3,735
Maintenance and services..................................... 369 1,141 2,324 424 1,094
------ ------ -------
Total revenues......................................... 1,446 4,515 9,292 1,226 4,829
Gross profit................................................... 1,181 3,820 7,727 999 3,752
Net loss....................................................... (234) (236) (7,876) (869) (1,303)
</TABLE>

<TABLE>
<CAPTION>
AT DECEMBER 31, 1997
--------------------------
ACTUAL AS ADJUSTED(2)
------- --------------
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents.......................................................... $ 7,683 $ 33,856
Working capital.................................................................... 6,801 32,974
Total assets....................................................................... 16,922 43,095
Redeemable convertible preferred stock............................................. 23,755 --
Total stockholders' equity (deficit)............................................... (14,455) 35,473
</TABLE>

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(1) Based on the number of shares outstanding as of December 31, 1997. Excludes
1,350,670 shares of Common Stock issuable upon exercise of outstanding
options as of December 31, 1997, with a weighted average exercise price of
$2.56 and as of January 20, 1998, 980,514 shares of Common Stock reserved
for issuance under the Company's stock plans. See "Management -- 1997 Stock
Option/Stock Issuance Plan," "-- 1997 Employee Stock Purchase Plan" and Note
6 of Notes to Consolidated Financial Statements.

(2) Adjusted to reflect the sale of 2,900,000 shares of Common Stock offered by
the Company hereby at an assumed initial public offering price of $9.00 per
share and after deducting underwriting discounts and commissions and
estimated offering expenses payable by the Company, and the application of
the net proceeds therefrom. See "Capitalization" and "Use of Proceeds."

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THE COMPANY

Micromuse develops, markets and supports a family of scalable, highly
configurable, rapidly deployable software solutions that enable Service Level
Management ("SLM") -- the effective monitoring and management of multiple
elements underlying an Information Technology ("IT") infrastructure, including
network devices, computing systems and applications, and the mapping of these
elements to the business services they impact. The Company's Netcool product
suite collects, normalizes and consolidates high volumes of event information
from heterogeneous network management environments into an active database which
de-duplicates and correlates the resulting data in real time, and then rapidly
distributes graphical views of the information to operators and administrators
responsible for monitoring service levels. Netcool's unique architecture allows
for the rapid, programmerless association of devices and specific attributes of
those devices to the business services they impact. This readily enables
administrators to create and modify their service views during systems
operations to monitor particular business services, rapidly identify which users
are affected by which network faults, pinpoint sources of network problems,
automate operator responses, facilitate problem resolution and report on the
results.

IT has become increasingly mission critical for businesses as vital
communications, control and information services depend on reliable IT
performance. Effective, adaptable management of IT infrastructure is
particularly important for organizations in the business of providing network
services, such as telecommunications carriers and Internet Service Providers
("ISPs"). With SLM, network service providers can both manage their large
internal networks and offer additional network services to corporations that
require ongoing service guarantees, as set forth in their Service Level
Agreements ("SLAs"). The market for these services, known as Managed Network
Services or Network Operations Outsourcing, has grown rapidly as corporations
outsource the management and operation of their LANs and WANs to service
providers, and was estimated to be approximately $5 billion in 1996, and
projected to grow to approximately $11 billion in 2001, according to
International Data Corp ("IDC"). In the enterprise, SLM permits IT staffs to
guarantee network availability and performance, predict problems and maintain
SLA-defined service levels for mission critical services such as credit card
verification and electronic commerce.

Traditional solutions typically have been unable to deliver SLM cost
effectively. To capitalize on this opportunity, the Company's products have been
specifically designed to deliver SLM through ease of use and the efficient
management of complex, evolving and mission critical networks. The Company
believes that Netcool products provide customers a rapid return on investment by
offering: (i) cost-effective solutions with shorter implementation times and a
high level of configurability; (ii) efficient solutions that leverage customers'
existing network management products and services; and (iii) scalable solutions
that enable both the expansion and enhancement of current services as well as
the rapid deployment of new services to end-users.

The Company's initial target market has been organizations with large,
technically complex and heterogeneous networks, the majority of whom have been
in the telecommunications, ISP and investment banking markets. The Company
markets and distributes to customers through its own sales force, OEMs, value
added resellers and systems integrators. The Company has distribution agreements
with Bay Networks, Cisco Systems, N.E.T., and Vanstar. As of December 31, 1997,
the Company had over 100 customers operating in and serving a variety of
industries. Customers include America Online, British Telecommunications, Cable
and Wireless, Cellular One, First Data Resources, Genuity, GE Information
Services, GTE Internetworking, Merrill Lynch, MindSpring, Morgan Stanley,
Netcom, Pacific Bell, PSINet, Siemens, and WorldCom/MFS/UUNet.

Micromuse plc was incorporated in England in 1989 and in March 1997 became
a subsidiary of Micromuse Inc., a Delaware corporation formed in connection with
a corporate reorganization and relocation of the corporate headquarters to San
Francisco, California (the "Reorganization"). As used herein, the term
"Micromuse" or the "Company" refers to Micromuse Inc., Micromuse plc, and their
other subsidiaries, unless the context otherwise requires or unless otherwise
expressly stated. The Company's principal executive offices are located at 139
Townsend Street, San Francisco, California 94107, and its telephone number at
that address is (415) 538-9090.

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RISK FACTORS

An investment in the shares of Common Stock offered hereby involves a high
degree of risk. The following factors, in addition to the other information
contained in this Prospectus, should be considered carefully in evaluating the
Company and its business before purchasing shares of Common Stock offered
hereby. This Prospectus contains forward-looking statements that involve risks
and uncertainties. The Company's actual results may differ materially from the
results discussed in such forward-looking statements. Factors that might cause
such a difference include, but are not limited to, those discussed below and in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business" as well as those discussed elsewhere in this
Prospectus.

LIMITED OPERATING HISTORY AS A SOFTWARE COMPANY; ANTICIPATED CONTINUING
LOSSES; UNCERTAINTY OF FUTURE OPERATING RESULTS. Although the Company began
offering services for the network and systems integration market in 1989, the
Company first shipped its internally developed software product,
Netcool/OMNIbus, for the Service Level Management ("SLM") market in January
1995. Accordingly, the Company has only a limited operating history as a
developer and provider of SLM software upon which an evaluation of its business
and prospects can be based. Since inception, the Company's software business has
incurred significant losses that were partially offset by profits from the
Company's systems integration business, which was divested in the fourth quarter
of fiscal 1997. The Company does not expect to achieve profitability for the
next several quarters, and there can be no assurance that it will be profitable
thereafter, or that the Company will sustain any such profitability if achieved.
The limited operating history of the Company makes the prediction of future
results of operations difficult if not impossible, and the Company and its
prospects must be considered in light of the risks, costs and difficulties
frequently encountered by emerging companies, particularly companies in the
competitive software industry. Although the Company has achieved recent revenue
growth, there can be no assurance that the Company can generate the substantial
additional revenue growth on a quarterly or annual basis necessary for the
Company to become profitable, or that any revenue growth that is achieved can be
sustained. In addition, the Company has increased, and plans to increase
further, its operating expenses in order to develop new distribution channels,
increase its sales and marketing efforts, implement and improve its operational,
financial and management information systems, broaden its technical services and
customer support capabilities, fund higher levels of research and development
and expand its administrative resources in anticipation of future growth. To the
extent that increases in such expenses are not subsequently followed by
increased revenues, the Company's business, operating results and financial
condition would be materially adversely affected. In addition, in view of recent
revenue growth, the rapidly evolving nature of its business and markets and its
limited operating history in its current market, the Company believes that
period-to-period comparisons of financial results are not necessarily meaningful
and should not be relied upon as an indication of future performance. As of
December 31, 1997, the Company had accumulated net losses of $11.4 million. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

VARIABILITY OF QUARTERLY OPERATING RESULTS; SEASONALITY. The Company's
quarterly operating results have fluctuated significantly in the past, and will
likely continue to fluctuate in the future, as a result of a number of factors,
many of which are outside the Company's control. These factors include changes
in the demand for the Company's software products and services; the size and
timing of specific sales; the timing of new hires; the level of product and
price competition that the Company encounters; changes in the mix of, and lack
of demand from, distribution channels through which products are sold; the
length of sales cycles; spending patterns and budgetary resources of its
customers on network management software solutions; the success of the Company's
new customer generation activities; introductions or enhancements of products,
or delays in the introductions or enhancements of products, by the Company or
its competitors; market acceptance of new products; the Company's ability to
anticipate and effectively adapt to developing markets and rapidly changing
technologies; the mix of products and services sold;

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changes in the Company's sales incentives; changes in the renewal rate of
support agreements; the mix of international and domestic revenue; product life
cycles; software defects and other product quality problems; the Company's
ability to attract, retain and motivate qualified personnel; changes in the mix
of sales to new and existing customers; the extent of industry consolidation;
expansion of the Company's international operations; and general domestic and
international economic and political conditions. The timing of large individual
sales has been difficult for the Company to predict, and large individual sales
have, in some cases, occurred in quarters subsequent to those anticipated by the
Company. There can be no assurance that the loss or deferral of one or more
significant sales would not have a material adverse effect on the Company's
quarterly operating results. In addition, the Company's business has experienced
and may continue to experience significant seasonality. Historically, a
disproportionate amount of the Company's annual revenues have been generated by
sales of its products during the Company's fourth fiscal quarter. There can be
no assurance that this trend will not continue.

The Company's software products are typically shipped when orders are
received, and consequently, license backlog at the beginning of any quarter has
typically represented only a small portion of that quarter's expected revenue.
In addition, the Company typically realizes a significant portion of license
revenue in the last month of a quarter, frequently in the last weeks or even
days of a quarter. As a result, license revenue in any quarter is difficult to
forecast because it is substantially dependent on orders booked and shipped in
that quarter. Moreover, the Company's sales cycles, from initial evaluation to
delivery of software, vary substantially from customer to customer. In addition,
the Company's expense levels are based in part on its expectations of future
orders and sales, which, given the Company's limited operating history, are
extremely difficult to predict. A substantial portion of the Company's operating
expenses are related to personnel, facilities, and sales and marketing programs.
The level of spending for such expenses cannot be adjusted quickly and is,
therefore, relatively fixed in the short term. If revenue falls below the
Company's expectations in a particular quarter, the Company's operating results
could be materially adversely affected. See "-- Lengthy Sales Cycle."

Based on all of the foregoing, the Company believes that future revenue,
expenses and operating results are likely to vary significantly from
quarter-to-quarter. As a result, quarter-to-quarter comparisons of operating
results are not necessarily meaningful or indicative of future performance.
Furthermore, the Company believes it is possible that in some future quarter the
Company's operating results will be below the expectations of public market
analysts or investors. In such event, or in the event that adverse conditions
prevail, or are perceived to prevail, with respect to the Company's business or
generally, the market price of the Company's Common Stock would likely be
materially adversely affected. See "Selected Consolidated Financial Data" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

MANAGEMENT OF GROWTH; NEED TO IMPROVE FINANCIAL SYSTEMS AND CONTROLS. The
Company has recently experienced a period of rapid revenue and customer growth
and a substantial expansion in the number of its personnel and in the scope and
the geographic area of its operations. The Company has grown from 57 employees
on March 31, 1997 to 138 employees on December 31, 1997 and currently plans to
continue to recruit more staff. This growth has resulted in new and increased
responsibilities for management personnel and has placed and continues to place
a significant strain upon the Company's management, operating and financial
systems and resources. Moreover, members of the Company's management team,
including, without limitation, the Senior Vice President, Finance and Senior
Vice President, Sales, have been in their current positions with the Company for
a limited period of time. To accommodate recent growth and to compete
effectively and manage future growth, if any, the Company will be required to
continue to implement and improve a variety of operational, financial and
management information systems, procedures and controls on a timely basis and to
expand, train, motivate and manage its work force. In particular, the Company
will be required to improve its accounting and financial reporting systems,
which currently require substantial management effort, and to suc-

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cessfully manage an increasing number of relationships with customers, suppliers
and employees. These demands will require the addition of new management
personnel, and the Company currently is in the process of recruiting individuals
to fill important management positions such as Chief Financial Officer, human
resources director and managers for research and development projects. Further,
as a consequence of the Reorganization, the Company will need to implement a
U.S.-based financial and accounting system. The Company's future success will
depend to a significant extent on the recruitment and retention of these key
personnel, particularly a Chief Financial Officer, the implementation and
improvement of operational, financial and management systems and the ability of
its current and future executive officers to operate effectively, both
independently and as a group. There can be no assurance that the Company will be
able to execute on a timely and cost-effective basis all that is necessary to
successfully manage any growth, and any failure to do so could have a material
adverse effect on the Company's business, operating results or financial
condition. See "Business -- Employees."

NEED TO EXPAND AND IMPROVE PRODUCTIVITY OF SALES FORCE, TECHNICAL SERVICES
AND CUSTOMER SUPPORT ORGANIZATION. To increase market penetration, the Company
has increased the size of its sales organization from 14 to 30 individuals
during the twelve months ended December 31, 1997. Based on the Company's
experience, it takes at least six months, if not longer, for a salesperson to
become fully productive. There can be no assurance that the Company will be
successful in increasing the productivity of its sales personnel, and the
failure to do so could have a material adverse effect on the Company's business,
financial condition or results of operations. As a result of the recent
expansion of the installed base of Netcool/OMNIbus, the demands on the Company's
technical services and customer support resources have grown rapidly. The
Company believes that a high level of technical services, training and customer
support is essential to maintaining its competitive position. The Company will
be required to significantly expand its technical services and customer support
organizations if it is to achieve significant additional revenue growth. In
addition, the Company has recently redeployed personnel from its discontinued
systems integration business and other newly hired personnel and the Company
expects that increased resources will be spent on training and transitioning
such personnel. Competition for additional qualified technical personnel to
perform the required functions is intense. There can be no assurance that the
Company's technical services and customer support resources will be sufficient
to manage any future growth in the Company's business, and any failure of the
Company to expand its technical services and customer support organizations
commensurate with any expansion of the installed base of Netcool/OMNIbus would
have a material adverse effect on the Company's business, operating results and
financial condition. See "Business -- Technical Services" and "-- Customer
Support."

NEED TO EXPAND DISTRIBUTION CHANNELS; DEPENDENCE ON THIRD-PARTY
RELATIONSHIPS. A key element of the Company's business strategy is to develop
relationships with leading network equipment and telecommunications providers
and to expand the third-party channel of distribution. The Company is currently
investing, and plans to continue to invest, significant resources to develop
these relationships and channels of distribution, which could adversely affect
the Company's ability to generate profits. Third-party distributors accounted
for approximately 11% and 8% of the Company's total revenues in fiscal 1997 and
the quarter ended December 31, 1997, respectively. There can be no assurance
that the Company will be able to attract additional distributors that will be
able to market the Company's products effectively. Many of the Company's
agreements with third-party distributors are nonexclusive, and many of the
companies with which the Company has agreements also have similar agreements
with the Company's competitors or potential competitors. The Company's
third-party distributors have significantly greater sales and marketing
resources than the Company, and there can be no assurance that their sales and
marketing efforts will not conflict with the Company's direct sales efforts. In
addition, although sales through third-party distributors result in reduced
sales and marketing expense with respect to such sales, the Company sells its
products to third-party distributors at reduced prices, resulting in lower gross
margins on such third-party sales. The Company believes that its success in

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penetrating markets for its SLM applications depends in large part on its
ability to maintain its current distribution relationships, in particular, those
with Cisco Systems ("Cisco") and Bay Networks ("Bay"), to cultivate additional
distribution relationships and to cultivate alternative distribution
relationships if distribution channels change. There can be no assurance that
network equipment and telecommunications providers and distributors will not
discontinue their relationships with the Company, compete directly with the
Company or form additional competing arrangements with the Company's competitors
or that the Company will be able to expand its distribution relationships beyond
what currently exists. See "Business -- Sales and Marketing" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

EMERGING SERVICE LEVEL MANAGEMENT MARKET; DEPENDENCE ON TELECOMMUNICATIONS
CARRIERS AND OTHER SERVICE PROVIDERS; DEMAND FOR SLM PRODUCTS. The market for
the Company's products is in an early stage of development. Although the rapid
expansion and increasing complexity of computer networks in recent years and the
resulting emergence of SLAs has increased the demand for SLM software products,
the awareness of and the need for such products is a recent development. Because
the market for these products is only beginning to develop, it is difficult to
assess the size of this market, the appropriate features and prices for products
to address this market, the optimal distribution strategy and the competitive
environment that will develop. Failure of the SLM market to grow at anticipated
rates or failure of the Company to properly assess and address the demands from
such market would have a material adverse effect on the Company's business,
operating results and financial condition. Historically, in excess of 20% of the
Company's software revenues have been derived from sales to investment banks.
However, as a result of the Company's strategy to focus on telecommunications
carriers, ISPs and other providers of managed networks, the Company expects
sales to investment banks to comprise a decreasing portion of total revenues
over the long-term. In excess of 40% of the Company's software revenues to date
have been derived from the sale of its products to telecommunications carriers,
such as ISPs, that deliver advanced communications services to their customers.
In addition, these providers are the central focus of the Company's sales
strategy. There can be no assurance that telecommunications carriers and other
service providers will be able to market their communications services
successfully, that SLM will gain widespread market acceptance or that
telecommunications carriers and other service providers will use the Company's
products in the deployment of their services. Delays in the introduction of
advanced services, such as network management outsourcing, failure of such
services to gain widespread market acceptance or the decision of
telecommunications carriers and other service providers not to use the Company's
products in the deployment of these services would have a material adverse
effect on the Company's business, operating results and financial condition.
There can be no assurance the Company will be able to penetrate these markets
further. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business -- Customers."

COMPETITION. The Company's products are designed for use in the evolving
SLM and enterprise network management markets. Competition in these markets is
intense and is characterized by rapidly changing technologies, new and evolving
industry standards, frequent new product introductions and rapid changes in
customer requirements. The Company's current and prospective competitors offer a
variety of solutions to address the SLM and enterprise network management
markets and generally fall within the following five categories: (i) customer's
internal design and development organizations that produce SLM and network
management applications for their particular needs, in some cases using multiple
instances of products from hardware and software vendors such as Sun
Microsystems, Inc. ("Sun"), Hewlett-Packard Company ("HP") and Cabletron
Systems, Inc. ("Cabletron"); (ii) vendors of network and systems management
frameworks including Computer Associates International, Inc. ("CA") and
International Business Machines Corporation ("IBM"); (iii) vendors of network
and systems management applications including HP, Sun and IBM; (iv) providers of
specific market applications including Boole & Babbage, Inc. ("Boole & Babbage")
and several smaller software vendors; and (v) systems integrators which
primarily provide programming services to develop customer specific applica-

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<PAGE> 10

tions including TCSI Corporation (formerly Teknekron Communications Systems,
Inc.) and Objective Systems Integrators, Inc. ("OSI"). In the future, as the
Company enters new markets, the Company expects that such markets will have
additional, market-specific competitors. In addition, because there are
relatively low barriers to entry in the software market, the Company expects
additional competition from other established and emerging companies. Increased
competition is likely to result in price reductions and may result in reduced
gross margins and loss of market share, any of which could materially adversely
affect the Company's business, operating results or financial condition.

Many of the Company's existing and potential customers continuously
evaluate whether to design and develop their own network operations support and
management applications or purchase them from outside vendors. Sometimes these
customers internally design and develop their own software solutions for their
particular needs and therefore may be reluctant to purchase products offered by
independent vendors such as the Company. As a result, the Company must
continuously educate existing and prospective customers as to the advantages of
the Company's products versus internally developed network operations support
and management applications.

Many of the Company's current and potential competitors have longer
operating histories and have significantly greater financial, technical, sales,
marketing and other resources, as well as greater name recognition and a larger
customer base, than the Company. As a result, they may be able to devote greater
resources to the development, promotion, sale and support of their products or
to respond more quickly to new or emerging technologies and changes in customer
requirements than the Company. Existing competitors could also increase their
market share by bundling products having management functionality offered by the
Company's products with their current applications. Moreover, the Company's
current and potential competitors may increase their share of the SLM market by
strategic alliances and/or the acquisition of competing companies. In addition,
network operating system vendors could introduce new or upgrade and extend
existing operating systems or environments that include management functionality
offered by the Company's products, which could render the Company's products
obsolete and unmarketable. There can be no assurance that the Company will be
able to compete successfully against current or future competitors or that
competitive pressures faced by the Company will not materially adversely affect
its business, operating results or financial condition. See "Business --
Competition."

LENGTHY SALES CYCLE. The Company's software is generally used for division-
or enterprise-wide, business-critical purposes and involves significant capital
commitments by customers. Potential customers generally commit significant
resources to an evaluation of available enterprise software and require the
Company to expend substantial time, effort and money educating them about the
value of the Company's solutions. Sales of the Company's software products often
require an extensive sales effort throughout a customer's organization because
decisions to license such software generally involve the evaluation of the
software by a significant number of customer personnel in various functional and
geographic areas, each often having specific and conflicting requirements. A
variety of factors, including actions by competitors and other factors over
which the Company has little or no control, may cause potential customers to
favor a particular supplier or to delay or forego a purchase. As a result of
these and other factors, the sales cycle for the Company's products is long,
typically about three to six months. As a result of the length of the sales
cycle for its software products, the Company's ability to forecast the timing
and amount of specific sales is limited, and the delay or failure to complete
one or more large license transactions could have a material adverse effect on
the Company's business, operating results or financial condition and cause the
Company's operating results to vary significantly from quarter to quarter. See
"-- Variability of Quarterly Operating Results; Seasonality," and
"Business -- Sales and Marketing."

DEPENDENCE ON KEY PERSONNEL. The Company's success is substantially
dependent upon a limited number of key management, sales, product development,
technical services and customer

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<PAGE> 11

support personnel. The loss of the services of one or more of such key employees
could have a material adverse effect on the Company's business, financial
condition or results of operations. In particular, the Company would be
materially adversely affected if it were to lose the services of Christopher J.
Dawes, Chief Executive Officer of the Company, who has provided significant
leadership and direction to the Company since its inception. The Company does
not have employment contracts with any of its key personnel. In addition, the
Company's success will be dependent upon its continuing ability to attract,
train and retain additional highly qualified management, sales, product
development, technical services and customer support personnel. The Company has
at times and continues to experience difficulty in recruiting qualified
personnel. Because the Company faces intense competition in its recruiting
activities, there can be no assurance that the Company will be able to attract
and/or retain qualified personnel, including without limitation a Chief
Financial Officer. Failure to attract and retain the necessary qualified
personnel on a timely basis could have a material adverse effect on the
Company's business, operating results or financial condition. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

PRODUCT CONCENTRATION. Other than discontinued operations, all of the
Company's revenues have been derived from licenses for its Netcool family of
products and related maintenance, training and consulting services. The Company
currently expects that Netcool/OMNIbus-related revenues will continue to account
for all or substantially all of the Company's revenues for the remainder of
fiscal 1998 and for the foreseeable future thereafter. Therefore, the Company's
future operating results, particularly in the near term, are significantly
dependent upon the continued market acceptance of Netcool/OMNIbus, improvements
to Netcool/OMNIbus and new and enhanced Netcool/OMNIbus applications. There can
be no assurance that Netcool/OMNIbus will continue to achieve market acceptance
or that the Company will be successful in developing, introducing or marketing
improvements to Netcool/OMNIbus or new or enhanced Netcool/OMNIbus applications.
The life cycles of Netcool/OMNIbus, including the Netcool/OMNIbus applications,
are difficult to estimate due in large part to the recent emergence of many of
the Company's markets, the effect of future product enhancements and
competition. A decline in the demand for Netcool/OMNIbus as a result of
competition, technological change or other factors would have a material adverse
effect on the Company's business, operating results and financial condition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business -- Products and Technology" and "-- Research and
Development."

SALES CONCENTRATION. To date, a significant portion of the Company's
revenues in any particular period has been attributable to a limited number of
customers. During the quarter ended December 31, 1997, Deutsche Bank AG, an
entity affiliated with Deutsche Morgan Grenfell, accounted for approximately 30%
of the Company's total revenues. See "Underwriting." In addition, America Online
accounted for 13% of total revenues in the quarter ended December 31, 1997. In
fiscal 1997, entities affiliated with WorldCom and entities affiliated with
British Telecommunications, accounted for 18% and 9%, respectively, of the
Company's total revenues. In addition, entities affiliated with British
Telecommunications accounted for 57% and 14% of the Company's total revenues for
fiscal 1995 and fiscal 1996, respectively. The Company expects that it will
continue to be dependent upon a limited number of customers for a significant
portion of its revenues in future periods. As a result of this concentration of
sales, the Company's business, operating results or financial condition could be
materially adversely affected by the failure of anticipated orders from
significant customers to materialize or by deferrals or cancellations of orders
by significant customers. In addition, there can be no assurance that revenue
from customers that have accounted for significant revenues in past periods,
individually or as a group, will continue, or if continued will reach or exceed
historical levels in any future period. The terms of the Company's agreements
with its customers typically contain a one-time license fee and a prepayment of
one year of maintenance fees. The maintenance agreement is renewable annually at
the option of the customer and there are no minimum payment obligations or
obligations to license additional software. Therefore, there can be no assurance
that any of the Company's current

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<PAGE> 12

customers will generate significant revenues in future periods. For example,
pre-existing customers may be part of, or become part of, large organizations
which standardize using a competitive product. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and
"Business -- Sales and Marketing."

NEW PRODUCTS AND RAPID TECHNOLOGICAL CHANGE; NEED TO MANAGE PRODUCT
TRANSITIONS; DEPENDENCE ON THIRD-PARTY SOFTWARE PLATFORMS. The market for the
Company's products is characterized by rapidly changing technologies, evolving
industry standards, changing regulatory environments, frequent new product
introductions and rapid changes in customer requirements. The introduction or
announcement of products by the Company or its competitors embodying new
technologies and the emergence of new industry standards and practices can
render existing products obsolete and unmarketable. As a result, the life cycles
of the Company's products are difficult to estimate. The Company's future
success will depend on its ability to enhance its existing products and to
develop and introduce, on a timely and cost-effective basis, new products and
product features that keep pace with technological developments and emerging
industry standards and address the increasingly sophisticated needs of its
customers. Historically, the Company has used its close working relationship
with large customers to define its product development direction. There can be
no assurance that the Company will be successful in developing and marketing new
products or product features that respond to technological change or evolving
industry standards, that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of these
new products and features, or that its new products or product features will
adequately meet the requirements of the marketplace and achieve market
acceptance. In particular, the widespread adoption of the Telecommunications
Management Network ("TMN") architecture for managing telecommunications networks
would force the Company to adapt its products to such standard, and there can be
no assurance that this could be done on a timely or cost-effective basis, if at
all. In addition, to the extent that any product upgrade or enhancement requires
extensive installation and configuration, current customers may postpone or
forgo the purchase of new versions of the Company's products. If the Company is
unable, for technological or other reasons, to develop and introduce
enhancements of existing products or new products in a timely manner, the
Company's business, operating results and financial condition will be materially
adversely affected. In addition, there can be no assurance that the introduction
or announcement of new product offerings by the Company or one or more of its
competitors will not cause customers to defer licensing of existing Company
products. Any such deferment of purchases could have a material adverse effect
on the Company's business, operating results or financial condition.

The Company's products are designed to operate on a variety of hardware and
software platforms employed by its customers in their networks. The Company must
continually modify and enhance its products to keep pace with changes in
hardware and software platforms and database technology. As a result,
uncertainties related to the timing and nature of new product announcements,
introductions or modifications by systems vendors, particularly Sun, IBM, HP,
Cabletron and Cisco and by vendors of relational database software, particularly
Oracle Corporation ("Oracle") and Sybase, Inc. ("Sybase"), could materially
adversely impact the Company's business, operating results or financial
condition. For example, the Company is currently endeavoring to modify certain
of its products to operate with the Microsoft Windows NT operating system. The
failure of the Company's products to operate effectively across the various
existing and evolving versions of hardware and software platforms and database
environments employed by customers could have a material adverse effect on the
Company's business, operating results or financial condition. See
"Business -- Research and Development."

RISK OF PRODUCT DEFECTS; PRODUCT LIABILITY. Software products as internally
complex as Netcool/OMNIbus frequently contain errors or defects, especially when
first introduced or when new versions or enhancements are released. Despite
extensive product testing by the Company, the Company has in the past released
versions of Netcool/OMNIbus with defects and has

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<PAGE> 13

discovered software errors in certain of its products after their introduction.
For example, version 3.0 of Netcool/OMNIbus, released in 1996, had a number of
material defects. The Company has in the past had to use a significant portion
of its technical personnel's time to address such defects without additional
revenue commensurate with such services. To the extent future product defects
require the allocation of a significant portion of the Company's technical
personnel's time, the Company business, operating results or financial condition
could be materially adversely affected. See " -- Need to Expand and Improve
Productivity of Sales Force, Technical Services and Customer Support
Organization." Additionally, there can be no assurance that, despite testing by
the Company and by current and potential customers, defects and errors will not
be found in new versions or enhancements after commencement of commercial
shipments, resulting in loss of revenues, delay in market acceptance or damage
to the Company's reputation, any of which could have a material adverse effect
upon the Company's business, operating results or financial condition.

Since the Company's products are used by its customers to monitor and
address network problems and avoid failures of the network to support critical
business functions, design defects, software errors, misuse of the Company's
products, incorrect data from network elements or other potential problems
within or out of the Company's control that may arise from the use of the
Company's products could result in financial or other damages to the Company's
customers. Such customers could seek damages from the Company for any such
losses, which, if successful, could have a material adverse effect on the
Company's business, operating results or financial condition. Furthermore, the
Company does not maintain product liability insurance. Although the Company's
license agreements with its customers typically contain provisions designed to
limit the Company's exposure to potential claims as well as any liabilities
arising from such claims, such provisions may not effectively protect the
Company against such claims and the liability and costs associated therewith.
Accordingly, any such claim could have a material adverse effect upon the
Company's business, results of operations or financial condition. See
"Business -- Products and Technology" and "-- Research and Development."

DEPENDENCE UPON PROPRIETARY TECHNOLOGY; RISK OF THIRD-PARTY CLAIMS OF
INFRINGEMENT. The Company's success and ability to compete is dependent in
significant part upon its proprietary software technology. The Company relies on
a combination of trade secret, copyright and trademark laws, nondisclosure and
other contractual agreements and technical measures to protect its proprietary
rights. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or to
obtain and use information that the Company regards as proprietary. There can be
no assurance that the steps taken by the Company to protect its proprietary
technology will prevent misappropriation of such technology, and such
protections may not preclude competitors from developing products with
functionality or features similar to the Company's products. In addition,
effective copyright and trade secret protection may be unavailable or limited in
certain foreign countries. While the Company believes that its products and
trademarks do not infringe upon the proprietary rights of third parties, there
can be no assurance that the Company will not receive future communications from
third parties asserting that the Company's products infringe, or may infringe,
the proprietary rights of third parties. The Company expects that software
product developers will be increasingly subject to infringement claims as the
number of products and competitors in the Company's industry segment grows and
the functionality of products in different industry segments overlaps. Any such
claims, with or without merit, could be time-consuming, result in costly
litigation and diversion of technical and management personnel, cause product
shipment delays or require the Company to develop non-infringing technology or
enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the Company
or at all. In the event of a successful claim of product infringement against
the Company and failure or inability of the Company to develop non-infringing
technology or license the infringed or similar technology, the Company's
business, operating results or financial condition could be

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<PAGE> 14

materially adversely affected. See "Business -- Intellectual Property and Other
Proprietary Rights."

RISKS ASSOCIATED WITH INTERNATIONAL LICENSING AND OPERATIONS. License,
maintenance and service revenue outside of the United States accounted for 76%,
55% and 48% of the Company's total revenue in fiscal 1995, 1996 and 1997,
respectively. The Company expects that international license, maintenance and
consulting revenue will continue to account for a significant portion of its
total revenue in future periods. The Company intends to enter into additional
international markets and to continue to expand its operations outside of the
United States by expanding its direct sale force and pursuing additional
strategic relationships. Such expansion will require significant management
attention and expenditure of significant financial resources and could adversely
affect the Company's ability to generate profits. To the extent that the Company
is unable to establish additional foreign operations in a timely manner, the
Company's growth, if any, in international sales will be limited, and the
Company's business, operating results or financial condition could be materially
adversely affected. The Company maintains a significant portion of its
operations, including the bulk of its software development operations, in the
United Kingdom. The Company's international operations and revenue involve a
number of inherent risks, including longer receivables collection periods and
greater difficulty in accounts receivable collection, difficulty in staffing and
managing foreign operations, an even lengthier sales cycle than with domestic
customers, the impact of possible recessionary environments in economies outside
the United States, unexpected changes in regulatory requirements, including a
slowdown in the rate of privatization of telecommunications service providers,
reduced protection for intellectual property rights in some countries and
tariffs and other trade barriers. There can be no assurance that the Company
will be able to sustain or increase revenue derived from international licensing
and service or that the foregoing factors will not have a material adverse
effect on the Company's future international license, service and other revenue,
and, consequently, on the Company's business, operating results or financial
condition. The Company pays the expenses of its international operations in
local currencies and does not currently engage in hedging transactions with
respect to such obligations. Currency exchange fluctuations in countries in
which the Company licenses its products or conducts operations could have a
material adverse effect on the Company's business, operating results or
financial condition by resulting in pricing levels that are not competitive or
expense levels that adversely impact profitability. In such event, gains and
losses on the conversion to United States dollars of accounts receivable and
accounts payable arising from international operations may contribute to
fluctuations in the Company's operating results. In addition, sales in Europe
and certain other parts of the world typically are adversely affected in the
quarter ending September 30 as many customers reduce their business activities
during the summer months. If the Company's international sales become a greater
component of total revenue, these seasonal factors may have a more pronounced
effect on the Company's operating results. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations,"
"Business -- Customers" and "-- Sales and Marketing."

RISKS ASSOCIATED WITH THIRD-PARTY LICENSES. The Company relies on certain
software that it licenses from third parties, including software that is
integrated with internally developed software and used in the Company's products
to perform key functions. There can be no assurance that these third-party
software licenses will continue to be available to the Company on commercially
reasonable terms or at all. Although the Company believes that alternative
software is available from other third-party suppliers, the loss of or inability
to maintain any of these software licenses or the inability of the third parties
to enhance in a timely and cost-effective manner their products in response to
changing customer needs, industry standards or technological developments could
result in delays or reductions in product shipments by the Company until
equivalent software could be developed internally or identified, licensed and
integrated, which would have a material adverse effect on the Company's
business, operating results and financial condition. See
"Business -- Intellectual Property and Other Proprietary Rights."

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YEAR 2000 COMPLIANCE. Many currently installed computer systems and
software products are coded to accept only two digit entries in the date code
field. These date code fields will need to accept four digit entries to
distinguish 21st century dates from 20th century dates. As a result, in less
than two years, computer systems and/or software used by many companies may need
to be upgraded to comply with such "Year 2000" requirements. Significant
uncertainty exists in the software industry concerning the potential effects
associated with such compliance. In the Company's standard license agreements,
the Company warrants to licensees that its software routines and programs are
Year 2000 compliant (i.e. that they accurately process date-related data within
any century and between two or more centuries). Although the Company believes
its software products are Year 2000 compliant, there can be no assurance that
the Company's software products contain all necessary software routines and
programs necessary for the accurate calculation, display, storage and
manipulation of data involving dates. If any of the Company's licensees
experience Year 2000 problems, such licensee could assert claims for damages
against the Company. Any such litigation could result in substantial costs and
diversion of the Company's resources even if ultimately decided in favor of the
Company. In addition, many companies are expending significant resources to
correct or patch their current software systems for Year 2000 compliance. These
expenditures may result in reduced funds available to purchase software products
such as those offered by the Company. The occurrence of any of the foregoing
could have a material adverse effect on the Company's business, operating
results or financial condition.

NO PRIOR TRADING MARKET FOR COMMON STOCK; POTENTIAL VOLATILITY OF STOCK
PRICE. Prior to this Offering, there has been no public market for the Common
Stock of the Company, and there can be no assurance that an active trading
market will develop or be sustained after this Offering. The initial public
offering price will be determined through negotiations among the Company, the
Selling Stockholders and the representatives of the Underwriters based on
several factors and may not be indicative of the market price of the Common
Stock after this Offering. The market price of the shares of Common Stock is
likely to be highly volatile and may be significantly affected by factors such
as actual or anticipated fluctuations in the Company's operating results,
announcements of technological innovations, new products or new contracts by the
Company or its competitors, developments with respect to copyrights or
proprietary rights, adoption of new accounting standards affecting the software
industry, general market conditions and other factors. In addition, the stock
market has from time to time experienced significant price and volume
fluctuations that have particularly affected the market price for the common
stocks of technology companies. These types of broad market fluctuations may
adversely affect the market price of the Company's Common Stock. In the past,
following periods of volatility in the market price of a company's securities,
securities class action litigation has often been initiated against such
company. Such litigation could result in substantial costs and a diversion of
management's attention and resources which could have a material adverse effect
upon the Company's business, operating results or financial condition. See
"Underwriting."

GENERAL ECONOMIC AND MARKET CONDITIONS. Segments of the software industry
have experienced significant economic downturns characterized by decreased
product demand, price erosion, work slowdowns and layoffs. The Company's
operations may in the future experience substantial fluctuations from period to
period as a consequence of general economic conditions affecting the timing of
orders from major customers and other factors affecting capital spending.
Although the Company has a diverse client base, it has targeted certain vertical
markets. Therefore, any economic downturns in general or in the targeted
vertical segments in particular would have a material adverse effect on the
Company's business, operating results and financial condition.

CONTROL BY EXISTING STOCKHOLDERS; BENEFITS OF THE OFFERING TO CURRENT
STOCKHOLDERS. Immediately after the closing of this Offering, 59% of the
outstanding Common Stock will be held by the directors and executive officers of
the Company, together with certain entities affiliated with

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<PAGE> 16

them, assuming no exercise of outstanding stock options. As a result, these
stockholders, if acting together, would be able to control substantially all
matters requiring approval by the stockholders of the Company, including the
election of all directors and approval of significant corporate transactions.
See "Management -- Executive Officers and Directors," "Certain Transactions" and
"Principal and Selling Stockholders."

Completion of the Offering contemplated hereby will result in substantial
benefits to the Company's existing stockholders and optionholders, including the
creation of a liquid trading market and the ability, subject to restrictions
under applicable securities laws and market stand-off agreements among such
security holders, the Underwriters and the Company, to sell shares in a public
market. However, there can be no assurance that an active public market will
develop or be sustained after this Offering. Upon the completion of this
Offering, assuming no exercise of the Underwriters' over-allotment option and no
exercise after December 31, 1997 of outstanding options, the aggregate market
value of Common Stock held by existing stockholders, assuming an initial public
offering price of $9.00 per share, and without regard to possible regulatory or
contractual restrictions on transfer, will be $105,308,604, representing a
substantial unrealized gain to existing stockholders. See " -- No Prior Trading
Market for Common Stock; Potential Volatility of Stock Price" and " -- Shares
Eligible for Future Sale." Certain officers of the Company will also benefit by
participating as Selling Stockholders in the Offering. At an assumed initial
public offering price of $9.00 per share and as a result of the difference
between the acquisition cost for such shares and the assumed initial public
offering price, the Selling Stockholders will realize substantial gains upon the
sale of their shares. See "Principal and Selling Stockholders."

ANTI-TAKEOVER EFFECTS OF CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE
LAW. Certain provisions of the Company's Restated Certificate of Incorporation
and Bylaws and certain provisions of Delaware law could delay or make difficult
a merger, tender offer or proxy contest involving the Company. The authorized
but unissued capital stock of the Company includes 5,000,000 shares of preferred
stock. The Board of Directors is authorized to provide for the issuance of such
preferred stock in one or more series and to fix the designations, preferences,
powers and relative, participating, optional or other rights and restrictions
thereof. Accordingly, the Company may in the future issue a series of preferred
stock, without further stockholder approval, that will have preference over the
Common Stock with respect to the payment of dividends and upon liquidation,
dissolution or winding-up of the Company. See "Description of Capital
Stock -- Preferred Stock." Further, Section 203 of the General Corporation Law
of the State of Delaware (as amended from time to time, the "DGCL"), which is
applicable to the Company, prohibits certain business combinations with certain
stockholders for a period of three years after they acquire 15% or more of the
outstanding voting stock of a corporation. In addition, the Restated Certificate
of Incorporation provides that, upon the closing of this Offering, the Board of
Directors will be divided into two classes of directors, with each class serving
a staggered two-year term. The classification of the Board of Directors has the
effect of generally requiring at least two annual stockholder meetings, instead
of one, to replace a majority of the Board members. Any of the foregoing could
adversely affect holders of the Common Stock or discourage or make difficult any
attempt to obtain control of the Company. See "Description of Capital
Stock -- Anti-takeover Effects of Provisions of the Certificate of
Incorporation, Bylaws and Delaware Law."

SHARES ELIGIBLE FOR FUTURE SALE. Sales of a substantial number of shares of
Common Stock (including shares issued upon the exercise of outstanding options)
in the public market after this Offering could materially adversely affect the
market price of the Common Stock. Such sales also might make it more difficult
for the Company to sell equity securities or equity-related securities in the
future at a time and price that the Company deems appropriate. See
"Management -- Employee Benefit Plans," "Shares Eligible for Future Sale" and
"Underwriting."

NO SPECIFIC USE OF PROCEEDS. The Company has not designated any specific
use for the net proceeds from the sale by the Company of the Common Stock
offered hereby. The Company expects to use the net proceeds for general
corporate purposes, including working capital to fund

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<PAGE> 17

anticipated operating losses and capital expenditures. The Company may, when the
opportunity arises, use an unspecified portion of the net proceeds to acquire or
invest in complementary businesses, products and technologies. From time to
time, in the ordinary course of business, the Company expects to evaluate
potential acquisitions of such businesses, products or technologies. However,
the Company has no present understandings, commitments or agreements with
respect to any material acquisition or investment. Accordingly, management will
have significant flexibility in applying the net proceeds of this Offering. The
failure of management to apply such funds effectively could have a material
adverse effect on the Company's business, operating results and financial
condition. See "Use of Proceeds."

DILUTION; POTENTIAL NEED FOR ADDITIONAL FINANCING; DIVIDEND
POLICY. Investors participating in this Offering will incur immediate and
substantial dilution of pro forma net tangible book value per share of $6.59
from the initial public offering price. To the extent outstanding options to
purchase the Company's Common Stock are exercised, there will be further
dilution. There can be no assurance that the Company will not require additional
funds to support its working capital requirements or for other purposes, in
which case the Company may seek to raise such additional funds through public or
private equity financing or from other sources. There can be no assurance that
such additional financing will be available or that, if available, such
financing will be obtained on terms favorable to the Company and would not
result in additional dilution to the Company's stockholders. The Company did not
pay or declare any cash dividends on the Common Stock or other securities during
fiscal 1996 or fiscal 1997 and does not anticipate paying cash dividends in the
foreseeable future. See "Dilution" and "Dividend Policy."

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<PAGE> 18

USE OF PROCEEDS

The net proceeds to the Company from the sale of 2,900,000 shares of Common
Stock to be sold by the Company in this Offering are estimated to be $23.2
million ($26.1 million if the Underwriters' over-allotment option is exercised
in full), after deducting underwriting discounts and commissions and estimated
offering expenses payable by the Company. The Company will not receive any of
the proceeds from the sale of shares of Common Stock by the Selling
Stockholders.

The principal purposes of the Offering are to increase the Company's equity
capital, to create a public market for the Common Stock, to facilitate future
access by the Company to public equity markets, to provide liquidity for certain
of the Company's existing stockholders and to provide increased visibility of
the Company in a marketplace where many of its competitors are publicly held
companies.

The Company has no current specific plans for the net proceeds of this
Offering, but the Company expects to use the proceeds of the Offering for
working capital and general corporate purposes. The Company may also use a
portion of the net proceeds for possible acquisition of businesses, products and
technologies that are complementary to those of the Company. Although the
Company has not identified any specific businesses, products or technologies
that it may acquire, nor are there any current agreements or negotiations with
respect to any such transactions, the Company from time to time evaluates such
opportunities. Pending such uses, the Company plans to invest the net proceeds
in short-term, interest-bearing, investment-grade securities. See "Risk
Factors -- No Specific Use of Proceeds."

DIVIDEND POLICY

The Company did not declare or pay any cash dividends on its capital stock
during fiscal 1996 or fiscal 1997 and does not expect to do so in the
foreseeable future. The Company anticipates that all future earnings, if any,
generated from operations will be retained by the Company to develop and expand
its business. Any future determination with respect to the payment of dividends
will be at the discretion of the Board of Directors and will depend upon, among
other things, the Company's operating results, financial condition and capital
requirements, the terms of then-existing indebtedness, general business
conditions and such other factors as the Board of Directors deems relevant.

17
<PAGE> 19

CAPITALIZATION

The following table sets forth the capitalization of the Company as of
December 31, 1997: (i) on an actual basis; (ii) on a pro forma basis to reflect
(A) the filing of a Restated Certificate of Incorporation upon the closing of
this Offering, (B) the exercise of a certain warrant resulting in the issuance
of 1,500,000 shares of the Company's Series A Preferred Stock at an exercise
price of $2.00 per share, and (C) the conversion of all outstanding shares of
the Company's Preferred Stock into Common Stock; and (iii) on such pro forma
basis as adjusted to reflect the offering of 2,900,000 shares of Common Stock
offered by the Company hereby and the receipt of the estimated net proceeds
therefrom at an assumed initial public offering price of $9.00 per share and
after deducting underwriting discounts and commissions and estimated offering
expenses. See "Use of Proceeds." This table should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and Notes thereto
appearing elsewhere in this Prospectus.

<TABLE>
<CAPTION>
DECEMBER 31, 1997(1)
-------------------------------------
PRO FORMA
ACTUAL PRO FORMA(2) AS ADJUSTED
-------- ------------ -----------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
Redeemable convertible preferred stock $0.01 par value;
5,988,336 shares authorized, actual; none, pro forma
and pro forma as adjusted; 4,488,336 shares issued
and outstanding, actual; none, pro forma and pro
forma as adjusted, respectively...................... $ 23,755 $ -- $ --
Stockholders' equity (deficit):........................
Preferred stock, $0.01 par value, no shares authorized,
actual and pro forma; 5,000,000 shares authorized,
no shares issued and outstanding, pro forma as
adjusted............................................. -- -- --
Common stock, $0.01 par value, 18,500,000 shares
authorized, 6,710,225 shares issued and outstanding,
actual; 60,000,000 shares authorized, pro forma and
pro forma as adjusted; 12,698,561 shares issued and
outstanding, pro forma; 15,598,561 shares issued and
outstanding, pro forma as adjusted................... 366 426 455
Additional paid-in capital............................. 2,101 28,796 51,940
Treasury stock, at cost: 897,605 shares................ (5,300) (5,300) (5,300)
Deferred compensation.................................. (201) (201) (201)
Accumulated deficit.................................... (11,421) (11,421) (11,421)
------- ------- -------
Total stockholders' equity (deficit)................. (14,455) 12,300 35,473
------- ------- -------
Total capitalization.............................. $ 9,300 $ 12,300 $35,473
======= ======= =======
</TABLE>

- ---------------

(1) Based on the number of shares outstanding as of December 31, 1997. Excludes
1,350,670 shares of Common Stock issuable upon exercise of outstanding
options as of December 31, 1997 with a weighted average exercise price of
$2.56 per share; and as of January 20, 1998, 980,514 shares reserved for
issuance under the Company's stock plans. See "Management -- 1997 Stock
Option/Stock Issuance Plan," "-- 1997 Employee Stock Purchase Plan" and Note
6 of Notes to Consolidated Financial Statements.

(2) Reflects the issuance of 1,500,000 shares of Series A Preferred Stock
issuable upon exercise of a warrant issued to Sierra Ventures V, L.P. at an
exercise price of $2.00 per share (the "Series A Warrant"). See Note 6 of
Notes to Consolidated Financial Statements.

18
<PAGE> 20

DILUTION

As of December 31, 1997, the Company had a pro forma net tangible book
value of $12,300,000, or approximately $1.04 per share of Common Stock after
giving pro forma effect to the exercise of the Series A Warrant and the
conversion of all outstanding preferred stock to common stock. "Net tangible
book value" represents the amount of tangible assets less total liabilities.
Without taking into account any other changes in the net tangible book value
after December 31, 1997, other than to give effect to the receipt by the Company
of the net proceeds from the sale of the shares of Common Stock offered by the
Company hereby at an assumed initial public offering price of $9.00 per share
and after deducting underwriting discounts and estimated offering expenses, the
pro forma net tangible book value of the Company as of December 31, 1997 would
have been $35,473,000, or $2.41 per share. This represents an immediate increase
in net tangible book value of $1.37 per share to existing stockholders and an
immediate dilution in net tangible book value of $6.59 per share to purchasers
of Common Stock in the Offering. Investors participating in this Offering will
incur immediate, substantial dilution. This is illustrated in the following
table:

<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................... $ 9.00
Pro forma net tangible book value per share as of December 31,
1997......................................................... $ 1.04
Increase per share attributable to new investors................ 1.37
------
Adjusted pro forma net tangible book value per share as of
December 31, 1997............................................... 2.41
------
Dilution per share to new investors............................... $ 6.59
======
</TABLE>

The following table summarizes on the pro forma basis described above as of
December 31, 1997, the difference between the existing stockholders and the
purchasers of shares in the Offering (at an assumed initial public offering
price of $9.00 per share) with respect to the number of shares of Common Stock
purchased from the Company, the total cash consideration paid and the average
price per share paid:

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
-------------------- --------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders(1)...... 12,698,561 81.4% $23,467,000 47.3% $1.85
New investors(2).............. 2,900,000 18.6 26,100,000 52.7 9.00
---------- ----- ----------- -----
Total............... 15,598,561 100.0% $49,567,000 100.0%
========== ===== =========== =====
</TABLE>

The foregoing computations are based on the number of shares outstanding as
of December 31, 1997 and exclude 1,350,670 shares of Common Stock issuable upon
exercise of outstanding options as of December 31, 1997 with a weighted average
exercise price of $2.56 per share, and as of January 20, 1998, an additional
980,514 shares reserved for issuance under the Company's stock plans. To the
extent outstanding options are exercised, there will be further dilution to new
investors. See "Management -- 1997 Stock Option/Stock Issuance Plan," "-- 1997
Employee Stock Purchase Plan" and Note 6 of Notes to Consolidated Financial
Statements.

- ---------------

(1) Includes 897,605 shares of Common Stock repurchased for $5.3 million at
cost, held as treasury stock.

(2) Sales by Selling Stockholders in this Offering will reduce the number of
shares held by existing stockholders to 11,700,956, or approximately 80%
(11,600,956 shares or approximately 77% if the Underwriters' over-allotment
option is exercised in full), and will increase the number of shares held by
new investors to 3,000,000, or approximately 20% (3,450,000 shares or
approximately 23% if the Underwriters' over-allotment option is exercised in
full) of the total number of shares of Common Stock to be outstanding after
this Offering.

19
<PAGE> 21

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data at September 30, 1996
and 1997 and for each of the years in the three-year period ended September 30,
1997 are derived from consolidated financial statements of the Company that have
been audited by KPMG Peat Marwick LLP ("KPMG"), independent certified public
accountants, and are included elsewhere in this Prospectus. The consolidated
balance sheet data at September 30, 1995 is derived from the audited
consolidated financial statements of the Company that are not included herein.
The consolidated statements of operations data for the years ended September 30,
1993 and 1994 and the consolidated balance sheet data at September 30, 1993 and
1994 are derived from unaudited consolidated financial statements and are not
included herein. The consolidated statement of operations data for the three
months ended December 31, 1996 and 1997 and the consolidated balance sheet data
at December 31, 1997 are derived from unaudited consolidated financial
statements included elsewhere in this Prospectus. The historical results are not
necessarily indicative of the operating results to be expected in the future.
The following selected consolidated financial data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements and Notes thereto included
elsewhere in this Prospectus.

<TABLE>
<CAPTION>
THREE MONTHS
ENDED DECEMBER
YEAR ENDED SEPTEMBER 30, 31,
------------------------------------------ ---------------
1993 1994 1995 1996 1997 1996 1997
----- ----- ------ ------ -------- ------ ------
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
License..................................................... $ -- $ 111 $1,077 $3,374 $ 6,968 $ 802 $3,735
Maintenance and services.................................... -- 3 369 1,141 2,324 424 1,094
----- ------ ------ ------ ------ ------ -------
Total revenues........................................ -- 114 1,446 4,515 9,292 1,226 4,829
----- ------ ------ ------ ------ ------ -------
Cost of revenues:
License..................................................... -- 61 163 311 523 61 315
Maintenance and services.................................... -- -- 102 384 1,042 166 762
----- ------ ------ ------ ------ ------ -------
Total cost of revenues................................ -- 61 265 695 1,565 227 1,077
----- ------ ------ ------ ------ ------ -------
Gross profit.................................................. -- 53 1,181 3,820 7,727 999 3,752
Operating expenses:
Sales and marketing......................................... -- 30 728 1,768 8,970 1,004 3,144
Research and development ................................... 224 318 708 1,582 2,042 303 1,069
General and administrative.................................. 78 236 584 996 4,244 467 892
----- ------ ------ ------ ------ ------ -------
Total operating expenses.............................. 302 584 2,020 4,346 15,256 1,774 5,105
----- ------ ------ ------ ------ ------ -------
Loss from operations.......................................... (302) (531) (839) (526) (7,529) (775) (1,353)
Other income (expense):
Interest income............................................. -- -- -- 8 64 6 126
Interest expense............................................ (17) (68) (106) (212) (1,268) (36) (301)
Other....................................................... -- -- -- 25 (200) 56 225
----- ------ ------ ------ ------ ------ -------
Loss before income taxes...................................... (319) (599) (945) (705) (8,933) (749) (1,303)
Income taxes ................................................. -- -- -- 100 -- -- --
----- ------ ------ ------ ------ ------ -------
Loss from continuing operations............................... (319) (599) (945) (805) (8,933) (749) (1,303)
Discontinued operations:
Income (loss) from discontinued operations.................. 633 335 711 569 (104) (120) --
Gain on disposal of discontinued operations(1).............. -- -- -- -- 1,161 -- --
----- ------ ------ ------ ------ ------ -------
Net income (loss)............................................. $ 314 $(264) $ (234) $ (236) $ (7,876) (869) (1,303)
Accretion on redeemable convertible preferred stock........... -- -- -- -- (755) -- (890)
----- ------ ------ ------ ------ ------ -------
Net income (loss) applicable to holders of common stock....... $ 314 $(264) $ (234) $ (236) $ (8,631) $ (869) (2,193)
===== ====== ====== ====== ====== ====== =======
Per share of common stock:
Pro forma basic and diluted loss from continuing
operations................................................ $ (0.83) $(0.11)
Pro forma basic and diluted loss from discontinued
operations................................................ $ (0.01) $ 0.00
Pro forma basic and diluted gain on disposal of discontinued
operations................................................ $ 0.11 $ 0.00
Pro forma basic and diluted net loss........................ $ (0.73) $(0.11)
Shares used in per share calculation(2)....................... 10,817 12,384
Cash dividends per share...................................... $ -- $ -- $ 0.01 $ -- $ -- $ -- $ --
===== ====== ====== ====== ====== ====== =======
</TABLE>

20
<PAGE> 22

<TABLE>
<CAPTION>
SEPTEMBER 30,
---------------------------------------------------- DECEMBER 31,
1993 1994 1995 1996 1997 1997
------ ----- ------- ------- ------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents............................. $ -- $ 18 $ 12 $ 594 $13,741 $ 7,683
Working capital (deficiency).......................... (259) (453) (383) (847) 13,181 6,801
Total assets.......................................... 4,375 4,492 5,767 9,107 22,740 16,922
Redeemable convertible preferred stock................ -- -- -- -- 22,865 23,755
Total stockholders' equity (deficit).................. 351 93 (203) (222) (7,234) (14,455)
</TABLE>

- ---------------

(1) See Note 2 of Notes to Consolidated Financial Statements.

(2) See Note 1 of Notes to Consolidated Financial Statements.

21
<PAGE> 23

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with
"Selected Consolidated Financial Data" and the Company's Consolidated Financial
Statements and Notes thereto included elsewhere in this Prospectus. This
Prospectus contains forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from the
results discussed in such forward-looking statements. Factors that might cause
such differences include, but are not limited to, those discussed below and in
"Risk Factors" and "Business" as well as those discussed elsewhere in this
Prospectus.

OVERVIEW

Micromuse develops, markets and supports a family of scalable, highly
configurable, rapidly deployable software solutions that enable Service Level
Management. The Company was founded in 1989 in London, England and historically
operated a systems integration business, reselling computer hardware and
software products and providing consulting services principally for managing
networks. Leveraging its expertise in network management and using funds
generated from the systems integration business, the Company developed its
Netcool/OMNIbus software, which the Company began shipping in January 1995. In
March 1997, the Company was reorganized in Delaware and relocated its
headquarters from London to San Francisco. In connection with the
Reorganization, the Company raised $4.9 million through the sale of equity
securities and arranged a $3.0 million credit facility. In September 1997, the
Company raised an additional $15.9 million through the sale of equity securities
and sold its systems integration business for approximately $400,000, net of
fees. With the proceeds from the financings and the sale of the systems
integration business, the Company expanded operations and substantially
increased development, sales and administrative headcount for the Netcool
business throughout the last three quarters of calendar 1997, growing from 57
employees on March 31, 1997 to 138 employees on December 31, 1997. To
accommodate recent growth and to compete effectively and manage future growth,
if any, the Company will be required to continue to implement and improve
operational, financial and management information systems, procedures and
controls on a timely basis and to expand, train, motivate and manage its work
force. See "Risk Factors -- Management of Growth; Need to Improve Financial
Systems and Controls" and "-- Need to Expand and Improve Productivity of Sales
Force, Technical Services and Customer Support Organization."

The Company's consolidated financial statements have been restated to
reflect the discontinuation of the operations associated with the Company's
systems integration business. In connection with such sale, the Company was
indemnified by the purchaser for work-in-process under existing contracts,
warranty claims under completed contracts and maintenance agreements, but
retained liability for completed contracts. See Note 2 of Notes to Consolidated
Financial Statements for information concerning this restatement.

Other than discontinued operations, all of the Company's revenues have been
derived from licenses for its Netcool family of products and related
maintenance, training and consulting services. The Company currently expects
that Netcool-related revenues will continue to account for all or substantially
all of the Company's revenues for the remainder of fiscal 1998 and for the
foreseeable future thereafter. As a result, the Company's future operating
results are dependent upon continued market acceptance of its Netcool products
and enhancements thereto. See "Risk Factors -- Emerging Service Level Management
Market; Dependence on Telecommunications Carriers and Other Service Providers;
Demand for SLM Products," and "-- Product Concentration."

As of December 31, 1997, Micromuse had licensed its Netcool products to
more than 100 customers worldwide. Micromuse licenses its software through its
direct sales force, OEMs and

22
<PAGE> 24

value added resellers. License revenues from OEMs and resellers accounted for
approximately 12%, 8%, 11% and 8% of the Company's total license revenues for
fiscal 1995, 1996, 1997 and the first quarter of fiscal 1998 respectively. The
Company's ability to achieve significant additional revenue growth in the future
will depend in large part on its success in recruiting and training sufficient
sales and technical services personnel, maintaining its current distribution
relationships and establishing additional relationships with OEMs, resellers and
systems integrators. For a discussion of the risks associated with expanding
distribution, see "Risk Factors -- Need to Expand Distribution Channels;
Dependence on Third-Party Relationships." As of December 31, 1997, the Company
had sold in excess of 60% of its software products to telecommunications
carriers, including ISPs, and investment banks.

As a result of the Company's multinational operations and sales, the
Company's operating results are subject to significant fluctuations based upon
changes in the exchange rates of certain currencies, particularly the British
pound, in relation to the U.S. dollar. For example, the Company's United States
headquarters are located in San Francisco, California, while its principal
product development operations are located in London, England. As a result, a
substantial portion of the Company's costs and expenses are denominated in
currencies other than the U.S. dollar. For the year ended September 30, 1997,
license, maintenance and service revenue outside of the United States accounted
for 48% of the Company's total revenues. See Note 8 of Notes to Consolidated
Financial Statements. The Company does not currently engage in risk management
activities with respect to its foreign currency exposure. Although management
will continue to monitor the Company's exposure to currency fluctuations, there
can be no assurance that exchange rate fluctuations will not have a material
adverse effect on the Company's business and operating results. See "Risk
Factors -- Risks Associated with International Licensing and Operations."

Although the Company's revenues have increased in each of the last five
quarters, after giving effect to the restatement of the financial statements due
to the sale of the systems integration business, the Company incurred net losses
in each quarter from inception through the quarter ended September 30, 1997,
with the exception of the quarter ended September 30, 1996, and had an
accumulated deficit of $11.4 million as of December 31, 1997. In addition, the
Company expects to incur net losses for the next several quarters. The Company's
limited operating history as a software developer, rapid expansion of operations
and headcount and the emerging nature of the market for SLM software make the
prediction of future operating results difficult. Accordingly, although the
Company has recently experienced revenue growth, such growth should not be
considered indicative of future revenue growth, if any, or of future operating
results. There can be no assurance that the Company's business strategies will
be successful or that the Company will be able to achieve profitability on a
quarterly or annual basis. See "Risk Factors -- Limited Operating History as a
Software Company; Anticipated Continuing Losses; Uncertainty of Future Operating
Results," "-- Variability of Quarterly Operating Results; Seasonality" and
"-- Management of Growth; Need to Improve Financial Systems and Controls."

23
<PAGE> 25

RESULTS OF OPERATIONS

The following table sets forth certain items in the Company's consolidated
statement of operations as a percentage of total revenues, except as indicated,
for the periods indicated:

<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, DECEMBER 31,
------------------------- ---------------
AS A PERCENTAGE OF TOTAL REVENUES 1995 1996 1997 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Revenues:
License.................................... 74.5% 74.7% 75.0% 65.4% 77.3%
Maintenance and services................... 25.5 25.3 25.0 34.6 22.7
----- ----- ----- ----- -----
Total revenues.......................... 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- -----
Cost of revenues:
License.................................... 11.3 6.9 5.6 5.0 6.5
Maintenance and services................... 7.0 8.5 11.2 13.5 15.8
----- ----- ----- ----- -----
Total cost of revenues.................. 18.3 15.4 16.8 18.5 22.3
----- ----- ----- ----- -----
Gross profit............................ 81.7 84.6 83.2 81.5 77.7
Operating expenses:
Sales and marketing........................ 50.3 39.2 96.5 81.9 65.1
Research and development................... 49.0 35.0 22.0 24.7 22.1
General and administrative................. 40.4 22.1 45.7 38.1 18.5
----- ----- ----- ----- -----
Total operating expenses................ 139.7 96.3 164.2 144.7 105.7
----- ----- ----- ----- -----
Loss from operations.................... (58.0) (11.7) (81.0) (63.2) (28.0)
Other income (expense)....................... (7.4) (3.9) (15.1) 2.1 1.0
Loss before income taxes................ (65.4) (15.6) (96.1) (61.1) (27.0)
Income taxes................................. -- 2.2 -- -- --
----- ----- ----- ----- -----
Loss from continuing operations......... (65.4) (17.8) (96.1) (61.1) (27.0)
Income (loss) from discontinued operations... 49.2 12.6 (1.1) (9.8) --
Gain on disposal of discontinued
operations................................. -- -- 12.4 -- --
Net loss................................ (16.2) (5.2) (84.8) (70.9) (27.0)
===== ===== ===== ===== =====
Accretion on redeemable convertible preferred
stock...................................... -- -- (8.1) -- (18.4)
----- ----- ----- ----- -----
Net loss applicable to holders of common
stock...................................... (16.2) (5.2) (92.9) (70.9) (45.4)
----- ----- ----- ----- -----
AS A PERCENTAGE OF RELATED REVENUES
Cost of license revenues..................... 15.1 9.2 7.5 7.6 8.4
Cost of maintenance and services revenues.... 27.6 33.7 44.8 39.2 69.7
</TABLE>

YEARS ENDED SEPTEMBER 30, 1995, 1996 AND 1997

Revenues. The Company's total revenues are derived from license revenues
for its Netcool family of products as well as associated maintenance, consulting
and training services revenues. License revenues are recognized upon the
acceptance of a purchase order and shipment of the software if no significant
obligations on the part of the Company remain and collection of the resulting
receivable is probable. Allowances for credit losses and for estimated future
returns are provided for upon shipment. Returns to date have not been material.
Maintenance revenues from ongoing customer support and product upgrades are
deferred and recognized ratably over the term of the maintenance agreement,
typically 12 months. Payments for maintenance fees (on initial order or on
renewal) are generally made in advance and are nonrefundable. Revenues for
consulting and training services are recognized as the services are performed.
See Note 1 of Notes to Consolidated Financial Statements. The Company has
recognized revenue, for all periods prior

24
<PAGE> 26

to and including September 30, 1997, in accordance with American Institute of
Certified Public Accountants Statement of Position 91-1 entitled Software
Revenue Recognition. For the quarter ended December 31, 1997, the Company has
recognized revenue in accordance with American Institute of Certified Public
Accountants Statement of Position 97-2 entitled Software Revenue Recognition.
There was no material change to the Company's accounting for revenue as a result
of the adoption of American Institute of Certified Public Accountants Statement
of Position 97-2.

The Company's total revenues increased from $1.4 million in fiscal 1995 to
$4.5 million in fiscal 1996 and to $9.3 million in fiscal 1997. License revenues
increased from $1.1 million in fiscal 1995 to $3.4 million in fiscal 1996 and to
$7.0 million in fiscal 1997, primarily as a result of an increase in the number
of product licenses sold and in average transaction size, reflecting increased
acceptance of Netcool/OMNIbus and expansion of the Company's direct sales
organization. Maintenance and services revenues increased from $369,000 in
fiscal 1995 to $1.1 million in fiscal 1996 and to $2.3 million in fiscal 1997,
as a result of providing maintenance and services to a larger installed base in
each successive year. The percentage of the Company's total revenues
attributable to software licenses has remained relatively constant at 75% in
each of fiscal 1995, 1996 and 1997. Maintenance and services revenues accounted
for 25% of total revenues in each of fiscal 1995, 1996 and 1997.

Revenues from U.S. operations grew from 24% of revenues in fiscal 1995 to
45% of revenues in fiscal 1996 and to 52% of revenues in fiscal 1997, reflecting
the Company's expansion of U.S. operations. International revenues include all
revenues other than from the United States. For a discussion of risks associated
with international sales see "Risk Factors -- Risks Associated with
International Licensing and Operations." See Note 8 of Notes to Consolidated
Financial Statements.

To date, the Company's revenues have resulted primarily from sales to the
telecommunications industry, ISPs and investment banks. License revenues from
telecommunications industry customers and ISPs accounted for 74%, 34% and 58% of
the Company's total license revenues in fiscal 1995, 1996 and 1997 respectively.
License revenues from investment banks accounted for 14%, 29% and 15% of total
license revenues in fiscal 1995, 1996 and 1997, respectively. In fiscal 1997,
entities affiliated with WorldCom and entities affiliated with British
Telecommunications, accounted for 18% and 9%, respectively, of the Company's
total revenue. In addition, entities affiliated with British Telecommunications
accounted for 57% and 14% of the Company's total revenues in fiscal 1995 and
fiscal 1996, respectively. See "Risk Factors -- Sales Concentration" and Note 9
of Notes to Consolidated Financial Statements.

Cost of Revenues. Cost of license revenues consists primarily of technology
license fees paid to third party software vendors and the costs of software
media, packaging and production. Cost of license revenues decreased as a
percentage of license revenues from 15% in fiscal 1995 to 9% in fiscal 1996, and
to 8% in fiscal 1997, as a result of economies of scale.

Cost of maintenance and services revenues consists primarily of
personnel-related costs incurred in providing maintenance, consulting and
training to customers. Cost of maintenance and services revenues increased as a
percentage of maintenance and services revenues from 28% in fiscal 1995 to 34%
in fiscal 1996, and to 45% in fiscal 1997, principally due to increased
personnel, facilities and travel costs associated with growth in the customer
support and technical services organizations. The Company expects that cost of
maintenance and services will continue to increase in dollar amounts in future
periods as the Company continues to hire additional customer support and
technical services personnel and expands its maintenance consulting and training
activities.

Sales and Marketing Expenses. Sales and marketing expenses consist
primarily of salaries, commissions and bonuses earned by personnel engaged in
sales, technical presales and marketing activities as well as the costs of trade
shows, public relations, marketing materials and other marketing activities.
Sales and marketing expenses increased from $728,000 in fiscal 1995 to

25
<PAGE> 27

$1.8 million in fiscal 1996 and to $9.0 million in fiscal 1997. The increases in
both fiscal 1996 and fiscal 1997 reflected the hiring of additional personnel in
connection with the building of the Company's sales force. In addition, sales
and marketing expenses increased in fiscal 1997 due to increased technical staff
and marketing personnel, compensation expense related to bonus shares issued,
increased facilities costs and costs associated with expanded marketing
activities. Sales and marketing expenses represented 50%, 39% and 96% of total
revenues in fiscal 1995, 1996 and 1997, respectively. The Company expects that
sales and marketing expenses will continue to increase in absolute dollar
amounts in future periods as the Company continues to hire additional sales,
technical services and marketing personnel, to increase marketing activities and
to build its indirect sales channel. See Note 6 of Notes to Consolidated
Financial Statements.

Research and Development Expenses. Research and development expenses
consist primarily of salaries and other personnel-related expenses and costs of
computer systems and software development tools. Research and development
expenses increased 123% from $708,000 in fiscal 1995 to $1.6 million in fiscal
1996 and 29% to $2.0 million in fiscal 1997. The increase in research and
development expenses in each year was primarily attributable to increased
personnel, additional facilities and an increase in the computer systems and
software development tools required by the additional personnel. In addition to
expanding its research and development facility in London, the Company
established a research and development team focused on application development
in its New York office in fiscal 1997. Research and development expenses
represented 49%, 35% and 22% of total revenue in fiscal 1995, 1996 and 1997,
respectively. The decrease as a percentage of total revenues was due to growth
in the Company's total revenues. The Company anticipates that it will commit
increasing resources to research and development in future periods to enhance
and extend its core technology and product line and, as a result, expects that
research and development expenses will increase in absolute dollars in future
periods. To date, all research and development costs have been expensed as
incurred. See Note 1 of Notes to Consolidated Financial Statements.

General and Administrative Expenses. General and administrative expenses
consist primarily of personnel costs for administration, finance, information
systems and human resources, as well as professional fees. General and
administrative expenses increased from $584,000 in fiscal 1995 to $996,000 in
fiscal 1996 and to $4.2 million in fiscal 1997. These increases in each year
were primarily due to increased staffing, facilities costs and associated
expenses necessary to manage and support the Company's increased scale of
operations and, in fiscal 1997, due to compensation expense related to bonus
shares issued. General and administrative expenses as a percentage of total
revenues were 40% in fiscal 1995, 22% in fiscal 1996 and 46% in fiscal 1997. The
decrease of general and administrative expenses as a percentage of total
revenues from fiscal 1995 to 1996 was primarily attributable to growth in total
revenues. The increase in general and administrative expenses as a percentage of
total revenues from fiscal 1996 to fiscal 1997 was primarily attributable to
personnel-related costs and to the payment of professional fees for various
matters, including the Reorganization, associated with the transfer of the
Company's headquarters from London to San Francisco. The Company expects that
its general and administrative expenses will increase in absolute dollar amounts
as the Company expands its administrative staff, adds infrastructure and incurs
additional costs related to the growth of its business and related to being a
public company, such as expenses related to directors' and officers' insurance,
investor relations programs and increased professional fees. See Note 6 of Notes
to Consolidated Financial Statements.

Other Income (Expense). The increase in interest expense from fiscal 1996
to fiscal 1997 was primarily attributable to the imputed interest relating to
the issuance of a warrant to purchase shares of Series A Preferred Stock issued
in connection with the provision of a line of credit to the Company. See Note 6
of Notes to Consolidated Financial Statements.

Provision for Income Taxes. As of September 30, 1997, the Company had
approximately $2.4 million and $1.4 million of net operating loss carryforwards
for federal and state tax purposes. The

26
<PAGE> 28

federal net operating loss carryforwards expire in 2012, and the state net
operating loss carryforwards expire primarily in 2002. Federal and state tax
laws impose substantial restrictions on the utilization of net operating loss
carryforwards in the event of an "ownership change" as defined in Section 382 of
the Internal Revenue Code. The Company has not yet determined whether an
ownership change occurred due to significant stock transactions in each of the
reporting years disclosed. If an ownership change has occurred, utilization of
the net operating loss carryforwards could be significantly reduced.
Additionally, loss carryforwards of either Micromuse Inc. or Micromuse USA Inc.
cannot be utilized against future profits generated by the other company. As of
September 30, 1997, the Company also had approximately $1.8 million and $200,000
of loss carryforwards in England and Australia, respectively. The Company has
provided a full valuation allowance on the deferred tax asset, consisting
primarily of net operating loss carryforwards, because of uncertainty regarding
its realizability. See Note 7 of Notes to Consolidated Financial Statements.

Discontinued Operations. In July 1997, the Company adopted a formal plan to
discontinue its Systems Integration division based in England. In September the
Company sold the division for approximately $400,000 in cash, net of fees. The
disposition of the division in September 1997 has been accounted for as a
discontinued operation in accordance with Accounting Principles Board Opinion
No. 30 and prior period consolidated financial statements have been restated to
reflect the discontinuation of the Systems Integration business. Revenue from
discontinued operations was $16.6 million, $14.0 million and $15.7 million,
respectively, in fiscal 1995, 1996 and 1997. The income (loss) from discontinued
operations of $711,000, $569,000, and ($104,000) in fiscal 1995, 1996, and 1997,
respectively, represents the operation's operating income, net of taxes. The
gain on disposal of discontinued operations of $1.2 million in fiscal 1997
represents the gain on disposal of the operation including net income from
operations of $256,000 from the measurement date to the disposal date. See Note
2 of Notes to Consolidated Financial Statements.

QUARTERS ENDED DECEMBER 31, 1996 AND 1997

Revenues. The Company's revenues increased from $1.2 million for the
quarter ended December 31, 1996 to $4.8 million for the quarter ended December
31, 1997. License revenues increased from $802,000 for the quarter ended
December 31, 1996 to $3.7 million for the quarter ended December 31, 1997,
primarily as a result of an increase in the number of product licenses sold and
an increase in the average transaction size, reflecting increased acceptance of
Netcool/OMNIbus and expansion of the Company's direct sales organization.
Maintenance and services revenues increased from $424,000 for the quarter ended
December 31, 1996 to $1.1 million for the quarter ended December 31, 1997, as a
result of providing maintenance and services to a larger installed base of
customers. The percentage of the Company's total revenue attributable to license
revenue increased from 65% in the quarter ended December 31, 1996 to 77% in the
quarter ended December 31, 1997, due primarily to an increased focus by the
Company in generating license revenues.

Cost of Revenues. Cost of revenues increased from $227,000 for the quarter
ended December 31, 1996 to $1.1 million for the quarter ended December 31, 1997.
Cost of license revenues as a percentage of license revenues increased from 5%
to 7% for the quarter ended December 31, 1997 compared to the quarter ended
December 31, 1996, resulting primarily from increased packaging costs. Cost of
maintenance and services increased as a percentage of maintenance and services
revenues from 39% for the quarter ended December 31, 1996 to 70% for the quarter
ended December 31, 1997 primarily as a result of increased personnel, facilities
and travel costs associated with growth in the customer support and technical
services organizations.

Sales and Marketing Expenses. Sales and marketing expenses increased from
$1.0 million for the quarter ended December 31, 1996 to $3.1 million for the
quarter ended December 31, 1997, primarily due to the increased personnel costs
associated with the expansion of the Company's

27
<PAGE> 29

sales and technical services departments, increased facilities costs, and costs
associated with expanded marketing activities. Sales and marketing expenses
declined as a percentage of total revenues from 82% for the quarter ended
December 31, 1996 to 65% for the quarter ended December 31, 1997 as a result of
productivity improvements in the Company's sales and technical services
organizations and as a result of reduced seasonality in revenues caused by
changes in the Company's sales incentive programs.

Research and Development Expenses. Research and development expenses
increased from $303,000 for the quarter ended December 31, 1996 to $1.1 million
for the quarter ended December 31, 1997 as a result of increased personnel,
additional facilities costs, and an increase in the computer systems and
software development tools required by the additional personnel. Research and
development costs declined as a percentage of total revenues from 25% for the
quarter ended December 31, 1996 to 22% for the quarter ended December 31, 1997,
primarily as a result of the increase in total revenues.

General and Administrative Expenses. General and administrative expenses
increased from $467,000 for the quarter ended December 31, 1996 to $892,000 for
the quarter ended December 31, 1997 as a result of increased personnel,
facilities costs, professional fees and associated expenses to support the
Company's increased scale of operations. General and administrative expenses as
a percentage of revenues declined due to the increase in total revenues.

Other Income (Expense). Interest expense for the quarter ended December 31,
1997 primarily for the amortization of debt issuance costs related to the
issuance of the Series A Warrant.

28
<PAGE> 30

QUARTERLY RESULTS OF OPERATIONS

The following tables set forth certain unaudited quarterly consolidated
statement of operations data for each quarter of the nine quarters in the period
ended December 31, 1997, as well as such data expressed as a percentage of the
Company's total revenues for the periods indicated. In the opinion of
management, this information has been presented on the same basis as the
consolidated financial statements appearing elsewhere in this Prospectus, and
all necessary adjustments, consisting only of normal recurring adjustments, have
been included in the amounts stated below to present fairly the unaudited
quarterly results when read in conjunction with the consolidated financial
statements of the Company and related notes thereto appearing elsewhere in this
Prospectus. The operating results for any quarter should not be considered
indicative of results of any future period.

<TABLE>
<CAPTION>
QUARTER ENDED
--------------------------------------------------------------------------------------------------
DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1995 1996 1996 1996 1996 1997 1997 1997 1997
-------- -------- -------- --------- -------- -------- -------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
License.............. $ 442 $ 528 $ 684 $ 1,720 $ 802 $ 1,095 $ 2,094 $ 2,977 $ 3,735
Maintenance and
services........... 67 234 322 518 424 616 590 694 1,094
----- ----- ------ ------ ------ ------- ------- ------- -------
Total revenues..... 509 762 1,006 2,238 1,226 1,711 2,684 3,671 4,829
----- ----- ------ ------ ------ ------- ------- ------- -------
Cost of revenues:
License.............. 50 75 54 132 61 108 155 199 315
Maintenance and
services........... 28 92 115 149 166 180 303 393 762
----- ----- ------ ------ ------ ------- ------- ------- -------
Total cost of
revenues......... 78 167 169 281 227 288 458 592 1,077
----- ----- ------ ------ ------ ------- ------- ------- -------
Gross profit........... 431 595 837 1,957 999 1,423 2,226 3,079 3,752
Operating expenses:
Sales and marketing.. 241 294 528 705 1,004 1,951 1,714 4,301 3,144
Research and
development........ 267 371 410 534 303 383 596 760 1,069
General and
administrative..... 143 142 272 439 467 1,553 714 1,510 892
----- ----- ------ ------ ------ ------- ------- ------- -------
Total operating
expenses......... 651 807 1,210 1,678 1,774 3,887 3,024 6,571 5,105
----- ----- ------ ------ ------ ------- ------- ------- -------
Income (loss) from
operations........... (220) (212) (373) 279 (775) (2,464) (798) (3,492) (1,353)
Other income
(expense)............ (51) (44) (53) (31) 26 (450) (464) (516) 50
----- ----- ------ ------ ------ ------- ------- ------- -------
Income (loss) before
income taxes......... (271) (256) (426) 248 (749) (2,914) (1,262) (4,008) (1,303)
Income taxes........... -- 59 30 11 -- -- -- -- --
----- ----- ------ ------ ------ ------- ------- ------- -------
Income (loss) from
continuing
operations........... (271) (315) (456) 237 (749) (2,914) (1,262) (4,008) (1,303)
Discontinued
operations:
Income (loss) from
discontinued
operations......... 211 218 197 (57) (120) 18 (2) -- --
Gain on disposal of
discontinued
operations......... -- -- -- -- -- -- -- 1,161 --
----- ----- ------ ------ ------ ------- ------- ------- -------
Net income (loss)...... (60) (97) (259) 180 (869) (2,896) (1,264) (2,847) (1,303)
Accretion on redeemable
convertible preferred
stock................ -- -- -- -- -- (89) (264) (402) (890)
----- ----- ------ ------ ------ ------- ------- ------- -------
Net income (loss)
applicable to holders
of common stock...... $ (60) $ (97) $ (259) $ 180 $ (869) $ (2,985) $ (1,528) $ (3,249) $ (2,193)
===== ===== ====== ====== ====== ======= ======= ======= =======
</TABLE>

29
<PAGE> 31

<TABLE>
<CAPTION>
AS A PERCENTAGE OF TOTAL REVENUES
--------------------------------------------------------------------------------------------------
DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1995 1996 1996 1996 1996 1997 1997 1997 1997
-------- -------- -------- --------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
License......... 86.8% 69.3% 68.0% 76.9% 65.4% 64.0% 78.0% 81.1% 77.3%
Maintenance and
services...... 13.2 30.7 32.0 23.1 34.6 36.0 22.0 18.9 22.7
----- ----- ----- ----- ----- ----- ----- ----- -----
Total
revenues.... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ----- ----- ----- ----- ----- -----
Cost of revenues:
License......... 9.8 9.8 5.4 5.9 5.0 6.3 5.8 5.4 6.5
Maintenance and
services...... 5.5 12.1 11.4 6.7 13.5 10.5 11.3 10.7 15.8
----- ----- ----- ----- ----- ----- ----- ----- -----
Total cost of
revenues........ 15.3 21.9 16.8 12.6 18.5 16.8 17.1 16.1 22.3
----- ----- ----- ----- ----- ----- ----- ----- -----
Gross profit...... 84.7 78.1 83.2 87.4 81.5 83.2 82.9 83.9 77.7
Operating
expenses:
Sales and
marketing..... 47.3 38.6 52.5 31.5 81.9 114.0 63.8 117.2 65.1
Research and
development... 52.5 48.7 40.8 23.8 24.7 22.4 22.2 20.7 22.1
General and
administrative.. 28.1 18.6 27.0 19.6 38.1 90.8 26.6 41.1 18.5
----- ----- ----- ----- ----- ----- ----- ----- -----
Total
operating
expenses.... 127.9 105.9 120.3 74.9 144.7 227.2 112.6 179.0 105.7
----- ----- ----- ----- ----- ----- ----- ----- -----
Income (loss) from
operations...... (43.2) (27.8) (37.1) 12.5 (63.2) (144.0) (29.7) (95.1) (28.0)
Other income
(expense)....... (10.0) (5.8) (5.2) (1.4) 2.1 (26.3) (17.3) (14.1) 1.0
----- ----- ----- ----- ----- ----- ----- ----- -----
Income (loss)
before income
taxes........... (53.2) (33.6) (42.3) 11.1 (61.1) (170.3) (47.0) (109.2) (27.0)
----- ----- ----- ----- ----- ----- ----- ----- -----
Income taxes...... -- 7.7 3.0 0.5 -- -- -- -- --
----- ----- ----- ----- ----- ----- ----- ----- -----
Income (loss) from
continuing
operations...... (53.2) (41.3) (45.3) 10.6 (61.1) (170.3) (47.0) (109.2) (27.0)
Discontinued
operations:
Income (loss)
from
discontinued
operations.... 41.4 28.6 19.6 (2.6) (9.8) 1.0 (0.1) -- --
Gain on sale of
discontinued
operations.... -- -- -- -- -- -- -- 31.7 --
----- ----- ----- ----- ----- ----- ----- ----- -----
Net income
(loss).......... (11.8) (12.7) (25.7) 8.0 (70.9) (169.3) (47.1) (77.5) (27.0)
Accretion on
redeemable
convertible
preferred
stock........... -- -- -- -- -- (5.2) (9.8) (11.0) (18.4)
----- ----- ----- ----- ----- ----- ----- ----- -----
Net income (loss)
applicable to
holders of
common stock.... (11.8) (12.7) (25.7) 8.0 (70.9) (174.5) (56.9) (88.5) (45.4)
===== ===== ===== ===== ===== ===== ===== ===== =====
</TABLE>

Revenues. The Company's total revenues have increased in each quarter
presented other than the quarter ended December 31, 1996. The increases have
been generally due to increased acceptance of the Company's Netcool products,
expansion of the Company's direct sales and technical pre-sales organizations,
increased transaction sizes and increased maintenance revenues reflecting the
growth in the installed base. The decrease in total revenues reflected in the
quarter ended December 31, 1996 was primarily attributable to the Company's
sales incentive program then in place, which encouraged fiscal year-end sales in
the preceding quarter. Due to a change in the Company's sales incentive program,
the Company did not experience a decrease in total revenues for the quarter
ended December 31, 1997. The Company expects fiscal year-end-related

30
<PAGE> 32

fluctuations will also be reduced in future periods due to an anticipated
increase in the percentage of revenues through indirect channels, which are less
subject to year-end fluctuations. If the changes in the sales incentive program
do not continue to impact the sales process as reflected in the quarter ended
December 31, 1997 or the increased sales through indirect channels do not occur,
fiscal year-end fluctuations in quarterly results may continue.

Operating Expenses. Operating expenses have generally increased in absolute
dollar amounts over the quarters shown due to the Company's increased staffing
in sales and marketing, product development and general and administrative
functions. In the quarter ended March 31, 1997, sales and marketing expenses
increased due to compensation expense related to shares bonused and an increase
in the number of sales and marketing personnel. General and administrative
expenses increased during the same quarter due to compensation expense related
to bonus shares issued and professional fees associated with the Reorganization.
In the quarter ended September 30, 1997, sales and marketing expense increased
due to increased commissions on higher bookings and a significant increase in
the number of sales and marketing personnel. General and administrative expenses
increased in the same quarter due to increased professional fees. In the quarter
ended December 31, 1997 sales and marketing expenses fell in absolute dollar
amounts due to reduced expenses associated with a reduced rate of hiring.
General and administrative expenses fell in absolute dollar amounts due to a
reduction in payments of professional fees. The Company's total operating
expenses as a percentage of total revenues for the quarter ended September 30,
1996 were lower than the preceding or following periods presented as a result of
the substantial increase in total revenues during the quarter primarily
attributable to the Company's sales incentive program then in place, which
encouraged fiscal year-end sales. The Company's operating expenses represented a
higher percentage of total revenues in the quarters ended December 31, 1996,
March 31, 1997, and September 30, 1997 than in the quarter ended June 30, 1997
as a result of: (i) greater growth in revenues during the quarter ended June 30,
1997; (ii) slower growth in personnel-related expenses during the quarter ended
June 30, 1997; and (iii) professional fees paid related to various matters,
including the Company's Reorganization, during the quarters ended December 31,
1996, March 31, 1997, and September 30, 1997.

Other Income (Expense). Interest expense in the quarters ended March 31,
1997, June 30, 1997 and September 30, 1997 increased primarily due to the
imputed interest related to the issuance of the Series A Warrant and due to
greater borrowings under a credit facility the Company maintained with National
Westminster Bank.

FACTORS AFFECTING QUARTERLY OPERATING RESULTS.

The Company's quarterly operating results have fluctuated significantly in
the past, and will likely continue to fluctuate in the future, as a result of a
number of factors, many of which are outside the Company's control. These
factors include changes in the demand for the Company's software products and
services; the size and timing of specific sales; the timing of new hires; the
level of product and price competition that the Company encounters; changes in
the mix of, and lack of demand from, distribution channels through which
products are sold; the length of sales cycles; spending patterns and budgetary
resources of its customers on network management software solutions; the success
of the Company's new customer generation activities; introductions or
enhancements of products, or delays in the introductions or enhancements of
products, by the Company or its competitors; market acceptance of new products;
the Company's ability to anticipate and effectively adapt to developing markets
and rapidly changing technologies; the mix of products and services sold;
changes in the Company's sales incentives; changes in the renewal rate of
support agreements; the mix of international and domestic revenue; product life
cycles; software defects and other product quality problems; the Company's
ability to attract, retain and motivate qualified personnel; changes in the mix
of sales to new and existing customers; the extent of industry consolidation;
expansion of the Company's international operations; and general domestic and
international economic and political conditions. The timing of large individual
sales

31
<PAGE> 33

has been difficult for the Company to predict, and large individual sales have,
in some cases, occurred in quarters subsequent to those anticipated by the
Company. There can be no assurance that the loss or deferral of one or more
significant sales would not have a material adverse effect on the Company's
quarterly operating results. In addition, the Company's business has experienced
and may continue to experience significant seasonality. Historically, a
disproportionate amount of the Company's annual revenues have been generated by
sales of its products during the Company's fiscal fourth quarter. There can be
no assurance that this trend will not continue.

The Company's software products are typically shipped when orders are
received, and consequently, license backlog at the beginning of any quarter has
typically represented only a small portion of that quarter's expected revenue.
In addition, the Company typically realizes a significant portion of license
revenue in the last month of a quarter, frequently in the last weeks or even
days of a quarter. As a result, license revenue in any quarter is difficult to
forecast because it is substantially dependent on orders booked and shipped in
that quarter. Moreover, the Company's sales cycles, from initial evaluation to
delivery of software, vary substantially from customer to customer. In addition,
the Company's expense levels are based in part on its expectations of future
orders and sales, which, given the Company's limited operating history, are
extremely difficult to predict. A substantial portion of the Company's operating
expenses are related to personnel, facilities, and sales and marketing programs.
This level of spending for such expenses cannot be adjusted quickly and is,
therefore, relatively fixed in the short term. If revenue falls below the
Company's expectations in a particular quarter, the Company's operating results
could be materially adversely affected. See "Risk Factors -- Lengthy Sales
Cycle."

In the Company's standard license agreements, the Company warrants to
licensees that its software routines and programs are Year 2000 compliant (i.e.
that they accurately process date-related data within any century and between
two or more centuries). Although the Company believes its software products are
Year 2000 compliant, there can be no assurance that the Company's software
products contain all necessary software routines and programs necessary for the
accurate calculation, display, storage and manipulation of data involving dates.
If any of the Company's licensees experience Year 2000 problems, such licensee
could assert claims for damages against the Company. Any such litigation could
result in substantial costs and diversion of the Company's resources even if
ultimately decided in favor of the Company. In addition, many companies are
expending significant resources to correct or patch their current software
systems for Year 2000 compliance. These expenditures may result in reduced funds
available to purchase software products such as those offered by the Company.
The occurrence of any of the foregoing could have a material adverse effect on
the Company's business, operating results or financial condition. See "Risk
Factors -- Year 2000 Compliance."

Based on all of the foregoing, the Company believes that future revenue,
expenses and operating results are likely to vary significantly from quarter to
quarter. As a result, quarter-to-quarter comparisons of operating results are
not necessarily meaningful or indicative of future performance. Furthermore, the
Company believes it is possible that in some future quarter the Company's
operating results will be below the expectations of public market analysts or
investors. In such event, or in the event that adverse conditions prevail, or
are perceived to prevail, with respect to the Company's business or generally,
the market price of the Company's Common Stock would likely be materially
adversely affected. See "Risk Factors -- Variability of Quarterly Operating
Results; Seasonality."

LIQUIDITY AND CAPITAL RESOURCES

The Company has funded its operations to date primarily through bank debt,
private sales of preferred equity securities totaling $20.8 million, cash
generated from discontinued operations and capital equipment lease lines. In
April 1996, the Company issued and sold notes convertible to Series A Preferred
Stock in the aggregate principal amount of $1,000,000. The notes were repaid
without conversion to Series A Preferred Stock. In March 1997, the Company sold
shares of

32
<PAGE> 34

Series B Preferred Stock for an aggregate of $4.9 million and entered into a
credit agreement (the "Credit Agreement") that provided the Company with a $3.0
million revolving credit line that terminates upon the earlier of the Offering
or after five years. In connection with the Credit Agreement, the Company issued
a warrant to purchase shares of Series A Preferred Stock for an aggregate
exercise price of $3.0 million that terminates upon the Offering if not
exercised prior thereto. During fiscal 1997, the Company had borrowed and repaid
a total of $1.0 million under the Credit Agreement and there was no balance
outstanding thereunder as of December 31, 1997. In September 1997, the Company
sold shares of Series C Preferred Stock for an aggregate of $15.9 million. In
November 1997, the Company repurchased shares of Common Stock for $5.0 million.
As of December 31, 1997, the Company had $7.7 million in cash and cash
equivalents. See "Certain Transactions" and Notes 4, 6 and 11 of Notes to
Consolidated Financial Statements.

Net cash used in operating activities in fiscal 1995 was primarily
attributable to a net loss and increases in accounts receivable and prepaid
expenses and other current assets. Net cash provided by operating activities in
fiscal 1996 was primarily attributable to growth in accounts payable and
deferred revenue, as well as the non-cash nature of depreciation and
amortization, which more than offset a net loss and growth in accounts
receivable and prepaid expenses and other current assets. Net cash used in
operating activities in fiscal 1997 was primarily attributable to a net loss of
$7.9 million. Net cash used in operating activities in the quarter ended
December 31, 1997 was primarily attributable to a net loss of $1.3 million and
an increase in accounts receivable offset by an increase in deferred revenues
and a decrease in related party loans.

Cash flows used in investing activities in each of fiscal 1995, 1996 and
1997 were attributable to capital expenditures. Net cash provided by financing
activities was primarily attributable to proceeds from a bank overdraft and
short-term notes in fiscal 1995, fiscal 1996 and to proceeds from the issuance
of redeemable convertible preferred stock in fiscal 1997. In the quarter ended
December 31, 1997, net cash used in financing activities was attributable to the
repurchase of shares of the Company's Common Stock for $5.0 million.

As of December 31, 1997, the Company's principal commitments consisted of
obligations under operating leases. See Note 10 of Notes to Consolidated
Financial Statements.

The Company believes that the net proceeds received by the Company from
this Offering, together with its current cash balances, its capital equipment
lease facility and the cash flows generated by operations, if any, will be
sufficient to meet its anticipated cash needs for working capital and capital
expenditures for the next 12 months. Thereafter, if cash generated from
operations is insufficient to satisfy the Company's liquidity requirements, the
Company may seek to sell additional equity or convertible debt securities or
obtain credit facilities. The sale of additional equity or debt securities could
result in additional dilution to the Company's stockholders. A portion of the
Company's cash may be used to acquire or invest in complementary businesses or
products or to obtain the right to use complementary technologies. From time to
time, in the ordinary course of business, the Company evaluates potential
acquisitions of such businesses, products or technologies. The Company has no
current plans, agreements or commitments, and is not currently engaged in any

negotiations with respect to any such transaction.

33
<PAGE> 35

BUSINESS

The Company's initial target market has been organizations with large,
technically complex and heterogeneous networks, the majority of whom have been
in the telecommunications, Internet Service Provider and investment banking
markets. The Company markets and distributes to these potential customers
through its own sales force, OEMs, value added resellers and systems
integrators. The Company has distribution agreements with Bay Networks, Cisco
Systems, N.E.T., and Vanstar. As of December 31, 1997, the Company had over 100
customers operating in and serving a variety of industries. Customers include
America Online, British Telecommunications, Cable and Wireless, Cellular One,
First Data Resources, Genuity, GE Information Services, GTE Internetworking,
Merrill Lynch, MindSpring, Morgan Stanley, Netcom, Pacific Bell, PSINet,
Siemens, and WorldCom/MFS/UUNet.

INDUSTRY BACKGROUND

IT has become increasingly mission critical for businesses as vital
communications, control and information services depend on reliable IT
performance. As a result, corporate management is increasingly requiring that IT
staffs meet pre-defined availability and performance levels for computing
processes, commonly known as service level agreements ("SLAs"). At the same
time, efficient management of IT infrastructure has become more difficult as
corporations have migrated from mainframe-based to distributed, client/server
computing environments resulting in complex and heterogeneous computing systems,
applications and networks. The advent of the Internet, intranets and extranets
has exacerbated this problem by increasing corporate reliance on IT while
accelerating the adoption of client/server distributed computing and adding
equipment complexities such as remote access technologies. In addition,
corporations must address rapid and unpredictable change in technology, in the
composition of their networks and in the demands of the business environment. As
a result, the ability to manage complex, growing and rapidly changing IT
environments cost-effectively is becoming a key driver of business performance
and, in some cases, a basis of competitive advantage.

The importance of effective, adaptable management of IT infrastructure is
particularly acute for organizations in the business of providing network
services, such as telecommunications carriers and ISPs. The size and complexity
of public networks has grown rapidly in response to the explosion of data
traffic caused by the Internet, intranets and extranets. Service providers now
must manage voice, data and video traffic over wireline or wireless
architectures by integrating numerous proprietary, legacy and emerging
technologies, such as ATM, CDMA, Frame Relay, GSM, IP, ISDN, SNA, SONET/SDH,
TDM, WDM, X.25 and xDSL, across vast geographies. At the same time, deregulation
and privatization have produced an environment of intense competition in these
markets. For example, fierce competition in the Internet access market has
forced ISPs to offer customers low, flat-rate, unlimited usage programs. In this
new environment, service

34
<PAGE> 36

providers are seeking to maximize profits and differentiate themselves based on
the breadth, quality, flexibility and cost of their services. One method of
differentiation used by service providers is the ability to offer customized
SLAs, guaranteeing the customer end-to-end service availability and performance.

Service Level Management ("SLM") is the effective monitoring and management
of multiple elements underlying an IT infrastructure, including network devices,
computing systems and applications, and the mapping of these elements to the
SLAs they impact. Efficient SLM allows service providers to associate these
elements with the services specified in SLAs and to maximize utilization of
their IT infrastructures. With SLM, network service providers can both manage
their large internal networks and offer additional network services to
corporations that require ongoing service guarantees. The market for these
services, known as Managed Network Services or Network Operations Outsourcing,
has grown rapidly as corporations outsource the management and operation of
their LANs and WANs to service providers, and was estimated to be approximately
$5 billion in 1996, and projected to grow to approximately $11 billion in 2001,
according to IDC. In the enterprise, SLM permits IT staffs to guarantee network
availability and performance, perform capacity planning, predict problems and
maintain SLA-defined service levels for mission critical services such as Wall
Street trading, credit card verification and electronic commerce. Cost-
effectively delivering the services specified in SLAs through the management of
IT infrastructure is the goal of SLM.

Effective SLM requires:

<TABLE>
<S> <C> <C>
- --------------------------------------------------------------------------------------------
COLLECTION OF DATA MANAGEMENT OF SERVICES MANAGEMENT OF CHANGE
- --------------------------------------------------------------------------------------------

- Collect data in real time - Map and associate elements - Adapt service profiles to
to services changes in IT or business
priorities during systems
operations
- Collect data from every - Create service profiles - Enable rapid provision of
element and management customized to SLAs new services
platform in an IT
infrastructure
- Process high volume of - Centralized monitoring of - Integrate new IT elements
data elements affecting seamlessly into profiles
services
- Filter redundancies - Remotely diagnose and - Scale operations to meet
resolve service impact network and business
demands
- --------------------------------------------------------------------------------------------
</TABLE>

Software solutions that deliver these benefits can provide customers rapid
return on investment ("ROI") on their SLM software purchases by enabling
reductions in the cost of management and ownership of these systems, as well as
by generating additional financial returns from existing IT infrastructures.

Traditional solutions typically have been unable to deliver SLM cost
effectively. Historically, communications providers have designed internal
network management systems based on proprietary applications. It has proven
difficult to integrate new technologies into these proprietary solutions, and
such systems often require costly development teams to maintain and update. In
addition, some organizations have used multiple third-party domain-based
management systems to monitor and manage all the elements that comprise a
service. However, since these systems only provide component-level views of a
portion of the IT infrastructure, they are unable to provide a comprehensive
view of all of the elements that may affect the services being offered. More
recently, third parties have designed operations support and network management
systems to integrate all the various components of a service. However, these
systems frequently require long development cycles and extensive consulting
projects to implement and therefore hinder an organization's ability to adapt
rapidly to changes in their business environment. As a result, these

35
<PAGE> 37

applications have generally proved either to be incapable of providing the level
of aggregation necessary for end-to-end SLA compliance, incapable of monitoring
the technical complexity and volume of events produced by complex and
heterogeneous networking environments, or too cumbersome to allow service
providers to cope with the increasing rate at which network services must be
deployed. The result has been the inability of such traditional approaches to
deliver SLM cost effectively. Moreover, corporate management, confronted with
environments of rapid change and intense competition, is increasingly demanding
end-to-end SLM solutions that deliver rapid ROI.

THE MICROMUSE SOLUTION

Micromuse develops, markets and supports a family of scalable, highly
configurable, rapidly deployable software solutions that enable SLM. The
Company's Netcool product suite collects, normalizes and consolidates high
volumes of event information from heterogeneous network management environments
into an active database which de-duplicates and correlates the resulting data in
real time, and then rapidly distributes graphical views of the information to
operators and administrators responsible for monitoring service levels.
Netcool's unique architecture allows for the rapid, programmerless association
of devices and specific attributes of those devices to the business services
they impact. This readily enables administrators to create and modify their
service views during systems operations to monitor particular business services,
rapidly identify which users are affected by which network faults, pinpoint
sources of network problems, automate operator responses, facilitate problem
resolutions and report on the results.

The Company's products are specifically designed for ease of use and
configuration and for the efficient management of and rapid deployment in
complex, evolving, large scale mission critical networks. In addition, service
providers can also use Netcool to remotely manage customer IT infrastructures
and provide their customers with views of the status of their IT environments.
The Company believes that Netcool products provide customers a rapid ROI by
offering: (i) cost-effective solutions with shorter implementation times and a
high level of configurability; (ii) efficient solutions that leverage customers'
existing network management products and services; and (iii) scalable solutions
that enable both the expansion and enhancement of current services as well as
the rapid deployment of new services to end users.

The Netcool product suite has the following features designed to enable the
cost-effective delivery of Service Level Management:

Efficient Management of Heterogeneous IT Infrastructure Elements. The
Company's Netcool suite of products utilizes sophisticated software agent
technology to gather event information from network devices and network
management platforms regardless of the transmission technology, management
protocols or media used in the network. After receiving all this data, Netcool's
Probes and object-oriented, memory-resident, active database technology
automatically normalizes and consolidates all events, de-duplicates repeated
events and then correlates the remaining information. Netcool enables the easy
association of events with services, and its sophisticated filtering
capabilities allow operators to focus on mission critical services and elements
of the network. Operators can manage their entire network and related services
though Netcool's common user interface. This approach to network management
helps to protect a customer's investment in their current systems. In addition,
Netcool helps to increase the efficiency of operators by minimizing the volume
and complexity of data generated from a customer's entire network and by
allowing additional underlying technologies to be implemented on the network
without costly operator training.

Rapid Deployment and Adaptability to Evolving IT Infrastructure. Due to its
unique design, the limited amount of programming necessary to install and
configure the product, and the extensive range of pre-existing Probes, Netcool
can be typically implemented in a matter of weeks into complex networking
environments. Netcool allows network administrators to quickly obtain an
enterprise-wide view of their networks and to manage fault data
"out-of-the-box." In addition,

36
<PAGE> 38

new Probes can be developed and deployed quickly during systems operation, which
allows for rapid and easy configuration of Netcool to meet new or changing
network environments. Furthermore, Netcool can easily adapt existing
associations to changes in network elements or business priorities. These
features allow customers to rapidly expand, scale and adapt to their evolving
networks without losing management control.

Programmerless Configuration and Ease of Use. Netcool's object-oriented
design enables programmerless configuration of the product through familiar
"drag-and-drop" principles and graphical user interfaces. As a result, network
administrators are easily able to create, modify and monitor specific views of
the status of any segment of the network during systems operation. Such rapid
configuration allows service providers to quickly introduce network services and
provision customized SLAs. Netcool's rapid installation and ease of
configuration minimizes the need for users to seek outside consultation.

Scalability Across Customer IT Infrastructure. Netcool's advanced
architecture allows customers to scale their networks without impairing their
ability to monitor and manage their networks. Netcool's scalability addresses
network management needs relating to performance, capacity, geography and
corporate structure, and is the reason many of the world's largest
telecommunications carriers and ISPs have selected Netcool as their management
platform. For example, one Netcool customer uses Netcool to manage in excess of
250,000 network devices.

Rapid Return on Investment. Netcool's products, which are designed for
rapid deployment and implementation, can provide a rapid ROI to customers.
Netcool products are generally operational in a matter of weeks. For example, a
leading ISP implemented Netcool throughout its U.S. network operating center in
one week. In addition, Netcool leverages existing infrastructure investment by
providing a common user interface that can be implemented alongside existing
management products such as HP OpenView, IBM NetView, Microsoft Windows NT,
Seagate Nervecenter Pro and Sun SunNet Manager, as well as tightly integrating
helpdesk products from companies like Remedy Corporation into the SLM
environment. Finally, Netcool products reduce the number of network operations
personnel required to effectively manage an enterprise-wide distributed network.
For example, Netcool permitted MindSpring to double the number of subscribers it
serves and the number of network devices it manages without increasing network
operations personnel.

STRATEGY

Micromuse's objective is to maintain its leadership position in the market
for Service Level Management software solutions. In order to achieve this
objective, Micromuse must be successful in its pursuit of the following
strategies:

Maintain Focus on Telecommunications Carriers, ISPs and Other Providers of
Managed Network Services. Telecommunications carriers, ISPs and other network
service providers operate some of the largest, most complex and fastest growing
IT infrastructures in the world. The Company originally developed Netcool to
deliver SLM to these service providers. As a result, these organizations can use
Netcool both to manage their own highly complex networks and to remotely manage
customer LAN and WAN IT infrastructures and provide their customers with views
of the status of their IT environments. With many large organizations
outsourcing network services and requiring more sophisticated SLAs, the Company
believes that continuing to target MNS providers, including telecommunications
carriers, ISPs, systems integrators and outsourcers, can accelerate expansion of
the Company's existing customer base. In addition, the Company believes that the
size, performance requirements and evolving nature of these companies' IT
infrastructures will provide direction for the Company's future products and SLM
solutions.

Expand Global Distribution Channels. The Company believes that Netcool's
ease of operation, design, adaptability and pricing make it well suited for
resale through indirect channels. Accordingly, the Company has complemented its
direct sales effort with a dedicated indirect sales force

37
<PAGE> 39

which focuses on distribution relationships with selected OEMs, value added
resellers, and systems integrators and intends to expand these channels. Current
distributors of the Company's products include Bay Networks, Cisco, Network
Equipment Technologies, Vanstar Corporation, and Wandel and Goltermann. In
addition, the Company intends to expand its direct sales force, currently
located in San Francisco, Boston, Chicago, Dallas, New York, Los Angeles,
Washington, D.C., London and Sydney.

Increase Penetration of Existing Customer Base. The Company has
historically generated a majority of its software revenue from sales to repeat
customers. Opportunities to increase sales to existing customers include: (i)
expansion of initial Netcool deployments; (ii) sales of new products to current
Netcool users; and (iii) the adoption of Netcool to manage networks of other
departments or subsidiaries of existing customers. The Company's current
customer base includes organizations with large, fast growing IT infrastructures
that present significant additional opportunity to the Company.

Extend Technical Leadership. Netcool contains a real-time, object-oriented,
memory-resident, active database optimized for the collection and processing of
event information from hundreds of thousands of computing devices. All data
de-duplication, correlation and response automation occur within the Netcool
active database. This design allows customers to collect and process all the
information in their networks rapidly and then view only the necessary subset of
that information needed to manage a particular SLA during systems operation. In
addition, the Netcool architecture attaches descriptive information to network
events which readily enables the association of these events with multiple
services. The Company believes that these technical advantages provide customers
with critical, real-time information about their networks and services and allow
them to implement Netcool faster than competing products. The Company plans to
leverage this key technical advantage into the development of new products
through its internal research and development efforts and partnerships with
leading research institutes such as Cambridge University Centre for
Communication Systems Research.

Leverage and Enhance Core Customer Relationships. The Company has
historically developed, and plans to continue to develop, its products in close
cooperation with its key customers. This is designed to enable the Company to
deliver timely solutions that effectively fulfill market requirements in rapidly
changing technology and business environments. For example, the Company worked
with a service provider to offer a customer network management service by
implementing Netcool to deliver views of the customer's managed network directly
to the customer and to associate customer circuit information with events. In
addition to these types of efforts, the Company plans to continue its annual
user groups and customer support programs in an effort to continue to further
understand market requirements.

Leverage Third-Party Applications. The Company plans to enhance the
functionality of its products by continuing to develop interfaces to
complementary third-party software applications. These applications include
Remedy's helpdesk system, standard relational database management systems, the
performance management systems of Concord Communications and Kaspia Systems, and
the network management application of Seagate Software. In addition, the Company
intends to further integrate the Netcool product suite with other
broadly-deployed management platforms such as HP OpenView, Sun SunNet Manager,
IBM NetView and Seagate NerveCenter Pro.

PRODUCTS AND TECHNOLOGY

Micromuse provides a suite of software products that enable SLM. The
Company's Netcool SLM solution includes Netcool/OMNIbus and its components for
event management, Netcool/ Reporter for service level reporting, and associated
related technical services. Netcool/OMNIbus collects, consolidates,
de-duplicates and correlates information from a wide range of network management
platforms and devices and then presents user-configurable views of subsets of

38
<PAGE> 40

network data. Netcool/Reporter uses this data to provide real-time and
historical reporting. Since customers can quickly associate each network element
(a network device, computing system or application) with a particular service,
Netcool products enable companies to efficiently set up, monitor, manage and
report on SLAs.

An illustration of the architecture of Netcool is set forth below:

GRAPHIC

NETCOOL/OMNIBUS. Netcool/OMNIbus is based on a three-tier, client/server
architecture and is the core application of the product suite. Netcool/OMNIbus
consists of four components: Netcool/OMNIbus Probes, the Netcool/OMNIbus
ObjectServer, Netcool/OMNIbus Desktops, and Netcool/OMNIbus Gateways. Probes
collect event information from existing network management systems, as well as
event messages from network devices, computing systems, applications or legacy
systems. The Probes then normalize and feed this event data into the
ObjectServer, an object-oriented, memory-resident active database. At the
ObjectServer, the event data is de-duplicated, correlated and associated with
other event data. By manipulating the data in the ObjectServer through the
Desktops, users can design customized views of event data to monitor segments of
the network or services that span the entire network. Gateways permit data to be
shared between multiple ObjectServers for load balancing or fail-over
facilities, exported to common relational database management systems (Oracle or
Sybase) for historical service level views, or integrated with other
applications such as Remedy's helpdesk application.

Probes. Probes are the first tier of Netcool's three-tier architecture.
Probes are primarily passive software interfaces that collect network event data
(including messaged network data such as faults, alerts, and traps) from
elements on the network or from domain-based network management systems. These
Probes can collect information presented from either management platforms and
devices (e.g. HP OpenView, Cabletron SPECTRUM, Cisco StrataView Plus, and
Newbridge 46020) and standard protocols such as screen oriented ASCII character
streams, application log files (e.g., syslog) TL1, SMNP, or any other method of
management information provision. They recognize Management Information Base
("MIB") information from switches and routers from leading vendors, including
Bay Networks, Cabletron, Cisco, 3Com and N.E.T. Probes use rules and lookup
tables to categorize and add information to events. As a result, network data
collected by the Probes is normalized into a common alert format and then passed
to the ObjectServer.

39
<PAGE> 41

The Company has developed 39 pre-built Probes, and a Probe API development
kit is available for customers to build probes for specialized in-house or
legacy systems. The following table lists Micromuse's existing Probes:

- --------------------------------------------------------------------------------

<TABLE>
<S> <C> <C> <C>
NETCOOL PROBES
- ----------------------------------------------------------------------------------------------------------------
Agile ATM Switch HP OpenView KBU Fivemere Ping Probe
Management IT/Operations Microsoft Windows NT Polycentre Watchdog
Ascom TimePlex Center v.4.x Event Log RoboMon Element
TimeView/2000 HP OpenView NNM Modular Probe Manager Probe
Cabletron SPECTRUM v.3.31 NET IDNX SimNet
Cisco StrataView v8.4 HP OpenView NNM NET Open/5000 Solstice Enterprise
Ericsson ACP1000 v.4.x HP Netlabs Manager
Ericsson MD110 HP OpenView NNM Newbridge 46020 Solstice SNM 2.3
Fibermux LightWatch v.5.x Nortel TN-MS Element Sybase Table
Generic Probe HTTP Command Controller for TN-1X Telematics Switch
GPT EMOS Log Format Netcool Probes Trapd (SNMP) Probe
Heartbeat Probe HTTP Server Error Log Operator Communications Unix Syslog Probe
HP OpenView IBM NetView Facility Probe
IT/Operations Informix Table Oracle Table
Center v.3.x
- ----------------------------------------------------------------------------------------------------------------
</TABLE>

ObjectServer. The ObjectServer, which is the second tier of Netcool's
three-tier architecture, is a real-time, object-oriented, memory-resident,
active database which stores and manages all the collected network events. The
ObjectServer consolidates, associates and de-duplicates normalized data from the
Probes, converting events, such as faults and alarms, into event objects that
can be easily manipulated to create associations and filters. The active
components of the ObjectServer include its de-duplication capability and its
ability to correlate event objects with other event objects, make decisions on
information, automate operator responses and facilitate problem resolution. The
ObjectServer, which has been designed and optimized for handling large volumes
of events messages, can process hundreds of alarms per second and can collect
data from multiple Probes concurrently. The ObjectServer architecture also
permits multiple authenticated users to view all the events throughout the
enterprise. In addition, since one network fault can impact several locations in
a distributed environment and can therefore trigger multiple events, the
ObjectServer is designed to automatically de-duplicate repeated events so that
network operators can easily identify the root cause. The Company believes that
the ObjectServer architecture provides the Company with a competitive advantage
in both the speed with which it collects network events and the ability to
associate event information with the services it manages.

Desktops. A Desktop, the third tier in Netcool's three-tier architecture,
is an integrated suite of software tools designed for use by operators and
administrators to create filters, customize views of network event data, monitor
several services simultaneously, and automatically resolve service problems.
Network operators can quickly build filters by responding to simple onscreen
queries about user preferences. They can also associate events with services
through the use of simple "drag-and-drop" technology that automatically creates
the Boolean logic and SQL required to retrieve the data from the ObjectServer.
In this way, non-programmers can manipulate the data in the ObjectServer to
custom-design views of event data. In addition, each operator can use Desktops
to resolve element problems directly or automate responses to common network
problems when critical thresholds are reached.

Operators can use Desktops to monitor services through either EventLists,
the EventList Console or ObjectiveView. The EventList presents a configurable
spreadsheet-like view of the de-duplicated faults and acts as the primary
interface through which operators access problem resolution tools. The EventList
Console depicts a concise view of the EventLists for several services while the
ObjectiveView provides a graphical view of the network or services which depend
upon it. Administrators can use Desktops to configure the ObjectServer and the
operator's

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<PAGE> 42

desktop environments. Desktops run on multiple computing platforms, including
UNIX/Motif, Microsoft Windows NT, or Web browsers via Java applications.

Gateways. Gateways are interfaces to other Micromuse products or to
third-party applications that allow sharing of Netcool event data. For example,
multiple Netcool ObjectServers can share data using a Gateway to offer customers
load-balancing and fail-over facilities. In addition, event data can be exported
through Gateways to databases such as Oracle or Sybase for historical analysis
and reporting or to trouble-ticketing packages such as Remedy's help desk
application.

NETCOOL/REPORTER. Netcool/Reporter, which is not yet commercially
available, is a Java-based application that generates reports on the real-time
and historical availability of network services, applications, business
processes or any customer-defined grouping of IT resources (both physical and
logical). Since Netcool/Reporter has been designed to leverage the archived data
from the service profiles created within Netcool/OMNIbus, it allows operators to
report on SLA compliance. Netcool/Reporter can produce availability data in
several graphical formats, including spreadsheets, 2D or 3D charts, and billing
forms. Netcool/Reporter provides both Service Level Reports and generic reports.
Service Level Reports allow operators to define individualized service levels by
designing their own report metrics. They can also be tailored to precisely match
the service level availability criteria described by SLAs. Generic reports are
pre-configured reports that use event time and frequency categories as the
primary variables. Netcool/Reporter is expected to be commercially available in
the second quarter of fiscal 1998.

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<PAGE> 43

The following table summarizes the Netcool product suite:

<TABLE>
<S> <C> <C>
- ----------------------------------------------------------------------------------------------
DATE OF
NETCOOL PRODUCT INTRODUCTION DESCRIPTION
- ----------------------------------------------------------------------------------------------
NETCOOL/OMNIBUS OBJECTSERVER

ObjectServer Solaris1 1994 Real-time, object-oriented, memory-
ObjectServer Solaris 2.x 1994 resident, active database system that
ObjectServer HP-UX9.x 1994 stores and manages all collected network
ObjectServer HP-UX10.x 1995 events.
ObjectServer AIX 4.x PowerPC 1997
- ----------------------------------------------------------------------------------------------
NETCOOL/OMNIBUS DESKTOP

X11/Motif Desktop 1994 Integrated suite of software tools that
Java EventList Desktop 1996 creates filters and customized views of
Microsoft Windows NT Desktop 1997 network event data, monitors several
services simultaneously and
automatically resolves service problems.
- ----------------------------------------------------------------------------------------------
NETCOOL/OMNIBUS GATEWAY

Remedy ARS 1994 Interfaces to other Micromuse products
Sybase RDBMS 10.x/11.x 1994 or third party applications that allow
ObjectServer 1994 sharing of Netcool event data.
SNMP Trap Forwarder 1995
Oracle RDBMS 7.x, 8.x 1997
File/Socket 1997
- ----------------------------------------------------------------------------------------------
NETCOOL/OMNIBUS PROBE

Basic Probes 1994-1997 Software that collects network event
Generic Probe 1996 data from network element devices or
Probe Development Kit 1994 from network management systems.
- ----------------------------------------------------------------------------------------------
NETCOOL/REPORTER* 1998 A Java-based application that uses
information stored by Netcool/OMNIbus to
generate reports on the real-time and
historical availability of networks or
other services.
- ----------------------------------------------------------------------------------------------
</TABLE>

- ---------------

* Netcool/Reporter is expected to be commercially available in the second
quarter of fiscal 1998.

Product Pricing. At least one Probe, ObjectServer, and Desktop are required
for Netcool/ OMNIbus to operate. Netcool/Reporter will be sold as an add-on
feature to Netcool/OMNIbus. Customers can choose the particular configuration of
Probes, ObjectServers, Desktops, and Gateways required for their existing
network configuration. The list price in the United States for each ObjectServer
is $25,000, each Probe, Gateway and Desktop is $7,500, and the list price for
Netcool/Reporter will be $15,000. Fees for implementations of Netcool/OMNIbus
typically range from $40,000 to $1.0 million.

CUSTOMERS

Micromuse sells its products to organizations with large and medium-size
networks, as well as network service providers which include telecommunications
carriers, ISPs, systems integrators and outsourcers. The Company's products are
used by a diverse set of customers in a variety of industries. As of December
31, 1997, the Company had over 100 customers in the following 6 countries: the
United States, Canada, the United Kingdom, Italy, Mexico, and the Netherlands.

42
<PAGE> 44

The following is a list of customers that have purchased in excess of $100,000
of the Company's Netcool family of products and services:

<TABLE>
<S> <C> <C>
- ----------------------------------------------------------------------------------------------
Telecommunications Internet Service Providers Investment Banking
British Telecommunications America Online Bear Stearns
British Telecommunications Genuity Deutsche Morgan Grenfell
MNS GTE Internetworking Merrill Lynch
BT Labs PSINet Morgan Stanley
BT North America Southwestern Bell Internet Salomon Smith Barney
BT Syncordia UUNet
CableTel (NTL)
Concert Cellular Commercial
GEIS
Ionica Cellular One Automobile Association (U.K.)
MFS Communications Hutchinson Orange PCS First Data Resources
Multisys Xypoint Instinet
Pacific Bell J.C. Penney
TMI Communications Equipment Nationwide Building Society
Vyvx Royal Automobile Club
WorldCom Ascom Timeplex Shell Oil Services
Bay Networks TRW
Cisco
Ericsson
Motorola
N.E.T.
Siemens
- ----------------------------------------------------------------------------------------------
</TABLE>

SELECTED CUSTOMER APPLICATIONS

<TABLE>
<S> <C>
- ---------------------------------------------------------------------------------------------------
CUSTOMER APPLICATION
- ---------------------------------------------------------------------------------------------------
MANAGED NETWORK SERVICE GEIS is a managed network services provider that maintains a
PROVIDER chain of support centers in locations around the world, including
(GEIS) the Netherlands, Hong Kong and Maryland. The worldwide GEIS
network comprises a variety of technologies, including Cisco
router-based IP, Telematics-based X.25, Stratacom-based frame
relay, and GEIS' own proprietary network. By installing Netcool,
GEIS was able to win the business of a large, multinational
conglomerate that required a secure view of the entire virtual
private network ("VPN") being provided by GEIS. Netcool made this
possible via its ability to easily append information to events
and associate them with specific customers, and to support a
firewalled Netcool system at the customer site.
- ---------------------------------------------------------------------------------------------------

INTERNET SERVICE PROVIDER MindSpring, a leading ISP focusing on delivering outstanding
(MINDSPRING) service and support to its customers, offers local Internet
service in more than 250 locations throughout the United States
and has over 240,000 customers. MindSpring uses Netcool to
provide next-generation management of the e-mail, Internet
access, and Web hosting services at its state-of-the-art Network
Operations Center ("NOC"). To manage these services, Netcool is
used in conjunction with Seagate's NerveCenter application to
collect data from over 15,000 modems, 400 terminal servers, 60
CSU/DSUs, 60 UNIX servers of various types, 50 hubs and switches,
and 60 Cisco routers. Netcool assimilates the information from
these diverse components and presents them as distinct service
views. Since installing Netcool in January 1997, MindSpring has
significantly increased the network infrastructure it maintains
(increasing from 7,500 managed devices to over 15,000) and the
customers it serves (100,000 to over 240,000) without increasing
the network operations staff. The entire operation is efficiently
managed by only 6 network administrators.
- ---------------------------------------------------------------------------------------------------
</TABLE>

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<PAGE> 45

SALES AND MARKETING

The Company markets its software and services primarily through its direct
sales organization in San Francisco, Boston, Chicago, Dallas, New York, Los
Angeles, Washington, D.C., London and Sydney. Additionally, the Company has a
growing channel organization and expects to generate an increasing percentage of
total sales through its OEMs, value added resellers and systems integrators. As
of December 31, 1997, the Company's sales organization consisted of 30
individuals. Six members of the sales organization work exclusively with the
OEMs, value-added resellers and systems integrators in both a sales and a
channel marketing capacity.

Typically, the sales process will include an initial sales presentation, a
product demonstration, at times a proof of concept evaluation, a closing meeting
and a purchase process. The sales process typically takes 90 to 180 days.
Companies often purchase Netcool products to manage their internal data network
initially and upon its demonstrated effectiveness subsequently make additional
and larger purchases. A majority of the Company's sales are from repeat
customers who generally purchase additional software as their networks expand,
or as additional sites within a customer learn of the services provided by, and
the benefits of, Netcool.

The Company has a number of marketing programs designed to inform potential
customers about the capabilities and benefits of the Company's products. The
Company's marketing efforts include technical leadership, participation in
industry trade shows, technical conferences and technology seminars, preparation
of competitive analyses, sales training, publication of technical and
educational articles in industry journals and advertising. As of December 31,
1997, the Company's marketing organization employed 6 people.

Although the Company increased the size of its sales organization from 14
to 30 individuals during the twelve-month period ended December 31, 1997, the
Company experienced difficulty in recruiting a sufficient number of qualified
sales people during that period. If the Company is to achieve significant
revenue growth in the future, it must both train successfully the members of its
existing sales force and recruit additional sales personnel. Competition for
such persons is intense, and there can be no assurance that the Company will be
able to either retain and adequately train its current sales force or attract
qualified sales personnel in the future. During the last fiscal year, the
Company hired a Senior Vice President, Sales, who is expected to be heavily
involved, among other things, in the recruitment of additional sales personnel.
Consequently, the Company is expected to have additional management capacity to
assist in the recruitment of additional sales personnel. If the Company is
unable to hire such people on a timely basis, the Company's business, operating
results or financial condition could be adversely affected. See "Risk
Factors -- Need to Expand and Improve Productivity of Sales Force, Technical
Services and Customer Support Organization."

To achieve significant growth in revenues in the future the Company must
continue to expand its network of distribution partners. The Company's network
of distribution partners currently includes VARs, systems integrators and OEM
partners, including Bay, Cisco, Network Equipment Technologies, Vanstar
Corporation, and Wandel and Goltermann. Such partners license the Company's
products at a discount to list price for re-licensing and may provide training,
support and technical and customer services to the end users of the Company's
products. At times, members of the Company's technical services organization
will assist a channel partner with training and technical support. The Company
offers a comprehensive channel partnering program consisting of training,
certification, technical support, priority communications regarding upcoming
activities and products, and joint sales and marketing activities. The Company
also has a joint marketing program with Concord Communications. There can be no
assurance that the Company will be able to continue to attract and retain VARs,
systems integrators and OEMs or that such organizations will be able to market
and sell the Company's products effectively. In addition, there can be no
assurance that the Company's existing or future channel partners will continue
to

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<PAGE> 46

represent the Company's products. See "Risk Factors -- Need to Expand
Distribution Channels; Dependence on Third-Party Relationships."

Because the Company first sold its software in the United Kingdom and was
previously domiciled in London, sales of its software outside of the United
States (i.e., "international sales") have historically comprised a significant
portion of the Company's total revenue. International sales accounted for 76%,
55%, and 48% of total revenues in fiscal 1995, 1996, and 1997, respectively. The
majority of these international sales were made to customers in the United
Kingdom and Europe. While the Company believes that there are significant
opportunities in the United Kingdom and Europe, it expects international
revenues from the United Kingdom and Europe as a percentage of total revenues to
decline in future quarters as the Company more fully exploits opportunities in
the United States and in the Pacific Rim. See "Risk Factors -- Risks Associated
with International Licensing and Operations."

TECHNICAL SERVICES

The Company's technical services organization provides customers with a
full range of support services including pre-sales demonstrations, evaluations,
implementations, consulting services, training, and ongoing technical support.
In addition, the technical services organization serves a variety of internal
functions, including drafting support and training documentation, product
management, product testing, research and development related to specific
customer industries. The Company believes that superior technical services and
support is critical to customer satisfaction and the development of customer
relationships. As of December 31, 1997, there were 37 individuals in the
Company's technical services organization. Members of the technical services
organization work closely with the Company's direct sales representatives and
channel partners to provide the following services to customers:

Pre-Sales Technical Support. Technical services personnel will often
accompany sales representatives to a customer site to provide a technical
overview and demonstration of the product or to educate customers about the
Company's products. In addition, they may help specify and implement a small
evaluation test environment at a customer site for more detailed customer review
of the product.

Post-Sales Technical Support and Consulting. Technical services personnel
will also assist end-users with the implementation and use of the Company's
products. In some cases, the Company's technical services personnel will be
engaged for limited post-sales consulting, which may include on-site custom
Probe development, implementation of the Company's products, or project
management. After full implementation, ongoing customer support obligations are
transferred to the Company's customer support organization, although technical
services personnel may be engaged for further support.

Education and Training. The technical services organization offers product
training to customers and product training and certification to channel
partners. The Company offers operator, administrator, and advanced administrator
training classes.

The recent growth of the Company and the expansion of the customer base of
Netcool has increased the demands on its technical services organization.
Competition for qualified technical personnel is intense. There can be no
assurance that the current resources in the Company's technical services
organization will be sufficient to manage any future growth in the Company's
business. Failure of the Company to expand its technical services organization
at least commensurate with the expansion in the installed base of Netcool
products would have a material adverse effect on the Company's business,
operating results and financial condition. See "Risk Factors -- Need to Expand
and Improve Productivity of Sales Force, Technical Services and Customer Support
Organization" and "-- Dependence on Key Personnel."

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<PAGE> 47

CUSTOMER SUPPORT

The customer support organization is responsible for providing ongoing
technical support for the Company's customers after implementation of the
product and for training the next generation of the Company's software engineers
and technical services personnel. Based on feedback by customers, the Company
believes that the quality and responsiveness of its customer support
organization provides it with a significant competitive advantage. As of
December 31, 1997, the Company employed 11 customer support personnel.

For an annual fee, a customer will receive toll-free telephone and email
support, as well as new releases of the Company's products. The Company offers
two support packages to its customers: 8 hours a day, 5 days a week support or
24 hours a day, 7 days a week support. While support personnel generally answer
the technical support calls and resolve most problems over the phone, Micromuse
will deploy any one of its more than 37 technical support personnel in the event
that an on-site visit is necessary.

RESEARCH AND DEVELOPMENT

The Company believes that its future success depends in large part on its
ability to continue to enhance existing products and develop new products that
maintain technological competitiveness and deliver rapid ROI to its customers.
The Company has historically developed and expects to continue to develop its
products in conjunction with its existing and potential customers. Extensive
product development input is obtained through customers, through the Company's
monitoring of end-user needs and changes in the marketplace and through
partnerships with leading research institutes such as Cambridge University
Centre for Communication Systems Research.

The Company's research and development organization is composed of two
related engineering groups. The core technology group is responsible for the
enhancement of Netcool/OMNIbus, including its real-time technologies and the
exploration of new directions and applications of the Company's core
ObjectServer, Probe, Gateway, and Desktop technologies. The application
development group is responsible for designing and developing off-the-shelf
products which leverage the technologies developed by the core technology group.
While both groups work closely with customers, the application development group
depends on customer contact and partnerships for the rapid development of new
SLM products. Both research and development groups work closely with the
Company's technical services organization and its marketing organization to
incorporate customer feedback and market requirements into their product
development agendas.

The Company has made and intends to continue to make substantial
investments in research and development. The Company's total expenses for
research and development for fiscal 1995, 1996, 1997 and the three months ended
December 31, 1997 were $708,000, $1.6 million, $2.0 million and $1.1 million,
respectively. Since the Company anticipates that it will continue to commit
substantial resources to research and development in the future, product
development expenses are expected to increase in absolute dollars in future
periods. To date, the Company's development efforts have not resulted in any
capitalized software development costs. As of December 31, 1997, the Company's
research and development organization consisted of 30 people.

The market for the Company's products is characterized by rapidly changing
technologies, evolving industry standards, changing regulatory environments,
frequent new product introductions and rapid changes in customer requirements.
The introduction or announcement of products by the Company or its competitors
embodying new technologies and the emergence of new industry standards and
practices can render existing products obsolete and unmarketable. As a result,
the life cycles of the Company's products are difficult to estimate. The
Company's future success will depend on its ability to enhance its existing
products and to develop and introduce, on a timely and cost-effective basis, new
products and product features that keep pace with technological developments and
emerging industry standards and that address the increasingly

46
<PAGE> 48

sophisticated needs of its customers. There can be no assurance that the Company
will be successful in developing and marketing new products or product features
that respond to technological change or evolving industry standards, that the
Company will not experience difficulties that could delay or prevent the
successful development, introduction and marketing of these new products and
features, or that its new products or product features will adequately meet the
requirements of the marketplace and achieve market acceptance. In particular,
the widespread adoption of the TMN architecture for managing telecommunications
networks would force the Company to adapt its products to such standard, and
there can be no assurance that this could be done on a timely or cost-effective
basis, if at all. In addition, to the extent that any product upgrade or
enhancement requires extensive installation and configuration, current customers
may postpone or forgo the purchase of new versions of the Company's products. If
the Company is unable, for technological or other reasons, to develop and
introduce enhancements of existing products or new products in a timely manner,
the Company's business, operating results and financial condition will be
materially adversely affected. See "Risk Factors -- New Products and Rapid
Technological Change; Need to Manage Product Transitions; Dependence on
Third-Party Software Platforms." In addition, software products as complex as
those offered by the Company may contain defects or failures when introduced or
when new versions or enhancements are released. See "Risk Factors -- Risk of
Product Defects; Product Liability."

COMPETITION

The Company's products are designed for use in the evolving SLM and
enterprise network management markets. Competition in these markets is intense
and is characterized by rapidly changing technologies, new and evolving industry
standards, frequent new product introductions and rapid changes in customer
requirements. The Company's current and prospective competitors offer a variety
of solutions to address the SLM and enterprise network management markets and
generally fall within the following five categories: (i) customer's internal
design and development organizations that produce SLM and network management
applications for their particular needs, in some cases using multiple instances
of products from hardware and software vendors such as Sun, HP and Cabletron;
(ii) vendors of network and systems management frameworks including Computer
Associates and IBM; (iii) vendors of network and systems management applications
including HP, Sun and IBM; (iv) providers of specific market applications
including Boole and Babbage and several smaller software vendors; and (v)
systems integrators who primarily provide programming services to develop
customer specific applications including TCSI and OSI. In the future, as the
Company enters new markets, the Company expects that such markets will have
additional, market-specific competitors. In addition, because there are
relatively low barriers to entry in the software market, the Company expects
additional competition from other established and emerging companies. Increased
competition may result in price reductions, reduced gross margins and loss of
market share, any of which could materially adversely affect the Company's
business, operating results or financial condition.

Many of the Company's existing and potential customers continuously
evaluate whether to design and develop their own network operations support and
management applications or purchase them from outside vendors. These customers
internally design and develop their own software solutions for their particular
needs and therefore may be reluctant to purchase products offered by independent
vendors such as the Company. As a result, the Company must continuously educate
existing and prospective customers as to the advantages of the Company's
products versus internally developed network operations support and management
applications.

47
<PAGE> 49

their products than the Company. Existing competitors could also increase their
market share by bundling products having management functionality offered by the
Company's products with their current applications. Moreover, the Company's
current and potential competitors may increase their share of the SLM market by
strategic alliances and/or the acquisition of competing companies. In addition,
network operating system vendors could introduce new, or upgrade and extend
existing, operating systems or environments that include management
functionality offered by the Company's products, which could render the
Company's products obsolete and unmarketable. There can be no assurance that the
Company will be able to compete successfully against current or future
competitors or that competitive pressures faced by the Company will not
materially adversely affect its business, operating results or financial
condition. See "Risk Factors -- Competition."

The principal competitive factors affecting the market for the Company's
software are price/performance, functionality and speed of implementation. The
Company currently believes it presently competes favorably with respect to each
of these factors. However, the Company's market is still evolving, and there can
be no assurance that the Company will be able to compete successfully against
current and future competitors and the failure to do so successfully will have a
material adverse effect upon the Company's business operating results and
financial condition.

INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS

The Company's success and ability to compete is dependent in significant
part upon its proprietary software technology. The Company relies on a
combination of trade secret, copyright and trademark laws, nondisclosure and
other contractual agreements and technical measures to protect its proprietary
rights. Despite the Company's efforts to protect its proprietary rights,
unauthorized parties may attempt to copy aspects of the Company's products or to
obtain and use information that the Company regards as proprietary. There can be
no assurance that the steps taken by the Company to protect its proprietary
technology will prevent misappropriation of such technology, and such
protections may not preclude competitors from developing products with
functionality or features similar to the Company's products. In addition,
effective copyright and trade secret protection may be unavailable or limited in
certain foreign countries. While the Company believes that its products and
trademarks do not infringe upon the proprietary rights of third parties, there
can be no assurance that the Company will not receive future communications from
third parties asserting that the Company's products infringe, or may infringe,
the proprietary rights of third parties. The Company expects that software
product developers will be increasingly subject to infringement claims as the
number of products and competitors in the Company's industry segment grows and
the functionality of products in different industry segments overlaps. Any such
claims, with or without merit, could be time-consuming, result in costly
litigation and diversion of technical and management personnel, cause product
shipment delays or require the Company to develop non-infringing technology or
enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the Company
or at all. In the event of a successful claim of product infringement against
the Company and failure or inability of the Company to develop non-infringing
technology or license the infringed or similar technology, the Company's
business, operating results or financial condition could be materially adversely
affected.

The Company relies on certain software that it licenses from third parties,
including software that is integrated with internally developed software and
used in the Company's products to perform key functions. There can be no
assurance that these third-party software licenses will continue to be available
to the Company on commercially reasonable terms or at all. Although the Company
believes that alternative software is available from other third-party
suppliers, the loss of or inability to maintain any of these software licenses
or the inability of the third parties to enhance in a timely and cost-effective
manner their products in response to changing customer needs, industry standards
or technological developments could result in delays or reductions in product

48
<PAGE> 50

shipments by the Company until equivalent software could be developed internally
or identified, licensed and integrated, which would have a material adverse
effect on the Company's business, operating results and financial condition. See
"Risk Factors -- Dependence upon Proprietary Technology; Risk of Third-Party
Claims of Infringement."

EMPLOYEES

As of December 31, 1997, the Company had 138 employees, including 30
engaged in research and development activities, 36 in sales and marketing, 37 in
technical services, 24 in administration and finance and 11 in customer support.
None of the Company's employees is represented by a collective bargaining
agreement, nor has the Company experienced work stoppages. The Company believes
that its relations with its employees are good.

The Company believes that its future success will depend in large part on
its ability to attract and retain highly-skilled managerial, sales, technical
services, customer support and product development personnel. The Company has at
times experienced and continues to experience difficulty in recruiting qualified
personnel, including without limitation a Chief Financial Officer. Competition
for qualified personnel in the software industry is intense, and there can be no
assurance that the Company will be successful in attracting and retaining such
personnel. Failure to attract and retain key personnel could materially
adversely affect on the Company's business, operating results or financial
condition. See "Risk Factors -- Management of Growth; Need to Improve Financial
Systems and Controls," "-- Need to Expand and Improve Productivity of Sales
Force, Technical Services and Customer Support Organization" and "-- Dependence
on Key Personnel."

FACILITIES

The Company's headquarters are located in 11,235 square feet of office
space in San Francisco, under a lease that expires on April 2002. The Company's
principal product development operations are located in approximately 16,085
square feet of office space in London. Approximately 7,210 square feet of this
office space is leased pursuant to a lease that expires on December 2002. The
remaining 8,875 square feet of office space is leased pursuant to a lease that
expires on March 2007. The Company also maintains offices in New York City,
Dallas and Sydney. During fiscal 1997 the Company's aggregate annual lease
payments were $538,000. The Company believes that its current facilities are
adequate for its needs through the next twelve months, and that, should it be
needed, suitable additional space will be available to accommodate expansion of
the Company's operations on commercially reasonable terms, although there can be
no assurance in this regard. See Note 10 of Notes to Consolidated Financial
Statements.

LITIGATION

The Company is not a party to any material legal proceeding.

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<PAGE> 51

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth certain information regarding the executive
officers and directors of the Company as of December 31, 1997:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---------------------------- --- ------------------------------------------------------
<S> <C> <C>
Christopher J. Dawes........ 38 President, Chief Executive Officer and Chairman of the
Board of Directors
Stephen A. Allott........... 39 Senior Vice President, Finance
Charles M. Silvey........... 33 Senior Vice President, Marketing
David N. Dorrance........... 36 Senior Vice President, Sales
Timothy J. Tokarsky......... 34 Vice President, Application Development
Mark J. Peach............... 38 Vice President, Core Technology
Helen M. Fairclough......... 36 Vice President, Operations
Peter Shearan............... 33 Vice President, Technical Services
Angela Dawes................ 35 Director of Sales, Western Region; Director
Jeffrey M. Drazan(1)(2)..... 39 Director
David C. Schwab(1)(2)....... 40 Director
</TABLE>

- ---------------

(1) Member of Audit Committee

(2) Member of Compensation Committee

CHRISTOPHER J. DAWES. Mr. Dawes has served as President, Chief Executive
Officer and Chairman of the Board of Directors of the Company since its
inception. Prior to co-founding the Company, Mr. Dawes served as Sales Manager
at Computer Associates International, Inc. ("Computer Associates") from June
1988 to September 1989. Mr. Dawes is a graduate of Electrical and Electronic
Engineering from the University of Adelaide, South Australia.

STEPHEN A. ALLOTT. Mr. Allott has served as the Company's Senior Vice
President, Finance since September 1997. From June 1997 to September 1997, Mr.
Allott served as Vice President, Global Telco Industry. From April 1996 to
September 1997, Mr. Allott served as Managing Director, Micromuse Europe. From
September 1995 to April 1996 he served as the Company's Business Development
Director. Prior to joining the Company, Mr. Allott served as a strategy
consultant with McKinsey & Company from September 1990 to September 1995. From
May 1988 to September 1990, Mr. Allott served as United Kingdom legal counsel
for Sun Microsystems, UK. Mr. Allott received his M.A., Law from Trinity
College, Cambridge and was called to the English Bar at Gray's Inn.

CHARLES M. SILVEY. Mr. Silvey has served as the Company's Senior Vice
President, Marketing since July 1997. From June 1994 to July 1997, Mr. Silvey
served as Vice President, Marketing. From January 1991 to June 1994, Mr. Silvey
served as Technical Marketing Manager. Prior to joining the Company, Mr. Silvey
served as Technical Marketing Executive for the European SunNet Manager program
for Sun Microsystems, UK from October 1989 to January 1991. Mr. Silvey received
his degree in Electronic and Electrical Engineering from City of Bath
University.

DAVID N. DORRANCE. Mr. Dorrance has served as the Company's Senior Vice
President, Sales since June 1997. Prior to joining the Company, Mr. Dorrance
served as Head of United Kingdom Oracle Applications Group for Deloitte & Touche
Consulting Group from March 1996 to June 1997. From September 1993 to May 1995,
Mr. Dorrance served as a sales manager at Sybase, Inc. ("Sybase"). From November
1989 to September 1993, Mr. Dorrance served as Director N.A. Sales and as a
director of SQL Solutions following its acquisition by Sybase. Mr. Dorrance
received his B.S. in Computer Science from the University of California at Santa
Barbara and an M.S. in Economics from the University of Oxford.

50
<PAGE> 52

TIMOTHY J. TOKARSKY. Mr. Tokarsky has served as the Company's Vice
President, Application Development since February 1997. Prior to joining the
Company, Mr. Tokarsky served as Vice President Distributed Systems Management
for Merrill Lynch & Co., Inc. from June 1995 to February 1997. From January 1994
to June 1995, Mr. Tokarsky served as Architect, Global Distributed Systems
Monitoring for Goldman Sachs & Co. From May 1993 to January 1994, Mr. Tokarsky
served as a system administrator for Standard and Poor's Rating Services. From
October 1992 to May 1993, Mr. Tokarsky served as a system administrator for
First Boston Corp. Mr. Tokarsky received his B.Sc. in Geophysics from McGill
University.

MARK J. PEACH. Mr. Peach has served as the Company's Vice President, Core
Technology since December 1996. From June 1994 to December 1996, Mr. Peach
served as an original architect and developer of Netcool/OMNIbus. Prior to
joining the Company, Mr. Peach served as Principal PreSales Engineer for Sun
Microsystems, Inc. and SunConnect from December 1989 to May 1994. Mr. Peach
received his B.Sc. in Mathematical Engineering from Loughborough University.

HELEN M. FAIRCLOUGH. Ms. Fairclough has served as the Company's Vice
President, Operations since November 1995. From June 1994 to November 1995, Ms.
Fairclough served as the Company's Manager, Operations. Prior to joining the
Company, Ms. Fairclough served as Business Operations Manager for Cap Gemini,
PLC from October 1991 to June 1994. Ms. Fairclough received her B.Sc. in
Resource Sciences/Geology from Kingston University and is a Member of The
Chartered Institute of Secretaries and Administrators.

PETER SHEARAN. Mr. Shearan has served as the Company's Vice President,
Technical Services since February 1996. From November 1995 to February 1996, Mr.
Shearan served as Senior Consultant in the Company's Netcool Business
Development department. Prior to joining the Company, Mr. Shearan served as a
systems manager for British Telecommunications from June 1984 to November 1995.
Mr. Shearan received his Qualifications in Computer Science from Southbank
University, London.

ANGELA DAWES. Mrs. Dawes has been a director of the Company since September
1997. Mrs. Dawes has also served as Director of Sales, Western Region since
January 1997. From July 1996 to January 1997, Mrs. Dawes served in various
capacities within the Company's sales department, most recently as Eastern
Region Director of Sales. From April 1993 to July 1996, Mrs. Dawes served as the
Company's Strategic Accounts Manager. Prior to joining the Company, Mrs. Dawes
served at Computer Associates in various capacities.

JEFFREY M. DRAZAN. Mr. Drazan has been a director of the Company since
December 1996. Mr. Drazan has been a general partner of Sierra Ventures, a
venture capital firm ("Sierra Ventures"), since 1984. Mr. Drazan also serves as
a director of FaxSav, Inc., an Internet messaging company; Retix, a
telecommunications equipment company; and Digital Generation Systems Inc., a
multimedia network services company. Mr. Drazan received his B.S.E. in
Management Systems from Princeton University and an MBA from New York
University's Graduate School of Business Administration.

DAVID C. SCHWAB. Mr. Schwab has been a director of the Company since
December 1996. Mr. Schwab has been a general partner of Sierra Ventures since
June 1996. Prior to joining Sierra Ventures, Mr. Schwab co-founded Scopus
Technology, Inc., a client-server software systems company, and served in
various capacities from August 1991 to June 1996, most recently as Vice
President of Sales. Mr. Schwab received his B.A. in Systems Engineering from
University of California San Diego, an M.S. and ENG. in Aerospace Engineering
from Stanford University, and an MBA from Harvard Business School.

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<PAGE> 53

BOARD COMPOSITION

The Board of Directors is currently comprised of four directors. Upon the
completion of this Offering, the terms of office of the Board of Directors will
be divided into two classes: Class I, whose term will expire at the next annual
meeting of stockholders, and Class II, whose term will expire at the subsequent
annual meeting of stockholders. The Class I directors are Angela Dawes and David
C. Schwab and the Class II directors are Christopher J. Dawes and Jeffrey M.
Drazan. At each annual meeting of stockholders after the initial classification,
the successors to directors whose term will then expire will be elected to serve
from the time of election and qualification until the second annual meeting
following election. This classification of the Board of Directors may have the
effect of delaying or preventing changes in control or management of the
Company.

Each officer is elected by and serves at the discretion of the Board of
Directors. Each of the Company's officers and directors, other than non-employee
directors, devotes substantially full time to the affairs of the Company. The
Company's non-employee directors devote such time to the affairs of the Company
as is necessary to discharge their duties. Christopher J. Dawes and Angela
Dawes, each a director of the Company, are married. There are no other family
relationships among any of the directors, officers or key employees of the
Company.

COMMITTEES OF THE BOARD OF DIRECTORS

The Audit Committee reviews, acts on and reports to the Board of Directors
with respect to various auditing and accounting matters, including the selection
of the Company's independent accountants, the scope of the annual audits, fees
to be paid to the independent accountants, the performance of the Company's
independent accountants and the accounting practices of the Company.

The Compensation Committee (effective upon the closing of this Offering)
establishes salaries, incentives and other forms of compensation for officers
and other employees of the Company and administers the incentive compensation
and benefit plans of the Company.

DIRECTOR COMPENSATION

Directors receive no cash remuneration for serving on the Board of
Directors but are reimbursed for reasonable expenses incurred by them in
attending meetings of the Board of Directors and Audit Committee. On July 15,
1997, the Company issued to each of Jeffrey M. Drazan and David C. Schwab 60,000
shares of Common Stock pursuant to the Company's 1997 Stock Option/Stock
Issuance Plan. Non-employee directors may also receive periodic option grants
under the Company's 1997 Stock Option/Stock Issuance Plan. See "-- 1997 Stock
Option/Stock Issuance Plan" and Note 6 of Notes to Consolidated Financial
Statements.

LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS

The Company's Restated Certificate of Incorporation limits the liability of
its directors for monetary damages arising from a breach of their fiduciary duty
as directors, except to the extent otherwise required by the Delaware General
Corporation Law. Such limitation of liability does not affect the availability
of equitable remedies such as injunctive relief or rescission.

The Company's Bylaws provide that the Company shall indemnify its directors
and officers to the fullest extent permitted by Delaware law, including in
circumstances in which indemnification is otherwise discretionary under Delaware
law. The Company has also entered into indemnification agreements with its
officers and directors containing provisions that may require the Company, among
other things, to indemnify such officers and directors against certain
liabilities that may arise by reason of their status or service as directors or
officers (other than liabilities arising from willful misconduct of a culpable
nature), to advance their expenses incurred as a result of any

52
<PAGE> 54

proceeding against them as to which they could be indemnified, and to obtain
directors' and officers' insurance if available on reasonable terms.

At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of the Company where indemnification will
be required or permitted. The Company is not aware of any threatened litigation
or proceeding that might result in a claim for such indemnification.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

None of the members of the Compensation Committee (effective upon the
closing of this Offering) is an officer or employee of the Company. No
interlocking relationship exists between the Company's Board or Compensation
Committee and the board of directors or compensation committee of any other
company, nor has such an interlocking relationship existed in the past.

EXECUTIVE COMPENSATION

The following Summary Compensation Table sets forth the compensation earned
by the Company's Chief Executive Officer and the four other most highly
compensated officers whose salary and bonus for the fiscal year ended September
30, 1997 exceeded $100,000 (collectively, the "Named Executive Officers"), for
services rendered in all capacities to the Company and its subsidiaries for the
fiscal year ended September 30, 1997.

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
------------
AWARDS
ANNUAL COMPENSATION ------------
-------------------------------------- SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY($) BONUS($) COMPENSATION($) OPTIONS(#) COMPENSATION($)
- --------------------------------- -------- -------- ---------------- ------------ ----------------
<S> <C> <C> <C> <C> <C>
Christopher J. Dawes............. $187,500 $157,495 $ 35,514(1) 0 $8,093(2)
President and Chief Executive
Officer
Stephen A. Allott................ 161,581 -- -- 19,033 --
Senior Vice President, Finance
Mark J. Peach.................... 108,614 -- 10,541(3) 15,320 --
Vice President, Core Technology
Peter Shearan.................... 110,597 -- 12,123(4) 44,440 --
Vice President, Technical
Services
Timothy J. Tokarsky.............. 108,814 -- -- 77,000 --
Vice President, Application
Development
</TABLE>

- ---------------

(1) Includes $14,162 car allowance, $6,530 payment for a golf club membership
and $12,975 payment for accounting fees.

(2) Company's contributions made to the Company's pension plan which is a
defined contribution plan. These contributions were paid in British pounds
sterling and have been translated into United States dollars solely for the
convenience of the reader at L1.00=$1.6185, based on the New York foreign
exchange selling rate at 4:00 p.m. Eastern time on September 30, 1997 as
reported in the Wall Street Journal.

(3) Includes $8,694 car allowance.

(4) Includes $9,919 car allowance.

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<PAGE> 55

OPTION GRANTS

The following table contains information concerning the stock option grants
made to each of the Named Executive Officers in the fiscal year ended September
30, 1997. No stock appreciation rights were granted to these individuals during
such year.

<TABLE>
<CAPTION>
POTENTIAL
REALIZABLE
VALUE AT ASSUMED
NUMBER OF INDIVIDUAL GRANT ANNUAL RATES OF
SECURITIES ---------------------------------------- STOCK
UNDERLYING % OF TOTAL PRICE APPRECIATION
OPTIONS OPTIONS GRANTED EXERCISE FOR OPTION TERM(3)
GRANTED TO EMPLOYEES IN PRICE EXPIRATION ------------------
NAME (#) 1997(1) ($/SH)(2) DATE 5%($) 10%($)
- ----------------------- ---------- --------------- --------- ---------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Christopher J. Dawes... 0 -- -- -- -- --
Stephen A. Allott...... 18,033(4) 1.98% $2.50 03/09/04 $18,353 $ 42,771
500(4) .05 2.50 05/18/04 509 1,186
500(4) .05 2.50 06/30/04 509 1,186
Mark J. Peach.......... 14,820(4) 1.63 2.50 05/18/04 15,083 35,150
500(4) .05 2.50 06/30/04 509 1,186
Peter Shearan.......... 43,940(4) 4.82 2.50 05/18/04 44,720 104,217
500(4) .05 2.50 06/30/04 509 1,186
Timothy J. Tokarsky.... 77,000(4) 8.45 2.50 03/09/04 78,367 182,628
</TABLE>

- ---------------

(1) Based on an aggregate of 911,196 options granted in fiscal 1997.

(2) The exercise price per share of options granted represented the fair market
value of the underlying shares of Common Stock on the dates the respective
options were granted as determined by the Company's Board of Directors. The
Company's Common Stock was not traded publicly at the time of the option
grants to the Named Executive Officers. The exercise price may be paid in
cash, in shares of the Company's Common Stock valued at fair market value on
the exercise date or through a cashless exercise procedure involving a
same-day sale of the purchased shares. The Company may also finance the
option exercise by loaning the optionee sufficient funds to pay the exercise
price for the purchased shares.

(3) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can
be no assurance provided to any executive officer or any other holder of the
Company's securities that the actual stock price appreciation over the
7-year option term will be at the assumed 5% or 10% levels or at any other
defined level. Unless the market price of the Common Stock appreciates over
the option term, no value will be realized from the option grants made to
the executive officers.

(4) Each of the options is immediately exercisable, but any shares purchased
under the options are subject to vesting requirements and may be repurchased
by the Company at the original exercise price paid per share upon the
optionee's cessation of service prior to vesting in such shares. The
repurchase right lapses with respect to 25% of the option shares upon
completion of one year of service from the vesting commencement date and the
balance in a series of equal monthly installments over the next 36 months of
service thereafter. The holder of purchased shares, whether or not subject
to the Company's repurchase right, is entitled to vote all such shares. The
option shares will vest immediately upon an acquisition of the Company by
merger or asset sale, unless the Company's repurchase right with respect to
the unvested option shares is assigned to the acquiring entity. Each option
has a maximum term of seven years, subject to earlier termination in the
event of the optionee's cessation of employment with the Company.

54
<PAGE> 56

OPTION EXERCISES AND FISCAL YEAR-END VALUES

The following table sets forth information concerning the year-end number
and value of unexercised options with respect to each of the Named Executive
Officers. No options and no stock appreciation rights were exercised by the
Named Executive Officers in fiscal year 1997, and no stock appreciation rights
were outstanding at the end of that year.

<TABLE>
<CAPTION>
NUMBER OF VALUE OF
SECURITIES UNEXERCISED
UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS
AT FY-END(#)(1) AT FY-END($)(2)
------------------- -----------------------
NAME VESTED UNVESTED VESTED UNVESTED
- ------------------------------------------------- ------ ------ -------- --------
<S> <C> <C> <C> <C>
Christopher J. Dawes............................. 0 0 -- --
Stephen A. Allott................................ 65,604 19,033 $320,804 $ 74,800
Mark J. Peach.................................... 67,700 15,320 306,024 60,208
Peter Shearan.................................... 9,769 62,715 52,104 249,942
Timothy J. Tokarsky.............................. 0 77,000 -- 302,610
</TABLE>

- ---------------

(1) Each of the options listed in the table is immediately exercisable, but any
shares purchased under the options will be subject to vesting requirements
and may be repurchased at the original exercise price per share upon the
optionee's cessation of service prior to vesting in such shares.

(2) Based on the fair market value of the Company's Common Stock at fiscal year
end (September 30, 1997) ($6.43 per share), as determined by the Company's
Board of Directors less the exercise price payable for such shares.

EMPLOYEE BENEFIT PLANS

1997 Stock Option/Stock Issuance Plan

In March 1997, the Company's Board of Directors adopted the Company's 1997
Stock Option/Stock Issuance Plan (the "Stock Option Plan"). The Stock Option
Plan was approved by the Company's stockholders in March 1997. On January 20,
1998, the Board of Directors approved an amendment and restatement of the Stock
Option Plan that, subject to stockholder approval, increased the number of
shares authorized under the plan and modified certain terms of the plan.

Pursuant to such amendment, the number of shares of Common Stock that are
reserved for issuance under the Stock Option Plan pursuant to the direct award
or sale of shares or the exercise of options is equal to 2,512,600 shares. If
any options granted under the Stock Option Plan are forfeited or terminate for
any other reason without having been exercised in full, then the unpurchased
shares subject to those options will become available for additional grants
under the Stock Option Plan. If shares granted or purchased under the Stock
Option Plan are forfeited, then those shares will also become available for
additional grants under the Stock Option Plan. The number of shares reserved for
issuance under the Stock Option Plan will be increased automatically on October
1 of each fiscal year, starting with October 1, 1999, by a number equal to the
lesser of (a) 1,000,000 shares or (b) 5% of the shares of Common Stock
outstanding at that time.

Under the Stock Option Plan, all employees (including officers) and
directors of the Company or any subsidiary and any independent contractor or
advisor who performs services for the Company or a subsidiary are eligible to
purchase shares of Common Stock and to receive awards of shares or grants of
nonstatutory options. Employees are also eligible to receive grants of incentive
stock options ("ISOs") intended to qualify under Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code"). The Stock Option Plan is
administered by the Board of Directors, which selects the persons to whom shares
will be sold or awarded or options will be granted, determines the number of
shares to be made subject to each sale, award or grant, and prescribes the other
terms and conditions of each sale, award or grant, including the type of
consideration to be paid to the Company upon sale or exercise and the vesting
schedule.

55
<PAGE> 57

The exercise price under any nonstatutory options generally must be at
least 85% of the fair market value of the Common Stock on the date of grant. The
exercise price under ISOs cannot be lower than 100% of the fair market value of
the Common Stock on the date of grant and, in the case of ISOs granted to
holders of more than 10% of the voting power of the Company, not less than 110%
of such fair market value. The term of an ISO cannot exceed 10 years, and the
term of an ISO granted to a holder of more than 10% of the voting power of the
Company cannot exceed five years.

As of December 31, 1997, options to purchase an aggregate of 1,350,670
shares of Common Stock were outstanding under the Stock Option Plan at a
weighted average exercise price of $2.56. As of December 31, 1997, a total of
57,045 shares of Common Stock are available for future issuance under the Stock
Option Plan.

1998 Employee Stock Purchase Plan

In January 1998, the Board of Directors adopted the Company's 1998 Employee
Stock Purchase Plan (the "ESPP") to provide employees of the Company with an
opportunity to purchase Common Stock through payroll deductions. The ESPP is
subject to approval by the stockholders of the Company. Under the ESPP 300,000
shares of Common Stock have been reserved for issuance. The ESPP is expected to
become effective at the time of this Offering. All full-time regular employees
who are employed by the Company on the effective date of this Offering will be
eligible to participate in the ESPP after completing a three-month waiting
period.

Eligible employees may contribute up to 15% of their total cash
compensation to the ESPP. Amounts withheld are applied at the end of every
six-month accumulation period to purchase shares of Common Stock, but not more
than 1,250 shares per accumulation period. The value of the Common Stock
(determined as of the beginning of the offering period) that may be purchased by
any participant in a calendar year is limited to $25,000. Participants may
withdraw their contributions at any time before stock is purchased.

The purchase price is equal to 85% of the lower of (a) the market price of
Common Stock immediately before the beginning of the applicable offering period
or (b) the market price of Common Stock at the time of the purchase. In general,
each offering period is 24 months long, but a new offering period begins every
six months. Thus up to four overlapping offering periods may be in effect at the
same time. An offering period continues to apply to a participant for the full
24 months, unless the market price of Common Stock is lower when a subsequent
offering period begins. In that event, the subsequent offering period
automatically becomes the applicable period for purposes of determining the
purchase price. The first accumulation and offering periods are expected to
commence on the effective date of this Offering and will end on July 31, 1998
and January 31, 2000, respectively.

CHANGE OF CONTROL ARRANGEMENTS

Upon a Corporate Transaction, each outstanding option shall automatically
accelerate so that each such option shall become fully exercisable and all of
the shares subject to each outstanding but unvested option shall vest in full or
applicable repurchase rights shall lapse, as the case may be, except to the
extent any such option is assumed or replaced with a comparable option by the
successor corporation. In addition, the Plan Administrator, the Board or an
authorized committee, shall have the discretion to provide for the automatic
acceleration of any options upon the occurrence of a Corporate Transaction. A
Corporate Transaction includes a merger or consolidation of the Company after
which the Company's then current stockholders own less than 50% of the surviving
corporation and a sale of all or substantially all of the assets of the Company.
In the event of a merger or other reorganization, outstanding options and
restricted shares will be subject to the agreement of merger or reorganization,
which may provide for the assumption of outstanding awards by the surviving
corporation or its parent, for their continuation by the Company (if the Company
is a surviving corporation), for accelerated vesting and accelerated expiration
or for settlement in cash.

56
<PAGE> 58

CERTAIN TRANSACTIONS

Since October 1, 1994, the Company has issued and sold securities to the
following persons who are principal stockholders, executive officers or
directors of the Company.

<TABLE>
<CAPTION>
SERIES A SERIES B SERIES C TOTAL SHARES
PREFERRED PREFERRED PREFERRED COMMON AS IF
INVESTOR(1) STOCK(2) STOCK(3) STOCK(4) STOCK CONVERTED(5)
- --------------------------- --------- --------- --------- ------ ------------
<S> <C> <C> <C> <C> <C>
Sierra Ventures V,
L.P.(6).................. 1,500,000 2,000,000 295,490 -- 3,795,490
CITICORP(7)................ -- -- 777,605 -- 777,605
Jeffrey M. Drazan(8)....... -- -- 15,552 60,000 75,552
David C. Schwab............ -- -- 15,552 60,000 75,552
</TABLE>

- ---------------

(1) See "Principal Stockholders" for more detail on shares held by these
purchasers.

(2) Reflects shares purchaseable upon exercise of a warrant to purchase shares
of Series A Preferred Stock at a per share exercise price of $2.00.

(3) The per share purchase price for the Series B Preferred Stock was $2.50.

(4) The per share purchase price for the Series C Preferred Stock was $6.43.

(5) Reflects a one-to-one conversion to Common Stock ratio for each share of
Series A, Series B and Series C Preferred Stock.

(6) Each of Jeffrey M. Drazan and David C. Schwab, each a general partner of SV
Associates V, LP, the general partner of Sierra Ventures V, L.P., is a
director of the Company.

(7) In connection with this purchase, CITICORP and the Company entered into an
agreement whereby CITICORP agreed not to vote in any election for the
directors of the Company any shares it holds in excess of 4.99% of the
outstanding capital stock of the Company entitled to vote on such matters,
assuming for the purposes of such calculation the exercise or conversion of
any securities exercisable or convertible into shares of Common Stock.

(8) Includes 7,776 shares of Series C Preferred Stock registered in the name of
the Sandra Drazan Living Trust and 7,776 shares of Series C Preferred Stock
registered in the name of ZD. Air, Inc.

In addition, the Company has granted options to certain of its executive
officers. See "Management -- Option Grants."

MARCH 1997 FINANCING

On March 6, 1997, the Company entered into the following transactions with
Sierra Ventures V, L.P.: (i) the Company issued 2,000,000 shares of Series B
Preferred Stock at a per share purchase price of $2.50; (ii) the Company issued
a warrant to purchase 1,500,000 shares of Series A Preferred Stock at a per
share exercise price of $2.00; and (iii) the Company and Sierra Ventures V, L.P.
entered into a Credit Agreement (the "Credit Agreement") whereby Sierra Ventures
V, L.P. agreed to make revolving loans to the Company in an aggregate amount of
up to $3.0 million for a period of five years. The Company had borrowed and
repaid an aggregate of $1.0 million under the Credit Agreement and as of
December 31, 1997 there was no outstanding balance under the Credit Agreement.
The Credit Agreement will terminate upon the Offering.

SEPTEMBER 1997 FINANCING

On September 8, 1997, the Company issued an aggregate of 2,488,336 shares
of Series C Preferred Stock at a per share purchase price of $6.43 to 18
investors, including 295,490 shares to Sierra Ventures V, L.P., 777,605 shares
to CITICORP, 15,552 shares to David C. Schwab, 7,776 shares to the Sandra Drazan
Living Trust and 7,776 shares to ZD. Air, Inc.

STOCK PURCHASES BY DIRECTORS

On July 15, 1997, the Company issued to each of Jeffrey M. Drazan and David
C. Schwab 60,000 shares of Common Stock at a per share purchase price of $2.50
pursuant to the Company's 1997 Stock Option/Stock Issuance Plan. See
"Management -- Employee Benefit Plans."

57
<PAGE> 59

REPURCHASES OF STOCK FROM CERTAIN OFFICERS

On July 15, 1997, the Company repurchased 120,000 shares of Common Stock at
a per share purchase price of $2.50 from Christopher J. Dawes, President and
Chief Executive of the Company. On November 13, 1997, the Company repurchased
777,605 shares of Common Stock at a per share purchase price of $6.43 from Mr.
Dawes.

LOANS TO CERTAIN OFFICERS

The Company has loaned funds to Christopher J. Dawes pursuant to interest
free loans. These loans have had fluctuating balances equaling in the aggregate
$158,613 at September 30, 1996 and $1.2 million at September 30, 1997. The
outstanding loan balance as of September 30, 1996 has been translated from
British pounds sterling into United States dollars solely for the convenience of
the reader at L1.00 = $1.6185, based on the New York foreign exchange selling
rate at 4:00 p.m. Eastern time as reported in the Wall Street Journal.

All future transactions, including loans between the Company and its
officers, directors, principal stockholders and their affiliates will be
approved by a majority of the Board of Directors, including a majority of the
independent and disinterested outside directors on the Board of Directors.

58
<PAGE> 60

PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth certain information regarding the beneficial
ownership of the Company's outstanding Common Stock as of December 31, 1997 and
as adjusted to reflect the sale of the Common Stock offered hereby for: (i) each
of the directors and Named Executive Officers of the Company; (ii) all directors
and executive officers of the Company as a group; and (iii) each other person
known by the Company to own beneficially more than 5% of the Company's Common
Stock. Except as otherwise indicated, the Company believes that the beneficial
owners of the Common Stock listed below, based on information furnished by such
owners have sole voting and investment power with respect to such shares.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED BEFORE THE OFFERING SHARES OWNED AFTER THE OFFERING
-------------------------- BEING --------------------------
NUMBER PERCENT(1)(2) OFFERED NUMBER PERCENT(1)(2)
---------- ------------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
NAMED EXECUTIVE OFFICERS AND
DIRECTORS
Christopher J. Dawes............ 2,831,626 24.0% 60,700 2,770,926 18.8%
Mark J. Peach(3)................ 93,020 * -- 93,020 *
Stephen A. Allott(4)............ 84,637 * -- 84,637 *
Timothy J. Tokarsky(5).......... 77,000 * -- 77,000 *
Peter Shearan(6)................ 72,484 * -- 72,484 *
Angela Dawes.................... 1,830,236 15.5 39,300 1,790,936 12.2
Jeffrey M. Drazan(7)............ 3,863,266 32.7 -- 3,863,266 26.3
3000 Sand Hill Road
Building 4, Suite 210
Menlo Park, CA 94025
David C. Schwab(8).............. 4,031,042 34.2 -- 4,031,042 27.4
3000 Sand Hill Road
Building 4, Suite 210
Menlo Park, CA 94025
OTHER 5% STOCKHOLDERS
Sierra Ventures V, L.P.(9)...... 3,795,490 32.2 -- 3,795,490 25.8
3000 Sand Hill Road
Building 4, Suite 210
Menlo Park, CA 94025
CITICORP(10).................... 777,605 6.6 -- 777,605 5.3
155 East 53rd Street
1 CITICORP Center
New York, NY 10043

ALL DIRECTORS AND EXECUTIVE
OFFICERS AS A GROUP (11
PERSONS)(11).................. 9,250,205 75.3 100,000 9,150,205 60.2
</TABLE>

- ---------------

* Less than 1%

(1) Assumes no exercise of the Underwriters' over-allotment option.

(2) Beneficial ownership is determined in accordance with the rules of the
Commission and generally includes voting or investment power with respect
to securities. Common Stock subject to options currently exercisable or
exercisable within 60 days of December 31, 1997 are deemed outstanding for
purposes of computing the percentage ownership of the person holding such
option but are not deemed outstanding for purposes of computing the
percentage ownership of any other person. Except where indicated, and
subject to community property laws where applicable, the persons in the
table above have sole voting and investment power with respect to all
Common Stock shown as beneficially owned by them. Unless otherwise
indicated, the address of each of the individuals listed in the table is
c/o Micromuse Inc., 139 Townsend Street, San Francisco, CA 94107.

(3) Includes 93,020 shares subject to options which are exercisable within 60
days of December 31, 1997.

(4) Includes 84,637 shares subject to options which are exercisable within 60
days of December 31, 1997.

(5) Includes 77,000 shares subject to options which are exercisable within 60
days of December 31, 1997.

(6) Includes 72,484 shares subject to options which are exercisable within 60
days of December 31, 1997.

59
<PAGE> 61

(7) Includes 3,795,490 shares held by Sierra Ventures V, L.P., including
1,500,000 shares issuable upon the exercise of a warrant for Series A
Preferred Stock of the Company at $2.00 per share issued to Sierra Ventures
V, L.P. and the conversion of such shares into Common Stock, and 7,776
shares held by ZD. Air, Inc., a corporation. Mr. Drazan, a director of the
Company, is a general partner of SV Associates V, LP, which is the general
partner of Sierra Ventures V, L.P. Mr. Drazan disclaims beneficial ownership
of the shares held by Sierra Ventures V, L.P. except to the extent of his
pecuniary interest therein arising from his general partnership interest in
SV Associates V, LP.

(8) Includes 3,795,490 shares held by Sierra Ventures V, L.P., including
1,500,000 shares issuable upon the exercise of a warrant for Series A
Preferred Stock of the Company at $2.00 per share issued to Sierra Ventures
V, L.P. and the conversion of such shares into Common Stock. Mr. Schwab, a
director of the Company, is a general partner of SV Associates V, LP, which
is the general partner of Sierra Ventures V, L.P. Mr. Schwab disclaims
beneficial ownership of the shares held by Sierra Ventures V, L.P. except to
the extent of his pecuniary interest therein arising from his general
partnership interest in SV Associates V, LP.

(9) Includes 1,500,000 shares issuable upon the exercise of a warrant for Series
A Preferred Stock of the Company issued to Sierra Ventures V, L.P. and the
conversion of such shares into Common Stock. Messrs. Drazan and Schwab, each
a director of the Company, are general partners of SV Associates V, LP,
which is the general partner of Sierra Ventures V, L.P. Each of Messrs.
Drazan and Schwab disclaim beneficial ownership of the shares held by Sierra
Ventures V, L.P. except to the extent of his pecuniary interest therein
arising from his general partnership interest in SV Associates V, LP.

(10) Pursuant to the terms of an Agreement between the Company and CITICORP,
dated as of September 8, 1997, CITICORP may vote in an election of the
Company's directors a number of its shares up to but not exceeding 4.99% of
the Company's outstanding Common Stock, including shares of Common Stock
issuable upon the exercise of outstanding options and shares of Common
Stock reserved for issuance under the Company's stock plans. The terms of
such agreement do not affect the rights of CITICORP to vote on any other
matter.

(11) Includes 489,525 shares of Common Stock issuable upon exercise of
immediately exercisable options held by certain officers and 3,803,266
shares held by entities affiliated with Messrs. Drazan and Schwab.

60
<PAGE> 62

DESCRIPTION OF CAPITAL STOCK

Upon the closing of this Offering, the authorized capital stock of the
Company will consist of 60,000,000 shares of Common Stock, $0.01 par value, and
5,000,000 shares of Preferred Stock, $0.01 par value.

COMMON STOCK

As of December 31, 1997, there were 11,800,956 shares of Common Stock
outstanding that were held of record by 37 stockholders (assuming the conversion
of all outstanding shares of Preferred Stock into 5,988,336 shares of Common
Stock, which includes the issuance of 1,500,000 shares of Common Stock as
converted upon the anticipated exercise of the Series A Warrant). There will be
14,700,956 shares of Common Stock outstanding (assuming no exercise of the
Underwriters' over-allotment option and assuming no exercise after December 31,
1997 of outstanding options) after giving effect to the sale of the shares of
Common Stock to the public offered hereby and the conversion of the Company's
Preferred Stock into Common Stock at a one-to-one ratio.

The holders of Common Stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to preferences that may be
applicable to any outstanding Preferred Stock, the holders of Common Stock are
entitled to receive ratably such dividends, if any, as may be declared from time
to time by the Board of Directors out of funds legally available therefor. See
"Dividend Policy." In the event of the liquidation, dissolution or winding up of
the Company, the holders of Common Stock are entitled to share ratably in all
assets remaining after payment of liabilities, subject to prior distribution
rights of Preferred Stock, if any, then outstanding. The Common Stock has no
preemptive or conversion rights or other subscription rights. There are no
redemption or sinking fund provisions applicable to the Common Stock. All
outstanding shares of Common Stock are fully paid and nonassessable, and the
shares of Common Stock to be issued upon completion of this Offering will be
fully paid and nonassessable.

PREFERRED STOCK

The Board of Directors has the authority to issue the Preferred Stock in
one or more series and to fix the rights, preferences, privileges and
restrictions thereof, including dividend rights, dividend rates, conversion
rights, voting rights, terms of redemption, redemption prices, liquidation
preferences and the number of shares constituting any series or the designation
of such series, without further vote or action by the stockholders. The issuance
of Preferred Stock may have the effect of delaying, deferring or preventing a
change in control of the Company without further action by the stockholders and
may adversely affect the voting and other rights of the holders of Common Stock.
The issuance of Preferred Stock with voting and conversion rights may adversely
affect the voting power of the holders of Common Stock, including the loss of
voting control to others. At present, the Company has no plans to issue any of
the Preferred Stock.

ANTI-TAKEOVER EFFECTS OF PROVISIONS OF THE CERTIFICATE OF INCORPORATION, BYLAWS
AND DELAWARE LAW

Certificate of Incorporation and Bylaws

The Company's Restated Certificate of Incorporation provides that, upon the
closing of this Offering, the Board of Directors will be divided into two
classes of directors, with each class serving a staggered two-year term. The
classification of the Board of Directors has the effect of generally requiring
at least two annual stockholder meetings, instead of one, to replace a majority
of the Board members. The Restated Certificate of Incorporation also provides
that, effective upon the closing of this Offering, all stockholder actions must
be effected at a duly called meeting and not by consent in writing. Provisions
of the Bylaws and the Restated Certificate of Incorporation provide that the
stockholders may amend the Bylaws or certain provisions of the Restated

61
<PAGE> 63

Certificate of Incorporation only with the affirmative vote of 75% of the
Company's capital stock. Further, the Bylaws (i) provide that only the Board of
Directors may call special meetings of the stockholders and (ii) establish an
advance notice procedure for stockholder proposals to be brought before an
annual meeting of stockholders of the Company, including proposed nominations of
persons for election to the Board of Directors. These provisions of the Restated
Certificate of Incorporation and Bylaws could discourage potential acquisition
proposals and could delay or prevent a change in control of the Company. These
provisions are intended to enhance the likelihood of continuity and stability in
the composition of the Board of Directors and in the policies formulated by the
Board of Directors and to discourage certain types of transactions that may
involve an actual or threatened change of control of the Company. These
provisions are designed to reduce the vulnerability of the Company to an
unsolicited acquisition proposal. The provisions also are intended to discourage
certain tactics that may be used in proxy fights. However, such provisions could
have the effect of discouraging others from making tender offers for the
Company's shares and, as a consequence, they also may inhibit fluctuations in
the market price of the Company's shares that could result from actual or
rumored takeover attempts. Such provisions also may have the effect of
preventing changes in the management of the Company. See "Risk
Factors -- Anti-takeover Effects of Certificate of Incorporation, Bylaws and
Delaware Law."

Delaware Takeover Statute

The Company is subject to Section 203 of the Delaware General Corporation
Law ("Section 203") which, subject to certain exceptions, prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder for a period of three years following the date that such stockholder
became an interested stockholder unless: (i) prior to such date, the board of
directors of the corporation approved either the business combination or the
transaction that resulted in the stockholder becoming an interested stockholder;
(ii) upon consummation of the transaction that resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at least
85% of the voting stock of the corporation outstanding at the time the
transaction commenced, excluding for purposes of determining the number of
shares outstanding those shares owned (x) by persons who are directors and also
officers and (y) by employee stock plans in which employee participants do not
have the right to determine confidentially whether shares held subject to the
plan will be tendered in a tender or exchange offer; or (iii) on or subsequent
to such date, the business combination is approved by the board of directors and
authorized at an annual or special meeting of stockholders, and not by written
consent, by the affirmative vote of at least 66 2/3% of the outstanding voting
stock that is not owned by the interested stockholder.

Section 203 defines business combinations to include: (i) any merger or
consolidation involving the corporation and the interested stockholder; (ii) any
sale, transfer, pledge or other disposition of 10% or more of the assets of the
corporation involving the interested stockholder; (iii) subject to certain
exceptions, any transaction that results in the issuance or transfer by the
corporation of any stock of the corporation to the interested stockholder; (iv)
any transaction involving the corporation that has the effect of increasing the
proportionate share of the stock of any class or series of the corporation
beneficially owned by the interested stockholder; or (v) the receipt by the
interested stockholder of the benefit of any loans, advances, guarantees,
pledges or other financial benefits provided by or through the corporation. In
general, Section 203 defines an interested stockholder as any entity or person
beneficially owning 15% or more of the outstanding voting stock of the
corporation and any entity or person affiliated with or controlling or
controlled by such entity or person.

REGISTRATION RIGHTS

After this Offering, the holders of 11,435,540 shares of Common Stock will
be entitled to certain rights with respect to the registration of such shares
under the Securities Act. Under the

62
<PAGE> 64

terms of the agreement between the Company and the holders of such registrable
securities, if the Company proposes to register any of its securities under the
Securities Act, either for its own account or for the account of other security
holders exercising registration rights, such holders are entitled to notice of
such registration and are entitled to include shares of such Common Stock
therein. Additionally, such holders are also entitled to certain demand
registration rights pursuant to which they may require the Company to file a
registration statement under the Securities Act at its expense with respect to
their shares of Common Stock, and the Company is required to use its best
efforts to effect such registration. Further, holders may require the Company to
file additional registration statements on Form S-3 at the Company's expense.
All of these registration rights are subject to certain conditions and
limitations, among them the right of the underwriters of an offering to limit
the number of shares included in such registration and the right of the Company
not to effect a requested registration within six months following an offering
of the Company's securities, including the Offering made hereby.

TRANSFER AGENT AND REGISTRAR

The Transfer Agent and Registrar for the Common Stock is ChaseMellon
Shareholder Services and its telephone number is (415) 743-1444.

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<PAGE> 65

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this Offering, the Company will have approximately
14,700,956 shares of Common Stock outstanding (assuming no exercise of options
or issuance of Common Stock subsequent to December 31, 1997 other than the
issuance of 1,500,000 shares of Common Stock as converted upon the anticipated
exercise of an outstanding warrant). All of the 3,000,000 shares sold in this
Offering are freely tradeable without restriction or further registration under
the Securities Act, except for any shares purchased by affiliates of the
Company, as that term is defined in Rule 144 under the Securities Act
("Affiliates"), which may generally be sold only in compliance with certain of
the limitations of Rule 144 described below.

The remaining 11,700,956 shares of Common Stock are deemed "restricted
securities" under Rule 144. Restricted shares may be sold in the public market
only if registered or if they qualify for an exemption from registration under
Rules 144, 144(k) or 701 promulgated under the Securities Act, which rules are
summarized below. As a result of the contractual restrictions described below
and the provisions of Rules 144, 144(k) and 701, no shares will be available for
immediate sale in the public market on the date of this Prospectus. Beginning
180 days after the date of this Prospectus, upon the expiration of transfer
restrictions specified in preexisting agreements or in lock-up agreements with
Deutsche Morgan Grenfell Inc., (i) no shares will be available for immediate
sale in the public market in accordance with Rule 144(k) and (ii) approximately
9,132,138 shares will be available for sale in the public market in accordance
with Rule 144 or Rule 701, subject to the volume and other resale limitations of
Rule 144, other than the one year holding period. The remaining 2,568,818 shares
are eligible for sale in the public market more than 180 days after the date of
this Prospectus.

All officers and directors and certain stockholders and certain option
holders of the Company have agreed not to offer, pledge, sell, contract to sell,
grant any option, right or warrant to purchase, or otherwise transfer or dispose
of, directly or indirectly (or enter into any swap or other arrangement that
transfers to another, in whole or in part, any of the economic consequences of
ownership of), any shares of Common Stock or any securities convertible into or
exercisable or exchangeable for shares of Common Stock, for a period of 180 days
after the date of this Prospectus, without the prior written consent of Deutsche
Morgan Grenfell Inc.

In general, under Rule 144, beginning approximately 90 days after the
effective date of the Registration Statement of which this Prospectus is a part,
a stockholder, including an Affiliate, who has beneficially owned his or her
restricted securities (as that term is defined in Rule 144) for at least one
year from the later of the date such securities were acquired from the Company
or (if applicable) the date they were acquired from an Affiliate, is entitled to
sell, within any three-month period, a number of such shares that does not
exceed the greater of 1% of the then outstanding shares of Common Stock
(approximately 147,010 shares immediately after this Offering) or the average
weekly trading volume in the Common Stock during the four calendar weeks
preceding the date on which notice of such sale was filed under Rule 144,
provided certain requirements concerning availability of public information,
manner of sale and notice of sale are satisfied. In addition, under Rule 144(k),
if a period of at least two years has elapsed between the later of the date
restricted securities were acquired from the Company, a stockholder who is not
an Affiliate of the Company at the time of sale and has not been an Affiliate of
the Company for at least three months prior to the sale is entitled to sell the
shares immediately without compliance with the foregoing requirements of Rule
144.

Securities issued in reliance on Rule 701 (such as shares of Common Stock
that may be acquired pursuant to the exercise of certain options granted prior
to this Offering) are also restricted securities and, beginning 90 days after
the date of this Prospectus, may be sold by stockholders other than Affiliates
of the Company subject only to the manner of sale provisions of Rule 144 and by
an Affiliate under Rule 144 without compliance with its one-year holding period
requirement. As of December 31, 1997, the holders of options exercisable into
approximately

64
<PAGE> 66

1,350,670 shares of Common Stock will be eligible to sell their shares upon the
expiration of transfer restrictions specified in the Stock Option Plan 180 days
after the date of this Prospectus, subject in certain cases to vesting of such
options.

Prior to this Offering, there has been no public market for the Common
Stock. No prediction can be made as to the effect, if any, that market sales of
shares or the availability of shares for sale will have on the market price of
the Common Stock prevailing from time to time. The Company is unable to estimate
the number of shares that may be sold in the public market pursuant to Rule 144,
since this will depend on the market price of the Common Stock, the personal
circumstances of the sellers and other factors. Nevertheless, sales of
significant amounts of the Common Stock of the Company in the public market
could adversely affect the market price of the Common Stock and could impair the
Company's ability to raise capital through an offering of its equity securities.

The Company intends to file after the effective date of this Offering a
Registration Statement on Form S-8 to register approximately 2,812,600 shares of
Common Stock subject to outstanding options or reserved for issuance pursuant to
the Stock Option Plan and the ESPP. Such Registration Statement will become
effective automatically upon filing. Shares issued under the foregoing plan,
after the filing of a Registration statement on Form S-8, may be sold in the
open market, subject, in the case of certain holders, to the Rule 144
limitations applicable to affiliates, the above-referenced preexisting transfer
restrictions and vesting restrictions imposed by the Company.

In addition, following this Offering, the holders of 11,435,540 shares of
outstanding Common Stock will, under certain circumstances, have rights to
require the Company to register their shares for future sale. See "Description
of Capital Stock -- Registration Rights."

65
<PAGE> 67

UNDERWRITING

The Underwriters named below, for whom Deutsche Morgan Grenfell Inc.,
NationsBanc Montgomery Securities, Inc. and Smith Barney Inc. are acting as
representatives (the "Representatives"), have severally agreed, subject to the
terms and conditions contained in the Underwriting Agreement (the form of which
will be filed as an exhibit to the Company's Registration Statement, of which
this Prospectus is a part), to purchase from the Company and the Selling
Stockholders the respective number of shares of Common Stock indicated below
opposite their respective names. The Underwriters are committed to purchase all
of the shares, if they purchase any.

<TABLE>
<CAPTION>
NUMBER
NAME OF SHARES
--------------------------------------------------------------------------- ---------
<S> <C>
Deutsche Morgan Grenfell Inc...............................................
NationsBanc Montgomery Securities, Inc.....................................
Smith Barney Inc...........................................................

---------
Total............................................................ 3,000,000
=========
</TABLE>

The Underwriting Agreement provides that the obligations of the several
Underwriters thereunder are subject to approval of certain legal matters by
counsel and to various other conditions.

The Representatives have advised the Company that the Underwriters propose
initially to offer the Common Stock to the public on the terms set forth on the
cover page of this Prospectus. The Underwriters may allow to selected dealers
(who may include the Underwriters) a concession of not more than $ per
share. The selected dealers may reallow a concession of not more than $ per
share to certain other dealers. After the initial public offering, the price and
concessions and re-allowances to dealers and other selling terms may be changed
by the Representatives. The Common Stock is offered subject to receipt and
acceptance by the Underwriters, and to certain other conditions, including the
right to reject orders in whole or in part. The Underwriters do not intend to
sell any of the shares of Common Stock offered hereby to accounts for which they
exercise discretionary authority.

The Company and certain Selling Stockholders have granted an option to the
Underwriters to purchase up to maximum of 450,000 additional shares of Common
Stock to cover over-allotments, if any, at the public offering price, less the
underwriting discount set forth on the cover page of this Prospectus. Such
option may be exercised at any time until 30 days after the date of the
Underwriting Agreement. To the extent the Underwriters exercise this option,
each of the Underwriters will be committed, subject to certain conditions, to
purchase such additional shares in approximately the same proportion as set
forth in the above table. The Underwriters may purchase such shares only to
cover overallotments made in connection with this offering.

In connection with this offering, the Company and the directors, executive
officers, Selling Stockholders and certain other stockholders have agreed not to
offer or sell any Common Stock until the expiration of 180 days following the
date of the final Prospectus without the prior written consent of Deutsche
Morgan Grenfell Inc.

The Underwriting Agreement provides that the Company and the Selling
Stockholders will indemnify the several Underwriters against certain
liabilities, including civil liabilities under the

66
<PAGE> 68

Securities Act, as amended, or will contribute to payments the Underwriters may
be required to make in respect thereof.

In September 1997, the Company issued 155,521 shares of the Company's
Series C Preferred Stock at a per share purchase price of $6.43 to DMG
Technology Ventures L.L.C. ("DMG Technology"), an affiliate of Deutsche Morgan
Grenfell Inc. The shares owned by DMG Technology represent less than 2% of the
outstanding capital stock of the Company before the Offering. All of such shares
were acquired from the Company as a part of an equity financing on the same
terms pursuant to which all other participants in the financing purchased their
shares. See "Certain Transactions -- September 1997 Financing."

In December 1996, Deutsche Bank AG ("Deutsche Bank"), an affiliate of
Deutsche Morgan Grenfell Inc., paid approximately $164,000 to the Company for a
license of the Company's software and a service and maintenance agreement in
connection therewith. In addition, the Company and Deutsche Bank entered into a
Software License Agreement dated September 19, 1997 whereby the Company granted
Deutsche Bank a non-exclusive irrevocable license to the Company's Netcool
products and agreed to provide service and maintenance to Deutsche Bank in
connection therewith, in exchange for approximately $3.2 million. In the quarter
ended December 31, 1997, Deutsche Bank accounted for 30% of the Company's total
revenue. Both transactions were consummated on terms established by arms-length
negotiations and on terms substantially similar to terms agreed upon by the
Company in other similar transactions entered into with its other customers at
approximately the same time.

In May 1996, Smith Barney Inc. ("Smith Barney") paid approximately $160,000
to the Company for a license of the Company's software and a service and
maintenance agreement in connection therewith. Smith Barney obtained such
license and service and maintenance agreement through arms-length negotiations
on terms substantially similar to terms obtained by other customers of the
Company at approximately the same time.

Prior to this offering, there has been no public market for the Common
Stock. The initial public offering price will be determined by negotiation
between the Company and the Representatives. The principal factors to be
considered in determining the public offering price include the information set
forth in this Prospectus and otherwise available to the Representatives; the
history and the prospects for the industry in which the Company will compete;
the ability of the Company's management; the prospects for future earnings of
the Company; the present state of the Company's development and its current
financial condition; the general condition of the securities markets at the time
of this offering; and the recent market prices of, and the demand for, publicly
traded common stock of generally comparable companies. Each of the
Representatives has informed the Company that it currently intends to make a
market in the shares subsequent to the effectiveness of this offering, but there
can be no assurance that the Representatives will take any action to make a
market in any securities of the Company.

Certain persons participating in this offering may over-allot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the Common Stock at levels above those which might otherwise prevail in the open
market, including by entering stabilizing bids, effecting syndicate covering
transactions or imposing penalty bids. A stabilizing bid means the placing of
any bid or effecting of any purchase for the purpose of pegging, fixing or
maintaining the price of the Common Stock. A syndicate covering transaction
means the placing of any bid on behalf of the underwriting syndicate or the
effecting of any purchase to reduce a short position created in connection with
this offering. A penalty bid means an arrangement that permits the Underwriters
to reclaim a selling concession from a syndicate member in connection with this
offering when shares of Common Stock sold by the syndicate member are purchased
in syndicate covering transactions. Such transactions may be effected on the
Nasdaq Stock Market, in the over-the-counter market, or otherwise. Such
stabilizing, if commenced, may be discontinued at any time.

67
<PAGE> 69

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Company and the Selling Stockholders by Gunderson Dettmer Stough Villeneuve
Franklin & Hachigian, LLP, Menlo Park, California. As of December 31, 1997, an
investment partnership comprised of members of that firm beneficially owned
7,776 shares of the Company's Series C Preferred Stock. Certain legal matters in
connection with the Offering will be passed upon for the Underwriters by Wilson
Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California.

EXPERTS

The consolidated financial statements of Micromuse Inc. as of September 30,
1996 and 1997, and for each of the years in the three-year period ended
September 30, 1997, have been included in this Prospectus and Registration
Statement in reliance upon the report of KPMG Peat Marwick LLP, independent
certified public accountants, appearing elsewhere herein, and upon the authority
of said firm as experts in accounting and auditing in the Registration
Statement.

ADDITIONAL INFORMATION

The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement (of which this Prospectus is a part and
which term shall encompass any amendments thereto) on Form S-1 pursuant to the
Securities Act with respect to the Common Stock offered hereby. This Prospectus
does not contain all the information set forth in the Registration Statement and
the exhibits and schedules thereto, certain portions of which are omitted as
permitted by the rules and regulations of the Commission. Statements made in
this Prospectus as to the contents of any contract, agreement or other document
referred to are not necessarily complete. With respect to any such contract,
agreement or other document filed as an exhibit to the Registration Statement,
reference is made to the exhibit for a more complete description of the matters
involved, and each such statement shall be deemed qualified in its entirety by
such reference.

Upon completion of the Offering, the Company will be subject to the
information requirements of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), and, in accordance therewith, will file reports and other
information with the Commission. The Registration Statement, the exhibits and
schedules forming a part thereof and the report and other information filed by
the Company with the Commission in accordance with the Exchange Act may be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549; 7 World Trade Center, 13th Floor, New York, New York 10048; and
Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661-2511. Copies of such material can also be obtained at prescribed
rates from the Public Reference Section of the Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549. Such material may also be accessed electronically
by means of the Commission's home page on the Internet at http://www.sec.gov.

The Company intends to furnish to its stockholders annual reports
containing audited consolidated financial statements examined by an independent
accounting firm and quarterly reports for the first three quarters of each
fiscal year containing interim unaudited consolidated financial information.

68
<PAGE> 70

MICROMUSE INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report......................................................... F-2
Consolidated Balance Sheets as of September 30, 1996, 1997 and December 31, 1997..... F-3
Consolidated Statements of Operations for the Years Ended September 30, 1995, 1996,
and 1997 and the three months ended December 31, 1996 and 1997..................... F-4
Consolidated Statements of Stockholders' Equity (Deficit) for the Years Ended
September 30, 1995, 1996, and 1997 and three months ended December 31, 1996 and
1997............................................................................... F-5
Consolidated Statements of Cash Flows for the Years Ended September 30, 1995, 1996,
and 1997 and three months ended December 31, 1996 and 1997......................... F-6
Notes to Consolidated Financial Statements........................................... F-7
</TABLE>

F-1
<PAGE> 71

INDEPENDENT AUDITORS' REPORT

The Board of Directors
Micromuse Inc.:

We have audited the accompanying consolidated balance sheets of Micromuse
Inc. and subsidiaries as of September 30, 1996 and 1997, and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for each of the years in the three-year period ended September 30, 1997.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Micromuse
Inc. and subsidiaries as of September 30, 1996, and 1997, and the results of
their operations and their cash flows for each of the years in the three-year
period ended September 30, 1997, in conformity with generally accepted
accounting principles.

KPMG Peat Marwick LLP

Palo Alto, California
December 10, 1997

F-2
<PAGE> 72

MICROMUSE INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

ASSETS

<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------------ -------------
1996 1997 1997
------ ------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents........................... $ 594 $13,741 $ 7,683
Accounts receivable................................. 5,682 4,461 5,590
Inventories......................................... 399 -- --
Prepaid expenses and other current assets........... 1,250 935 1,150
Related party loan.................................. 159 1,153 --
------ ------ --------
Total current assets........................ 8,084 20,290 14,423
Property and equipment, net........................... 1,023 2,450 2,499
------ ------ --------
$9,107 $22,740 $ 16,922
====== ====== ========

LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable.................................... $4,048 $ 2,654 $ 1,812
Bank overdraft...................................... 1,351 -- --
Current portion of capital lease obligations........ 114 -- --
Accrued expenses.................................... 971 3,133 2,413
Short-term notes.................................... 1,275 -- --
Deferred revenue.................................... 1,172 1,322 3,397
------ ------ --------
Total current liabilities................... 8,931 7,109 7,622
Long-term liabilities:
Long-term portion of capital lease obligations...... 130 -- --
Long-term notes..................................... 268 -- --
Commitments and contingencies
Redeemable convertible preferred stock:
Series A, B, and C redeemable convertible preferred
stock; $0.01 par value; 1,500,000, 2,000,000, and
2,488,336 shares authorized, respectively in
1997; none, 2,000,000, and 2,488,336 shares
issued and outstanding, respectively in 1997 and
December 31, 1997 (aggregate liquidation value of
$21,000,000)..................................... -- 22,865 23,755
Stockholders' deficit:
Common stock, $0.01 par value; 18,500,000 shares
authorized; 6,099,753, 6,705,853 and 6,710,225
shares issued and outstanding in 1996, 1997 and
December 31, 1997, respectively.................. 61 366 366
Additional paid-in capital.......................... 264 2,091 2,101
Treasury stock, at cost: 120,000 and 897,605 shares
in 1997 and December 31, 1997, respectively...... -- (300) (5,300)
Deferred compensation............................... -- (215) (201)
Cumulative translation adjustment................... 50 52 --
Accumulated deficit................................. (597) (9,228) (11,421)
------ ------ --------
Total stockholders' deficit................. (222) (7,234) (14,455)
------ ------ --------
$9,107 $22,740 $ 16,922
====== ====== ========
</TABLE>

See accompanying notes to consolidated financial statements.

F-3
<PAGE> 73

MICROMUSE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
THREE MONTHS
ENDED DECEMBER
YEAR ENDED SEPTEMBER 30, 31,
------------------------- -----------------
1995 1996 1997 1996 1997
------ ------ ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
License.................................. $1,077 $3,374 $ 6,968 $ 802 $ 3,735
Maintenance and services................. 369 1,141 2,324 424 1,094
------ ------ ------- ------ -------
Total revenues................... 1,446 4,515 9,292 1,226 4,829
------ ------ ------- ------ -------
Cost of revenues:
License.................................. 163 311 523 61 315
Maintenance and services................. 102 384 1,042 166 762
------ ------ ------- ------ -------
Total cost of revenues........... 265 695 1,565 227 1,077
------ ------ ------- ------ -------
Gross profit..................... 1,181 3,820 7,727 999 3,752
------ ------ ------- ------ -------
Operating expenses:
Sales and marketing...................... 728 1,768 8,970 1,004 3,144
Research and development................. 708 1,582 2,042 303 1,069
General and administrative............... 584 996 4,244 467 892
------ ------ ------- ------ -------
Total operating expenses......... 2,020 4,346 15,256 1,774 5,105
------ ------ ------- ------ -------
Loss from operations............. (839) (526) (7,529) (775) (1,353)
Other income (expense):
Interest income.......................... 8 64 6 126
Interest expense......................... (106) (212) (1,268) (36) (301)
Other.................................... -- 25 (200) 56 225
------ ------ ------- ------ -------
Loss before income taxes......... (945) (705) (8,933) (749) (1,303)
Income taxes............................... -- 100 -- -- --
------ ------ ------- ------ -------
Loss from continuing
operations..................... (945) (805) (8,933) (749) (1,303)
Discontinued operations:
Income (loss) from discontinued
operations............................ 711 569 (104) (120) --
Gain on disposal of discontinued
operations............................ -- -- 1,161 -- --
------ ------ ------- ------ -------
Net loss......................... (234) (236) (7,876) (869) (1,303)
Accretion on redeemable convertible
preferred stock.......................... -- -- (755) -- (890)
------ ------ ------- ------ -------
Net loss applicable to holders of
common stock................... $ (234) $ (236) $(8,631) $ (869) $(2,193)
====== ====== ======= ====== =======
Per share of common stock:
Pro forma basic and diluted loss from
continuing operations................. $ (0.83) $ (0.11)
Pro forma basic and diluted loss from
discontinued operations............... $ (0.01) $ 0.00
Pro forma basic and diluted gain on
disposal of discontinued operations... $ 0.11 $ 0.00
Pro forma basic and diluted net loss..... $ (0.73) $ (0.11)
======= =======
Shares used in per share calculation....... 10,817 12,384
======= =======
</TABLE>

See accompanying notes to consolidated financial statements.

F-4
<PAGE> 74

MICROMUSE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)

<TABLE>
<CAPTION>
TOTAL
COMMON STOCK ADDITIONAL TREASURY STOCK DEFERRED CUMULATIVE STOCKHOLDERS'
--------------- PAID-IN ---------------- STOCK TRANSLATION ACCUMULATED EQUITY
SHARES AMOUNT CAPITAL SHARES AMOUNT COMPENSATION ADJUSTMENT DEFICIT (DEFICIT)
------ ------ ---------- ------ ------- ------------ ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances as of
September 30,
1994............... 2,969 $ 30 $ 47 -- $ -- $ -- $ -- $ 13 $ 90
Issuance of common
stock.............. 2,968 29 48 -- -- -- -- (77) --
Foreign currency
translation
adjustment......... -- -- -- -- -- -- 4 -- 4
Net loss............. -- -- -- -- -- -- -- (234) (234)
Dividend............. -- -- -- -- -- -- -- (63) (63)
----- ---- ------ ---- ------ ------ -------- -------- -------
Balances as of
September 30,
1995............... 5,937 59 95 -- -- -- 4 (361) (203)
Issuance of common
stock.............. 163 2 2 -- -- -- -- -- 4
Deferred compensation
related to grants
of stock options... -- -- 167 -- -- (167) -- -- --
Amortization of
deferred employee
compensation....... -- -- -- -- -- 167 -- -- 167
Foreign currency
translation
adjustment......... -- -- -- -- -- -- 46 -- 46
Net loss............. -- -- -- -- -- -- -- (236) (236)
----- ---- ------ ---- ------ ------ -------- -------- -------
Balances as of
September 30,
1996............... 6,100 61 264 -- -- -- 50 (597) (222)
Bonus shares
issued............. 450 5 1,138 -- -- -- -- -- 1,143
Stock options
exercised.......... 36 -- 130 -- -- -- -- -- 130
Compensation expense
related to stock
transfers.......... -- -- 210 -- -- -- -- -- 210
Treasury stock
purchased.......... -- -- -- (120) (300) -- -- -- (300)
Issuance of common
stock.............. 120 300 120 -- -- -- -- -- 420
Deferred compensation
related to grants
of stock options... -- -- 229 -- -- (229) -- -- --
Amortization of
deferred employee
compensation....... -- -- -- -- -- 14 -- -- 14
Foreign currency
translation
adjustment......... -- -- -- -- -- -- 2 -- 2
Net loss............. -- -- -- -- -- -- -- (7,876) (7,876)
Accretion on
redeemable
convertible
preferred stock.... -- -- -- -- -- -- -- (755) (755)
----- ---- ------ ---- ------ ------ -------- -------- -------
Balances as of
September 30,
1997............... 6,706 366 2,091 (120) (300) (215) 52 (9,228) (7,234)
Stock options
exercised
(unaudited)........ 4 -- 10 -- -- -- -- -- 10
Treasury stock
purchased
(unaudited)........ -- -- -- (778) (5,000) -- -- -- (5,000)
Amortization of
deferred employee
compensation
(unaudited)........ -- -- -- -- -- 14 -- -- 14
Foreign currency
translation
adjustment
(unaudited)........ -- -- -- -- -- -- (52) -- (52)
Net loss
(unaudited)........ -- -- -- -- -- -- -- (1,303) (1,303)
Accretion on
redeemable
convertible
preferred stock
(unaudited)........ -- -- -- -- -- -- -- (890) (890)
----- ---- ------ ---- ------ ------ -------- -------- -------
Balances as of
December 31, 1997
(unaudited)........ 6,710 $366 $2,101 (898) $(5,300) $ (201) $ -- $ (11,421) $ (14,455)
===== ==== ====== ==== ====== ====== ======== ======== =======
</TABLE>

See accompanying notes to consolidated financial statements.

F-5
<PAGE> 75

MICROMUSE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
THREE MONTHS
ENDED DECEMBER
YEAR ENDED SEPTEMBER 30, 31,
------------------------------ -----------------
1995 1996 1997 1996 1997
-------- -------- -------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................... $ (234) $ (236) $ (7,876) $ (869) $(1,303)
Adjustments to reconcile net loss to net
cash provided by (used in) operating
activities:
Depreciation and amortization............. 489 603 669 181 286
Loss on disposal of assets................ 484 242 51 4 --
Debt issuance costs....................... -- -- 1,350 -- --
Amortization of deferred employee
compensation............................ -- 167 14 -- 14
Compensation expense related to stock
transfers............................... -- -- 330 -- --
Compensation expense relating to bonus
shares issued........................... -- -- 1,143 -- --
Changes in operating assets and
liabilities:
Accounts receivable..................... (1,372) (2,495) 1,221 707 (1,129)
Inventories............................. 747 (53) 399 (636) --
Prepaid expenses and other current
assets............................... (618) (294) 315 (57) (215)
Related party loan...................... (25) (127) (994) (718) 1,153
Accounts payable........................ 85 1,806 (1,394) 684 (842)
Accrued expenses........................ 255 149 2,162 (89) (720)
Deferred revenue........................ 111 548 150 463 2,075
Long-term taxes payable................. 17 (22) -- -- --
-------- -------- -------- ------- -------
Net cash provided by (used in)
operating activities............... (61) 288 (2,460) (330) (681)
-------- -------- -------- ------- -------
Cash flows used in investing
activities - capital expenditures........... (397) (602) (2,147) (113) (335)
-------- -------- -------- ------- -------
Cash flows from financing activities:
Bank overdraft.............................. 309 677 (1,351) (25) --
Proceeds from short-term notes.............. 324 951 (1,000) 2,500 --
Payment of short-term notes................. -- -- (2,275) (1,071) --
Proceeds from long-term notes payable....... 414 -- -- --
Payments on long-term notes payable......... (204) (205) (268) -- --
Payments on capital lease obligations....... (332) (577) (244) (20) --
Proceeds from issuance of common stock...... -- 4 430 -- 10
Purchase of treasury stock.................. -- -- (300) -- (5,000)
Proceeds from issuance of redeemable
convertible preferred stock............... -- -- 20,760 -- --
Payment of dividends........................ (63) -- -- -- --
-------- -------- -------- ------- -------
Net cash provided by (used in)
financing activities............... 448 850 15,752 1,384 (4,990)
-------- -------- -------- ------- -------
Effect of exchange rate changes on cash and
cash equivalents............................ 4 46 2 10 (52)
-------- -------- -------- ------- -------
Net increase (decrease) in cash and cash
equivalents................................. (6) 582 13,147 951 (6,058)
Cash and cash equivalents at beginning of
year........................................ 18 12 594 594 13,741
-------- -------- -------- ------- -------
Cash and cash equivalents at end of year...... $ 12 $ 594 $ 13,741 1,545 7,683
======== ======== ======== ======= =======
Supplemental disclosures of cash flow
information:
Cash paid during the year - interest........ $ 79 $ 159 $ 154 86 --
======== ======== ======== ======= =======
Noncash financing activities - accretion on
redeemable convertible preferred stock.... $ -- $ -- $ 755 -- 890
======== ======== ======== ======= =======
</TABLE>

See accompanying notes to consolidated financial statements.

F-6
<PAGE> 76

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1995, 1996, AND 1997

(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED

DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business

Micromuse Inc. and subsidiaries (the Company) develops, markets, and
supports a family of scaleable, highly configurable, rapidly deployable,
software solutions for the effective monitoring and management of multiple
elements underlying an enterprise's information technology infrastructure. The
Company maintains its U.S. headquarters in California and its European
headquarters in London, England.

Micromuse plc was incorporated in England in 1989 and operated in the
United States through its subsidiary, Micromuse (USA) Inc., a Texas corporation.
In 1997, Micromuse plc became a subsidiary of Micromuse Inc., a Delaware
corporation. The Company entered into a stock exchange agreement with the
stockholders of the English corporation in March 1997. The Company's Board of
Directors approved an exchange of one share in the English corporation for
5.9365 shares in the Delaware corporation. The Certificate of Incorporation of
the Delaware corporation authorizes 18,500,000 shares of common stock at $0.01
par value per share and 5,988,336 shares of preferred stock at $0.01 par value
per share. The accompanying consolidated financial statements have been
retroactively restated to give effect to the reorganization and exchange of
common stock.

Registration Statement

In December 1997, the Board of Directors authorized the filing of a
registration statement with the Securities and Exchange Commission (SEC)
permitting the Company to sell shares of the Company's common stock in
connection with a proposed initial public offering (IPO). If the offering is
consummated under the terms presently anticipated, all the currently outstanding
shares of Series B preferred stock will automatically convert into 2,000,000
shares of common stock upon the closing of the proposed IPO. All of the
outstanding shares of Series C preferred stock will convert into 2,488,336
shares of common stock upon the written consent or agreement of the holders of
two-thirds of the outstanding shares of Series A, B, and C voting together as a
single class. The conversion of the preferred stock has been reflected in the
pro forma stockholders' equity as of September 30, 1997.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of
the Company and its subsidiaries. All significant intercompany balances and
transactions have been eliminated.

Use of Estimates

The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from these estimates.

F-7
<PAGE> 77

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997

(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED

DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

Cash Equivalents

The Company considers all highly liquid instruments with a purchased
maturity of 90 days or less to be cash equivalents.

Concentration of Credit Risk

Financial instruments consist of cash and trade receivables. Trade
receivables potentially subject the Company to concentrations of credit risk.
The Company closely monitors extensions of credit and has not experienced
significant credit losses in the past. Credit losses have been provided for in
the consolidated financial statements and have been within management's
expectations.

Fair Value of Financial Instruments

The fair value of the Company's cash and cash equivalents, accounts
receivable, accounts payable and the redeemable convertible preferred stock
approximate their respective carrying amounts defined as the amount at which the
instrument could be exchanged in a current transaction between willing parties.

Property and Equipment

Property and equipment are recorded at cost less accumulated depreciation.
Depreciation is calculated using the straight-line method over the estimated
useful lives of the assets, generally three years.

During 1996, the Company adopted the provisions of Statement of Financial
Accounting Standards (SFAS) No. 121, Accounting for the Impairment of Long-lived
Assets and for Long-lived Assets to Be Disposed Of. The adoption of SFAS No. 121
did not have a material effect on the Company's consolidated financial position
or results of operations.

Revenue Recognition

Revenues from software licenses are generally recognized upon shipment,
provided that no significant obligations remain and collection of the resulting
receivable is probable. Maintenance revenues for customer support are deferred
and recognized ratably over the term of the maintenance period, generally one
year. Consulting revenue is recognized when services are performed. In October
1997, the American Institute of Certified Public Accountants issued Statement of
Position 97-2, Software Revenue Recognition (SOP 97-2). SOP 97-2 generally
requires revenue earned on software arrangements involving multiple elements
such as software products, upgrades, enhancements, postcontract customer
support, installation and training to be allocated to each element based on the
relative fair values of the elements. The fair value of an element must be based
on evidence which is specific to the vendor. The revenue allocated to software
products, including specified upgrades or enhancements generally is recognized
upon delivery of the products. The revenue allocated to postcontract customer
support generally is recognized ratably over the term of the support, and
revenue allocated to service elements generally is recognized as the services
are performed. If evidence of the fair value for all element arrangement does
not exist, all revenue from the arrangement is deferred until such evidence
exists or until all elements are delivered. SOP 97-2

F-8
<PAGE> 78

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997

(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED

DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

was adopted effective October 1, 1997. There was no material change to the
Company's accounting for revenue as a result of the adoption of SOP 97-2.

Research and Development Costs

In accordance with SFAS No. 86, Accounting for the Costs of Computer
Software to Be Sold, Leased, or Otherwise Marketed, development costs related to
software products are expensed as incurred until the technological feasibility
of the product has been established. Technological feasibility in the Company's
circumstances occurs when a working model is completed. After technological
feasibility is established, additional costs would be capitalized. The Company
believes its process for developing software is essentially completed concurrent
with the establishment of technological feasibility, and, accordingly, no
research and development costs have been capitalized to date.

Income Taxes

The Company accounts for income taxes using the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amount of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which the temporary
differences are expected to be recovered or settled.

Stock-Based Compensation

The Company accounts for its stock-based compensation arrangements using
the intrinsic value method. As such, compensation expense is recorded when on
the date of grant the fair value of the underlying common stock exceeds the
exercise price for stock options or the purchase price for issuance or sales of
common stock.

Foreign Currency Translation

The functional currency of the Company's foreign subsidiaries is the local
foreign currency. The Company translates the assets and liabilities of its
foreign subsidiaries to U.S. dollars at the rates of exchange in effect at the
end of the year. Revenues and expenses are translated at the average rates of
exchange for the year. Translation adjustments and the effects of exchange rate
changes on intercompany transactions of long-term investment nature are included
in stockholders' deficit in the consolidated balance sheets. Gains and losses
resulting from foreign currency transactions denominated in a currency other
than the functional currency are included in income and have not been
significant to the Company's consolidated operating results in any period.

Pro Forma Net Loss Per Share

Pro forma basic net loss per share is computed using the weighted average
number of shares of common stock and redeemable convertible preferred stock
outstanding on an as-if converted basis. Pro forma diluted net loss per share is
computed using the weighted average number of shares of common stock and
redeemable convertible preferred stock outstanding on an as-if converted basis
and, when dilutive, common equivalent shares from options to purchase common
stock using the treasury stock method.

F-9
<PAGE> 79

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997

(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED

DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

Pursuant to certain SEC Staff Accounting Bulletins, common stock and
convertible preferred stock issued for consideration below the assumed IPO
price, and stock options granted and warrants issued with exercise prices below
the assumed IPO price during the 12-month period prior to the date of the
initial filing of the registration statement, even when antidilutive, have been
included in the calculation of pro forma net loss per share, using the treasury
stock method based on the assumed IPO price, as if they were outstanding for all
periods presented prior to their issuance or grant.

Unaudited Interim Financial Information

The consolidated financial information as of December 31, 1997 and for the
three months ended December 31, 1996 and 1997 is unaudited, but includes all
adjustments (consisting only of normal recurring adjustments) that the Company
considers necessary for a fair presentation of the financial position at such
dates and the operations and cash flows for the periods then ended. Operating
results for the three months ended December 31, 1997 are not necessarily
indicative of results that may be expected for the entire year.

Recent Accounting Pronouncements

In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income.
SFAS No. 130 establishes standards for reporting and displaying comprehensive
income and its components in the consolidated financial statements. It does not,
however, require a specific format for the statement, but requires the Company
to display an amount representing total comprehensive income for the period in
that financial statement. The Company is in the process of determining its
preferred format. This statement is effective for fiscal years beginning after
December 15, 1997.

In June 1997, the FASB issued SFAS No. 131, Disclosures about Segments of
an Enterprise and Related Information. SFAS No. 131 establishes standards for
the way public business enterprises report information about operating segments
in annual financial statements and requires those enterprises to report selected
information about operating segments in interim financial reports issued to
stockholders. SFAS No. 131 is effective for financial statements for periods
beginning after December 31, 1997. The Company has not yet determined whether it
has any separately reportable business segments.

2. DISCONTINUED OPERATIONS

In July 1997, the Company adopted a formal plan to discontinue its Systems
Integration division based in England. In September the Company sold the
division for approximately $400,000 in cash, net of fees. The disposition of the
division in September 1997 has been accounted for as a discontinued operation in
accordance with APB Opinion No. 30 and prior period consolidated financial
statements have been restated to reflect the discontinuation of the Systems
Integration business. Revenue from discontinued operations was $16.6 million,
$14.0 million and $15.7 million, respectively in fiscal 1995, 1996 and 1997. The
income (loss) from discontinued operations of $711,000, $569,000, and ($104,000)
in fiscal 1995, 1996, and 1997, respectively, represents the operation's
operating income. The gain on disposal of discontinued operations of $1.2
million in fiscal 1997 represents the gain on disposal of the operation
including net income from operations of $256,000 from the measurement date to
the disposal date. The

F-10
<PAGE> 80

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED
DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

following assets and liabilities are included in the consolidated balance sheet
as of September 30, 1996 (in thousands):

<TABLE>
<CAPTION>
1996
-------
<S> <C>
Cash and cash equivalents........................................ $ 162
Accounts receivable.............................................. 4,137
Inventory........................................................ 399
Prepaid expenses and other current assets........................ 692
Property and equipment........................................... 710
-------
Total assets..................................................... 6,100
Deferred revenue................................................. (1,049)
Other liabilities................................................ (6,131)
-------
Net liabilities.................................................. $(1,080)
=======
</TABLE>

If the revenues of the Systems Integration business and purchaser combined
exceed $22.9 million in the first year following the disposal date, additional
consideration of $250,000 is payable to the Company. At the end of the option
period, which expires at December 16, 1997, the purchaser has the option to pay
the Company further consideration of $250,000. If the purchaser decides not to
pay this amount, the Company is released from all obligations to perform any
services for the purchaser except as explicitly specified by the contract. As of
September 30, 1997, the Company has not recorded either of these amounts.

3. BALANCE SHEET COMPONENTS

Property and equipment

<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------ DECEMBER 31,
1996 1997 1997
------- ------ -------------
<S> <C> <C> <C>
In thousands:
Computer equipment.................... $ 1,583 $2,819 $ 3,114
Furniture and fixtures................ 196 959 976
Other................................. 591 597 620
------ ------ ------
2,370 4,375 4,710
Less accumulated depreciation......... (1,347) (1,925) (2,211)
------ ------ ------
$ 1,023 $2,450 $ 2,499
====== ====== ======
</TABLE>

Accrued expenses

<TABLE>
<S> <C> <C> <C>
In thousands:
Payroll and commission related........ $ 125 $ 996 $ 1,222
Other................................. 846 2,137 1,201
------- ------ -------------
$ 971 $3,133 2,423
======= ====== ==========
</TABLE>

F-11
<PAGE> 81

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997

(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED

DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

4. RELATED PARTY TRANSACTIONS

In July 1997, the Company repurchased, from a stockholder who is an officer
and a director, 120,000 shares of common stock at $2.50 per share for a total
price of $300,000.

In November 1997, the Company repurchased, from a stockholder who is an
officer and a director, 777,605 shares of common stock at $6.43 per share for a
total price of $5.0 million. The stockholder used a portion of the proceeds to
repay an interest free loan from the Company.

5. NOTES PAYABLE

In February 1995, the Company entered into a $597,000 loan agreement with a
bank, bearing interest at 10% per annum, expiring in December 2000. The note was
repaid in full by the Company in 1997.

In April 1996, the Company entered into a convertible promissory note
agreement for $1,000,000. The note was convertible to Series A Preferred Stock.
The note was repaid in full by the Company in December 1996.

6. STOCKHOLDERS' EQUITY

Redeemable Convertible Preferred Stock

Redeemable convertible preferred stock as of September 30, 1997, was
comprised of the following:

<TABLE>
<CAPTION>
SHARES ISSUED CARRYING
AND OUTSTANDING VALUE
--------------- -----------
<S> <C> <C>
Series A.................................... -- $ 1,468,000
Series B.................................... 2,000,000 5,333,000
Series C.................................... 2,488,336 16,064,000
---------- -----------
4,488,336 $22,865,000
========== ===========
</TABLE>

Holders of Series A, B, and C preferred stock may convert all or part of
their shares at any time after the date of issuance into such number of common
stock as is determined by dividing $2.00, $2.50 and $6.43, respectively, by the
conversion price in effect at the time. Conversion is automatic upon the closing
of an IPO of the Company's common stock, with respect to Series A and B, at a
price of not less than $6.86 per share and with aggregate proceeds of not less
than $10 million and with respect to Series C, at a price not less than $9.65
per share if such public offering occurs on or before September 8, 1998, and
$12.86 per share thereafter, and with aggregate proceeds of not less than $10
million or by written consent or agreement of the holders of two-thirds of the
outstanding shares of Series A, B, and C voting together as a single class.

The holders of the Series A, B, and C preferred stock shall be entitled to
receive noncumulative dividends of $0.20, $0.25, and $0.643 per share per annum,
respectively, when, and if, declared by the Board of Directors.

Upon the occurrence of a liquidation event, such as a dissolution of the
Company or a merger or sale of assets, the holders of Series A, B, and C
preferred stock shall be entitled to receive in preference to holders of common
stock an amount equal to the original issuance price and an amount equal to
declared but unpaid dividends, and thereafter, share any remaining proceeds on a
pro rata basis with the holders of common stock based on the number of shares of
common stock held by each, assuming full conversion of Series A, B, and C
preferred stock.

F-12
<PAGE> 82

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997

(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED

DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

The Company shall redeem the Series A, B, and C preferred stock at the
option of the holders of preferred stock after March 6, 2002, subject to
reasonable financial stability considerations, payable quarterly thereafter
until satisfied. The holders of preferred stock shall be entitled to a
redemption price per share equal to the original issuance price, plus an
annually compounded 15% cumulative rate of return thereon. The Company is
accruing the 15% rate of return to the redemption date. The amount currently
accrued is included in the carrying value of the redeemable convertible
preferred stock.

A $3.0 million line of credit was made available to the Company in March
1997. Interest under the line of credit was at no more than prime plus 2% and
funds drawn were to be used to finance an acquisition or other vehicle of growth
as approved by the Board of Directors. The $3.0 million line of credit was
available as of September 30, 1997. If exercised, the line of credit will become
due and payable upon the earliest of a qualified public offering, a qualified
acquisition, or expiration of the Series A warrant issued in conjunction with
the line of credit. During fiscal 1997, the Company drew down $1.0 million which
was repaid as of September 30, 1997. The warrant expires on the earlier of March
2002, or the closing date of a public offering, merger, or acquisition of the
Company. The warrant issued in conjunction with the line of credit allows the
holder to purchase 1,500,000 shares of the Series A preferred stock at an
exercise price of $2.00 per share. The warrant was initially recorded at fair
value of $1,350,000 which is included in the carrying value of the Series A
preferred stock and treated as a debt issuance cost. This cost is being
amortized to interest expense over the period from the date of issuance to the
anticipated date of the initial public offering, which resulted in a noncash
interest charge of $1,050,000 in fiscal 1997 and the remaining debt issuance
cost at September 30, 1997 is included in prepaid expenses and other current
costs.

Common Stock

In March 1997, approximately 450,000 shares of common stock were issued to
stockholders as bonuses. The Company recorded compensation expense of $1,138,000
for the fair market value of such shares. During fiscal 1997, the principal
stockholders transferred shares of common stock to certain employees. The
Company recorded compensation expense of $210,000 for the difference between the
fair market value and the transfer price of the common stock.

Under the Company's 1997 Stock Option/Stock Issuance Plan (the Plan),
options to purchase up to an aggregate of approximately 1,532,000 shares of
common stock may be granted to employees, officers, directors, and consultants.
If the warrant to purchase 1,500,000 shares of Series A is exercised upon an
IPO, options to purchase an additional 166,666 shares of common stock will be
reserved under the Plan. The Plan provides for the issuance of incentive options
to employees that must be granted at an exercise price not less than 100% (110%
if the person to whom the option is granted is a 10% stockholder) of the fair
market value of the common stock on the date of grant. Options generally vest
over four years from the date of grant. The options expire between 5 and 10
years from the grant date, and any vested options must normally be exercised
within three months after termination of employment. The Plan is administered by
the Company's Board of Directors.

F-13
<PAGE> 83

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997

(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED

DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

A summary of the status of the Company's options under the plan is as
follows:

<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
--------------------------------------
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
NUMBER EXERCISE FAIR
OF SHARES PRICE VALUE
---------- --------- ---------
<S> <C> <C> <C>
Balances as of September 30, 1994.... 444,875 $2.41 --
Granted at market value.............. 31,208 2.40 --
--------- ------- ----
Balances as of September 30, 1995.... 476,083 2.41 --
Granted at greater than market
value.............................. 212,266 3.21 0.10
Granted at market value.............. 70,765 2.31 0.36
Granted at less than market value.... 133,915 1.06 1.43
Canceled............................. (317,650) 2.31 --
--------- ------- ----
Balances as of September 30, 1996.... 575,379 2.43 --
Granted at greater than market
value.............................. 269,992 2.50 1.25
Granted at market value.............. 640,856 2.55 0.43
Exercised............................ (36,320) 3.50 --
Canceled............................. (137,821) 3.31 --
--------- ------- ----
Balances as of September 30, 1997.... 1,312,086 2.38 --
Granted at market value (unaudited).. 50,724 7.20 1.10
Exercised (unaudited)................ (4,371) 2.31 --
Canceled (unaudited)................. (7,769) 2.76 --
--------- ------- ----
Balances as of December 31, 1997
(unaudited)........................ 1,350,670 2.56 --
========= ======= ====
</TABLE>

As of September 30, 1996 and 1997 and December 31, 1997, 338,083, 267,687
and 276,406 shares, with weighted-average exercise prices of $2.43, $1.97 and
$1.98, were fully vested and exercisable, respectively. As of December 31, 1997,
57,045 shares are available for grant.

The following table summarizes information concerning outstanding and
exercisable options under the plans outstanding as of September 30, 1997 and
December 31, 1997:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------------------------- OPTIONS EXERCISABLE
WEIGHTED- ----------------------
AVERAGE WEIGHTED- WEIGHTED-
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE LIFE (IN EXERCISE EXERCISE
PRICES SHARES YEARS) PRICE SHARES PRICE
------------- --------- ---------- ---------- ------- ----------
<S> <C> <C> <C> <C> <C> <C>
September 30, 1997 $0.03-2.50 1,237,984 9.13 $ 2.29 202,875 $ 1.43
$6.43 74,102 6.34 3.99 64,862 3.64
--------- ---- ----- ------- -----
1,312,086 8.97 $ 2.38 267,687 $ 1.97
========= ==== ===== ======= =====
December 31, 1997 $0.03-3.64 1,291,432 8.73 $ 2.35 276,406 $ 1.98
$6.43-8.00 59,240 9.79 7.08 -- --
--------- ---- ----- ------- -----
1,350,671 8.77 $ 2.56 276,406 $ 1.98
========= ==== ===== ======= =====
</TABLE>

F-14
<PAGE> 84

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997

(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED

DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

The Company uses the intrinsic value-based method to account for all of its
employee stock-based compensation plans. Accordingly, no compensation cost has
been recognized for its stock options in the accompanying consolidated financial
statements because the fair value of the underlying common stock equals or
exceeds the exercise price of the stock options at the date of grant, except
with respect to certain options issued in 1996 and during fiscal 1997. The
Company has recorded deferred stock compensation expense of $167,000 and
$229,000 for the difference at the grant date between the exercise price and the
fair value of the common stock underlying the options issued in September 1996
and fiscal 1997, respectively. The $167,000 was amortized in fiscal 1996 as the
options were fully vested upon issuance and $14,000 of the $229,000 was
amortized in both fiscal 1997 and in the three month period ended December 31,
1997 as the options vest over four years.

Had compensation cost for the Company's stock options been determined in a
manner consistent with SFAS No. 123, Accounting for Stock-Based Compensation,
the Company's net loss and loss per share would not have been materially
different from that disclosed in the Consolidated Statements of Operations.

The per share weighted-average fair value of stock options granted during
1996, 1997 and the three month period ended December 31, 1997 was $0.57, $0.67
and $1.10, respectively, on the date of grant using the minimum value method
with the following weighted assumptions: 1996 -- expected dividend yield 0.0%,
risk-free interest rate of 6.06%, and expected life of 3 years; 1997 -- expected
dividend yield of 0.0%, risk-free interest rate of 6.28%, and expected life of 3
years; three months ended December 31, 1997 -- expected dividend yield of 0.0%,
risk-free interest rate of 5.71%, and expected life of 3 years.

In July 1997, 120,000 shares were issued to two directors at $2.50 per
share, under the Plan. The Company has recorded stock compensation expense of
$120,000, for the difference between the issuance price and the fair market
value of the common stock.

Preferred Stock

In 1997, the Board of Directors approved an amendment to the Certificate of
Incorporation to allow, upon completion of the IPO, the issuance of up to
5,000,000 shares of preferred stock and to determine the price, rights,
preferences, and privileges, including voting and redemption rights of those
shares without further vote or action by the stockholders.

7. INCOME TAXES

The provision for income taxes attributable to continuing operations in
fiscal 1996 was primarily for current federal income taxes. As of September 30,
1997, the Company had approximately $2.4 million and $1.4 million of net
operating loss carryforwards for federal and state purposes, respectively. The
federal net operating loss carryforwards expire in 2012. The state net operating
loss carryforwards expire primarily in 2002. The difference between the federal
and state net operating loss carryforwards is due primarily to a 50% limitation
on net operating loss carryforwards for California purposes. As of September 30,
1997, the Company also had approximately $1.8 million and $200,000 of loss
carryforwards in England and Australia, respectively. The loss carryforwards of
the English company can be carried forward indefinitely. The Australian loss
carryforwards can also be carried forward indefinitely, subject to certain
restrictions.

F-15
<PAGE> 85

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997

(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED

DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

The tax effects of temporary differences that give rise to significant
portions of deferred tax assets as of September 30, 1996 and 1997, are presented
below (in thousands):

<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Various accruals and reserves not deductible for tax
purposes.................................................. $ -- $ 498
Net operating loss carryforwards............................ 28 1,525
Property and equipment...................................... 56 124
Other....................................................... -- 25
------- -------
Total deferred tax assets......................... 84 2,172
Valuation allowance......................................... (84) (2,172)
------- -------
Net deferred tax assets........................... $ -- $ --
======= =======
</TABLE>

The valuation allowance increased by $2.1 million for the year ended
September 30, 1997.

Income (loss) before income taxes is comprised as follows (in thousands):

<TABLE>
<CAPTION>
1995 1996 1997
----- ------- -------
<S> <C> <C> <C>
United States.................................... $ (5) $ 851 $(4,931)
Europe........................................... (940) (1,556) (4,002)
------- ------- -------
Total....................................... $(945) $ (705) $(8,933)
======= ======= =======
</TABLE>

Federal and state tax laws impose substantial restrictions on the
utilization of net operating loss carryforwards in the event of an "ownership
change" as defined in Section 382 of the Internal Revenue Code. The Company has
not yet determined whether an ownership change occurred due to significant stock
transactions in each of the reporting years disclosed. If an ownership change
has occurred, utilization of the net operating loss carryforwards could be
significantly reduced. Additionally, loss carryforwards of either Micromuse Inc.
or Micromuse USA Inc. cannot be utilized against future profits generated by the
other company.

Total income tax expense from continuing operations differs from expected
income tax expense (computed by applying the U.S. federal corporate income tax
rate of 34% to profit (loss) before taxes, as follows (in thousands):

<TABLE>
<CAPTION>
1995 1996 1997
----- ----- -------
<S> <C> <C> <C>
Income tax expense (benefit) at federal statutory
rate............................................... $(321) $(240) $(2,532)
State income taxes, net of federal income tax
benefit............................................ -- 10 --
Unutilized losses.................................... 321 345 2,514
Change in beginning of year valuation allowance...... -- (16) --
Other................................................ -- 1 18
----- ----- -------
$ -- $ 100 $ --
====== ====== =======
</TABLE>

F-16
<PAGE> 86

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED
DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

8. GEOGRAPHIC INFORMATION

The Company markets its products primarily from its operations in the
United States. Direct sales in Europe are primarily to customers in France,
Germany, and the United Kingdom. Information regarding operations in different
geographic regions is as follows (in thousands):

<TABLE>
<CAPTION>
1995 1996 1997
------ ------ -------
<S> <C> <C> <C>
Revenues:
United States.................................... $ 349 $2,030 $ 4,810
Europe........................................... 1,097 2,485 4,482
------ ------ -------
Total.................................... $1,446 $4,515 $ 9,292
====== ====== =======
Income (loss) from continuing operations:
United States.................................... $ (5) $ 725 $(4,931)
Europe........................................... (940) (1,530) (4,002)
------ ------ -------
Total.................................... $ (945) $ (805) $(8,933)
====== ====== =======
Identifiable assets:
United States.................................... $ 164 $1,467 $15,398
Europe........................................... 302 1,540 7,342
Assets related to discontinued operations........ 5,301 6,100 --
------ ------ -------
Total.................................... $5,767 $9,107 $22,740
====== ====== =======
</TABLE>

Intercompany transfers between geographic areas are accounted for using the
transfer prices in effect for subsidiaries.

9. MAJOR CUSTOMERS

A summary of the net sales to major customers that exceed 10% of total
revenues during each of the years in the three-year period ended September 30,
1997, and the amount due from these customers as of September 30, 1997, follows
(accounts receivable in thousands):

<TABLE>
<CAPTION>
ACCOUNTS
1995 1996 1997 RECEIVABLE
---- ---- ---- ----------
<S> <C> <C> <C> <C>
Customer 1................................ -- -- 18% $311
Customer 2................................ 57% 14% 9% 898
</TABLE>

10. COMMITMENTS

The Company leases its facilities and certain equipment under noncancelable
operating leases. The lease agreements expire at various dates during the next
11 years.

Rent expense was approximately $80,000, $215,000 and $538,000 for the years
ended September 30, 1995, 1996, and 1997, respectively. Future minimum lease
payments under noncancelable operating leases will be approximately $890,000,
$822,000, $764,000, $667,000, $325,000 and $825,000 for each of the years in the
five-year period and thereafter, respectively.

In August 1997, the Company obtained a lease facility of $300,000 for
equipment. The term of the lease facility is 42 months. As of September 30,
1997, the lease facility remained unused.

F-17
<PAGE> 87

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997

(INFORMATION AS OF DECEMBER 31, 1997 AND FOR THE THREE MONTHS ENDED

DECEMBER 31, 1996 AND 1997 IS UNAUDITED)

11. PRO FORMA INFORMATION (UNAUDITED)

The following table reflects the exercise of the Series A preferred stock
warrant and the conversion of the redeemable convertible preferred stock into
common stock in the accompanying consolidated balance sheet (in thousands):

<TABLE>
<CAPTION>
DECEMBER 31, 1997
------------------------------------------
HISTORICAL ADJUSTMENTS PRO FORMA
----------- ----------- ----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash.................................. $ 7,683 $ 3,000 $ 10,683
Other current assets.................. 6,740 -- 6,740
------- ------- ------
Total current assets.......... 14,423 3,000 17,423
Other noncurrent assets................. 2,499 -- 2,499
------- ------- ------
Total assets.................. $ 16,922 $ 3,000 $ 19,922
======= ======= ======
Total liabilities....................... $ 7,622 $ -- $ 7,622
Redeemable convertible preferred
stock................................. 23,755 (23,755) --
Stockholders' equity (deficit)
Common stock.......................... 366 60 426
Additional paid-in capital............ 2,101 26,695 28,796
Treasury stock, at cost:
897,605 shares..................... (5,300) -- (5,300)
Deferred stock compensation........... (201) -- (201)
Accumulated deficit................... (11,421) -- (11,421)
------- ------- ------
Total stockholders' equity
(deficit)........................ (14,455) 26,755 12,300
------- ------- ------
Total liabilities and
stockholders' equity
(deficit)................... $ 16,922 $ 3,000 $ 19,922
======= ======= ======
</TABLE>

F-18
<PAGE> 88

Netcool(R), Micro Muse M(R) and the Micromuse logo are registered
trademarks of the Company and Micromuse(TM) NETCOOL/OMNIbus(TM) and
Netcool/Reporter(TM) are trademarks of the Company. All other trademarks or
service marks appearing in this Prospectus are trademarks or service marks of
the respective companies that utilize them.
<PAGE> 89

APPENDIX -- DESCRIPTION OF GRAPHICS

INSIDE FRONT COVER

NETCOOL SUITE LOGO

Graphic: Illustration of operators managing Internet, Web Connects, Network
Devises, Databases, Applications, Systems, LANs and Carrier Services.

Caption: Netcool/OMNIbus is a state-of-the-art service level management system,
designed for building and managing views of business services in realtime.

Photo:

Caption: Telecommunications Firms. Using Netcool, the availability of a Telco's
ATM, Frame Relay, or other managed service can be discovered in realtime.

Photo:

Caption: Internet Service Providers. In the ISP world, Netcool monitors the
status of user-to-Internet connections and services such as Web hosting.

Photo:

Caption: Mission-Critical Enterprises. In large scale, global networks, Netcool
monitors the availability of any application, such as e-mail or Wall Street
trading.

BACK OUTSIDE COVER

Micromuse Inc. logo.

GATEFOLD

Caption: Reduced cost of ownership. No need to retool. Off the shelf, Netcool
collects event data from existing disparate management systems across the
enterprise . . . and formats it into one centralized data repository.

Reduced problem isolation time. Netcool provides operators with a realtime,
enterprise-wide view of network and service status, allowing operators to
quickly isolate and resolve problems.

Maximized operator efficiency. Operators use drag-and-drop to custom-design
their own personalized "service views" of event data . . . and view them in
realtime.

Minimal staffing requirements. Netcool reduces data overload and adapts quickly
to network changes, enabling fewer staff to manage network growth and
change.

Full leveraging of collected data. Off-the-shelf gateways direct event data to
historical databases such as Oracle or Sybase, the Remedy AR System, or
other Netcool data repositories.

Micromuse is a leader in service level management technologies that are designed
to deliver a rapid return on investment.

Graphic: Illustration of Netcool ObjectServer gathering information via Probes
from Internet, Web Connects, Network Devices, Databases, Applications,
Systems, LANs and Carrier Services.

Netcool Suite logo.

Caption: ...designed to deliver a rapid return on investment in service level
management deployments.

Screen Shot:
Caption: Using the Netcool ViewBuilder, operators design their own
views of network-wide events.

Screen Shot:
Caption: Netcool/Reporter manipulates data in the ObjectServer to output
availability reports for analysis by administrators.

Screen Shot:
Caption: Netcool/Reporter outputs data in graphical formats that can be
matched with Service Level Agreements.

Screen Shot:
Caption: The FilterBuilder allows operators to intuitively associate events
with network services and applications.

Screen Shot:
Caption: At the EventList Console, "lava lamps" allow managers to recognize
critical events -- shown in red -- before a service is affected.

Screen Shot:
Caption: EventLists let each operator view only those events that affect
services they are responsible for monitoring.

Screen Shot:
Caption: The ObjectiveView provides operators with a single topological view of
the enterprise through which to access EventLists.

Micromuse Inc. logo.

PAGE 39

Graphic: Illustration of the architecture of the Company's Netcool
product suite.
<PAGE> 90

NO DEALER, SALESMAN, OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS IN
CONNECTION WITH THE OFFERING COVERED BY THIS PROSPECTUS. IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY, THE SELLING STOCKHOLDERS OR THE UNDERWRITERS. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF ANY OFFER TO BUY, THE
COMMON STOCK IN ANY JURISDICTION WHERE, OR TO ANY PERSON TO WHOM, IT IS UNLAWFUL
TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR
ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION
THAT THERE HAS NOT BEEN ANY CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF.

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
The Company........................... 4
Risk Factors.......................... 5
Use of Proceeds....................... 17
Dividend Policy....................... 17
Capitalization........................ 18
Dilution.............................. 19
Selected Consolidated Financial
Data................................ 20
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 22
Business.............................. 34
Management............................ 50
Certain Transactions.................. 57
Principal and Selling Stockholders.... 59
Description of Capital Stock.......... 61
Shares Eligible for Future Sale....... 64
Underwriting.......................... 66
Legal Matters......................... 68
Experts............................... 68
Additional Information................ 68
Index to Financial Statements......... F-1
</TABLE>

UNTIL , 1998 (25 DAYS AFTER THE COMMENCEMENT OF THIS OFFERING),
ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER
A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
- ---------------------------------------------------------

LOGO

3,000,000 SHARES

COMMON STOCK
DEUTSCHE MORGAN GRENFELL

NATIONSBANC MONTGOMERY SECURITIES

SALOMON SMITH BARNEY

PROSPECTUS

, 1998
<PAGE> 91

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the Company in connection
with the sale of Common Stock being registered. All amounts are estimates except
the SEC registration fee and the NASD filing fees.

<TABLE>
<S> <C>
SEC Registration fee.................................................. $ 9,160
NASD fee.............................................................. 3,605
Nasdaq National Market listing fee.................................... 1,000
Printing and engraving expenses....................................... 195,000
Legal fees and expenses............................................... 450,000
Accounting fees and expenses.......................................... 390,000
Blue sky fees and expenses............................................ 5,000
Transfer agent fees................................................... 20,000
Miscellaneous fees and expenses....................................... 26,235
---------
Total....................................................... $1,100,000
=========
</TABLE>

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

Section 145 of the Delaware General Corporation Law authorizes a court to
award or a corporation's Board of Directors to grant indemnification to
directors and officers in terms sufficiently broad to permit such
indemnification under certain circumstances for liabilities (including
reimbursement for expenses incurred) arising under the Securities Act of 1933,
as amended (the "Securities Act"). Article IX, Section 1, of the Registrant's
Bylaws provides for mandatory indemnification of its directors and officers and
permissible indemnification of employees and other agents to the maximum extent
permitted by the Delaware General Corporation Law. The Registrant's Restated
Certificate of Incorporation provides that, pursuant to Delaware law, its
directors shall not be liable for monetary damages for breach of the directors'
fiduciary duty as directors to the Company and its stockholders. This provision
in the Restated Certificate of Incorporation does not eliminate the directors'
fiduciary duty, and in appropriate circumstances equitable remedies such as
injunctive or other forms of non-monetary relief will remain available under
Delaware law. In addition, each director will continue to be subject to
liability for breach of the director's duty of loyalty to the Company for acts
or omissions not in good faith or involving intentional misconduct, for knowing
violations of law, for actions leading to improper personal benefit to the
director, and for payment of dividends or approval of stock repurchases or
redemptions that are unlawful under Delaware law. The provision also does not
affect a director's responsibilities under any other law, such as the federal
securities laws or state or federal environmental laws. The Registrant has
entered into Indemnification Agreements with its officers and directors, a form
of which is attached as Exhibit 10.1 hereto and incorporated herein by
reference. The Indemnification Agreements provide the Registrant's officers and
directors with further indemnification to the maximum extent permitted by the
Delaware General Corporation Law. Reference is made to Section 6 of the
Underwriting Agreement contained in Exhibit 1.1 hereto, indemnifying officers
and directors of the Registrant against certain liabilities.

II-1
<PAGE> 92

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

Since September 30, 1994, the Registrant has sold and issued the following
unregistered securities:

1. The Registrant issued and sold 120,000 shares of its Common Stock
at a per share price of $2.50 for an aggregate purchase price of $300,000
to certain directors pursuant to direct issuances under its 1997 Stock
Option/Stock Issuance Plan (Exhibit 10.2).

2. On April 18, 1996, the Registrant issued and sold notes convertible
to Series A Preferred Stock in the aggregate principal amount of $1,000,000
to M.D. Strategic, L.P., Seedling Fund, L.P. and P.V. II, L.P. The notes
were repaid without conversion to Series A Preferred Stock.

3. On March 6, 1997, the Registrant issued and sold a warrant
exercisable for 1,500,000 shares of Series A Preferred Stock at $2.00 per
share in consideration for the execution and delivery of a Credit Agreement
whereby Sierra Ventures V, L.P. agreed to make revolving loans to the
Registrant in an aggregate amount of up to $3,000,000 for a period of five
years and 2,000,000 shares of Series B Preferred Stock for an aggregate
purchase price of $5,000,000 to Sierra Ventures V, L.P.

4. On September 8, 1997, the Registrant issued and sold 2,488,336
shares of Series C Preferred Stock for an aggregate purchase price of
$16,000,000.48 to a group of eighteen investors.

The issuances described in Item 15(a)(1) were deemed exempt from
registration under the Act in reliance upon Rule 701 promulgated under the Act.
The issuance of the securities described in items 15(a)(2), (3) and (4) were
deemed to be exempt from registration under the act in reliance on Section 4(2)
of the Act as transactions by an issuer not involving any public offering. In
addition, the recipients of the above-described securities represented their
intentions to acquire the securities for investment only and not with a view to
or for sale in connection with any distribution thereof. Appropriate legends
were affixed to the share certificates and warrants issued in such transactions.
All recipients had adequate access, through employment or other relationships
with the Registrant, to information about the Registrant.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------------------------------------------------------------------------------
<S> <C>
1.1+ Form of Underwriting Agreement (preliminary form).
2.1+ Agreement for the sale of the systems integration business of Micromuse plc by and
among Micromuse plc, Horizon Open Systems (UK) Limited and Horizon Computer
Services Limited, dated as of September 16, 1997.
3.1+ Restated Certificate of Incorporation of the Registrant, as amended to date.
3.2** Form of Restated Certificate of Incorporation to be filed upon the closing of the
offering made pursuant to this Registration Statement.
3.3+ Bylaws of the Registrant.
3.4** Form of Amended and Restated Bylaws to be effective upon the effectiveness of this
Registration Statement.
4.1 Reference is made to Exhibits 3.1, 3.2, 3.3, 3.4. and 10.4.
4.2* Specimen Common Stock certificate.
5.1** Opinion of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP.
</TABLE>

II-2
<PAGE> 93

<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- -----------------------------------------------------------------------------------
<S> <C>
10.1+ Form of Indemnity Agreement to be entered into between the Registrant and its
directors and officers prior to the effectiveness of this Registration Statement.
10.2** 1997 Stock Option/Stock Issuance Plan and forms of agreements thereunder.
10.3** 1997 Employee Stock Purchase Plan.
10.4** Amended and Restated Investors' Rights Agreement by and among the Registrant and
certain stockholders of the Registrant, dated as of September 8, 1997.
10.5+ Office lease, dated as of March 25, 1997, by and between the Registrant and SOMA
Partners, L.P.
10.6+ Office lease, dated as of March 3, 1997, by and between Micromuse plc, Marldown
Limited and Christopher J. Dawes.
10.7+ Office lease, dated as of March 3, 1993, by and between Micromuse plc, Guildquote
Limited and Christopher J. Dawes.
10.8+ Agreement for the sale of the systems integration business of Micromuse plc dated
as of September 16, 1997. Reference is made to Exhibit 2.1.
11** Computation of weighted average shares outstanding.
21.1+ Subsidiaries of the Registrant.
23.1** Consent of KPMG Peat Marwick LLP, Independent Auditors.
23.2** Consent of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP. Reference
is made to Exhibit 5.1.
24.1 Power of Attorney (see page II-5).
27+ Financial Data Schedule.
</TABLE>

- ---------------

* To be filed by amendment.

** Are filed herewith.

+ Filed previously.

(B) FINANCIAL STATEMENT SCHEDULES

ITEM 17. UNDERTAKINGS

The Registrant hereby undertakes to provide to the Underwriters at the
closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.

Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the Delaware General Corporation Law, the Restated
Certificate of Incorporation or the Bylaws of the Registrant, the Underwriting
Agreement, or otherwise, the Registrant has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act, and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by the Registrant of expenses incurred or paid by a director,
officer, or controlling person of the Registrant in the successful defense of
any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered hereunder,
the Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate jurisdiction
the question of whether such indemnification by it is against public policy as
expressed in the Securities Act and will be governed by the final adjudication
of such issue.

II-3
<PAGE> 94

The Registrant hereby undertakes that:

(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of Prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a
form of Prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.

(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of Prospectus shall
be deemed to be a new Registration Statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.

II-4
<PAGE> 95

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this amendment to the Registration Statement No.
333-42177 to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of San Francisco, State of California, on this 20th day
of January, 1998.

MICROMUSE INC.

By: /s/ CHRISTOPHER J. DAWES
------------------------------------
Christopher J. Dawes
President and Chief Executive
Officer

POWER OF ATTORNEY

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, AS AMENDED,
THIS REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED:

<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------------------------------------------- ------------------------- -------------------
<C> <S> <C>

/s/ CHRISTOPHER J. DAWES President, Chief January 20, 1998
- --------------------------------------------- Executive Officer and
Christopher J. Dawes Director (Principal
Executive Officer)

/s/ STEPHEN A. ALLOTT Senior Vice President, January 20, 1998
- --------------------------------------------- Finance (Principal
Stephen A. Allott Financial and Accounting
Officer)

/s/ ANGELA DAWES* Director of Sales, January 20, 1998
- --------------------------------------------- Western Region and
Angela Dawes Director

/s/ JEFFREY M. DRAZAN* Director January 20, 1998
- ---------------------------------------------
Jeffrey M. Drazan

/s/ DAVID C. SCHWAB* Director January 20, 1998
- ---------------------------------------------
David C. Schwab

*By: /s/ CHRISTOPHER J. DAWES
- ---------------------------------------------
Christopher J. Dawes
(Attorney-in-Fact)

/s/ STEPHEN A. ALLOTT
- ---------------------------------------------
Stephen A. Allott
(Attorney-in-Fact)
</TABLE>

II-5
<PAGE> 96

MICROMUSE INC. AND SUBSIDIARIES

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS

(IN THOUSANDS)

<TABLE>
<CAPTION>
BALANCE AT DEDUCTIONS: BALANCE AT
BEGINNING OF WRITE OFFS END OF
DESCRIPTION PERIOD ADDITIONS OF ACCOUNTS PERIOD
------------ --------- ----------- ----------
<S> <C> <C> <C> <C>
Allowance for returns and doubtful accounts
Three months ended December 31, 1997
(unaudited)................................ $ -- $30 $-- $ 30
</TABLE>

S-1
<PAGE> 97

EXHIBIT INDEX

(a) EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
- ------- ------------------------------------------------------------------------------------
<S> <C>
1.1+ Form of Underwriting Agreement (preliminary form).
2.1+ Agreement for the sale of the systems integration business of Micromuse plc by and
among Micromuse plc, Horizon Open Systems (UK) Limited and Horizon Computer Services
Limited, dated as of September 16, 1997.
3.1+ Restated Certificate of Incorporation of the Registrant, as amended to date.
3.2** Form of Restated Certificate of Incorporation to be filed upon the closing of the
offering made pursuant to this Registration Statement.
3.3+ Bylaws of the Registrant.
3.4** Form of Amended and Restated Bylaws to be effective upon the effectiveness of this
Registration Statement.
4.1 Reference is made to Exhibits 3.1, 3.2, 3.3, 3.4, and 10.4.
4.2* Specimen Common Stock certificate.
5.1** Opinion of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP.
10.1+ Form of Indemnity agreement to be entered into between the Registrant and its
directors and officers prior to the effectiveness of this Registration Statement.
10.2** 1997 Stock Option/Stock Issuance Plan and forms of agreements thereunder.
10.3** 1997 Employee Stock Purchase Plan.
10.4** Amended and Restated Investors' Rights Agreement by and among the Registrant and
certain stockholders of the Registrant, dated as of September 8, 1997.
10.5+ Office lease, dated as of March 25, 1997, by and between the Registrant and SOMA
Partners, L.P.
10.6+ Office lease, dated as of March 3, 1997, by and between Micromuse plc, Marldown
Limited and Christopher J. Dawes.
10.7+ Office lease dated as of March 3, 1997, by and between Micromuse plc, Guildquote
Limited and Christopher J. Dawes.
10.8+ Agreement for the sale of the systems integration business of Micromuse plc dated as
of September 16, 1997. Reference is made to Exhibit 2.1.
11** Computation of weighted average shares outstanding.
21.1+ Subsidiaries of the Registrant.
23.1** Consent of KPMG Peat Marwick LLP, Independent Auditors.
23.2** Consent of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP. Reference
is made to Exhibit 5.1.
24.1 Power of Attorney (see page II-5).
27+ Financial Data Schedule.
</TABLE>

- ---------------

* To be filed by amendment.

** Are filed herewith.

+ Filed previously.

<PAGE> 1
EXHIBIT 3.2

RESTATED
CERTIFICATE OF INCORPORATION OF
MICROMUSE INC.
A DELAWARE CORPORATION

(PURSUANT TO SECTIONS 228, 242 AND 245
OF THE DELAWARE GENERAL CORPORATION LAW)

Micromuse Inc., a corporation organized and existing under the
General Corporation Law of the State of Delaware (the "General Corporation Law")

DOES HEREBY CERTIFY:

FIRST: That this corporation was originally incorporated on
May 1, 1996, pursuant to the General Corporation Law.

SECOND: That the Board of Directors duly adopted resolutions
proposing to amend and restate the Amended and Restated Certificate of
Incorporation of this corporation, declaring said amendment and restatement to
be advisable and in the best interests of this corporation and its stockholders,
and authorizing the appropriate officers of this corporation to solicit the
consent of the stockholders therefor, which resolution setting forth the
proposed amendment and restatement is as follows:

"RESOLVED, that the Restated Certificate of Incorporation of this
corporation, as amended, be amended and restated in its entirety as follows:

ARTICLE I

The name of the corporation is Micromuse Inc. (the
"Corporation").

ARTICLE II

The address of the registered office of this corporation in the
State of Delaware is 1013 Centre Road, in the City of Wilmington, County of New
Castle. The name of its registered agent at such address is Corporation Services
Company.

ARTICLE III

The nature of the business or purposes to be conducted or
promoted is to engage in any lawful act or activity for which corporations may
be organized under the General Corporation Law of Delaware.

ARTICLE IV

The Corporation is authorized to issue two classes of stock to be
designated common stock ("Common Stock") and preferred stock ("Preferred
Stock"). The number of

<PAGE> 2
shares of Common Stock authorized to be issued is Sixty Million (60,000,000),
par value $.01 per share, and the number of Preferred Stock authorized to be
issued is Five Million (5,000,000), par value $.01 per share.

The Preferred Stock may be issued from time to time in one or
more series, without further stockholder approval. The Board of Directors is
hereby authorized, in the resolution or resolutions adopted by the Board of
Directors providing for the issue of any wholly unissued series of Preferred
Stock, within the limitations and restrictions stated in this Restated
Certificate of Incorporation (the "Restated Certificate"), to fix or alter the
dividend rights, dividend rate, conversion rights, voting rights, rights and
terms of redemption (including sinking fund provisions), the redemption price or
prices, and the liquidation preferences of any wholly unissued series of
Preferred Stock, and the number of shares constituting any such series and the
designation thereof, or any of them, and to increase or decrease the number of
shares of any series subsequent to the issue of shares of that series, but not
below the number of shares of such series then outstanding. In case the number
of shares of any series shall be so decreased, the shares constituting such
decrease shall resume the status that they had prior to the adoption of the
resolution originally fixing the number of shares of such series.

ARTICLE V

Except as otherwise provided in this Restated Certificate, in
furtherance and not in limitation of the powers conferred by statute, the Board
of Directors is expressly authorized to make, repeal, alter, amend and rescind
any or all of the Bylaws of the Corporation.

ARTICLE VI

The number of directors of the Corporation shall be fixed from
time to time by a bylaw or amendment thereof duly adopted by the Board of
Directors or by the stockholders.

The Board of Directors shall be and is divided into two classes,
Class I and Class II. Such classes shall be as nearly equal in number of
directors as possible. Each director shall serve for a term ending on the second
annual meeting following the annual meeting at which such director was elected;
provided, however, that the directors first elected to Class I shall serve for a
term ending on the annual meeting next following the end of fiscal year 1998 and
the directors first elected to Class II shall serve for a term ending on the
second annual meeting next following the end of fiscal year 1999. The foregoing
notwithstanding, each director shall serve until such director's successor shall
have been duly elected and qualified, unless such director shall resign, become
disqualified, disabled or shall otherwise be removed.

At each annual election, directors chosen to succeed those whose
terms then expire shall be of the same class as the directors they succeed,
unless by reason of any intervening changes in the authorized number of
directors, the Board shall designate one or more directorships whose term then
expires as directorships of another class in order more nearly to achieve
equality of number of directors between the classes.

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Notwithstanding the rule that the two classes shall be as nearly
equal in number of directors as possible, in the event of any change in the
authorized number of directors each director then continuing to serve as such
shall nevertheless continue as a director of the class of which the director is
a member until the expiration of the director's current term, or the director's
prior death, resignation or removal. If any newly created directorship may,
consistently with the rule that the two classes shall be as nearly equal in
number of directors as possible, be allocated to either class, the Board shall
allocate it to that of the available class whose term of office is due to expire
at the earliest date following such allocation.

ARTICLE VII

Elections of directors need not be by written ballot unless the
Bylaws of the Corporation shall so provide.

ARTICLE VIII

Except as otherwise provided in this Restated Certificate, any
action required or permitted to be taken by the stockholders of the Corporation
must be effected at an annual or special meeting of the stockholders of the
Corporation, and may not be effected by any consent in writing of such
stockholders.

ARTICLE IX

A director of the Corporation shall not be personally liable to
the Corporation or its stockholders for monetary damages for breach of fiduciary
duty as a director, except for liability (i) for any breach of the director's
duty of loyalty to the Corporation or its stockholders, (ii) for acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law, (iii) under Section 174 of the Delaware General Corporation
Law, or (iv) for any transaction from which the director derived any improper
personal benefit. If the Delaware General Corporation Law is amended after
approval by the stockholders of this Article to authorize corporate action
further eliminating or limiting the personal liability of directors then the
liability of a director of the Corporation shall be eliminated or limited to the
fullest extent permitted by the Delaware General Corporation Law as so amended.

Any repeal or modification of the foregoing provisions of this
Article IX by the stockholders of the Corporation shall not adversely affect any
right or protection of a director of the Corporation existing at the time of, or
increase the liability of any director of this Corporation with respect to any
acts or omissions of such director occurring prior to, such repeal or
modification.

ARTICLE X

In addition to any vote of the holders of any class or series of
the stock of this Corporation required by law or by this Restated Certificate,
the affirmative vote of the holders of a majority of the voting power of all of
the then outstanding shares of capital stock of the Corporation entitled to vote
generally in the election of directors, voting together as a single

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class, shall be required to amend or repeal the provisions of ARTICLE I, ARTICLE
II, and ARTICLE III of this Restated Certificate. Notwithstanding any other
provision of this Certificate of Incorporation or any provision of law which
might otherwise permit a lesser vote or no vote, but in addition to any vote of
the holders of any class or series of the stock of this Corporation required by
law or by this Restated Certificate, the affirmative vote of the holders of at
least seventy-five percent (75%) of the voting power of all of the then
outstanding shares of the capital stock of the Corporation entitled to vote
generally in the election of directors, voting together as a single class, shall
be required to amend or repeal any provision of this Restated Certificate not
specified in the preceding sentence.

* * * *

THIRD: The foregoing Restated Certificate of Incorporation has
been duly adopted by the Corporation's Board of Directors in accordance with the
applicable provisions of Section 245 of the General Corporation Law of the State
of Delaware.

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IN WITNESS WHEREOF, the undersigned has signed this Certificate
this ___ day of ____________, 199_.

________________________________________
Christopher J. Dawes
President and Chief Executive Officer

ATTEST:

____________________________________
Anthony Issacs
Assistant Secretary

<PAGE> 1
EXHIBIT 3.4

AMENDED AND RESTATED BYLAWS
OF
MICROMUSE INC.
A DELAWARE CORPORATION

ARTICLE I

OFFICES

SECTION 1. The registered office shall be in the City of
Wilmington, County of New Castle, State of Delaware.

SECTION 2. The corporation may also have offices at such other
places both within and without the State of Delaware as the Board of Directors
may from time to time determine or the business of the corporation may require.

ARTICLE II

MEETINGS OF STOCKHOLDERS

SECTION 1. All meetings of the stockholders for the election of
directors shall be held at such time and place, within or without the State of
Delaware, as may be fixed from time to time by the Board of Directors, and
stated in the notice of the meeting. Meetings of stockholders for any other
purpose may be held at such time and place, within or without the State of
Delaware, as shall be stated in the notice of the meeting or in a duly executed
waiver of notice thereof.

SECTION 2.

(a) Annual meetings of stockholders, commencing with the year 1998,
shall be held at such date and time as shall be designated from time to time by
the Board of Directors and stated in the notice of the meeting, at which they
shall elect by a plurality vote a board of directors, and transact such other
business as may properly be brought before the meeting.

(b) Nominations of persons for election to the Board of Directors of the
Corporation and the proposal of business to be considered by the stockholders
may be made at an annual meeting of stockholders (i) pursuant to the
Corporation's notice of meeting, (ii) by or at the direction of the Board of
Directors or (iii) by any stockholder of the Corporation who was a stockholder
of record at the time of giving of the notice provided for in this by-law, who
is entitled to vote at the meeting and who complied with the notice procedures
set forth in this by-law.

(c) For nominations or other business to be properly brought before an
annual meeting by a stockholder pursuant to clause (iii) of paragraph (b) of
this by-law, the stockholder

<PAGE> 2
must have given timely notice thereof in writing to the Secretary of the
Corporation and any such business must otherwise be a proper matter for
stockholder action under Delaware law. To be timely, a stockholder's notice
shall be delivered to the Secretary at the principal executive offices of the
Corporation not less than 60 days nor more than 90 days prior to the first
anniversary of the preceding year's annual meeting; provided, however, that in
the event that the date of the annual meeting is advanced by more than 30 days
or delayed by more than 60 days from such anniversary date, notice by the
stockholder to be timely must be so delivered not earlier than the 90th day
prior to such annual meeting and not later than the close of business on the
later of the 60th day prior to such annual meeting or the 10th day following the
day on which public announcement of the date of such meeting is first made. Such
stockholder's notice shall set forth (i) as to each person whom the stockholder
proposes to nominate for election or reelection as a director all information
relating to such person that is required to be disclosed in solicitations of
proxies for election of directors, or is otherwise required, in each case
pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended
(the "Exchange Act") (including such person's written consent to being named in
the proxy statement as a nominee and to serving as a director if elected); (ii)
as to any other business that the stockholder proposes to bring before the
meeting, a brief description of the business desired to be brought before the
meeting, the reasons for conducting such business at the meeting and any
material interest in such business of such stockholder and the beneficial owner,
if any, on whose behalf the proposal is made; and (iii) as to the stockholder
giving the notice and the beneficial owner, if any, on whose behalf the
nomination or proposal is made (a) the name and address of such stockholder, as
they appear on the Corporation's books, and of such beneficial owner and (b) the
class and number of shares of the Corporation which are owned beneficially and
of record by such stockholder and such beneficial owner.

(d) Notwithstanding anything in the second sentence of paragraph (c) of
this by-law to the contrary, in the event that the number of directors to be
elected to the Board of Directors of the Corporation is increased and there is
no public announcement naming all of the nominees for director or specifying the
size of the increased Board of Directors made by the Corporation at least 70
days prior to the first anniversary of the preceding year's annual meeting, a
stockholder's notice required by this by-law shall also be considered timely,
but only with respect to nominees for any new positions created by such
increase, if it shall be delivered to the Secretary at the principal executive
offices of the Corporation not later than the close of business on the 10th day
following the day on which such public announcement is first made by the
Corporation.

(e) Only such persons who are nominated in accordance with the
procedures set forth in these By-laws shall be eligible to serve as directors
and only such business shall be conducted at an annual meeting of stockholders
as shall have been brought before the meeting in accordance with the procedures
set forth in these By-laws. The chairman of the meeting shall have the power and
duty to determine whether a nomination or any business proposed to be brought
before the meeting was made in accordance with the procedures set forth in these
By-laws. The chairman of the meeting shall have the power and duty to determine
whether a nomination or any business proposed to be brought before the meeting
was made in accordance with the procedures set forth in these By-laws, and, if
any proposed nomination or business is not

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in compliance with these By-laws, to declare that such defective proposed
business or nomination shall be disregarded.

(f) For purposes of these By-laws, "public announcement" shall mean
disclosure in a press release reported by the Dow Jones News Service, Associated
Press or a comparable national news service or in a document publicly filed by
the Corporation with the Securities and Exchange Commission pursuant to Section
13, 14 or 15(d) of the Exchange Act.

(g) Notwithstanding the foregoing provisions of this by-law, a
stockholder shall also comply with all applicable requirements of the Exchange
Act and the rules and regulations thereunder with respect to the matters set
forth in this by-law. Nothing in this by-law shall be deemed to affect any
rights of stockholders to request inclusion of proposals in the Corporation's
proxy statement pursuant to Rule 14a-8 under the Exchange Act.

SECTION 3. Written notice of the annual meeting stating the
place, date and hour of the meeting shall be given to each stockholder entitled
to vote at such meeting not fewer than ten (10) nor more than sixty (60) days
before the date of the meeting.

SECTION 4. The officer who has charge of the stock ledger of the
corporation shall prepare and make, at least ten (10) days before every meeting
of stockholders, a complete list of the stockholders entitled to vote at the
meeting, arranged in alphabetical order, and showing the address of each
stockholder and the number of shares registered in the name of each stockholder.
Such list shall be open to the examination of any stockholder, for any purpose
germane to the meeting, during ordinary business hours, for a period of at least
ten (10) days prior to the meeting, either at a place within the city where the
meeting is to be held, which place shall be specified in the notice of the
meeting, or, if not so specified, at the place where the meeting is to be held.
The list shall also be produced and kept at the time and place of the meeting
during the whole time thereof, and may be inspected by any stockholder who is
present.

SECTION 5. Special meetings of the stockholders, for any purpose
or purposes, unless otherwise prescribed by statute or by the certificate of
incorporation, may be called at any time by the Board of Directors pursuant to a
resolution approved by a majority of the whole Board of Directors. Such
resolution shall state the purpose or purposes of the proposed meeting.

SECTION 6. Written notice of a special meeting stating the
place, date and hour of the meeting and the purpose or purposes for which the
meeting is called, shall be given not fewer than ten (10) nor more than sixty
(60) days before the date of the meeting, to each stockholder entitled to vote
at such meeting.

SECTION 7. Business transacted at any special meeting of
stockholders shall be limited to the purposes stated in the notice.

SECTION 8. The holders of a majority of the stock issued and
outstanding and entitled to vote thereat, present in person or represented by
proxy, shall constitute a quorum at all meetings of the stockholders for the
transaction of business except as otherwise provided

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by statute or by the certificate of incorporation. If, however, such quorum
shall not be present or represented at any meeting of the stockholders, the
stockholders entitled to vote thereat, present in person or represented by
proxy, shall have power to adjourn the meeting from time to time, without notice
other than announcement at the meeting, until a quorum shall be present or
represented. At such adjourned meeting at which a quorum shall be present or
represented any business may be transacted that might have been transacted at
the meeting as originally notified. If the adjournment is for more than thirty
(30) days, or if after the adjournment a new record date is fixed for the
adjourned meeting, a notice of the adjourned meeting shall be given to each
stockholder of record entitled to vote at the meeting.

SECTION 9. When a quorum is present at any meeting, the vote of
the holders of a majority of the stock having voting power present in person or
represented by proxy shall decide any question brought before such meeting,
unless the question is one upon which by express provision of the statutes or of
the certificate of incorporation, a different vote is required, in which case
such express provision shall govern and control the decision of such question.

SECTION 10. Unless otherwise provided in the certificate of
incorporation, each stockholder shall at every meeting of the stockholders be
entitled to one vote in person or by proxy for each share of the capital stock
having voting power held by such stockholder, but no proxy shall be voted on
after three (3) years from its date, unless the proxy provides for a longer
period.

SECTION 11. Unless otherwise provided in the certificate of
incorporation, any action required to be taken at any annual or special meeting
of stockholders of the corporation, or any action which may be taken at any
annual or special meeting of such stockholders, may be taken without a meeting,
without prior notice and without a vote, if a consent in writing, setting forth
the action so taken, shall be signed by the holders of outstanding stock having
not less than the minimum number of votes that would be necessary to authorize
or take such action at a meeting at which all shares entitled to vote thereon
were present and voted. Prompt notice of the taking of the corporate action
without a meeting by less than unanimous written consent shall be given to those
stockholders who have not consented in writing.

ARTICLE III

DIRECTORS

SECTION 1. The number of directors shall be fixed from time to
time exclusively by the Board of Directors pursuant to a resolution adopted by a
majority of the total number of authorized directors (whether or not there exist
any vacancies in previously authorized directorships at the time any such
resolution is presented to the Board for adoption). Directors shall be divided
into three classes, as nearly equal in number as reasonably possible, with the
term of office of the first class to expire at the 1998 annual meeting of
stockholders, the term of office of the second class to expire at the 1999
annual meeting of stockholders and the term of office of the third class to
expire at the 2000 annual meeting of stockholders. At each annual

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meeting of stockholders following such initial classification and election,
directors elected to succeed those directors whose terms expire shall be elected
for a term of office to expire at the third succeeding annual meeting of
stockholders after their election. All directors shall hold office until the
expiration of term for which elected, and until their respective successors are
elected and qualified, except in the case of the death, resignation or removal
of any director. Directors need not be stockholders.

SECTION 2. Vacancies and newly created directorships resulting
from any increase in the authorized number of directors may be filled by a
majority of the directors then in office, though less than a quorum, or by a
sole remaining director, and not by stockholders, and the directors so chosen
shall hold office until the next annual election and until their successors are
duly elected and shall qualify, unless sooner displaced. If there are no
directors in office, then an election of directors may be held in the manner
provided by statute.

SECTION 3. The business of the corporation shall be managed by
or under the direction of its board of directors, which may exercise all such
powers of the corporation and do all such lawful acts and things as are not by
statute or by the certificate of incorporation or by these bylaws directed or
required to be exercised or done by the stockholders.

MEETINGS OF THE BOARD OF DIRECTORS

SECTION 4. The Board of Directors of the corporation may hold
meetings, both regular and special, either within or without the State of
Delaware.

SECTION 5. The first meeting of each newly elected Board of
Directors shall be held at such time and place as shall be fixed by the vote of
the stockholders at the annual meeting and no notice of such meeting shall be
necessary to the newly elected directors in order legally to constitute the
meeting, provided a quorum shall be present. In the event of the failure of the
stockholders to fix the time or place of such first meeting of the newly elected
Board of Directors, or in the event such meeting is not held at the time and
place so fixed by the stockholders, the meeting may be held at such time and
place as shall be specified in a notice given as hereinafter provided for
special meetings of the Board of Directors, or as shall be specified in a
written waiver signed by all of the directors.

SECTION 6. Regular meetings of the Board of Directors may be
held without notice at such time and at such place as shall from time to time be
determined by the board.

SECTION 7. Special meetings of the Board of Directors may be
called by the president on ten (10) days' notice to each director by mail or
forty-eight (48) hours notice to each director either personally or by
telephone, telegram or facsimile; special meetings shall be called by the
president or secretary in like manner and on like notice on the written request
of two (2) directors unless the board consists of only one director, in which
case special meetings shall be called by the president or secretary in like
manner and on like notice on the written request of the sole director.

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SECTION 8. At all meetings of the board a majority of the
directors shall constitute a quorum for the transaction of business and the act
of a majority of the directors present at any meeting at which there is a quorum
shall be the act of the Board of Directors, except as may be otherwise
specifically provided by statute or by the certificate of incorporation. If a
quorum shall not be present at any meeting of the Board of Directors, the
directors present thereat may adjourn the meeting from time to time, without
notice other than announcement at the meeting, until a quorum shall be present.

SECTION 9. Unless otherwise restricted by the certificate of
incorporation of these bylaws, any action required or permitted to be taken at
any meeting of the Board of Directors or of any committee thereof may be taken
without a meeting, if all members of the board or committee, as the case may be,
consent thereto in writing, and the writing or writings are filed with the
minutes of proceedings of the board or committee.

SECTION 10. Unless otherwise restricted by the certificate of
incorporation or these bylaws, members of the Board of Directors, or any
committee designated by the Board of Directors, may participate in a meeting of
the Board of Directors, or any committee, by means of conference telephone or
similar communications equipment by means of which all persons participating in
the meeting can hear each other, and such participation in a meeting shall
constitute presence in person at the meeting.

COMMITTEES OF DIRECTORS

SECTION 11. The Board of Directors may, by resolution passed by
a majority of the whole board, designate one (1) or more committees, each
committee to consist of one (1) or more of the directors of the corporation. The
board may designate one (1) or more directors as alternate members of any
committee, who may replace any absent or disqualified member at any meeting of
the committee.

In the absence of disqualification of a member of a committee, the
member or members thereof present at any meeting and not disqualified from
voting, whether or not he or she or they constitute a quorum, may unanimously
appoint another member of the Board of Directors to act at the meeting in the
place of any such absent or disqualified member.

Any such committee, to the extent provided in the resolution of the
Board of Directors, shall have and may exercise all the powers and authority of
the Board of Directors in the management of the business and affairs of the
corporation, and may authorize the seal of the corporation to be affixed to all
papers that may require it; but no such committee shall have the power or
authority in reference to amending the certificate of incorporation, adopting an
agreement of merger or consolidation, recommending to the stockholders the sale,
lease or exchange of all or substantially all of the corporation's property and
assets, recommending to the stockholders a dissolution of the corporation or a
revocation of a dissolution, or amending the bylaws of the corporation; and,
unless the resolution or the certificate of incorporation expressly so provide,
no such committee shall have the power or authority to declare a dividend or to
authorize the issuance of stock. Such committee or committees shall have such
name or names as may be determined from time to time by resolution adopted by
the Board of Directors.

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SECTION 12. Each committee shall keep regular minutes of its
meetings and report the same to the Board of Directors when required.

COMPENSATION OF DIRECTORS

SECTION 13. Unless otherwise restricted by the certificate of
incorporation or these bylaws, the Board of Directors shall have the authority
to fix the compensation of directors. The directors may be paid their expenses,
if any, of attendance at each meeting of the Board of Directors and may be paid
a fixed sum for attendance at each meeting of the Board of Directors or a stated
salary as director. No such payment shall preclude any director from serving the
corporation in any other capacity and receiving compensation therefor. Members
of special or standing committees may be allowed like compensation for attending
committee meetings.

REMOVAL OF DIRECTORS

SECTION 14. Unless otherwise restricted by the certificate of
incorporation or bylaw, any director or the entire Board of Directors may be
removed, with or without cause, by the holders of a majority of shares entitled
to vote at an election of directors.

ARTICLE IV

NOTICES

SECTION 1. Whenever, under the provisions of the statutes or of
the certificate of incorporation or of these bylaws, notice is required to be
given to any director or stockholder, it shall not be construed to mean personal
notice, but such notice may be given in writing, by mail, addressed to such
director or stockholder, at his address as it appears on the records of the
corporation, with postage thereon prepaid, and such notice shall be deemed to be
given at the time when the same shall be deposited in the United States mail.
Notice to directors may also be given by telegram, telephone or facsimile.

SECTION 2. Whenever any notice is required to be given under the
provisions of the statutes or of the certificate of incorporation or of these
bylaws, a waiver thereof in writing, signed by the person or persons entitled to
said notice, whether before or after the time stated therein, shall be deemed
equivalent thereto.

ARTICLE V

OFFICERS

SECTION 1. The officers of the corporation shall be chosen by
the Board of Directors and shall be a president, treasurer and a secretary. The
Board of Directors may elect from among its members a Chairman of the Board and
a Vice Chairman of the Board. The Board of Directors may also choose one or more
vice-presidents, assistant secretaries and assistant treasurers. Any number of
offices may be held by the same person, unless the

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certificate of incorporation or these bylaws otherwise provide.

SECTION 2. The Board of Directors at its first meeting after
each annual meeting of stockholders shall choose a president, a treasurer, and a
secretary, and may choose vice presidents, assistant secretaries and assistant
treasurers.

SECTION 3. The Board of Directors may appoint such other
officers and agents as it shall deem necessary who shall hold their offices for
such terms and shall exercise such powers and perform such duties as shall be
determined from time to time by the board.

SECTION 4. The salaries of all officers and agents of the
corporation shall be fixed by the Board of Directors.

SECTION 5. The officers of the corporation shall hold office
until their successors are chosen and qualify. Any officer elected or appointed
by the Board of Directors may be removed at any time by the affirmative vote of
a majority of the Board of Directors. Any vacancy occurring in any office of the
corporation shall be filled by the Board of Directors.

THE CHAIRMAN OF THE BOARD

SECTION 6. The Chairman of the Board, if any, shall preside at
all meetings of the Board of Directors and of the stockholders at which he or
she shall be present. He or she shall have and may exercise such powers as are,
from time to time, assigned to him or her by the Board and as may be provided by
law.

SECTION 7. In the absence of the Chairman of the Board, the Vice
Chairman of the Board, if any, shall preside at all meetings of the Board of
Directors and of the stockholders at which he or she shall be present. He or she
shall have and may exercise such powers as are, from time to time, assigned to
him or her by the Board and as may be provided by law.

THE PRESIDENT AND VICE-PRESIDENTS

SECTION 8. The president shall be the chief executive officer of
the corporation; and in the absence of the Chairman and Vice Chairman of the
Board the president shall preside at all meetings of the stockholders and the
Board of Directors; the president shall have general and active management of
the business of the corporation and shall see that all orders and resolutions of
the Board of Directors are carried into effect.

SECTION 9. The president shall execute bonds, mortgages and
other contracts requiring a seal, under the seal of the corporation, except
where required or permitted by law to be otherwise signed and executed and
except where the signing and execution thereof shall be expressly delegated by
the Board of Directors to some other officer or agent of the corporation.

SECTION 10. In the absence of the president or in the event of
the

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president's inability or refusal to act, the vice-president, if any, (or in the
event there be more than one vice-president, the vice-presidents in the order
designated by the directors, or in the absence of any designation, then in the
order of their election) shall perform the duties of the president, and when so
acting, shall have all the powers of and be subject to all the restrictions upon
the president. The vice-presidents shall perform such other duties and have such
other powers as the Board of Directors may from time to time prescribe.

THE SECRETARY AND ASSISTANT SECRETARY

SECTION 11. The secretary shall attend all meetings of the Board
of Directors and all meetings of the stockholders and record all the proceedings
of the meetings of the corporation and of the Board of Directors in a book to be
kept for that purpose and shall perform like duties for the standing committees
when required. The secretary shall give, or cause to be given, notice of all
meetings of the stockholders and special meetings of the Board of Directors, and
shall perform such other duties as may be prescribed by the Board of Directors
or president, under whose supervision he or she shall be. The secretary shall
have custody of the corporate seal of the corporation and the secretary, or an
assistant secretary, shall have authority to affix the same to any instrument
requiring it and when so affixed, it may be attested by his signature or by the
signature of such assistant secretary. The Board of Directors may give general
authority to any other officer to affix the seal of the corporation and to
attest the affixing by his signature.

SECTION 12. The assistant secretary, or if there be more than
one, the assistant secretaries in the order determined by the Board of Directors
(or if there be no such determination, then in the order of their election)
shall, in the absence of the secretary or in the event of his inability or
refusal to act, perform the duties and exercise the powers of the secretary and
shall perform such other duties and have such other powers as the board of
directors may from time to time prescribe.

TREASURER AND ASSISTANT TREASURERS

SECTION 13. The treasurer shall have the custody of the
corporate funds and securities and shall keep full and accurate accounts of
receipts and disbursements in books belonging to the corporation and shall
deposit all moneys and other valuable effects in the name and to the credit of
the corporation in such depositories as may be designated by the Board of
Directors. Unless otherwise appointed, the chief financial officer shall be the
treasurer.

SECTION 14. The treasurer shall disburse the funds of the
corporation as may be ordered by the Board of Directors, taking proper vouchers
for such disbursements, and shall render to the president and the Board of
Directors, at its regular meetings, or when the Board of Directors so requires,
an account of all his or her transactions as treasurer and of the financial
condition of the corporation.

SECTION 15. If required by the Board of Directors, the treasurer
shall give the corporation a bond (which shall be renewed every six years) in
such sum and with such surety or sureties as shall be satisfactory to the Board
of Directors for the faithful performance of

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the duties of the treasurer's office and for the restoration to the corporation,
in case of the treasurer's death, resignation, retirement or removal from
office, of all books, papers, vouchers, money and other property of whatever
kind in the treasurer's possession or under the treasurer's control belonging to
the corporation.

SECTION 16. The assistant treasurer, or if there shall be more
than one, the assistant treasurers in the order determined by the Board of
Directors (or if there be no such determination, then in the order of their
election) shall, in the absence of the treasurer or in the event of the
treasurer's inability or refusal to act, perform the duties and exercise the
powers of the treasurer and shall perform such other duties and have such other
powers as the Board of Directors may from time to time prescribe.

ARTICLE VI

CERTIFICATE OF STOCK

SECTION 1. Every holder of stock in the corporation shall be
entitled to have a certificate, signed by, or in the name of the corporation by,
the chairman or vice-chairman of the Board of Directors, or the president or a
vice-president and the treasurer or an assistant treasurer, or the secretary or
an assistant secretary of the corporation, certifying the number of shares owned
by such stockholder in the corporation.

Certificates may be issued for partly paid shares and in such case upon
the face or back of the certificates issued to represent any such partly paid
shares, the total amount of the consideration to be paid therefor, and the
amount paid thereon shall be specified.

If the corporation shall be authorized to issue more than one class of
stock or more than one series of any class, the powers, designations,
preferences and relative, participating, optional or other special rights of
each class of stock or series thereof and the qualification, limitations or
restrictions of such preferences and/or rights shall be set forth in full or
summarized on the face or back of the certificate that the corporation shall
issue to represent such class or series of stock, provided that, except as
otherwise provided in section 202 of the General Corporation Law of Delaware, in
lieu of the foregoing requirements, there may be set forth on the face or back
of the certificate that the corporation shall issue to represent such class or
series of stock, a statement that the corporation will furnish without charge to
each stockholder who so requests the powers, designations, preferences and
relative, participating, optional or other special rights of each class of stock
or series thereof and the qualifications, limitations or restrictions of such
preferences and/or rights.

SECTION 2. Any of or all the signatures on the certificate may
be facsimile. In case any officer, transfer agent or registrar who has signed or
whose facsimile signature has been placed upon a certificate shall have ceased
to be such officer, transfer agent or registrar before such certificate is
issued, it may be issued by the corporation with the same effect as if he or she
were such officer, transfer agent or registrar at the date of issue.

LOST CERTIFICATES

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SECTION 3. The Board of Directors may direct a new certificate
or certificates to be issued in place of any certificate or certificates
theretofore issued by the corporation alleged to have been lost, stolen or
destroyed, upon the making of an affidavit of that fact by the person claiming
the certificate of stock to be lost, stolen or destroyed. When authorizing such
issue of a new certificate or certificates, the Board of Directors may, in its
discretion and as a condition precedent to the issuance thereof, require the
owner of such lost, stolen or destroyed certificate or certificates, or his
legal representative, to advertise the same in such manner as it shall require
and/or to give the corporation a bond in such sum as it may direct as indemnity
against any claim that may be made against the corporation with respect to the
certificate alleged to have been lost, stolen or destroyed.

TRANSFER OF STOCK

SECTION 4. Upon surrender to the corporation or the transfer
agent of the corporation of a certificate for shares duly endorsed or
accompanied by proper evidence of succession, assignation or authority to
transfer, it shall be the duty of the corporation to issue a new certificate to
the person entitled thereto, cancel the old certificate and record the
transaction upon its books.

FIXING RECORD DATE

SECTION 5. In order that the corporation may determine the
stockholders entitled to notice of or to vote at any meeting of stockholder or
any adjournment thereof, or to express consent to corporate action in writing
without a meeting, or entitled to receive payment of any dividend or other
distribution or allotment of any rights, or entitled to exercise any rights in
respect of any change, conversion or exchange of stock or for the purpose of any
other lawful action, the Board of Directors may fix, in advance, a record date,
which shall not be more than sixty (60) nor less than ten (10) days before the
date of such meeting, nor more than sixty (60) days prior to any other action. A
determination of stockholders of record entitled to notice of or to vote at a
meeting of stockholders shall apply to any adjournment of the meeting; provided,
however, that the Board of Directors may fix a new record date for the adjourned
meeting.

REGISTERED STOCKHOLDERS

SECTION 6. The corporation shall be entitled to recognize the
exclusive right of a person registered on its books as the owner of shares to
receive dividends, and to vote as such owner, and to hold liable for calls and
assessments a person registered on its books as the owner of shares and shall
not be bound to recognize any equitable or other claim to or interest in such
share or shares on the part of any other person, whether or not it shall have
express or other notice thereof, except as otherwise provided by the laws of
Delaware.

ARTICLE VII

GENERAL PROVISIONS

DIVIDENDS

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SECTION 1. Dividends upon the capital stock of the corporation,
subject to the provisions of the certificate of incorporation, if any, may be
declared by the Board of Directors at any regular or special meeting, pursuant
to law. Dividends may be paid in cash, in property, or in shares of the capital
stock, subject to the provisions of the certificate of incorporation.

SECTION 2. Before payment of any dividend, there may be set
aside out of any funds of the corporation available for dividends such sum or
sums as the directors from time to time, in their absolute discretion, think
proper as a reserve or reserves to meet contingencies, or for equalizing
dividends, or for repairing or maintaining any property of the corporation, or
for such other purposes as the directors shall think conducive to the interest
of the corporation, and the directors may modify or abolish any such reserve in
the manner in which it was created.

CHECKS

SECTION 3. All checks or demands for money and notes of the
corporation shall be signed by such officer or officers or such other person or
persons as the Board of Directors may from time to time designate.

FISCAL YEAR

SECTION 4. The fiscal year of the corporation shall be fixed by
resolution of the Board of Directors.

SEAL

SECTION 5. The Board of Directors may adopt a corporate seal
having inscribed thereon the name of the corporation, the year of its
organization and the words "Corporate Seal, Delaware." The seal may be used by
causing it or a facsimile thereof to be impressed or affixed or reproduced or
otherwise.

INDEMNIFICATION

SECTION 6. The corporation shall hold harmless and indemnify any
person entitled to the benefits of indemnification pursuant to this Article 7
(such person being hereunder referred to as "Indemnitee") to the full extent
authorized or permitted by the provisions of Section 145 of the Delaware General
Corporation Law (the "Law"), as such may be amended from time to time, and by
this Article 7, as such may be amended. In furtherance of the foregoing
indemnification, and without limiting the generality thereof:

(a) PROCEEDINGS OTHER THAN PROCEEDINGS BY OR IN THE RIGHT OF THE
CORPORATION. Indemnitee shall be entitled to the rights of indemnification
provided in this Section 6(a) if, by reason of his Corporate Status (as
hereinafter defined), he is, or is threatened to be made, a party to or
participant in any Proceeding (as hereinafter defined) other than a Proceeding
by or in the right of the corporation. Pursuant to this Section 6(a), Indemnitee
shall be indemnified against all Expenses (as hereinafter defined), judgments,
penalties, fines and

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amounts paid in settlement actually and reasonably incurred by him or on his
behalf in connection with such Proceeding or any claim, issue or matter therein,
if he acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interests of the corporation and, with respect to any
criminal Proceeding, had no reasonable cause to believe his conduct was
unlawful.

(b) PROCEEDINGS BY OR IN THE RIGHT OF THE CORPORATION.
Indemnitee shall be entitled to the rights of indemnification provided in this
Section 6(b) if, by reason of his Corporate Status, he is, or is threatened to
be made, a party to or participant in any Proceeding brought by or in the right
of the corporation. Pursuant to this Section 6(b), Indemnitee shall be
indemnified against all Expenses actually and reasonably incurred by him or on
his behalf in connection with such Proceeding if he acted in good faith and in a
manner he reasonably believed to be in or not opposed to the best interests of
the corporation; provided, however, that, if applicable law so provides, no
indemnification against such Expenses shall be made in respect of any claim,
issue or matter in such Proceeding as to which Indemnitee shall have been
adjudged to be liable to the corporation unless and to the extent that the Court
of Chancery of the State of Delaware shall determine that such indemnification
may be made.

(c) INDEMNIFICATION FOR EXPENSES OF A PARTY WHO IS WHOLLY OR
PARTLY SUCCESSFUL. Notwithstanding any other provision hereunder, to the extent
that Indemnitee is, by reason of his Corporate Status, a party to and is
successful, on the merits or otherwise, in any Proceeding, he shall be
indemnified to the maximum extent permitted by law against all Expenses actually
and reasonably incurred by him or on his behalf in connection therewith. If
Indemnitee is not wholly successful in such Proceeding but is successful, on the
merits or otherwise, as to one or more but less than all claims, issues or
matters in such Proceeding, the corporation shall indemnify Indemnitee against
all Expenses actually and reasonably incurred by him or on his behalf in
connection with each successfully resolved claim, issue or matter. For purposes
of this Section and without limitation, the termination of any claim, issue or
matter in such a Proceeding by dismissal, with or without prejudice, shall be
deemed to be a successful result as to such claim, issue or matter.

SECTION 7. In addition to, and without regard to any limitations
on, the indemnification provided for in Section 6, the corporation shall and
hereby does indemnify and hold harmless Indemnitee against all Expenses,
judgments, penalties, fines and amounts paid in settlement actually and
reasonably incurred by him or on his behalf if, by reason of his Corporate
Status, he is, or is threatened to be made, a party to or participant in any
Proceeding (including a Proceeding by or in the right of the corporation),
including, without limitation, all liability arising out of the negligence or
active or passive wrongdoing of Indemnitee. The only limitation that shall exist
upon the corporation's obligations hereunder shall be that the corporation shall
not be obligated to make any payment to Indemnitee that is finally determined
(under the procedures, and subject to the presumptions, set forth in Sections 11
and 12 hereof) to be unlawful under Delaware law.

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SECTION 8.

(a) Whether or not the indemnification provided in Sections 6
and 7 hereof is available, in respect of any threatened, pending or completed
action, suit or proceeding in which corporation is jointly liable with
Indemnitee (or would be if joined in such action, suit or proceeding),
corporation shall pay, in the first instance, the entire amount of any judgment
or settlement of such action, suit or proceeding without requiring Indemnitee to
contribute to such payment and corporation hereby waives and relinquishes any
right of contribution it may have against Indemnitee. The corporation shall not
enter into any settlement of any action, suit or proceeding in which corporation
is jointly liable with Indemnitee (or would be if joined in such action, suit or
proceeding) unless such settlement provides for a full and final release of all
claims asserted against Indemnitee.

(b) Without diminishing or impairing the obligations of the
corporation set forth in the preceding subparagraph, if, for any reason,
Indemnitee shall elect or be required to pay all or any portion of any judgment
or settlement in any threatened, pending or completed action, suit or proceeding
in which corporation is jointly liable with Indemnitee (or would be if joined in
such action, suit or proceeding), corporation shall contribute to the amount of
expenses (including attorneys' fees), judgments, fines and amounts paid in
settlement actually and reasonably incurred and paid or payable by Indemnitee in
proportion to the relative benefits received by the corporation and all
officers, directors or employees of the corporation other than Indemnitee who
are jointly liable with Indemnitee (or would be if joined in such action, suit
or proceeding), on the one hand, and Indemnitee, on the other hand, from the
transaction from which such action, suit or proceeding arose; provided, however,
that the proportion determined on the basis of relative benefit may, to the
extent necessary to conform to law, be further adjusted by reference to the
relative fault of corporation and all officers, directors or employees of the
corporation other than Indemnitee who are jointly liable with Indemnitee (or
would be if joined in such action, suit or proceeding), on the one hand, and
Indemnitee, on the other hand, in connection with the events that resulted in
such expenses, judgments, fines or settlement amounts, as well as any other
equitable considerations which the law may require to be considered. The
relative fault of corporation and all officers, directors or employees of the
corporation other than Indemnitee who are jointly liable with Indemnitee (or
would be if joined in such action, suit or proceeding), on the one hand, and
Indemnitee, on the other hand, shall be determined by reference to, among other
things, the degree to which their actions were motivated by intent to gain
personal profit or advantage, the degree to which their liability is primary or
secondary, and the degree to which their conduct is active or passive.

(c) The corporation shall fully indemnify and hold Indemnitee
harmless from any claims of contribution which may be brought by officers,
directors or employees of the corporation other than Indemnitee who may be
jointly liable with Indemnitee.

SECTION 9. Notwithstanding any other provision hereof, to the
extent that Indemnitee is, by reason of his Corporate Status, a witness in any
Proceeding to which Indemnitee is not a party, he shall be indemnified against
all Expenses actually and reasonably incurred by him or on his behalf in
connection therewith.

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SECTION 10. Notwithstanding any other provision hereof, the
corporation shall advance all Expenses incurred by or on behalf of Indemnitee in
connection with any Proceeding by reason of Indemnitee's Corporate Status within
ten (10) days after the receipt by the corporation of a statement or statements
from Indemnitee requesting such advance or advances from time to time, whether
prior to or after final disposition of such Proceeding. Such statement or
statements shall reasonably evidence the Expenses incurred by Indemnitee and
shall include or be preceded or accompanied by an undertaking by or on behalf of
Indemnitee to repay any Expenses advanced if it shall ultimately be determined
that Indemnitee is not entitled to be indemnified against such Expenses. Any
advances and undertakings to repay pursuant to this Section 10 shall be
unsecured and interest free. Notwithstanding the foregoing, the obligation of
the corporation to advance Expenses pursuant to this Section 10 shall be subject
to the condition that, if, when and to the extent that the corporation
determines that Indemnitee would not be permitted to be indemnified under
applicable law, the corporation shall be entitled to be reimbursed, within
thirty (30) days of such determination, by Indemnitee (who hereby agrees to
reimburse the corporation) for all such amounts theretofore paid; provided,
however, that if Indemnitee has commenced or thereafter commences legal
proceedings in a court of competent jurisdiction to secure a determination that
Indemnitee should be indemnified under applicable law, any determination made by
the corporation that Indemnitee would not be permitted to be indemnified under
applicable law shall not be binding and Indemnitee shall not be required to
reimburse the corporation for any advance of Expenses until a final judicial
determination is made with respect thereto (as to which all rights of appeal
therefrom have been exhausted or lapsed).

SECTION 11. It is the intent of the corporation to secure for
Indemnitee rights of indemnity that are as favorable as may be permitted under
the law and public policy of the State of Delaware. Accordingly, the following
procedures and presumptions shall apply in the event of any question as to
whether Indemnitee is entitled to indemnification under this Article 7:

(a) To obtain indemnification (including, but not limited to,
the advancement of Expenses and contribution by the corporation), Indemnitee
shall submit to the corporation a written request, including therein or
therewith such documentation and information as is reasonably available to
Indemnitee and is reasonably necessary to determine whether and to what extent
Indemnitee is entitled to indemnification. The Secretary of the corporation
shall, promptly upon receipt of such a request for indemnification, advise the
Board of Directors in writing that Indemnitee has requested indemnification.

(b) Upon written request by Indemnitee for indemnification
pursuant to the first sentence of Section 11(a) hereof, a determination, if
required by applicable law, with respect to Indemnitee's entitlement thereto
shall be made in the specific case by one of the following three methods, which
shall be at the election of Indemnitee: (1) by a majority vote of the
disinterested directors, even though less than a quorum, or (2) by independent
legal counsel in a written opinion, or (3) by the stockholders.

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by Independent Counsel pursuant to Section 11(b) hereof, the Independent Counsel
shall be selected as provided in this Section 11(c). The Independent Counsel
shall be selected by Indemnitee (unless Indemnitee shall request that such
selection be made by the Board of Directors). Indemnitee or the corporation, as
the case may be, may, within 10 days after such written notice of selection
shall have been given, deliver to the corporation or to Indemnitee, as the case
may be, a written objection to such selection; provided, however, that such
objection may be asserted only on the ground that the Independent Counsel so
selected does not meet the requirements of "Independent Counsel" as defined in
Section 18 hereunder, and the objection shall set forth with particularity the
factual basis of such assertion. Absent a proper and timely objection, the
person so selected shall act as Independent Counsel. If a written objection is
made and substantiated, the Independent Counsel selected may not serve as
Independent Counsel unless and until such objection is withdrawn or a court has
determined that such objection is without merit. If, within 20 days after
submission by Indemnitee of a written request for indemnification pursuant to
Section 11(a) hereof, no Independent Counsel shall have been selected and not
objected to, either the corporation or Indemnitee may petition the Court of
Chancery of the State of Delaware or other court of competent jurisdiction for
resolution of any objection which shall have been made by the corporation or
Indemnitee to the other's selection of Independent Counsel and/or for the
appointment as Independent Counsel of a person selected by the court or by such
other person as the court shall designate, and the person with respect to whom
all objections are so resolved or the person so appointed shall act as
Independent Counsel under Section 11(b) hereof. The corporation shall pay any
and all reasonable fees and expenses of Independent Counsel incurred by such
Independent Counsel in connection with acting pursuant to Section 11(b) hereof,
and the corporation shall pay all reasonable fees and expenses incident to the
procedures of this Section 11(c), regardless of the manner in which such
Independent Counsel was selected or appointed.

(d) In making a determination with respect to entitlement to
indemnification hereunder, the person or persons or entity making such
determination shall presume that Indemnitee is entitled to indemnification under
this Article 7 if Indemnitee has submitted a request for indemnification in
accordance with Section 11(a) hereunder. Anyone seeking to overcome this
presumption shall have the burden of proof and the burden of persuasion, by
clear and convincing evidence.

(e) Indemnitee shall be deemed to have acted in good faith if
Indemnitee's action is based on the records or books of account of the
Enterprise, including financial statements, or on information supplied to
Indemnitee by the officers of the Enterprise in the course of their duties, or
on the advice of legal counsel for the Enterprise or on information or records
given or reports made to the Enterprise by an independent certified public
accountant or by an appraiser or other expert selected with reasonable care by
the Enterprise. In addition, the knowledge and/or actions, or failure to act, of
any director, officer, agent or employee of the Enterprise shall not be imputed
to Indemnitee for purposes of determining the right to indemnification under
this Article 7. Whether or not the foregoing provisions of this Section 11(e)
are satisfied, it shall in any event be presumed that Indemnitee has at all
times acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interests of the corporation. Anyone seeking to overcome
this presumption shall have the burden

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of proof and the burden of persuasion, by clear and convincing evidence.

(f) If the person, persons or entity empowered or selected under
Section 11 to determine whether Indemnitee is entitled to indemnification shall
not have made a determination within thirty (30) days after receipt by the
corporation of the request therefor, the requisite determination of entitlement
to indemnification shall be deemed to have been made and Indemnitee shall be
entitled to such indemnification, absent (i) a misstatement by Indemnitee of a
material fact, or an omission of a material fact necessary to make Indemnitee's
statement not materially misleading, in connection with the request for
indemnification, or (ii) a prohibition of such indemnification under applicable
law; provided, however, that such 30 day period may be extended for a reasonable
time, not to exceed an additional fifteen (15) days, if the person, persons or
entity making the determination with respect to entitlement to indemnification
in good faith requires such additional time for the obtaining or evaluating
documentation and/or information relating thereto; and provided, further, that
the foregoing provisions of this Section 11(g) shall not apply if the
determination of entitlement to indemnification is to be made by the
stockholders pursuant to Section 11(b) hereunder and if (A) within fifteen (15)
days after receipt by the corporation of the request for such determination the
Board of Directors or the Disinterested Directors, if appropriate, resolve to
submit such determination to the stockholders for their consideration at an
annual meeting thereof to be held within seventy five (75) days after such
receipt and such determination is made thereat, or (B) a special meeting of
stockholders is called within fifteen (15) days after such receipt for the
purpose of making such determination, such meeting is held for such purpose
within sixty (60) days after having been so called and such determination is
made thereat.

(g) Indemnitee shall cooperate with the person, persons or
entity making such determination with respect to Indemnitee's entitlement to
indemnification, including providing to such person, persons or entity upon
reasonable advance request any documentation or information which is not
privileged or otherwise protected from disclosure and which is reasonably
available to Indemnitee and reasonably necessary to such determination. Any
Independent Counsel, member of the Board of Directors, or stockholder of the
corporation shall act reasonably and in good faith in making a determination
under this Article 7 of the Indemnitee's entitlement to indemnification. Any
costs or expenses (including attorneys' fees and disbursements) incurred by
Indemnitee in so cooperating with the person, persons or entity making such
determination shall be borne by the corporation (irrespective of the
determination as to Indemnitee's entitlement to indemnification) and the
corporation hereby indemnifies and shall hold Indemnitee harmless therefrom.

(h) The corporation acknowledges that a settlement or other
disposition short of final judgment may be successful if it permits a party to
avoid expense, delay, distraction, disruption and uncertainty. In the event that
any action, claim or proceeding to which Indemnitee is a party is resolved in
any manner other than by adverse judgment against Indemnitee (including, without
limitation, settlement of such action, claim or proceeding with or without
payment of money or other consideration) it shall be presumed that Indemnitee
has been successful on the merits or otherwise in such action, suit or
proceeding. Anyone seeking to overcome this presumption shall have the burden of
proof and the burden of persuasion, by clear

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and convincing evidence.

SECTION 12.

(a) In the event that (i) a determination is made pursuant to
this Article 7 that Indemnitee is not entitled to indemnification hereunder,
(ii) advancement of Expenses is not timely made pursuant to Section 10
hereunder, (iii) no determination of entitlement to indemnification shall have
been made pursuant to Section 11(b) hereunder within 90 days after receipt by
the corporation of the request for indemnification, (iv) payment of
indemnification is not made pursuant to this Article 7 within ten (10) days
after receipt by the corporation of a written request therefor, or (v) payment
of indemnification is not made within ten (10) days after a determination has
been made that Indemnitee is entitled to indemnification or such determination
is deemed to have been made pursuant to Section 11 hereunder, Indemnitee shall
be entitled to an adjudication in an appropriate court of the State of Delaware,
or in any other court of competent jurisdiction, of his entitlement to such
indemnification. Indemnitee shall commence such proceeding seeking an
adjudication within 180 days following the date on which Indemnitee first has
the right to commence such proceeding pursuant to this Section 12(a). The
corporation shall not oppose Indemnitee's right to seek any such adjudication.

(b) In the event that a determination shall have been made
pursuant to Section 11(b) hereunder that Indemnitee is not entitled to
indemnification, any judicial proceeding commenced pursuant to this Section 12
shall be conducted in all respects as a de novo trial, on the merits and
Indemnitee shall not be prejudiced by reason of that adverse determination under
Section 11(b).

(c) If a determination shall have been made pursuant to Section
11(b) hereunder that Indemnitee is entitled to indemnification, the corporation
shall be bound by such determination in any judicial proceeding commenced
pursuant to this Section 12, absent a prohibition of such indemnification under
applicable law.

(d) In the event that Indemnitee, pursuant to this Section 12,
seeks a judicial adjudication of his rights under, or to recover damages for
breach of, this Article 7, or to recover under any directors' and officers'
liability insurance policies maintained by the corporation the corporation shall
pay on his behalf, in advance, any and all expenses (of the types described in
the definition of Expenses in Section 17 hereunder) actually and reasonably
incurred by him in such judicial adjudication, regardless of whether Indemnitee
ultimately is determined to be entitled to such indemnification, advancement of
expenses or insurance recovery.

(e) The corporation shall be precluded from asserting in any
judicial proceeding commenced pursuant to this Section 12 that the procedures
and presumptions hereunder are not valid, binding and enforceable and shall
stipulate in any such court that the corporation is bound by all the provisions
hereunder.

SECTION 13.

(a) The rights of indemnification as provided hereunder shall
not be

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deemed exclusive of any other rights to which Indemnitee may at any time be
entitled under applicable law, the certificate of incorporation of the
corporation, these Bylaws, any agreement, a vote of stockholders or a resolution
of directors, or otherwise. No amendment, alteration or repeal hereunder or of
any provision hereof shall limit or restrict any right of Indemnitee under this
Article 7 in respect of any action taken or omitted by such Indemnitee in his
Corporate Status prior to such amendment, alteration or repeal. To the extent
that a change in the Law, whether by statute or judicial decision, permits
greater indemnification than would be afforded currently hereunder and any
indemnification agreement between the corporation and the Indemnitee, it is the
intent of the parties hereto that Indemnitee shall enjoy the greater benefits so
afforded by such change. No right or remedy herein conferred is intended to be
exclusive of any other right or remedy, and every other right and remedy shall
be cumulative and in addition to every other right and remedy given hereunder or
now or hereafter existing at law or in equity or otherwise. The assertion or
employment of any right or remedy hereunder, or otherwise, shall not prevent the
concurrent assertion or employment of any other right or remedy.

(b) To the extent that the corporation maintains an insurance
policy or policies providing liability insurance for directors, officers,
employees, or agents or fiduciaries of the corporation or of any other
corporation, partnership, joint venture, trust, employee benefit plan or other
enterprise which such person serves at the request of the corporation,
Indemnitee shall be covered by such policy or policies in accordance with its or
their terms to the maximum extent of the coverage available for any such
director, officer, employee or agent under such policy or policies.

(c) In the event of any payment pursuant to this Article 7 or
any indemnification agreement between the corporation and Indemnitee, the
corporation shall be subrogated to the extent of such payment to all of the
rights of recovery of Indemnitee, who shall execute all papers required and take
all action necessary to secure such rights, including execution of such
documents as are necessary to enable the corporation to bring suit to enforce
such rights.

(d) The corporation shall not be liable to make any payment of
amounts otherwise indemnifiable hereunder if and to the extent that Indemnitee
has otherwise actually received such payment under any insurance policy,
contract, agreement or otherwise.

SECTION 14. Notwithstanding any other provision hereunder,
Indemnitee shall not be entitled to indemnification with respect to any
Proceeding brought by Indemnitee, or any claim therein, unless (a) the bringing
of such Proceeding or making of such claim shall have been approved by the Board
of Directors of the corporation or (b) such Proceeding is being brought by the
Indemnitee to assert, interpret or enforce his rights as set forth herein or in
any indemnification agreement between the corporation and the Indemnitee.

SECTION 15. All agreements and obligations of the corporation
contained in this Article 7 shall continue during the period Indemnitee is an
officer or director of the corporation (or is or was serving at the request of
the corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other enterprise) and shall

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continue thereafter so long as Indemnitee shall be subject to any Proceeding (or
any proceeding commenced under Section 12 hereof) by reason of his Corporate
Status, whether or not he is acting or serving in any such capacity at the time
any liability or expense is incurred for which indemnification can be provided
hereunder. The terms of this Article 7 shall be binding upon and inure to the
benefit of and be enforceable by the parties hereto and their respective
successors (including any direct or indirect successor by purchase, merger,
consolidation or otherwise to all or substantially all of the business or assets
of the corporation), assigns, spouses, heirs, executors and personal and legal
representatives. The terms of this Article 7 shall continue in effect regardless
of whether Indemnitee continues to serve as an officer or director of the
corporation or any other Enterprise at the corporation's request.

SECTION 16. To the extent requested by the Indemnitee and
approved by the Board of Directors of the corporation, the corporation may at
any time and from time to time provide security to the Indemnitee for the
corporation's obligations hereunder through an irrevocable bank line of credit,
funded trust or other collateral. Any such security, once provided to the
Indemnitee, may not be revoked or released without the prior written consent of
the Indemnitee.

SECTION 17. For purposes of this Article 7:

(a) "Corporate Status" describes the status of a person who is
or was a director, officer, employee or agent or fiduciary of the corporation or
of any other corporation, partnership, joint venture, trust, employee benefit
plan or other enterprise which such person is or was serving at the express
written request of the corporation.

(b) "Disinterested Director" means a director of the corporation
who is not and was not a party to the Proceeding in respect of which
indemnification is sought by Indemnitee.

(c) "Enterprise" shall mean the corporation and any other
corporation, partnership, joint venture, trust, employee benefit plan or other
enterprise of which Indemnitee is or was serving at the express written request
of the corporation as a director, officer, employee, agent or fiduciary.

(d) "Expenses" shall include all reasonable attorneys' fees,
retainers, court costs, transcript costs, fees of experts, witness fees, travel
expenses, duplicating costs, printing and binding costs, telephone charges,
postage, delivery service fees, and all other disbursements or expenses of the
types customarily incurred in connection with prosecuting, defending, preparing
to prosecute or defend, investigating, participating, or being or preparing to
be a witness in a Proceeding.

(e) "Independent Counsel" means a law firm, or a member of a law
firm, that is experienced in matters of corporation law and neither presently
is, nor in the past five years has been, retained to represent: (i) the
corporation or Indemnitee in any matter material to either such party (other
than with respect to matters concerning the Indemnitee under this Article 7, or
of other indemnitees under similar indemnification agreements), or (ii) any

20
<PAGE> 21

other party to the Proceeding giving rise to a claim for indemnification
hereunder. Notwithstanding the foregoing, the term "Independent Counsel" shall
not include any person who, under the applicable standards of professional
conduct then prevailing, would have a conflict of interest in representing
either the corporation or Indemnitee in an action to determine Indemnitee's
rights under this Article 7. The corporation shall pay the reasonable fees of
the Independent Counsel referred to above and to fully indemnify such counsel
against any and all Expenses, claims, liabilities and damages arising out of or
relating to this Article 7 or its engagement pursuant hereto.

(f) "Proceeding" includes any threatened, pending or completed
action, suit, arbitration, alternate dispute resolution mechanism,
investigation, inquiry, administrative hearing or any other actual, threatened
or completed proceeding, whether brought by or in the right of the corporation
or otherwise and whether civil, criminal, administrative or investigative, in
which Indemnitee was, is or will be involved as a party or otherwise, by reason
of the fact that Indemnitee is or was a director of the corporation, by reason
of any action taken by him or of any inaction on his part while acting as an
officer or director of the corporation, or by reason of the fact that he is or
was serving at the request of the corporation as a director, officer, employee
or agent of another corporation, partnership, joint venture, trust or other
Enterprise; in each case whether or not he is acting or serving in any such
capacity at the time any liability or expense is incurred for which
indemnification can be provided under this Article 7; including one pending on
or before the date hereunder; and excluding one initiated by an Indemnitee
pursuant to Section 7 hereunder to enforce his rights under this Article 7.

SECTION 18. If any provision or provisions hereunder shall be
held by a court of competent jurisdiction to be invalid, void, illegal or
otherwise unenforceable for any reason whatsoever: (a) the validity, legality
and enforceability of the remaining provisions hereunder (including without
limitation, each portion of any section hereunder containing any such provision
held to be invalid, illegal or unenforceable, that is not itself invalid,
illegal or unenforceable) shall not in any way be affected or impaired thereby
and shall remain enforceable to the fullest extent permitted by law; and (b) to
the fullest extent possible, the provisions hereunder (including, without
limitation, each portion of any section hereunder containing any such provision
held to be invalid, illegal or unenforceable, that is not itself invalid,
illegal or unenforceable) shall be construed so as to give effect to the intent
manifested thereby.

ARTICLE VIII

AMENDMENTS

SECTION 1. These bylaws may be altered, amended or repealed or
new bylaws may be adopted by stockholders holding at least seventy-five percent
(75%) of the corporation's outstanding capital stock ("Amending Stockholders")
or by the Board of Directors, when such power is conferred upon the Board of
Directors by the certificate of incorporation at any regular meeting of the
stockholders or of the Board of Directors or by the Amending Stockholders at any
special meeting of the stockholders or by the Board of Directors at any special
meeting of the Board of Directors if notice of such alteration, amendment,
repeal or

21
<PAGE> 22
adoption of new bylaws be contained in the notice of such special meeting. If
the power to adopt, amend or repeal bylaws is conferred upon the Board of
Directors by the certificate or incorporation it shall not divest or limit the
power of the stockholders to adopt, amend or repeal bylaws.

<PAGE> 1
EXHIBIT 5.1

January 20, 1998

Micromuse Inc.
139 Townsend Street
San Francisco, CA 94107

Re: Registration Statement on Form S-1
-----------------------------------

Ladies and Gentlemen:

We have examined the Registration Statement on Form S-1 (File No.
333-42177) originally filed by Micromuse Inc. (the "Company") with the
Securities and Exchange Commission (the "Commission") on December 12, 1997, as
thereafter amended or supplemented (the "Registration Statement"), in connection
with the registration under the Securities Act of 1933, as amended, of up to
3,450,000 shares of the Company's Common Stock (the "Shares"). The Shares, which
include an over-allotment option granted by certain stockholders of the Company
to the Underwriters to purchase up to 450,000 additional shares of the Company's
Common Stock, are to be sold to the Underwriters by the Company and certain
stockholders of the Company as described in the Registration Statement for
resale to the public. As your counsel in connection with this transaction, we
have examined the proceedings taken and are familiar with the proceedings
proposed to be taken by you in connection with the sale and issuance of the
Shares.

It is our opinion that, upon completion of the proceedings being
taken or contemplated by us, as your counsel, to be taken prior to the issuance
of the Shares and upon completion of the proceedings being taken in order to
permit such transactions to be carried out in accordance with the securities
laws of the various states where required, the Shares, when issued and sold in
the manner described in the Registration Statement and in accordance with the
resolutions adopted by the Board of Directors of the Company, will be legally
and validly issued, fully paid and non-assessable. The Shares being sold by the
stockholders of the Company have been validly issued, are non-assessable and, to
our knowledge, are fully paid. Our opinion with respect to the Shares being sold
by the stockholders of the Company being fully paid is based solely upon your
written representations to us with respect to the consideration received for
such Shares.

We consent to the use of this opinion as an exhibit to said
Registration Statement, and further consent to the use of our name wherever
appearing in said Registration Statement, including the prospectus constituting
a part thereof, and in any amendment or supplement thereto.

Very truly yours,

/s/ Gunderson Dettmer Stough Villeneuve Franklin &
Hachigian, LLP

Gunderson Dettmer Stough
Villeneuve Franklin & Hachigian, LLP

<PAGE> 1
EXHIBIT 10.2

MICROMUSE INC.

1997 STOCK OPTION/STOCK ISSUANCE PLAN

(AS AMENDED AND RESTATED JANUARY 20, 1998)

<PAGE> 2
TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
ARTICLE I. GENERAL PROVISIONS . . . . . . . . . . . . . . . . . . . . . . . . . . 1

I. PURPOSE OF THE PLAN . . . . . . . . . . . . . . . . . . . . . . . 1

II. STRUCTURE OF THE PLAN . . . . . . . . . . . . . . . . . . . . . . 1

III. ADMINISTRATION OF THE PLAN . . . . . . . . . . . . . . . . . . . . 1

IV. ELIGIBILITY . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

V. STOCK SUBJECT TO THE PLAN . . . . . . . . . . . . . . . . . . . . 3

ARTICLE II. DISCRETIONARY OPTION GRANT PROGRAM . . . . . . . . . . . . . . . . . . 5

I. OPTION TERMS . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
A. Exercise Price . . . . . . . . . . . . . . . . . . . . . . . . 5
B. Exercise and Term of Options . . . . . . . . . . . . . . . . . 6
C. Effect of Termination of Service . . . . . . . . . . . . . . . 6
D. Stockholder Rights . . . . . . . . . . . . . . . . . . . . . . 7
E. Repurchase Rights . . . . . . . . . . . . . . . . . . . . . . 7
F. First Refusal Rights . . . . . . . . . . . . . . . . . . . . . 7
G. Limited Transferability of Options . . . . . . . . . . . . . . 7

II. INCENTIVE OPTIONS . . . . . . . . . . . . . . . . . . . . . . . . 8
A. Eligibility . . . . . . . . . . . . . . . . . . . . . . . . . 8
B. Exercise Price . . . . . . . . . . . . . . . . . . . . . . . . 8
C. Dollar Limitation . . . . . . . . . . . . . . . . . . . . . . 8
D. 10% Stockholder . . . . . . . . . . . . . . . . . . . . . . . 8

III. CORPORATE TRANSACTION/CHANGE IN CONTROL . . . . . . . . . . . . . 8

IV. CANCELLATION AND REGRANT OF OPTIONS . . . . . . . . . . . . . . . 10

V. STOCK APPRECIATION RIGHTS . . . . . . . . . . . . . . . . . . . . 10

ARTICLE III. STOCK ISSUANCE PROGRAM . . . . . . . . . . . . . . . . . . . . . . . 12

I. STOCK ISSUANCE TERMS . . . . . . . . . . . . . . . . . . . . . . . 12
A Purchase Price . . . . . . . . . . . . . . . . . . . . . . . . 12
B Vesting Provisions . . . . . . . . . . . . . . . . . . . . . . 12

II. CORPORATE TRANSACTION/CHANGE IN CONTROL . . . . . . . . . . . . . 13
</TABLE>

i
<PAGE> 3

<TABLE>
<S> <C>
III. SHARE ESCROW/LEGENDS . . . . . . . . . . . . . . . . . . . . . . . 14

ARTICLE IV. MISCELLANEOUS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

I. FINANCING . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

II. TAX WITHHOLDING . . . . . . . . . . . . . . . . . . . . . . . . . 15

III. EFFECTIVE DATE AND TERM OF THE PLAN . . . . . . . . . . . . . . . 16

IV. AMENDMENT OF THE PLAN . . . . . . . . . . . . . . . . . . . . . . 16

V. USE OF PROCEEDS . . . . . . . . . . . . . . . . . . . . . . . . . 17

VI. REGULATORY APPROVALS . . . . . . . . . . . . . . . . . . . . . . . 17

VII. NO EMPLOYMENT/SERVICE RIGHTS . . . . . . . . . . . . . . . . . . . 17

VIII. FINANCIAL REPORTS . . . . . . . . . . . . . . . . . . . . . . . . 17
</TABLE>

<PAGE> 4
MICROMUSE INC.
1997 STOCK OPTION/STOCK ISSUANCE PLAN
(As amended and restated January 20, 1998)

ARTICLE I

GENERAL PROVISIONS
I. PURPOSE OF THE PLAN

This 1997 Stock Option/Stock Issuance Plan is intended to
promote the interests of Micromuse Inc., a Delaware corporation, by providing
eligible persons with the opportunity to acquire a proprietary interest, or
otherwise increase their proprietary interest, in the Corporation as an
incentive for them to remain in the service of the Corporation.

Capitalized terms shall have the meanings assigned to such
terms in the attached Appendix.

II. STRUCTURE OF THE PLAN

A. The Plan shall be divided into three separate equity
programs:

(i) the Discretionary Option Grant
Program under which eligible persons may, at the discretion of the Plan
Administrator, be granted options to purchase shares of Common Stock, and

(ii) the Stock Issuance Program under
which eligible persons may, at the discretion of the Plan Administrator, be
issued shares of Common Stock directly, either through the immediate purchase
of such shares or as a bonus for services rendered to the Corporation (or any
Parent or Subsidiary).

B. The provisions of Articles One and Four shall apply
to all equity programs under the Plan and shall accordingly govern the
interests of all persons under the Plan.

III. ADMINISTRATION OF THE PLAN

A. Prior to the Section 12(g) Registration Date, the
Discretionary Option Grant and Stock Issuance Programs shall be administered by
the Board.

B. Beginning with the Section 12(g) Registration Date,
the Primary Committee shall have sole and exclusive authority to administer the
Discretionary Option Grant and Stock Issuance Programs with respect to Section
16 Insiders. Administration of the Discretionary Option Grant and Stock
Issuance Programs with respect to all other persons eligible to participate in
those programs may, at the Board's discretion, be vested in the Primary
<PAGE> 5

Committee or a Secondary Committee, or the Board may retain the power to
administer those programs with respect to all such persons.

C. Members of the Primary Committee or any Secondary
Committee shall serve for such period of time as the Board may determine and
may be removed by the Board at any time. The Board may also at any time
terminate the functions of any Secondary Committee and reassume all powers and
authority previously delegated to such committee.

D. Each Plan Administrator shall, within the scope of
its administrative functions under the Plan, have full power and authority to
establish such rules and regulations as it may deem appropriate for proper
administration of the Discretionary Option Grant and Stock Issuance Programs
and to make such determinations under, and issue such interpretations of, the
provisions of such programs and any outstanding options or stock issuances
thereunder as it may deem necessary or advisable. Decisions of the Plan
Administrator within the scope of its administrative functions under the Plan
shall be final and binding on all parties who have an interest in the
Discretionary Option Grant or Stock Issuance Program under its jurisdiction or
any option or stock issuance thereunder.

E. Service on the Primary Committee or the Secondary
Committee shall constitute service as a Board member, and members of each such
committee shall accordingly be entitled to full indemnification and
reimbursement as Board members for their service on such committee. No member
of the Primary Committee or the Secondary Committee shall be liable for any act
or omission made in good faith with respect to the Plan or any option grants or
stock issuances under the Plan.

IV. ELIGIBILITY

A. The persons eligible to participate in the
Discretionary Option Grant and Stock Issuance Programs are as follows:

(i) Employees,

(ii) non-employee members of the Board or
the board of directors of any Parent or Subsidiary, and

(iii) consultants and other independent
advisors who provide services to the Corporation (or any Parent or Subsidiary).

B. Each Plan Administrator shall, within the scope of
its administrative jurisdiction under the Plan, have full authority (subject to
the provisions of the Plan) to determine, (i) with respect to the option grants
under the Discretionary Option Grant Program, which eligible persons are to
receive option grants, the time or times when such option grants are to be
made, the number of shares to be covered by each such grant, the status of the
granted option as either an Incentive Option or a Non-Statutory Option, the
time or times at which each option is to become exercisable, the vesting
schedule (if any) applicable to the option shares and the maximum term for
which the option is to remain outstanding and (ii) with respect to stock

2
<PAGE> 6

issuances under the Stock Issuance Program, which eligible persons are to
receive stock issuances, the time or times when such issuances are to be made,
the number of shares to be issued to each Participant, the vesting schedule (if
any) applicable to the issued shares and the consideration to be paid for such
shares.

C. The Plan Administrator shall have the absolute
discretion either to grant options in accordance with the Discretionary Option
Grant Program or to effect stock issuances in accordance with the Stock
Issuance Program.

V. STOCK SUBJECT TO THE PLAN

A. The stock issuable under the Plan shall be shares of
authorized but unissued or reacquired Common Stock, including shares
repurchased by the Corporation on the open market. The maximum number of
shares of Common Stock which may be issued over the term of the Plan shall not
exceed two million four hundred ninety-three thousand seven hundred and
seventy-one (2,493,771) shares. Such share increase is comprised of the (i)
one million five hundred thirty-two thousand and eighty-six (1,532,086) shares
previously reserved under the Plan, of which 57,045 shares remain available for
option grant and (ii) an additional increase of nine hundred eighty thousand
five hundred fourteen (980,514) shares authorized by the Board under the
Plan.

B. The number of shares of Common Stock available for
issuance under the Plan shall automatically increase on October 1 of each
fiscal year during the term of the Plan, beginning with October 1, 1999, by an
amount equal to the lesser of (i) one million (1,000,000) shares of Common
Stock or (ii) five percent (5%) of the total number of shares of Common Stock
then outstanding. No Incentive Options may be granted on the basis of the
additional shares of Common Stock resulting from such annual increases.

C. No one person participating in the Plan may receive
options, separately exercisable stock appreciation rights and direct stock
issuances for more than 500,000 shares of Common Stock per calendar year
beginning with the 1997 calendar year.

D. Shares of Common Stock subject to outstanding options
shall be available for subsequent issuance under the Plan to the extent (i) the
options expire or terminate for any reason prior to exercise in full or (ii)
the options are cancelled in accordance with the cancellation-regrant
provisions of Section IV of Article Two. Unvested shares issued under the Plan
and subsequently repurchased by the Corporation at the original issue price
paid per share pursuant to the Corporation's repurchase rights under the Plan
shall be added back to the number of shares of Common Stock reserved for
issuance under the Plan and shall accordingly be available for reissuance
through one or more subsequent option grants or direct stock issuances under
the Plan. However, should the exercise price of an option under the Plan be
paid with shares of Common Stock or should shares of Common Stock otherwise
issuable under the Plan be withheld by the Corporation in satisfaction of the
withholding taxes incurred in connection with the exercise of an option or the
vesting of a stock issuance under the Plan, then the number of shares of Common
Stock available for issuance under the Plan shall be reduced by the gross

3
<PAGE> 7

number of shares for which the option is exercised or which vest under the
stock issuance, and not by the net number of shares of Common Stock issued to
the holder of such option or stock issuance.

E. Should any change be made to the Common Stock by
reason of any stock split, stock dividend, recapitalization, combination of
shares, exchange of shares or other change affecting the outstanding Common
Stock as a class without the Corporation's receipt of consideration,
appropriate adjustments shall be made to (i) the maximum number and/or class of
securities issuable under the Plan, (ii) the number and/or class of securities
for which any one person may be granted options, separately exercisable stock
appreciation rights and direct stock issuances per calendar year and (iii) the
number and/or class of securities and the exercise price per share in effect
under each outstanding option in order to prevent the dilution or enlargement
of benefits thereunder. The adjustments determined by the Plan Administrator
shall be final, binding and conclusive.

4
<PAGE> 8

ARTICLE II

DISCRETIONARY OPTION GRANT PROGRAM

I. OPTION TERMS

Each option shall be evidenced by one or more documents in the
form approved by the Plan Administrator; provided, however, that each such
document shall comply with the terms specified below. Each document evidencing
an Incentive Option shall, in addition, be subject to the provisions of the
Plan applicable to such options.

A. EXERCISE PRICE.

1. The exercise price per share shall be fixed
by the Plan Administrator in accordance with the following provisions:

(i) The exercise price per share shall
not be less than eighty-five percent (85%) of the Fair Market Value per share
of Common Stock on the option grant date.

(ii) If the person to whom the option is
granted is a 10% Stockholder, then the exercise price per share shall not be
less than one hundred ten percent (110%) of the Fair Market Value per share of
Common Stock on the option grant date.

2. The exercise price shall become immediately
due upon exercise of the option and shall, subject to the provisions of Section
I of Article Four and the documents evidencing the option, be payable in cash
or check made payable to the Corporation. Should the Common Stock be
registered under Section 12(g) of the 1934 Act at the time the option is
exercised, then the exercise price may also be paid as follows:

(i) in shares of Common Stock held for
the requisite period necessary to avoid a charge to the Corporation's earnings
for financial reporting purposes and valued at Fair Market Value on the
Exercise Date, or

(ii) to the extent the option is
exercised for vested shares, through a special sale and remittance procedure
pursuant to which the Optionee shall concurrently provide irrevocable written
instructions to (a) a Corporation-designated brokerage firm to effect the
immediate sale of the purchased shares and remit to the Corporation, out of the
sale proceeds available on the settlement date, sufficient funds to cover the
aggregate exercise price payable for the purchased shares plus all applicable
Federal, state and local income and employment taxes required to be withheld by
the Corporation by reason of such exercise and (b) the Corporation to deliver
the certificates for the purchased shares directly to such brokerage firm in
order to complete the sale.

5
<PAGE> 9

Except to the extent such sale and remittance procedure is
utilized, payment of the exercise price for the purchased shares must be made
on the Exercise Date.

B. EXERCISE AND TERM OF OPTIONS. Each option shall be
exercisable at such time or times, during such period and for such number of
shares as shall be determined by the Plan Administrator and set forth in the
documents evidencing the option. However, no option shall have a term in
excess of ten (10) years measured from the option grant date or, if required by
the United Kingdom or Australian tax or securities laws, a term in excess of
seven (7) years.

C. EFFECT OF TERMINATION OF SERVICE.

1. The following provisions shall govern the
exercise of any options held by the Optionee at the time of cessation of
Service or death:

(i) Should the Optionee cease to remain
in Service for any reason other than death, Disability or Misconduct, then the
Optionee shall have a period of three (3) months following the date of such
cessation of Service during which to exercise each outstanding option held by
such Optionee.

(ii) Should Optionee's Service terminate
by reason of Disability, then the Optionee shall have a period of twelve (12)
months following the date of such cessation of Service during which to exercise
each outstanding option held by such Optionee.

(iii) If the Optionee dies while holding
an outstanding option, then the personal representative of his or her estate or
the person or persons to whom the option is transferred pursuant to the
Optionee's will or the laws of inheritance shall have a twelve (12)-month
period following the date of the Optionee's death to exercise such option.

(iv) Under no circumstances, however,
shall any such option be exercisable after the specified expiration of the
option term.

(v) During the applicable post-Service
exercise period, the option may not be exercised in the aggregate for more than
the number of vested shares for which the option is exercisable on the date of
the Optionee's cessation of Service. Upon the expiration of the applicable
exercise period or (if earlier) upon the expiration of the option term, the
option shall terminate and cease to be outstanding for any vested shares for
which the option has not been exercised. However, the option shall,
immediately upon the Optionee's cessation of Service, terminate and cease to be
outstanding to the extent the option is not otherwise at that time exercisable
for vested shares.

(vi) Should the Optionee's Service be
terminated for Misconduct, then all outstanding options held by the Optionee
shall terminate immediately and cease to be outstanding.

6
<PAGE> 10

2. The Plan Administrator shall have the
discretion, exercisable either at the time an option is granted or at any time
while the option remains outstanding, to:

(i) extend the period of time for which
the option is to remain exercisable following the Optionee's cessation of
Service from the period otherwise in effect for that option to such greater
period of time as the Plan Administrator shall deem appropriate, but in no
event beyond the expiration of the option term, and/or

(ii) permit the option to be exercised,
during the applicable post-Service exercise period, not only with respect to
the number of vested shares of Common Stock for which such option is
exercisable at the time of the Optionee's cessation of Service but also with
respect to one or more additional installments in which the Optionee would have
vested under the option had the Optionee continued in Service.

D. STOCKHOLDER RIGHTS. The holder of an option shall
have no stockholder rights with respect to the shares subject to the option
until such person shall have exercised the option, paid the exercise price and
become a holder of record of the purchased shares.

E. REPURCHASE RIGHTS. The Plan Administrator shall have
the discretion to grant options which are exercisable for unvested shares of
Common Stock. Should the Optionee cease Service while holding such unvested
shares, the Corporation shall have the right to repurchase, at the exercise
price paid per share, any or all of those unvested shares. The terms upon
which such repurchase right shall be exercisable (including the period and
procedure for exercise and the appropriate vesting schedule for the purchased
shares) shall be established by the Plan Administrator and set forth in the
document evidencing such repurchase right. The Plan Administrator may not
impose a vesting schedule upon the option grant or any shares of Common Stock
subject to that option which is more restrictive than twenty percent (20%) per
year vesting, with the initial vesting to occur not later than one (1) year
after the option grant date. However, such limitation shall not be applicable
to any option grants made to individuals who are officers of the Corporation,
non-employee Board members or independent consultants.

F. FIRST REFUSAL RIGHTS. Until such time as the Common
Stock is first registered under Section 12(g) of the 1934 Act, the Corporation
shall have the right of first refusal with respect to any proposed disposition
by the Optionee (or any successor in interest) of any shares of Common Stock
issued under the Plan. Such right of first refusal shall be exercisable in
accordance with the terms established by the Plan Administrator set forth in
the document evidencing such right.

G. LIMITED TRANSFERABILITY OF OPTIONS. During the
lifetime of the Optionee, the option shall be exercisable only by the Optionee
and shall not be assignable or transferable other than by will or by the laws
of descent and distribution following the Optionee's death.

7
<PAGE> 11

II. INCENTIVE OPTIONS

The terms specified below shall be applicable to all Incentive
Options. Except as modified by the provisions of this Section II, all the
provisions of Articles One, Two and Four shall be applicable to Incentive
Options. Options which are specifically designated as Non-Statutory Options
when issued under the Plan shall not be subject to the terms of this Section
II.

A. ELIGIBILITY. Incentive Options may only be granted
to Employees.

B. EXERCISE PRICE. The exercise price per share shall
not be less than one hundred percent (100%) of the Fair Market Value per share
of Common Stock on the option grant date.

C. DOLLAR LIMITATION. The aggregate Fair Market Value
of the shares of Common Stock (determined as of the respective date or dates of
grant) for which one or more options granted to any Employee under the Plan (or
any other option plan of the Corporation or any Parent or Subsidiary) may for
the first time become exercisable as Incentive Options during any one (1)
calendar year shall not exceed the sum of One Hundred Thousand Dollars
($100,000). To the extent the Employee holds two (2) or more such options
which become exercisable for the first time in the same calendar year, the
foregoing limitation on the exercisability of such options as Incentive Options
shall be applied on the basis of the order in which such options are granted.

D. 10% STOCKHOLDER. If any Employee to whom an
Incentive Option is granted is a 10% Stockholder, then the option term shall
not exceed five (5) years measured from the option grant date.

III. CORPORATE TRANSACTION/CHANGE IN CONTROL

A. In the event of any Corporate Transaction, each
outstanding option shall automatically accelerate so that each such option
shall, immediately prior to the effective date of the Corporate Transaction,
become fully exercisable for all of the shares of Common Stock at the time
subject to such option and may be exercised for any or all of those shares as
fully-vested shares of Common Stock. However, an outstanding option shall NOT
so accelerate if and to the extent: (i) such option is, in connection with the
Corporate Transaction, either to be assumed by the successor corporation (or
parent thereof) or to be replaced with a comparable option to purchase shares
of the capital stock of the successor corporation (or parent thereof), (ii)
such option is to be replaced with a cash incentive program of the successor
corporation which preserves the spread existing on the unvested option shares
at the time of the Corporate Transaction and provides for subsequent payout in
accordance with the same vesting schedule applicable to such option or (iii)
the acceleration of such option is subject to other limitations imposed by the
Plan Administrator at the time of the option grant. The determination of
option comparability under clause (i) above shall be made by the Plan
Administrator, and its determination shall be final, binding and conclusive.

8
<PAGE> 12

B. All outstanding repurchase rights shall also
terminate automatically, and the shares of Common Stock subject to those
terminated rights shall immediately vest in full, in the event of any Corporate
Transaction, except to the extent: (i) those repurchase rights are to be
assigned to the successor corporation (or parent thereof) in connection with
such Corporate Transaction or (ii) such accelerated vesting is precluded by
other limitations imposed by the Plan Administrator at the time the repurchase
right is issued.

C. Notwithstanding Section III.A. and Section III.B. of
this Article Two, the Plan Administrator shall have the discretion, exercisable
either at the time the option is granted or at any time while the option
remains outstanding, to provide for the automatic acceleration of one or more
outstanding options (and the automatic termination of one or more outstanding
repurchase rights with the immediate vesting of the shares of Common Stock
subject to those rights) upon the occurrence of a Corporate Transaction,
whether or not those options are to be assumed or replaced (or those repurchase
rights are to be assigned) in the Corporate Transaction. The Plan
Administrator shall also have the discretion to grant options which do not
accelerate whether or not such options are assumed (and to provide for
repurchase rights that do not terminate whether or not such rights are
assigned) in connection with a Corporate Transaction.

D. Immediately following the consummation of the
Corporate Transaction, all outstanding options shall terminate and cease to be
outstanding, except to the extent assumed by the successor corporation (or
parent thereof).

E. Each option which is assumed in connection with a
Corporate Transaction shall be appropriately adjusted, immediately after such
Corporate Transaction, to apply to the number and class of securities which
would have been issuable to the Optionee in consummation of such Corporate
Transaction had the option been exercised immediately prior to such Corporate
Transaction. Appropriate adjustments shall also be made to (i) the number and
class of securities available for issuance under the Plan following the
consummation of such Corporate Transaction, (ii) the exercise price payable per
share under each outstanding option, provided the aggregate exercise price
payable for such securities shall remain the same and (iii) the maximum number
of securities and/or class of securities for which any one person may be
granted stock options, separately exercisable stock appreciation rights and
direct stock issuances under the Plan.

F. The Plan Administrator shall have the discretion,
exercisable at the time the option is granted or at any time while the option
remains outstanding, to provide for the automatic acceleration of any options
which are assumed or replaced in a Corporate Transaction and do not otherwise
accelerate at that time (and the termination of any of the Corporation's
outstanding repurchase rights which do not otherwise terminate at the time of
the Corporate Transaction) in the event the Optionee's Service should
subsequently terminate by reason of an Involuntary Termination within eighteen
(18) months following the effective date of such Corporate Transaction. Any
options so accelerated shall remain exercisable for fully-vested shares until
the earlier of (i) the expiration of the option term or (ii) the expiration of
the one (1)-year period measured from the effective date of the Involuntary
Termination.

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<PAGE> 13

G. The Plan Administrator shall have the discretion,
exercisable either at the time the option is granted or at any time while the
option remains outstanding, to (i) provide for the automatic acceleration of
one or more outstanding options (and the automatic termination of one or more
outstanding repurchase rights with the immediate vesting of the shares of
Common Stock subject to those rights) upon the occurrence of a Change in
Control or (ii) condition any such option acceleration (and the termination of
any outstanding repurchase rights) upon the subsequent Involuntary Termination
of the Optionee's Service within a specified period (not to exceed eighteen
(18) months) following the effective date of such Change in Control. Any
options accelerated in connection with a Change in Control shall remain fully
exercisable until the expiration or sooner termination of the option term.

H. The portion of any Incentive Option accelerated in
connection with a Corporate Transaction or Change in Control shall remain
exercisable as an Incentive Option only to the extent the applicable One
Hundred Thousand Dollar ($100,000) limitation is not exceeded. To the extent
such dollar limitation is exceeded, the accelerated portion of such option
shall be exercisable as a Non-Statutory Option under the Federal tax laws.

I. The grant of options under the Discretionary Option
Grant Program shall in no way affect the right of the Corporation to adjust,
reclassify, reorganize or otherwise change its capital or business structure or
to merge, consolidate, dissolve, liquidate or sell or transfer all or any part
of its business or assets.

IV. CANCELLATION AND REGRANT OF OPTIONS

The Plan Administrator shall have the authority to effect, at
any time and from time to time, with the consent of the affected option
holders, the cancellation of any or all outstanding options under the
Discretionary Option Grant Program and to grant in substitution new options
covering the same or different number of shares of Common Stock but with an
exercise price per share based on the Fair Market Value per share of Common
Stock on the new grant date.

V. STOCK APPRECIATION RIGHTS

A. The Plan Administrator shall have full power and
authority to grant to selected Optionees tandem stock appreciation rights
and/or limited stock appreciation rights.

B. The following terms shall govern the grant and
exercise of tandem stock appreciation rights:

(i) One or more Optionees may be granted
the right, exercisable upon such terms as the Plan Administrator may establish,
to elect between the exercise of the underlying option for shares of Common
Stock and the surrender of that option in exchange for a distribution from the
Corporation in an amount equal to the excess of (a) the Fair Market Value (on
the option surrender date) of the number of shares in which the Optionee is at

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<PAGE> 14

the time vested under the surrendered option (or surrendered portion thereof)
over (b) the aggregate exercise price payable for such shares.

(ii) No such option surrender shall be
effective unless it is approved by the Plan Administrator. If the surrender is
so approved, then the distribution to which the Optionee shall be entitled may
be made in shares of Common Stock valued at Fair Market Value on the option
surrender date, in cash, or partly in shares and partly in cash, as the Plan
Administrator shall in its sole discretion deem appropriate.

(iii) If the surrender of an option is
rejected by the Plan Administrator, then the Optionee shall retain whatever
rights the Optionee had under the surrendered option (or surrendered portion
thereof) on the option surrender date and may exercise such rights at any time
prior to the later of (a) five (5) business days after the receipt of the
rejection notice or (b) the last day on which the option is otherwise
exercisable in accordance with the terms of the documents evidencing such
option, but in no event may such rights be exercised more than ten (10) years
after the option grant date.

C. The following terms shall govern the grant and
exercise of limited stock appreciation rights:

(i) One or more Section 16 Insiders may
be granted limited stock appreciation rights with respect to their outstanding
options.

(ii) Upon the occurrence of a Hostile
Take-Over, each such individual holding one or more options with such a limited
stock appreciation right shall have the unconditional right (exercisable for a
thirty (30)-day period following such Hostile Take-Over) to surrender each such
option to the Corporation, to the extent the option is at the time exercisable
for vested shares of Common Stock. In return for the surrendered option, the
Optionee shall receive a cash distribution from the Corporation in an amount
equal to the excess of (a) the Take-Over Price of the shares of Common Stock
which are at the time vested under each surrendered option (or surrendered
portion thereof) over (b) the aggregate exercise price payable for such shares.
Such cash distribution shall be paid within five (5) days following the option
surrender date.

(iii) Neither the approval of the Plan
Administrator nor the consent of the Board shall be required in connection with
such option surrender and cash distribution.

(iv) The balance of the option (if any)
shall continue in full force and effect in accordance with the documents
evidencing such option.

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<PAGE> 15
ARTICLE III

STOCK ISSUANCE PROGRAM

I. STOCK ISSUANCE TERMS

Shares of Common Stock may be issued under the Stock Issuance
Program through direct and immediate issuances without any intervening option
grants. Each such stock issuance shall be evidenced by a Stock Issuance
Agreement which complies with the terms specified below.

A. PURCHASE PRICE.

1. The purchase price per share shall be fixed
by the Plan Administrator, but shall not be less than eighty-five percent (85%)
of the Fair Market Value per share of Common Stock on the issue date. However,
the purchase price per share of Common Stock issued to a 10% Stockholder shall
not be less than one hundred and ten percent (110%) of such Fair Market Value.

2. Subject to the provisions of Section I of
Article Four, shares of Common Stock may be issued under the Stock Issuance
Program for any of the following items of consideration which the Plan
Administrator may deem appropriate in each individual instance:

(i) cash or check made payable to the
Corporation, or

(ii) past services rendered to the
Corporation (or any Parent or Subsidiary).

B. VESTING PROVISIONS.

1. Shares of Common Stock issued under the Stock
Issuance Program may, in the discretion of the Plan Administrator, be fully and
immediately vested upon issuance or may vest in one or more installments over
the Participant's period of Service or upon attainment of specified performance
objectives. However, the Plan Administrator may not impose a vesting schedule
upon any stock issuance effected under the Stock Issuance Program which is more
restrictive than twenty percent (20%) per year vesting, with initial vesting to
occur not later than one (1) year after the issuance date. Such limitation
shall not apply to any Common Stock issuances made to the officers of the
Corporation, non-employee Board members or independent consultants.

2. Any new, substituted or additional securities
or other property (including money paid other than as a regular cash dividend)
which the Participant may have the right to receive with respect to the
Participant's unvested shares of Common Stock by reason of any stock dividend,
stock split, recapitalization, combination of shares, exchange of shares or
other change affecting the outstanding Common Stock as a class without the
Corporation's

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<PAGE> 16

receipt of consideration shall be issued subject to (i) the same vesting
requirements applicable to the Participant's unvested shares of Common Stock
and (ii) such escrow arrangements as the Plan Administrator shall deem
appropriate.

3. The Participant shall have full stockholder
rights with respect to any shares of Common Stock issued to the Participant
under the Stock Issuance Program, whether or not the Participant's interest in
those shares is vested. Accordingly, the Participant shall have the right to
vote such shares and to receive any regular cash dividends paid on such shares.

4. Should the Participant cease to remain in
Service while holding one or more unvested shares of Common Stock issued under
the Stock Issuance Program or should the performance objectives not be attained
with respect to one or more such unvested shares of Common Stock, then those
shares shall be immediately surrendered to the Corporation for cancellation,
and the Participant shall have no further stockholder rights with respect to
those shares. To the extent the surrendered shares were previously issued to
the Participant for consideration paid in cash or cash equivalent (including
the Participant's purchase-money indebtedness), the Corporation shall repay to
the Participant the cash consideration paid for the surrendered shares and
shall cancel the unpaid principal balance of any outstanding purchase- money
note of the Participant attributable to the surrendered shares.

5. The Plan Administrator may in its discretion
waive the surrender and cancellation of one or more unvested shares of Common
Stock (or other assets attributable thereto) which would otherwise occur upon
the cessation of the Participant's Service or the non-attainment of the
performance objectives applicable to those shares. Such waiver shall result in
the immediate vesting of the Participant's interest in the shares of Common
Stock as to which the waiver applies. Such waiver may be effected at any time,
whether before or after the Participant's cessation of Service or the
attainment or non-attainment of the applicable performance objectives.

II. CORPORATE TRANSACTION/CHANGE IN CONTROL

A. All of the Corporation's outstanding repurchase
rights under the Stock Issuance Program shall terminate automatically, and all
the shares of Common Stock subject to those terminated rights shall immediately
vest in full, in the event of any Corporate Transaction, except to the extent
(i) those repurchase rights are assigned to the successor corporation (or
parent thereof) in connection with such Corporate Transaction or (ii) such
accelerated vesting is precluded by other limitations imposed in the Stock
Issuance Agreement.

B. Notwithstanding Section II.A. of this Article Three,
the Plan Administrator shall have the discretionary authority, exercisable
either at the time the unvested shares are issued or any time while the
Corporation's repurchase rights remain outstanding under the Stock Issuance
Program, to provide that those rights shall automatically terminate in whole or
in part, and the shares of Common Stock subject to those terminated rights
shall immediately vest, in the event of a Corporate Transaction, whether or not
those repurchase rights are to be

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<PAGE> 17

assigned to the successor corporation (or its parent) in connection with such
Corporate Transaction. The Plan Administrator shall also have the discretion
to provide for repurchase rights with terms different from those in effect
under this Section II in connection with a Corporate Transaction.

C. The Plan Administrator shall have the discretion,
exercisable either at the time the unvested shares are issued or at any time
while the Corporation's repurchase rights remain outstanding, to provide that
any repurchase rights that are assigned in the Corporate Transaction shall
automatically terminate, and the shares of Common Stock subject to those
terminated rights shall immediately vest in full, in the event the
Participant's Service should subsequently terminate by reason of an Involuntary
Termination within eighteen (18) months following the effective date of such
Corporate Transaction.

D. The Plan Administrator shall have the discretion,
exercisable either at the time the unvested shares are issued or at any time
while the Corporation's repurchase right remains outstanding, to (i) provide
for the automatic termination of one or more outstanding repurchase rights and
the immediate vesting of the shares of Common Stock subject to those rights
upon the occurrence of a Change in Control or (ii) condition any such
accelerated vesting upon the subsequent Involuntary Termination of the
Participant's Service within a specified period (not to exceed eighteen (18)
months) following the effective date of such Change in Control.

III. SHARE ESCROW/LEGENDS

Unvested shares may, in the Plan Administrator's discretion,
be held in escrow by the Corporation until the Participant's interest in such
shares vests or may be issued directly to the Participant with restrictive
legends on the certificates evidencing those unvested shares.

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<PAGE> 18
ARTICLE IV

MISCELLANEOUS

I. FINANCING

A. The Plan Administrator may permit any Optionee or
Participant to pay the option exercise price under the Discretionary Option
Grant Program or the purchase price for shares issued under the Stock Issuance
Program by delivering a full-recourse, interest bearing promissory note payable
in one or more installments. The terms of any such promissory note (including
the interest rate and the terms of repayment) shall be established by the Plan
Administrator in its sole discretion. In all events, the maximum credit
available to the Optionee or Participant may not exceed the sum of (i) the
aggregate option exercise price or purchase price payable for the purchased
shares plus (ii) any Federal, state and local income and employment tax
liability incurred by the Optionee or the Participant in connection with the
option exercise or share purchase.

B. The Plan Administrator may, in its discretion,
determine that one or more such promissory notes shall be subject to
forgiveness by the Corporation in whole or in part upon such terms as the Plan
Administrator may deem appropriate.

II. TAX WITHHOLDING

A. The Corporation's obligation to deliver shares of
Common Stock upon the exercise of options or upon the issuance or vesting of
such shares under the Plan shall be subject to the satisfaction of all
applicable Federal, state and local income and employment tax withholding
requirements and any United Kingdom income or employment tax withholding
requirements.

B. The Plan Administrator may, in its discretion,
provide any or all holders of Non-Statutory Options or unvested shares of
Common Stock under the Plan with the right to use shares of Common Stock in
satisfaction of all or part of the Taxes incurred by such holders in connection
with the exercise of their options or the vesting of their shares. Such right
may be provided to any such holder in either or both of the following formats:

(i) Stock Withholding: The election to
have the Corporation withhold, from the shares of Common Stock otherwise
issuable upon the exercise of such Non-Statutory Option or the vesting of such
shares, a portion of those shares with an aggregate Fair Market Value equal to
the percentage of the Taxes (not to exceed one hundred percent (100%))
designated by the holder.

(ii) Stock Delivery: The election to
deliver to the Corporation, at the time the Non-Statutory Option is exercised
or the shares vest, one or more shares of Common Stock previously acquired by
such holder (other than in connection with the option

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<PAGE> 19

exercise or share vesting triggering the Taxes) with an aggregate Fair Market
Value equal to the percentage of the Taxes (not to exceed one hundred percent
(100%)) designated by the holder.

III. EFFECTIVE DATE AND TERM OF THE PLAN

A. The Plan shall become effective on the Plan Effective
Date. Options may be granted at any time on or after the Plan Effective Date.
However, no options granted under the Plan may be exercised, and no shares
shall be issued under the Plan, until the Plan is approved by the Corporation's
stockholders. If such stockholder approval is not obtained within twelve (12)
months after the Plan Effective Date, then all options previously granted under
this Plan shall terminate and cease to be outstanding, and no further options
shall be granted and no shares shall be issued under the Plan.

B. The Plan shall terminate upon the earliest of (i)
March 6, 2006, (ii) the date on which all shares available for issuance under
the Plan shall have been issued as fully-vested shares or (iii) the termination
of all outstanding options in connection with a Corporate Transaction. Upon
such Plan termination, all outstanding options and unvested stock issuances
shall continue to have force and effect in accordance with the provisions of
the documents evidencing such options or issuances.

IV. AMENDMENT OF THE PLAN

A. The Board shall have complete and exclusive power and
authority to amend or modify the Plan in any or all respects. However, no such
amendment or modification shall adversely affect any rights and obligations
with respect to options, stock appreciation rights or unvested stock issuances
at the time outstanding under the Plan unless the Optionee or the Participant
consents to such amendment or modification. In addition, amendments to the
Plan shall be subject to approval of the Corporation's stockholders to the
extent required by applicable laws or regulations.

B. Options to purchase shares of Common Stock may be
granted under the Discretionary Option Grant Program and shares of Common Stock
may be issued under the Stock Issuance Program that are in each instance in
excess of the number of shares then available for issuance under the Plan,
provided any excess shares actually issued under those programs are held in
escrow until there is obtained stockholder approval of an amendment
sufficiently increasing the number of shares of Common Stock available for
issuance under the Plan. If such stockholder approval is not obtained within
twelve (12) months after the date the first such excess grants or issuances are
made, then (i) any unexercised options granted on the basis of such excess
shares shall terminate and cease to be outstanding and (ii) the Corporation
shall promptly refund to the Optionees and the Participants the exercise or
purchase price paid for any excess shares issued under the Plan and held in
escrow, together with interest (at the applicable Short Term Federal Rate) for
the period the shares were held in escrow, and such shares shall thereupon be
automatically cancelled and cease to be outstanding.

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<PAGE> 20

V. USE OF PROCEEDS

Any cash proceeds received by the Corporation from the sale of
shares of Common Stock under the Plan shall be used for general corporate
purposes.

VI. REGULATORY APPROVALS

A. The implementation of the Plan, the granting of any
option or stock appreciation right under the Plan and the issuance of any
shares of Common Stock (i) upon the exercise of any option or stock
appreciation right or (ii) under the Stock Issuance Program shall be subject to
the Corporation's procurement of all approvals and permits required by
regulatory authorities having jurisdiction over the Plan, the options and stock
appreciation rights granted under it and the shares of Common Stock issued
pursuant to it.

B. No shares of Common Stock or other assets shall be
issued or delivered under the Plan unless and until there shall have been
compliance with all applicable requirements of Federal and state securities
laws and all applicable listing requirements of any stock exchange (or the
Nasdaq National Market, if applicable) on which Common Stock is then listed for
trading.

VII. NO EMPLOYMENT/SERVICE RIGHTS

Nothing in the Plan shall confer upon the Optionee or the
Participant any right to continue in Service for any period of specific
duration or interfere with or otherwise restrict in any way the rights of the
Corporation (or any Parent or Subsidiary employing or retaining such person) or
of the Optionee or the Participant, which rights are hereby expressly reserved
by each, to terminate such person's Service at any time for any reason, with or
without cause.

VIII. FINANCIAL REPORTS

The Corporation shall deliver a balance sheet and an income
statement at least annually to each individual holding an outstanding option
under the Plan, unless such individual is a key Employee whose duties in
connection with the Corporation (or any Parent or Subsidiary) assure such
individual access to equivalent information.

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<PAGE> 21
APPENDIX

The following definitions shall be in effect under the Plan:

A. BOARD shall mean the Corporation's Board of
Directors.

B. CHANGE IN CONTROL shall mean a change in ownership or
control of the Corporation effected through either of the following
transactions:

(i) the acquisition, directly or indirectly, by
any person or related group of persons (other than the Corporation or a person
that directly or indirectly controls, is controlled by, or is under common
control with, the Corporation), of beneficial ownership (within the meaning of
Rule 13d-3 of the 1934 Act) of securities possessing more than fifty percent
(50%) of the total combined voting power of the Corporation's outstanding
securities pursuant to a tender or exchange offer made directly to the
Corporation's stockholders, which the Board does not recommend such
stockholders to accept, or

(ii) a change in the composition of the Board over
a period of thirty-six (36)consecutive months or less such that a majority of
the Board members ceases, by reason of one or more contested elections for
Board membership, to be comprised of individuals who either (A) have been Board
members continuously since the beginning of such period or (B) have been
elected or nominated for election as Board members during such period by at
least a majority of the Board members described in clause (A) who were still in
office at the time the Board approved such election or nomination.

C. CODE shall mean the Internal Revenue Code of 1986, as
amended.

D. COMMON STOCK shall mean the Corporation's common
stock.

E. CORPORATE TRANSACTION shall mean either of the
following stockholder-approved transactions to which the Corporation is a
party:

(i) a merger or consolidation in which securities
possessing more than fifty percent (50%) of the total combined voting power of
the Corporation's outstanding securities are transferred to a person or persons
different from the persons holding those securities immediately prior to such
transaction; or

(ii) the sale, transfer or other disposition of
all or substantially all of the Corporation's assets in complete liquidation or
dissolution of the Corporation.

F. CORPORATION shall mean Micromuse Inc., a Delaware
corporation, and any corporate successor to all or substantially all of the
assets or voting stock of Micromuse Inc. which shall by appropriate action
adopt the Plan.

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G. DISABILITY shall mean the inability of the Optionee
or the Participant to engage in any substantial gainful activity by reason of
any medically determinable physical or mental impairment and shall be
determined by the Plan Administrator on the basis of such medical evidence as
the Plan Administrator deems warranted under the circumstances.

H. DISCRETIONARY OPTION GRANT PROGRAM shall mean the
discretionary option grant program in effect under the Plan.

I. EMPLOYEE shall mean an individual who is in the
employ of the Corporation (or any Parent or Subsidiary), subject to the control
and direction of the employer entity as to both the work to be performed and
the manner and method of performance.

J. EXERCISE DATE shall mean the date on which the
Corporation shall have received written notice of the option exercise.

K. FAIR MARKET VALUE per share of Common Stock on any
relevant date shall be determined in accordance with the following provisions:

(i) If the Common Stock is at the time traded on
the Nasdaq National Market, then the Fair Market Value shall be the closing
price per share of Common Stock on the date in question, as such price is
reported by the National Association of Securities Dealers on the Nasdaq
National Market or any successor system. If there is no closing price for the
Common Stock on the date in question, then the Fair Market Value shall be the
closing price on the last preceding date for which such quotation exists.

(ii) If the Common Stock is at the time listed on
any Stock Exchange, then the Fair Market Value shall be the closing selling
price per share of Common Stock on the date in question on the Stock Exchange
determined by the Plan Administrator to be the primary market for the Common
Stock, as such price is officially quoted in the composite tape of transactions
on such exchange. If there is no closing selling price for the Common Stock on
the date in question, then the Fair Market Value shall be the closing selling
price on the last preceding date for which such quotation exists.

(iii) For purposes of any option grants made on the
Underwriting Date, the Fair Market Value shall be deemed to be equal to the
price per share at which the Common Stock is sold in the initial public
offering pursuant to the Underwriting Agreement.

(iv) For purposes of any option grants made prior
to the Underwriting Date, the Fair Market Value shall be determined by the Plan
Administrator after taking into account such factors as the Plan Administrator
shall deem appropriate.

L. HOSTILE TAKE-OVER shall mean the acquisition,
directly or indirectly, by any person or related group of persons (other than
the Corporation or a person that directly or indirectly controls, is controlled
by, or is under common control with, the Corporation) of beneficial ownership
(within the meaning of Rule 13d-3 of the 1934 Act) of securities possessing
more than fifty percent (50%) of the total combined voting power of the
Corporation's

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<PAGE> 23

outstanding securities pursuant to a tender or exchange offer made directly to
the Corporation's stockholders which the Board does not recommend such
stockholders to accept.

M. INCENTIVE OPTION shall mean an option which satisfies
the requirements of Code Section 422.

N. INVOLUNTARY TERMINATION shall mean the termination of
the Service of any individual which occurs by reason of:

(i) such individual's involuntary dismissal or
discharge by the Corporation for reasons other than Misconduct, or

(ii) such individual's voluntary resignation
following (A) a change in his or her position with the Corporation which
materially reduces his or her level of responsibility, (B) a reduction in his
or her level of compensation (including base salary, fringe benefits and
participation in corporate-performance based bonus or incentive programs) by
more than fifteen percent (15%) or (C) a relocation of such individual's place
of employment by more than fifty (50) miles, provided and only if such change,
reduction or relocation is effected by the Corporation without the individual's
consent.

O. MISCONDUCT shall mean the commission of any act of
fraud, embezzlement or dishonesty by the Optionee or Participant, any
unauthorized use or disclosure by such person of confidential information or
trade secrets of the Corporation (or any Parent or Subsidiary), or any other
intentional misconduct by such person adversely affecting the business or
affairs of the Corporation (or any Parent or Subsidiary) in a material manner.
The foregoing definition shall not be deemed to be inclusive of all the acts or
omissions which the Corporation (or any Parent or Subsidiary) may consider as
grounds for the dismissal or discharge of any Optionee, Participant or other
person in the Service of the Corporation (or any Parent or Subsidiary).

P. 1934 ACT shall mean the Securities Exchange Act of
1934, as amended.

Q. NON-STATUTORY OPTION shall mean an option not
intended to satisfy the requirements of Code Section 422.

R. OPTIONEE shall mean any person to whom an option is
granted under the Plan.

S. PARENT shall mean any corporation (other than the
Corporation) in an unbroken chain of corporations ending with the Corporation,
provided each corporation in the unbroken chain (other than the Corporation)
owns, at the time of the determination, stock possessing fifty percent (50%) or
more of the total combined voting power of all classes of stock in one of the
other corporations in such chain.

T. PARTICIPANT shall mean any person who is issued
shares of Common Stock under the Stock Issuance Program.

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<PAGE> 24

U. PLAN shall mean the Corporation's 1997 Stock
Option/Stock Issuance Plan, as set forth in this document.

V. PLAN ADMINISTRATOR shall mean the particular entity,
whether the Primary Committee, the Board or the Secondary Committee, which is
authorized to administer the Discretionary Option Grant and Stock Issuance
Programs with respect to one or more classes of eligible persons, to the extent
such entity is carrying out its administrative functions under those programs
with respect to the persons under its jurisdiction.

W. PLAN EFFECTIVE DATE shall mean March 7, 1997, the
date on which the Plan was adopted by the Board.

X. PRIMARY COMMITTEE shall mean the committee of two (2)
or more non-employee Board members appointed by the Board to administer the
Discretionary Option Grant and Stock Issuance Programs with respect to Section
16 Insiders.

Y. SECONDARY COMMITTEE shall mean a committee of two (2)
or more Board members appointed by the Board to administer the Discretionary
Option Grant and Stock Issuance Programs with respect to eligible persons other
than Section 16 Insiders.

Z. SECTION 12(G) REGISTRATION DATE shall mean the date
on which the Common Stock is first registered under Section 12(g) of the 1934
Act.

AA. SECTION 16 INSIDER shall mean an officer or director
of the Corporation subject to the short-swing profit liabilities of Section 16
of the 1934 Act.

BB. SERVICE shall mean the performance of services to the
Corporation (or any Parent or Subsidiary) by a person in the capacity of an
Employee, a non-employee member of the board of directors or a consultant or
independent advisor, except to the extent otherwise specifically provided in
the documents evidencing the option grant or stock issuance.

CC. STOCK EXCHANGE shall mean either the American Stock
Exchange or the New York Stock Exchange.

DD. STOCK ISSUANCE AGREEMENT shall mean the agreement
entered into by the Corporation and the Participant at the time of issuance of
shares of Common Stock under the Stock Issuance Program.

EE. STOCK ISSUANCE PROGRAM shall mean the stock issuance
program in effect under the Plan.

FF. SUBSIDIARY shall mean any corporation (other than the
Corporation) in an unbroken chain of corporations beginning with the
Corporation, provided each corporation (other than the last corporation) in the
unbroken chain owns, at the time of the determination, stock possessing fifty
percent (50%) or more of the total combined voting power of all classes of
stock in one of the other corporations in such chain.

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GG. TAKE-OVER PRICE shall mean the greater of (i) the
Fair Market Value per share of Common Stock on the date the option is
surrendered to the Corporation in connection with a Hostile Take-Over or (ii)
the highest reported price per share of Common Stock paid by the tender offeror
in effecting such Hostile Take-Over. However, if the surrendered option is an
Incentive Option, the Take-Over Price shall not exceed the clause (i) price per
share.

HH. TAXES shall mean the Federal, state and local income
and employment tax liabilities incurred by the holder of Non- Statutory Options
or unvested shares of Common Stock in connection with the exercise of those
options or the vesting of those shares.

II. 10% STOCKHOLDER shall mean the owner of stock (as
determined under Code Section 424(d)) possessing more than ten percent (10%) of
the total combined voting power of all classes of stock of the Corporation (or
any Parent or Subsidiary).

JJ. UNDERWRITING AGREEMENT shall mean the agreement
between the Corporation and the underwriter or underwriters managing the
initial public offering of the Common Stock.

KK. UNDERWRITING DATE shall mean the date on which the
Underwriting Agreement is executed and the initial public offering price of the
Common Stock is established.

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MICROMUSE INC.
STOCK PURCHASE AGREEMENT

AGREEMENT made this ______ day of ____________, _____, by and
between Micromuse Inc., a Delaware corporation, and _______________________,
Optionee under the Corporation's 1997 Stock Option/Stock Issuance Plan.

All capitalized terms in this Agreement shall have the meanings
assigned to them in this Agreement or in the attached Appendix.

A. EXERCISE OF OPTION

1. EXERCISE. Optionee hereby purchases ______ shares of Common
Stock (the "Purchased Shares") pursuant to that certain option (the "Option")
granted Optionee on ____________________, 199__ (the "Grant Date") to purchase
up to _______________ shares of Common Stock (the "Purchased Shares") under the
Plan at the exercise price of $___________ per share (the "Exercise Price").

2. PAYMENT. Concurrently with the delivery of this Agreement to
the Corporation, Optionee shall pay the Exercise Price for the Purchased Shares
in accordance with the provisions of the Option Agreement and shall deliver
whatever additional documents may be required by the Option Agreement as a
condition for exercise, together with a duly-executed blank Assignment Separate
from Certificate (in the form attached hereto as Exhibit I) with respect to the
Purchased Shares.

3. STOCKHOLDER RIGHTS. Until such time as the Corporation
exercises the Repurchase Right or the First Refusal Right, Optionee (or any
successor in interest) shall have all the rights of a stockholder (including
voting, dividend and liquidation rights) with respect to the Purchased Shares,
subject, however, to the transfer restrictions of Articles B and C.

B. SECURITIES LAW COMPLIANCE

1. RESTRICTED SECURITIES. The Purchased Shares have not been
registered under the 1933 Act and are being issued to Optionee in reliance upon
the exemption from such registration provided by SEC Rule 701 for stock
issuances under compensatory benefit plans such as the Plan. Optionee hereby
confirms that Optionee has been informed that the Purchased Shares are
restricted securities under the 1933 Act and may not be resold or transferred
unless the Purchased Shares are first registered under the Federal securities
laws or unless an exemption from such registration is available. Accordingly,
Optionee hereby acknowledges that Optionee is prepared to hold the Purchased
Shares for an indefinite period and that Optionee is aware that SEC Rule 144
issued under the 1933 Act which exempts certain resales of unrestricted
securities is not presently available to exempt the resale of the Purchased
Shares from the registration requirements of the 1933 Act.

<PAGE> 27

2. RESTRICTIONS ON DISPOSITION OF PURCHASED SHARES. Optionee
shall make no disposition of the Purchased Shares (other than a Permitted
Transfer) unless and until there is compliance with all of the following
requirements:

(i) Optionee shall have provided the Corporation with a
written summary of the terms and conditions of the proposed disposition.

(ii) Optionee shall have complied with all requirements
of this Agreement applicable to the disposition of the Purchased Shares.

(iii) Optionee shall have provided the Corporation with
written assurances, in form and substance satisfactory to the Corporation, that
(a) the proposed disposition does not require registration of the Purchased
Shares under the 1933 Act or (b) all appropriate action necessary for compliance
with the registration requirements of the 1933 Act or any exemption from
registration available under the 1933 Act (including Rule 144) has been taken.

The Corporation shall not be required (i) to transfer on its
books any Purchased Shares which have been sold or transferred in violation of
the provisions of this Agreement or (ii) to treat as the owner of the Purchased
Shares, or otherwise to accord voting, dividend or liquidation rights to, any
transferee to whom the Purchased Shares have been transferred in contravention
of this Agreement.

3. RESTRICTIVE LEGENDS. The stock certificates for the Purchased
Shares shall be endorsed with one or more of the following restrictive legends:

"The shares represented by this certificate have not been
registered under the Securities Act of 1933. The shares may not be sold
or offered for sale in the absence of (a) an effective registration
statement for the shares under such Act, (b) a "no action" letter of the
Securities and Exchange Commission with respect to such sale or offer or
(c) satisfactory assurances to the Corporation that registration under
such Act is not required with respect to such sale or offer."

"The shares represented by this certificate are subject to
certain repurchase rights and rights of first refusal granted to the
Corporation and accordingly may not be sold, assigned, transferred,
encumbered, or in any manner disposed of except in conformity with the
terms of a written agreement dated _________, 199____ between the
Corporation and the registered holder of the shares (or the predecessor
in interest to the shares). A copy of such agreement is maintained at
the Corporation's principal corporate offices."

C. TRANSFER RESTRICTIONS

1. RESTRICTION ON TRANSFER. Except for any Permitted Transfer,
Optionee shall not transfer, assign, encumber or otherwise dispose of any of the
Purchased Shares which are subject to the Repurchase Right. In addition,
Purchased Shares which are released from the

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<PAGE> 28
Repurchase Right shall not be transferred, assigned, encumbered or otherwise
disposed of in contravention of the First Refusal Right or the Market Stand-Off.

2. TRANSFEREE OBLIGATIONS. Each person (other than the
Corporation) to whom the Purchased Shares are transferred by means of a
Permitted Transfer must, as a condition precedent to the validity of such
transfer, acknowledge in writing to the Corporation that such person is bound by
the provisions of this Agreement and that the transferred shares are subject to
(i) the Repurchase Right, (ii) the First Refusal Right and (iii) the Market
Stand-Off, to the same extent such shares would be so subject if retained by
Optionee.

3. MARKET STAND-OFF.

(a) In connection with any underwritten public offering by
the Corporation of its equity securities pursuant to an effective registration
statement filed under the 1933 Act, including the Corporation's initial public
offering, Owner shall not sell, make any short sale of, loan, hypothecate,
pledge, grant any option for the purchase of, or otherwise dispose or transfer
for value or otherwise agree to engage in any of the foregoing transactions with
respect to, any Purchased Shares without the prior written consent of the
Corporation or its underwriters. Such restriction (the "Market Stand-Off") shall
be in effect for such period of time from and after the effective date of the
final prospectus for the offering as may be requested by the Corporation or such
underwriters. In no event, however, shall such period exceed one hundred eighty
(180) days and the Market Stand-Off shall in all events terminate two (2) years
after the effective date of the Corporation's initial public offering.

(b) Owner shall be subject to the Market Stand-Off
provided and only if the officers and directors of the Corporation are also
subject to similar restrictions.

(c) Any new, substituted or additional securities which
are by reason of any Recapitalization or Reorganization distributed with respect
to the Purchased Shares shall be immediately subject to the Market Stand-Off, to
the same extent the Purchased Shares are at such time covered by such
provisions.

(d) In order to enforce the Market Stand-Off, the
Corporation may impose stop-transfer instructions with respect to the Purchased
Shares until the end of the applicable stand-off period.

D. REPURCHASE RIGHT

1. GRANT. The Corporation is hereby granted the right (the
"Repurchase Right"), exercisable at any time during the sixty (60)-day period
following the date Optionee ceases for any reason to remain in Service or (if
later) during the sixty (60)-day period following the execution date of this
Agreement, to repurchase at the Exercise Price any or all of the Purchased
Shares in which Optionee is not, at the time of his or her cessation of Service,
vested in accordance with the Vesting Schedule applicable to those shares or the
special acceleration

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<PAGE> 29
provisions of Paragraph D.6 of this Agreement (such shares to be hereinafter
referred to as the "Unvested Shares").

2. EXERCISE OF THE REPURCHASE RIGHT. The Repurchase Right shall
be exercisable by written notice delivered to each Owner of the Unvested Shares
prior to the expiration of the sixty (60)-day exercise period. The notice shall
indicate the number of Unvested Shares to be repurchased and the date on which
the repurchase is to be effected, such date to be not more than thirty (30) days
after the date of such notice. The certificates representing the Unvested Shares
to be repurchased shall be delivered to the Corporation on or before the close
of business on the date specified for the repurchase. Concurrently with the
receipt of such stock certificates, the Corporation shall pay to Owner, in cash
or cash equivalents (including the cancellation of any purchase-money
indebtedness), an amount equal to the Exercise Price previously paid for the
Unvested Shares which are to be repurchased from Owner.

3. TERMINATION OF THE REPURCHASE RIGHT. The Repurchase Right
shall terminate with respect to any Unvested Shares for which it is not timely
exercised under Paragraph D.2. In addition, the Repurchase Right shall terminate
and cease to be exercisable with respect to any and all Purchased Shares in
which Optionee vests in accordance with the Vesting Schedule. All Purchased
Shares as to which the Repurchase Right lapses shall, however, remain subject to
(i) the First Refusal Right and (ii) the Market Stand-Off.

4. AGGREGATE VESTING LIMITATION. If the Option is exercised in
more than one increment so that Optionee is a party to one or more other Stock
Purchase Agreements (the "Prior Purchase Agreements") which are executed prior
to the date of this Agreement, then the total number of Purchased Shares as to
which Optionee shall be deemed to have a fully-vested interest under this
Agreement and all Prior Purchase Agreements shall not exceed in the aggregate
the number of Purchased Shares in which Optionee would otherwise at the time be
vested, in accordance with the Vesting Schedule, had all the Purchased Shares
(including those acquired under the Prior Purchase Agreements) been acquired
exclusively under this Agreement.

5. RECAPITALIZATION. Any new, substituted or additional
securities or other property (including cash paid other than as a regular cash
dividend) which is by reason of any Recapitalization distributed with respect to
the Purchased Shares shall be immediately subject to the Repurchase Right and
any escrow requirements hereunder, but only to the extent the Purchased Shares
are at the time covered by such right or escrow requirements. Appropriate
adjustments to reflect such distribution shall be made to the number and/or
class of Purchased Shares subject to this Agreement and to the price per share
to be paid upon the exercise of the Repurchase Right in order to reflect the
effect of any such Recapitalization upon the Corporation's capital structure;
provided, however, that the aggregate purchase price shall remain the same.

6. CORPORATE TRANSACTION.

(a) The Repurchase Right shall automatically terminate in
its entirety, and all the Purchased Shares shall vest in full, immediately prior
to the consummation of any

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<PAGE> 30

Corporate Transaction, except to the extent the Repurchase Right is to be
assigned to the successor entity in such Corporate Transaction.

(b) To the extent the Repurchase Right remains in effect
following a Corporate Transaction, such right shall apply to any new securities
or other property (including any cash payments) received in exchange for the
Purchased Shares in consummation of the Corporate Transaction, but only to the
extent the Purchased Shares are at the time covered by such right. Appropriate
adjustments shall be made to the price per share payable upon exercise of the
Repurchase Right to reflect the effect of the Corporate Transaction upon the
Corporation's capital structure; provided, however, that the aggregate purchase
price shall remain the same. The new securities or other property (including any
cash payments) issued or distributed with respect to the Purchased Shares in
consummation of the Corporate Transaction shall be immediately deposited in
escrow with the Corporation (or the successor entity) and shall not be released
from escrow until Optionee vests in such securities or other property in
accordance with the same Vesting Schedule in effect for the Purchased Shares.

(c) The Repurchase Right may also terminate on an
accelerated basis, and the Purchased Shares shall immediately vest in full, in
accordance with the terms and conditions of any special addendum attached to
this Agreement.

E. RIGHT OF FIRST REFUSAL

1. GRANT. The Corporation is hereby granted the right of first
refusal (the "First Refusal Right"), exercisable in connection with any proposed
transfer of the Purchased Shares in which Optionee has vested in accordance with
the provisions of Article D. For purposes of this Article E, the term "transfer"
shall include any sale, assignment, pledge, encumbrance or other disposition of
the Purchased Shares intended to be made by Owner, but shall not include any
Permitted Transfer.

2. NOTICE OF INTENDED DISPOSITION. In the event any Owner of
Purchased Shares in which Optionee has vested desires to accept a bona fide
third-party offer for the transfer of any or all of such shares (the Purchased
Shares subject to such offer to be hereinafter referred to as the "Target
Shares"), Owner shall promptly (i) deliver to the Corporation written notice
(the "Disposition Notice") of the terms of the offer, including the purchase
price and the identity of the third-party offeror, and (ii) provide satisfactory
proof that the disposition of the Target Shares to such third-party offeror
would not be in contravention of the provisions set forth in Articles B and C.

3. EXERCISE OF THE FIRST REFUSAL RIGHT. The Corporation shall,
for a period of twenty-five (25) days following receipt of the Disposition
Notice, have the right to repurchase any or all of the Target Shares subject to
the Disposition Notice upon the same terms as those specified therein or upon
such other terms (not materially different from those specified in the
Disposition Notice) to which Owner consents. Such right shall be exercisable by
delivery of written notice (the "Exercise Notice") to Owner prior to the
expiration of the twenty-five (25)-day exercise period. If such right is
exercised with respect to all the Target Shares, then

5
<PAGE> 31
the Corporation shall effect the repurchase of such shares, including payment of
the purchase price, not more than five (5) business days after delivery of the
Exercise Notice; and at such time the certificates representing the Target
Shares shall be delivered to the Corporation.

Should the purchase price specified in the Disposition Notice be
payable in property other than cash or evidences of indebtedness, the
Corporation shall have the right to pay the purchase price in the form of cash
equal in amount to the value of such property. If Owner and the Corporation
cannot agree on such cash value within ten (10) days after the Corporation's
receipt of the Disposition Notice, the valuation shall be made by an appraiser
of recognized standing selected by Owner and the Corporation or, if they cannot
agree on an appraiser within twenty (20) days after the Corporation's receipt of
the Disposition Notice, each shall select an appraiser of recognized standing
and the two (2) appraisers shall designate a third appraiser of recognized
standing, whose appraisal shall be determinative of such value. The cost of such
appraisal shall be shared equally by Owner and the Corporation. The closing
shall then be held on the later of (i) the fifth (5th) business day following
delivery of the Exercise Notice or (ii) the fifth (5th) business day after such
valuation shall have been made.

4. NON-EXERCISE OF THE FIRST REFUSAL RIGHT. In the event the
Exercise Notice is not given to Owner prior to the expiration of the twenty-five
(25)-day exercise period, Owner shall have a period of thirty (30) days
thereafter in which to sell or otherwise dispose of the Target Shares to the
third-party offeror identified in the Disposition Notice upon terms (including
the purchase price) no more favorable to such third-party offeror than those
specified in the Disposition Notice; provided, however, that any such sale or
disposition must not be effected in contravention of the provisions of Articles
B and C. The third-party offeror shall acquire the Target Shares free and clear
of the First Refusal Right, but the acquired shares shall remain subject to the
provisions of Article B and Paragraph C.3. In the event Owner does not effect
such sale or disposition of the Target Shares within the specified thirty
(30)-day period, the First Refusal Right shall continue to be applicable to any
subsequent disposition of the Target Shares by Owner until such right lapses.

5. PARTIAL EXERCISE OF THE FIRST REFUSAL RIGHT. In the event the
Corporation makes a timely exercise of the First Refusal Right with respect to a
portion, but not all, of the Target Shares specified in the Disposition Notice,
Owner shall have the option, exercisable by written notice to the Corporation
delivered within five (5) business days after Owner's receipt of the Exercise
Notice, to effect the sale of the Target Shares pursuant to either of the
following alternatives:

(i) sale or other disposition of all the Target Shares
to the third-party offeror identified in the Disposition Notice, but in full
compliance with the requirements of Paragraph E.4, as if the Corporation did not
exercise the First Refusal Right; or

(ii) sale to the Corporation of the portion of the
Target Shares which the Corporation has elected to purchase, such sale to be
effected in substantial conformity with the provisions of Paragraph E.3. The
First Refusal Right shall continue to be applicable to any subsequent
disposition of the remaining Target Shares until such right lapses.

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<PAGE> 32

Owner's failure to deliver timely notification to the Corporation
shall be deemed to be an election by Owner to sell the Target Shares pursuant to
alternative (i) above.

6. RECAPITALIZATION/REORGANIZATION.

(a) Any new, substituted or additional securities or other
property which is by reason of any Recapitalization distributed with respect to
the Purchased Shares shall be immediately subject to the First Refusal Right,
but only to the extent the Purchased Shares are at the time covered by such
right.

(b) In the event of a Reorganization, the First Refusal Right
shall remain in full force and effect and shall apply to the new capital stock
or other property received in exchange for the Purchased Shares in consummation
of the Reorganization, but only to the extent the Purchased Shares are at the
time covered by such right.

7. Lapse. The First Refusal Right shall lapse upon the earliest
to occur of (i) the first date on which shares of the Common Stock are held of
record by more than five hundred (500) persons, (ii) a determination is made by
the Board that a public market exists for the outstanding shares of Common Stock
or (iii) a firm commitment underwritten public offering, pursuant to an
effective registration statement under the 1933 Act, covering the offer and sale
of the Common Stock in the aggregate amount of at least ten million dollars
($10,000,000). However, the Market Stand-Off shall continue to remain in full
force and effect following the lapse of the First Refusal Right.

F. SPECIAL TAX ELECTION

The acquisition of the Purchased Shares may result in adverse tax
consequences which may be avoided or mitigated by filing an election under Code
Section 83(b). Such election must be filed within thirty (30) days after the
date of this Agreement. A description of the tax consequences applicable to the
acquisition of the Purchased Shares and the form for making the Code Section
83(b) election are set forth in Exhibit II. OPTIONEE SHOULD CONSULT WITH HIS OR
HER TAX ADVISOR TO DETERMINE THE TAX CONSEQUENCES OF ACQUIRING THE PURCHASED
SHARES AND THE ADVANTAGES AND DISADVANTAGES OF FILING THE CODE SECTION 83(b)
ELECTION. OPTIONEE ACKNOWLEDGES THAT IT IS OPTIONEE'S SOLE RESPONSIBILITY, AND
NOT THE CORPORATION'S, TO FILE A TIMELY ELECTION UNDER CODE SECTION 83(b), EVEN
IF OPTIONEE REQUESTS THE CORPORATION OR ITS REPRESENTATIVES TO MAKE THIS FILING
ON HIS OR HER BEHALF.

G. GENERAL PROVISIONS

1. ASSIGNMENT. The Corporation may assign the Repurchase Right
and/or the First Refusal Right to any person or entity selected by the Board,
including (without limitation) one or more stockholders of the Corporation. If
the assignee of the Repurchase Right is other than (i) a wholly owned subsidiary
of the Corporation or (ii) the parent corporation

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<PAGE> 33
owning one hundred percent (100%) of the Corporation's outstanding capital
stock, then such assignee must make a cash payment to the Corporation, upon the
assignment of the Repurchase Right, in an amount equal to the excess (if any) of
(i) the Fair Market Value of the Purchased Shares at the time subject to the
assigned Repurchase Right over (ii) the aggregate repurchase price payable for
the Purchased Shares.

2. NO EMPLOYMENT OR SERVICE CONTRACT. Nothing in this Agreement
or in the Plan shall confer upon Optionee any right to continue in Service for
any period of specific duration or interfere with or otherwise restrict in any
way the rights of the Corporation (or any Parent or Subsidiary employing or
retaining Optionee) or of Optionee, which rights are hereby expressly reserved
by each, to terminate Optionee's Service at any time for any reason, with or
without cause.

3. NOTICES. Any notice required to be given under this Agreement
shall be in writing and shall be deemed effective upon personal delivery or upon
deposit in the U.S. mail, registered or certified, postage prepaid and properly
addressed to the party entitled to such notice at the address indicated below
such party's signature line on this Agreement or at such other address as such
party may designate by ten (10) days advance written notice under this paragraph
to all other parties to this Agreement.

4. NO WAIVER. The failure of the Corporation in any instance to
exercise the Repurchase Right or the First Refusal Right shall not constitute a
waiver of any other repurchase rights and/or rights of first refusal that may
subsequently arise under the provisions of this Agreement or any other agreement
between the Corporation and Optionee. No waiver of any breach or condition of
this Agreement shall be deemed to be a waiver of any other or subsequent breach
or condition, whether of like or different nature.

5. CANCELLATION OF SHARES. If the Corporation shall make
available, at the time and place and in the amount and form provided in this
Agreement, the consideration for the Purchased Shares to be repurchased in
accordance with the provisions of this Agreement, then from and after such time,
the person from whom such shares are to be repurchased shall no longer have any
rights as a holder of such shares (other than the right to receive payment of
such consideration in accordance with this Agreement). Such shares shall be
deemed purchased in accordance with the applicable provisions hereof, and the
Corporation shall be deemed the owner and holder of such shares, whether or not
the certificates therefor have been delivered as required by this Agreement.

H. MISCELLANEOUS PROVISIONS

1. OPTIONEE UNDERTAKING. Optionee hereby agrees to take whatever
additional action and execute whatever additional documents the Corporation may
deem necessary or advisable in order to carry out or effect one or more of the
obligations or restrictions imposed on either Optionee or the Purchased Shares
pursuant to the provisions of this Agreement.

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<PAGE> 34

2. AGREEMENT IS ENTIRE CONTRACT. This Agreement constitutes the
entire contract between the parties hereto with regard to the subject matter
hereof. This Agreement is made pursuant to the provisions of the Plan and shall
in all respects be construed in conformity with the terms of the Plan.

3. GOVERNING LAW. This Agreement shall be governed by, and
construed in accordance with, the laws of the State of Delaware without resort
to that State's conflict-of-laws rules.

4. COUNTERPARTS. This Agreement may be executed in
counterparts, each of which shall be deemed to be an original, but all of which
together shall constitute one and the same instrument.

5. SUCCESSORS AND ASSIGNS. The provisions of this Agreement shall
inure to the benefit of, and be binding upon, the Corporation and its successors
and assigns and upon Optionee, Optionee's permitted assigns and the legal
representatives, heirs and legatees of Optionee's estate, whether or not any
such person shall have become a party to this Agreement and have agreed in
writing to join herein and be bound by the terms hereof.

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<PAGE> 35
IN WITNESS WHEREOF, the parties have executed this Agreement on
the day and year first indicated above.

MICROMUSE INC.

By:_____________________________________

Title:__________________________________

Address: ________________________________________

________________________________________

________________________________________
OPTIONEE

Address: ________________________________________

________________________________________

<PAGE> 36
EXHIBIT I

ASSIGNMENT SEPARATE FROM CERTIFICATE

FOR VALUE RECEIVED ___________ hereby sell(s), assign(s) and
transfer(s) unto Micromuse Inc. (the "Corporation"), ___________ (_____) shares
of the Common Stock of the Corporation standing in his or her name on the books
of the Corporation represented by Certificate No. _______ herewith and do(es)
hereby irrevocably constitute and appoint _______________ Attorney to transfer
the said stock on the books of the Corporation with full power of substitution
in the premises.

Dated: ______________

Signature_______________________________

INSTRUCTION: Please do not fill in any blanks other than the signature line.
Please sign exactly as you would like your name to appear on the issued stock
certificate. The purpose of this assignment is to enable the Corporation to
exercise the Repurchase Right without requiring additional signatures on the
part of Optionee.

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EXHIBIT II

FEDERAL INCOME TAX CONSEQUENCES AND
SECTION 83(b) TAX ELECTION

I. FEDERAL INCOME TAX CONSEQUENCES AND SECTION 83(b) ELECTION FOR
EXERCISE OF NON-STATUTORY OPTION. If the Purchased Shares are acquired pursuant
to the exercise of a Non-Statutory Option, as specified in the Grant Notice,
then under Code Section 83, the excess of the Fair Market Value of the Purchased
Shares on the date any forfeiture restrictions applicable to such shares lapse
over the Exercise Price paid for such shares will be reportable as ordinary
income on the lapse date. For this purpose, the term "forfeiture restrictions"
includes the right of the Corporation to repurchase the Purchased Shares
pursuant to the Repurchase Right. However, Optionee may elect under Code Section
83(b) to be taxed at the time the Purchased Shares are acquired, rather than
when and as such Purchased Shares cease to be subject to such forfeiture
restrictions. Such election must be filed with the Internal Revenue Service
within thirty (30) days after the date of the Agreement. Even if the Fair Market
Value of the Purchased Shares on the date of the Agreement equals the Exercise
Price paid (and thus no tax is payable), the election must be made to avoid
adverse tax consequences in the future. The form for making this election is
attached as part of this exhibit. FAILURE TO MAKE THIS FILING WITHIN THE
APPLICABLE THIRTY (30)-DAY PERIOD WILL RESULT IN THE RECOGNITION OF ORDINARY
INCOME BY OPTIONEE AS THE FORFEITURE RESTRICTIONS LAPSE.

II. FEDERAL INCOME TAX CONSEQUENCES AND CONDITIONAL SECTION 83(b)
ELECTION FOR EXERCISE OF INCENTIVE OPTION. If the Purchased Shares are acquired
pursuant to the exercise of an Incentive Option, as specified in the Grant
Notice, then the following tax principles shall be applicable to the Purchased
Shares:

(i) For regular tax purposes, no taxable income will be
recognized at the time the Option is exercised.

(ii) The excess of (a) the Fair Market Value of the Purchased
Shares on the date the Option is exercised or (if later) on the date any
forfeiture restrictions applicable to the Purchased Shares lapse over (b) the
Exercise Price paid for the Purchased Shares will be includible in Optionee's
taxable income for alternative minimum tax purposes.

(iii) If Optionee makes a disqualifying disposition of the
Purchased Shares, then Optionee will recognize ordinary income in the year of
such disposition equal in amount to the excess of (a) the Fair Market Value of
the Purchased Shares on the date the Option is exercised or (if later) on the
date any forfeiture restrictions applicable to the Purchased Shares lapse over
(b) the Exercise Price paid for the Purchased Shares. Any additional gain
recognized upon the disqualifying disposition will be either short-term or
long-term capital gain depending upon the period for which the Purchased Shares
are held prior to the disposition.

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(iv) For purposes of the foregoing, the term "forfeiture
restrictions" will include the right of the Corporation to repurchase the
Purchased Shares pursuant to the Repurchase Right. The term "disqualifying
disposition" means any sale or other disposition(1) of the Purchased Shares
within two (2) years after the Grant Date or within one (1) year after the
exercise date of the Option.

(v) In the absence of final Treasury Regulations relating to
Incentive Options, it is not certain whether Optionee may, in connection with
the exercise of the Option for any Purchased Shares at the time subject to
forfeiture restrictions, file a protective election under Code Section 83(b)
which would limit (a) Optionee's alternative minimum taxable income upon
exercise and (b) Optionee's ordinary income upon a disqualifying disposition to
the excess of the Fair Market Value of the Purchased Shares on the date the
Option is exercised over the Exercise Price paid for the Purchased Shares.
Accordingly, such election if properly filed will only be allowed to the extent
the final Treasury Regulations permit such a protective election. Page 2 of the
attached form for making the election should be filed with any election made in
connection with the exercise of an Incentive Option.

- ----------
(1) Generally, a disposition of shares purchased under an Incentive Option
includes any transfer of legal title, including a transfer by sale, exchange or
gift, but does not include a transfer to the Optionee's spouse, a transfer into
joint ownership with right of survivorship if Optionee remains one of the joint
owners, a pledge, a transfer by bequest or inheritance or certain tax free
exchanges permitted under the Code.

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SECTION 83(b) ELECTION

This statement is being made under Section 83(b) of the Internal
Revenue Code, pursuant to Treas. Reg. Section 1.83-2.

(1) The taxpayer who performed the services is:

Name:
Address:
Taxpayer Ident. No.:

(2) The property with respect to which the election is being made is
_________ shares of the common stock of Micromuse Inc.

(3) The property was issued on _______________, _____.

(4) The taxable year in which the election is being made is the calendar
year _____.

(5) The property is subject to a repurchase right pursuant to which the
issuer has the right to acquire the property at the original purchase
price if for any reason taxpayer's employment with the issuer is
terminated. The issuer's repurchase right lapses in a series of
installments over a four (4)-year period ending on _______________,
200___.

(6) The fair market value at the time of transfer (determined without
regard to any restriction other than a restriction which by its terms
will never lapse) is $ _________ per share.

(7) The amount paid for such property is $ _________ per share.

(8) A copy of this statement was furnished to Micromuse Inc. for whom
taxpayer rendered the services underlying the transfer of property.

(9) This statement is executed on _______________, _____.

_____________________________ ________________________________________
Spouse (if any) Taxpayer

This election must be filed with the Internal Revenue Service Center with which
taxpayer files his or her Federal income tax returns and must be made within
thirty (30) days after the execution date of the Stock Purchase Agreement. This
filing should be made by registered or certified mail, return receipt requested.
Optionee must retain two (2) copies of the completed form for filing with his or
her Federal and state tax returns for the current tax year and an additional
copy for his or her records.

S-1
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The property described in the above Section 83(b) election is
comprised of shares of common stock acquired pursuant to the exercise of an
incentive stock option under Section 422 of the Internal Revenue Code (the
"Code"). Accordingly, it is the intent of the Taxpayer to utilize this election
to achieve the following tax results:

1. The purpose of this election is to have the alternative
minimum taxable income attributable to the purchased shares measured by the
amount by which the fair market value of such shares at the time of their
transfer to the Taxpayer exceeds the purchase price paid for the shares. In the
absence of this election, such alternative minimum taxable income would be
measured by the spread between the fair market value of the purchased shares and
the purchase price which exists on the various lapse dates in effect for the
forfeiture restrictions applicable to such shares. The election is to be
effective to the full extent permitted under the Code.

2. Section 421(a)(1) of the Code expressly excludes from income
any excess of the fair market value of the purchased shares over the amount paid
for such shares. Accordingly, this election is also intended to be effective in
the event there is a "disqualifying disposition" of the shares, within the
meaning of Section 421(b) of the Code, which would otherwise render the
provisions of Section 83(a) of the Code applicable at that time. Consequently,
the Taxpayer hereby elects to have the amount of disqualifying disposition
income measured by the excess of the fair market value of the purchased shares
on the date of transfer to the Taxpayer over the amount paid for such shares.
Since Section 421(a) presently applies to the shares which are the subject of
this Section 83(b) election, no taxable income is actually recognized for
regular tax purposes at this time, and no income taxes are payable, by the
Taxpayer as a result of this election.

THIS PAGE 2 IS TO BE ATTACHED TO ANY SECTION 83(b) ELECTION FILED IN CONNECTION
WITH THE EXERCISE OF AN INCENTIVE STOCK OPTION UNDER THE FEDERAL TAX LAWS.

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<PAGE> 41
APPENDIX

The following definitions shall be in effect under the Agreement:

A. AGREEMENT shall mean this Stock Purchase Agreement.

B. BOARD shall mean the Corporation's Board of Directors.

C. CODE shall mean the Internal Revenue Code of 1986, as amended.

D. COMMON STOCK shall mean the Corporation's common stock.

E. CORPORATE TRANSACTION shall mean either of the following
stockholder-approved transactions:

(i) a merger or consolidation in which securities possessing
more than fifty percent (50%) of the total combined voting power of the
Corporation's outstanding securities are transferred to a person or persons
different from the persons holding those securities immediately prior to such
transaction, or

(ii) the sale, transfer or other disposition of all or
substantially all of the Corporation's assets in complete liquidation or
dissolution of the Corporation.

F. CORPORATION shall mean Micromuse Inc., a Delaware corporation,
and any successor corporation to all or substantially all of the assets or
voting stock of Micromuse Inc. which shall by appropriate action adopt the Plan.

G. DISPOSITION NOTICE shall have the meaning assigned to such
term in Paragraph E.2.

H. EXERCISE NOTICE shall have the meaning assigned to such term
in Paragraph E.3.

I. EXERCISE PRICE shall have the meaning assigned to such term in
Paragraph A.1.

J. FAIR MARKET VALUE of a share of Common Stock on any relevant
date, prior to the initial public offering of the Common Stock, shall be
determined by the Plan Administrator after taking into account such factors as
it shall deem appropriate.

K. FIRST REFUSAL RIGHT shall mean the right granted to the
Corporation in accordance with Article E.

L. GRANT DATE shall have the meaning assigned to such term in
Paragraph A.1.

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<PAGE> 42

M. GRANT NOTICE shall mean the Notice of Grant of Stock Option
pursuant to which Optionee has been informed of the basic terms of the Option.

N. INCENTIVE OPTION shall mean an option which satisfies the
requirements of Code Section 422.

O. MARKET STAND-OFF shall mean the market stand-off restriction
specified in Paragraph C.3.

P. 1933 ACT shall mean the Securities Act of 1933, as amended.

Q. 1934 ACT shall mean the Securities Exchange Act of 1934, as
amended.

R. NON-STATUTORY OPTION shall mean an option not intended to
satisfy the requirements of Code Section 422.

S. OPTION shall have the meaning assigned to such term in
Paragraph A.1.

T. OPTION AGREEMENT shall mean all agreements and other documents
evidencing the Option.

U. OPTIONEE shall mean the person to whom the Option is granted
under the Plan.

V. OWNER shall mean Optionee and all subsequent holders of the
Purchased Shares who derive their chain of ownership through a Permitted
Transfer from Optionee.

W. PARENT shall mean any corporation (other than the Corporation)
in an unbroken chain of corporations ending with the Corporation, provided each
corporation in the unbroken chain (other than the Corporation) owns, at the time
of the determination, stock possessing fifty percent (50%) or more of the total
combined voting power of all classes of stock in one of the other corporations
in such chain.

X. PERMITTED TRANSFER shall mean (i) a gratuitous transfer of the
Purchased Shares, provided and only if Optionee obtains the Corporation's prior
written consent to such transfer, (ii) a transfer of title to the Purchased
Shares effected pursuant to Optionee's will or the laws of intestate succession
following Optionee's death or (iii) a transfer to the Corporation in pledge as
security for any purchase-money indebtedness incurred by Optionee in connection
with the acquisition of the Purchased Shares.

Y. PLAN shall mean the Corporation's 1997 Stock Option/Stock
Issuance Plan.

Z. PLAN ADMINISTRATOR shall mean either the Board or a committee
of the Board acting in its capacity as administrator of the Plan.

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<PAGE> 43
AA. PRIOR PURCHASE AGREEMENT shall have the meaning assigned to
such term in Paragraph D.4.

BB. PURCHASED SHARES shall have the meaning assigned to such term
in Paragraph A.1.

CC. RECAPITALIZATION shall mean any stock split, stock dividend,
recapitalization, combination of shares, exchange of shares or other change
affecting the Corporation's outstanding Common Stock as a class without the
Corporation's receipt of consideration.

DD. REORGANIZATION shall mean any of the following transactions:

(i) a merger or consolidation in which the Corporation is
not the surviving entity,

(ii) a sale, transfer or other disposition of all or
substantially all of the Corporation's assets,

(iii) a reverse merger in which the Corporation is the
surviving entity but in which the Corporation's outstanding voting securities
are transferred in whole or in part to a person or persons different from the
persons holding those securities immediately prior to the merger, or

(iv) any transaction effected primarily to change the
state in which the Corporation is incorporated or to create a holding company
structure.

EE. REPURCHASE RIGHT shall mean the right granted to the
Corporation in accordance with Article D.

FF. SEC shall mean the Securities and Exchange Commission.

GG. SERVICE shall mean the Optionee's performance of services for
the Corporation (or any Parent or Subsidiary) in the capacity of an employee,
subject to the control and direction of the employer entity as to both the work
to be performed and the manner and method of performance, a non-employee member
of the board of directors or an independent consultant.

HH. SUBSIDIARY shall mean any corporation (other than the
Corporation) in an unbroken chain of corporations beginning with the
Corporation, provided each corporation (other than the last corporation) in the
unbroken chain owns, at the time of the determination, stock possessing fifty
percent (50%) or more of the total combined voting power of all classes of stock
in one of the other corporations in such chain.

II. TARGET SHARES shall have the meaning assigned to such term in
Paragraph E.2.

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JJ. VESTING SCHEDULE shall mean the vesting schedule specified in
the Grant Notice pursuant to which the Optionee is to vest in the Option Shares
in a series of installments over his or her period of Service.

KK. UNVESTED SHARES shall have the meaning assigned to such term
in Paragraph D.1.

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<PAGE> 45
MICROMUSE INC.
STOCK OPTION AGREEMENT

RECITALS

A. The Board has adopted the Plan for the purpose of retaining
the services of selected Employees, non-employee members of the Board or the
board of directors of any Parent or Subsidiary and consultants and other
independent advisors in the service of the Corporation (or any Parent or
Subsidiary).

B. Optionee is to render valuable services to the Corporation (or
a Parent or Subsidiary), and this Agreement is executed pursuant to, and is
intended to carry out the purposes of, the Plan in connection with the
Corporation's grant of an option to Optionee.

C. All capitalized terms in this Agreement shall have the
meanings assigned to them in the attached Appendix.

NOW, THEREFORE, it is hereby agreed as follows:

1. GRANT OF OPTION. The Corporation hereby grants to Optionee, as
of the Grant Date, an option to purchase up to the number of Option Shares
specified in the Grant Notice. The Option Shares shall be purchasable from time
to time during the option term specified in Paragraph 2 at the Exercise Price.

2. OPTION TERM. This option shall have a term of ten (10) years
measured from the Grant Date and shall accordingly expire at the close of
business on the Expiration Date, unless sooner terminated in accordance with
Paragraph 5 or 6.

3. LIMITED TRANSFERABILITY. During Optionee's lifetime, this
option shall be exercisable only by Optionee and shall not be assignable or
transferable other than by will or by the laws of descent and distribution
following Optionee's death.

4. DATES OF EXERCISE. This option shall become exercisable for
the Option Shares in one or more installments as specified in the Grant Notice.
As the option becomes exercisable for such installments, those installments
shall accumulate and the option shall remain exercisable for the accumulated
installments until the Expiration Date or sooner termination of the option term
under Paragraph 5 or 6.

5. CESSATION OF SERVICE. The option term specified in Paragraph 2
shall terminate (and this option shall cease to be outstanding) prior to the
Expiration Date should any of the following provisions become applicable:

(a) Should Optionee cease to remain in Service for any reason
(other than death, Disability or Misconduct) while this option is outstanding,
then Optionee shall have a period of three (3) months (commencing with the date
of such cessation of Service) during which

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<PAGE> 46

to exercise this option, but in no event shall this option be exercisable at any
time after the Expiration Date.

(b) Should Optionee die while this option is outstanding, then
the personal representative of Optionee's estate or the person or persons to
whom the option is transferred pursuant to Optionee's will or in accordance with
the laws of inheritance shall have the right to exercise this option. Such right
shall lapse, and this option shall cease to be outstanding, upon the earlier of
(i) the expiration of the twelve (12)-month period measured from the date of
Optionee's death or (ii) the Expiration Date.

(c) Should Optionee cease Service by reason of Disability
while this option is outstanding, then Optionee shall have a period of twelve
(12) months (commencing with the date of such cessation of Service) during which
to exercise this option. In no event shall this option be exercisable at any
time after the Expiration Date.

Note: Exercise of this option on a date later than three (3)
months following cessation of Service due to Disability will
result in loss of favorable Incentive Option treatment, unless
such Disability constitutes Permanent Disability. In the event
that Incentive Option treatment is not available, this option
will be taxed as a Non-Statutory Option upon exercise.

(d) During the limited period of post-Service exercisability,
this option may not be exercised in the aggregate for more than the number of
Option Shares in which Optionee is, at the time of Optionee's cessation of
Service, vested pursuant to the Vesting Schedule specified in the Grant Notice
or the special vesting acceleration provisions of Paragraph 6. Upon the
expiration of such limited exercise period or (if earlier) upon the Expiration
Date, this option shall terminate and cease to be outstanding for any vested
Option Shares for which the option has not been exercised. To the extent
Optionee is not vested in the Option Shares at the time of Optionee's cessation
of Service, this option shall immediately terminate and cease to be outstanding
with respect to those shares.

(e) Should Optionee's Service be terminated for Misconduct,
then this option shall terminate immediately and cease to remain outstanding.

6. ACCELERATED VESTING.

(a) In the event of any Corporate Transaction, the Option
Shares at the time subject to this option but not otherwise vested shall
automatically vest in full so that this option shall, immediately prior to the
effective date of the Corporate Transaction, become fully exercisable for all of
those Option Shares and may be exercised for any or all of those Option Shares
as fully-vested shares of Common Stock. However, the Option Shares shall NOT
vest on such an accelerated basis if and to the extent: (i) this option is
assumed by the successor corporation (or parent thereof) in the Corporate
Transaction and the Corporation's repurchase rights with respect to the unvested
Option Shares are assigned to such successor corporation (or parent thereof) or
(ii) this option is to be replaced with a cash incentive program of the
successor

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<PAGE> 47
corporation (or parent thereof) which preserves the spread existing on the
unvested Option Shares at the time of the Corporate Transaction (the excess of
the Fair Market Value of those Option Shares over the Exercise Price payable for
such shares) and provides for subsequent payout in accordance with the same
Vesting Schedule applicable to those unvested Option Shares as set forth in the
Grant Notice.

(b) Immediately following the Corporate Transaction, this
option shall terminate and cease to be outstanding, except to the extent assumed
by the successor corporation (or parent thereof) in connection with the
Corporate Transaction.

(c) If this option is assumed in connection with a Corporate
Transaction, then this option shall be appropriately adjusted, immediately after
such Corporate Transaction, to apply to the number and class of securities which
would have been issuable to Optionee in consummation of such Corporate
Transaction had the option been exercised immediately prior to such Corporate
Transaction, and appropriate adjustments shall also be made to the Exercise
Price, provided the aggregate Exercise Price shall remain the same.

(d) The Option Shares may also vest upon an accelerated basis
in accordance with the terms and conditions of any special addendum attached to
this Agreement.

(e) This Agreement shall not in any way affect the right of
the Corporation to adjust, reclassify, reorganize or otherwise change its
capital or business structure or to merge, consolidate, dissolve, liquidate or
sell or transfer all or any part of its business or assets.

7. ADJUSTMENT IN OPTION SHARES. Should any change be made to the
Common Stock by reason of any stock split, stock dividend, recapitalization,
combination of shares, exchange of shares or other change affecting the
outstanding Common Stock as a class without the Corporation's receipt of
consideration, appropriate adjustments shall be made to (i) the total number
and/or class of securities subject to this option and (ii) the Exercise Price in
order to reflect such change and thereby preclude a dilution or enlargement of
benefits hereunder.

8. STOCKHOLDER RIGHTS. The holder of this option shall not have
any stockholder rights with respect to the Option Shares until such person shall
have exercised the option, paid the Exercise Price and become a holder of record
of the purchased shares.

9. MANNER OF EXERCISING OPTION.

(a) In order to exercise this option with respect to all or
any part of the Option Shares for which this option is at the time exercisable,
Optionee (or any other person or persons exercising the option) must take the
following actions:

(i) Execute and deliver to the Corporation a Purchase
Agreement for the Option Shares for which the option is exercised.

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<PAGE> 48

(ii) Pay the aggregate Exercise Price for the purchased
shares in one or more of the following forms:

(A) cash or check made payable to the Corporation; or

(B) a promissory note payable to the Corporation, but
only to the extent authorized by the Plan Administrator in
accordance with Paragraph 14.

Should the Common Stock be registered under Section 12(g)
of the 1934 Act at the time the option is exercised, then the
Exercise Price may also be paid as follows:

(C) in shares of Common Stock held by Optionee (or
any other person or persons exercising the option) for the
requisite period necessary to avoid a charge to the Corporation's
earnings for financial reporting purposes and valued at Fair
Market Value on the Exercise Date; or

(D) to the extent the option is exercised for vested
Option Shares, through a special sale and remittance procedure
pursuant to which Optionee (or any other person or persons
exercising the option) shall concurrently provide irrevocable
instructions (I) to a Corporation-designated brokerage firm to
effect the immediate sale of the purchased shares and remit to
the Corporation, out of the sale proceeds available on the
settlement date, sufficient funds to cover the aggregate Exercise
Price payable for the purchased shares plus all applicable
Federal, state and local income and employment taxes required to
be withheld by the Corporation by reason of such exercise and
(II) to the Corporation to deliver the certificates for the
purchased shares directly to such brokerage firm in order to
complete the sale.

Except to the extent the sale and remittance procedure is
utilized in connection with the option exercise, payment of the
Exercise Price must accompany the Purchase Agreement delivered to
the Corporation in connection with the option exercise.

(iii) Furnish to the Corporation appropriate documentation
that the person or persons exercising the option (if other than
Optionee) have the right to exercise this option.

(iv) Execute and deliver to the Corporation such written
representations as may be requested by the Corporation in order for it
to comply with the applicable requirements of Federal and state
securities laws.

(v) Make appropriate arrangements with the Corporation (or
Parent or Subsidiary employing or retaining Optionee) for the
satisfaction of all Federal,

4
<PAGE> 49

state and local income and employment tax withholding requirements
applicable to the option exercise.

(b) As soon as practical after the Exercise Date, the
Corporation shall issue to or on behalf of Optionee (or any other person or
persons exercising this option) a certificate for the purchased Option Shares,
with the appropriate legends affixed thereto.

10. REPURCHASE RIGHTS. ALL OPTION SHARES ACQUIRED UPON THE
EXERCISE OF THIS OPTION SHALL BE SUBJECT TO CERTAIN RIGHTS OF THE CORPORATION
AND ITS ASSIGNS TO REPURCHASE THOSE SHARES IN ACCORDANCE WITH THE TERMS
SPECIFIED IN THE PURCHASE AGREEMENT.

11. COMPLIANCE WITH LAWS AND REGULATIONS.

(a) The exercise of this option and the issuance of the
Option Shares upon such exercise shall be subject to compliance by the
Corporation and Optionee with all applicable requirements of law relating
thereto and with all applicable regulations of any stock exchange (or the Nasdaq
National Market, if applicable) on which the Common Stock may be listed for
trading at the time of such exercise and issuance.

(b) The inability of the Corporation to obtain approval from
any regulatory body having authority deemed by the Corporation to be necessary
to the lawful issuance and sale of any Common Stock pursuant to this option
shall relieve the Corporation of any liability with respect to the non-issuance
or sale of the Common Stock as to which such approval shall not have been
obtained. The Corporation, however, shall use its best efforts to obtain all
such approvals.

12. SUCCESSORS AND ASSIGNS. Except to the extent otherwise
provided in Paragraphs 3 and 6, the provisions of this Agreement shall inure to
the benefit of, and be binding upon, the Corporation and its successors and
assigns and Optionee, Optionee's assigns and the legal representatives, heirs
and legatees of Optionee's estate.

13. NOTICES. Any notice required to be given or delivered to the
Corporation under the terms of this Agreement shall be in writing and addressed
to the Corporation at its principal corporate offices. Any notice required to be
given or delivered to Optionee shall be in writing and addressed to Optionee at
the address indicated below Optionee's signature line on the Grant Notice. All
notices shall be deemed effective upon personal delivery or upon deposit in the
U.S. mail, postage prepaid and properly addressed to the party to be notified.

14. FINANCING. The Plan Administrator may, in its absolute
discretion and without any obligation to do so, permit Optionee to pay the
Exercise Price for the purchased Option Shares by delivering a full-recourse,
interest-bearing promissory note secured by those

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<PAGE> 50
Option Shares. The payment schedule in effect for any such promissory note shall
be established by the Plan Administrator in its sole discretion.

15. CONSTRUCTION. This Agreement and the option evidenced hereby
are made and granted pursuant to the Plan and are in all respects limited by and
subject to the terms of the Plan. All decisions of the Plan Administrator with
respect to any question or issue arising under the Plan or this Agreement shall
be conclusive and binding on all persons having an interest in this option.

16. GOVERNING LAW. The interpretation, performance and
enforcement of this Agreement shall be governed by the laws of the State of
Delaware without resort to that State's conflict-of-laws rules.

17. STOCKHOLDER APPROVAL. If the Option Shares covered by this
Agreement exceed, as of the Grant Date, the number of shares of Common Stock
which may be issued under the Plan as last approved by the stockholders, then
this option shall be void with respect to such excess shares, unless stockholder
approval of an amendment sufficiently increasing the number of shares of Common
Stock issuable under the Plan is obtained in accordance with the provisions of
the Plan.

18. ADDITIONAL TERMS APPLICABLE TO AN INCENTIVE OPTION. In the
event this option is designated an Incentive Option in the Grant Notice, the
following terms and conditions shall also apply to the grant:

(a) This option shall cease to qualify for favorable tax
treatment as an Incentive Option if (and to the extent) this option is exercised
for one or more Option Shares: (i) more than three (3) months after the date
Optionee ceases to be an Employee for any reason other than death or Permanent
Disability or (ii) more than twelve (12) months after the date Optionee ceases
to be an Employee by reason of Permanent Disability.

(b) This option shall not become exercisable in the calendar
year in which granted if (and to the extent) the aggregate Fair Market Value
(determined at the Grant Date) of the Common Stock for which this option would
otherwise first become exercisable in such calendar year would, when added to
the aggregate value (determined as of the respective date or dates of grant) of
the Common Stock and any other securities for which one or more other Incentive
Options granted to Optionee prior to the Grant Date (whether under the Plan or
any other option plan of the Corporation or any Parent or Subsidiary) first
become exercisable during the same calendar year, exceed One Hundred Thousand
Dollars ($100,000) in the aggregate. To the extent the exercisability of this
option is deferred by reason of the foregoing limitation, the deferred portion
shall become exercisable in the first calendar year or years thereafter in which
the One Hundred Thousand Dollar ($100,000) limitation of this Paragraph 18(b)
would not be contravened, but such deferral shall in all events end immediately
prior to the effective date of a Corporate Transaction in which this option is
not to be assumed, whereupon the option shall become immediately exercisable as
a Non-Statutory Option for the deferred portion of the Option Shares.

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<PAGE> 51
(c) Should Optionee hold, in addition to this option, one or
more other options to purchase Common Stock which become exercisable for the
first time in the same calendar year as this option, then the foregoing
limitations on the exercisability of such options as Incentive Options shall be
applied on the basis of the order in which such options are granted.

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<PAGE> 52
APPENDIX

The following definitions shall be in effect under the Agreement:

A. AGREEMENT shall mean this Stock Option Agreement.

B. BOARD shall mean the Corporation's Board of Directors.

C. CODE shall mean the Internal Revenue Code of 1986, as amended.

D. COMMON STOCK shall mean the Corporation's common stock.

E. CORPORATE TRANSACTION shall mean either of the following
stockholder-approved transactions to which the Corporation is a party:

(i) a merger or consolidation in which securities
possessing more than fifty percent (50%) of the total combined voting
power of the Corporation's outstanding securities are transferred to a
person or persons different from the persons holding those securities
immediately prior to such transaction, or

(ii) the sale, transfer or other disposition of all
or substantially all of the Corporation's assets in complete liquidation
or dissolution of the Corporation.

G. DISABILITY shall mean the inability of Optionee to engage in
any substantial gainful activity by reason of any medically determinable
physical or mental impairment and shall be determined by the Plan Administrator
on the basis of such medical evidence as the Plan Administrator deems warranted
under the circumstances. Disability shall be deemed to constitute PERMANENT
DISABILITY in the event that such Disability is expected to result in death or
has lasted or can be expected to last for a continuous period of twelve (12)
months or more.

H. EMPLOYEE shall mean an individual who is in the employ of the
Corporation (or any Parent or Subsidiary), subject to the control and direction
of the employer entity as to both the work to be performed and the manner and
method of performance.

I. EXERCISE DATE shall mean the date on which the option shall
have been exercised in accordance with Paragraph 9 of the Agreement.

J. EXERCISE PRICE shall mean the exercise price payable per
Option Share as specified in the Grant Notice.

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K. EXPIRATION DATE shall mean the date on which the option
expires as specified in the Grant Notice.

L. FAIR MARKET VALUE per share of Common Stock on any relevant
date shall be determined in accordance with the following provisions:

(i) If the Common Stock is at the time traded on
the Nasdaq National Market, then the Fair Market Value shall be the
closing price per share of Common Stock on the date in question, as the
price is reported by the National Association of Securities Dealers on
the Nasdaq National Market or any successor system. If there is no
closing price for the Common Stock on the date in question, then the
Fair Market Value shall be the closing price on the last preceding date
for which such quotation exists.

(ii) If the Common Stock is at the time listed on
any Stock Exchange, then the Fair Market Value shall be the closing
selling price per share of Common Stock on the date in question on the
Stock Exchange determined by the Plan Administrator to be the primary
market for the Common Stock, as such price is officially quoted in the
composite tape of transactions on such exchange. If there is no closing
selling price for the Common Stock on the date in question, then the
Fair Market Value shall be the closing selling price on the last
preceding date for which such quotation exists.

(iii) If the Common Stock is at the time neither
listed on any Stock Exchange nor traded on the Nasdaq National Market,
then the Fair Market Value shall be determined by the Plan Administrator
after taking into account such factors as the Plan Administrator shall
deem appropriate.

M. GRANT DATE shall mean the date of grant of the option as
specified in the Grant Notice.

N. GRANT NOTICE shall mean the Notice of Grant of Stock Option
accompanying the Agreement, pursuant to which Optionee has been informed of the
basic terms of the option evidenced hereby.

O. INCENTIVE OPTION shall mean an option which satisfies the
requirements of Code Section 422.

P. MISCONDUCT shall mean the commission of any act of fraud,
embezzlement or dishonesty by Optionee, any unauthorized use or disclosure by
Optionee of confidential information or trade secrets of the Corporation (or any
Parent or Subsidiary), or any other intentional misconduct by Optionee adversely
affecting the business or affairs of the Corporation (or any Parent or
Subsidiary) in a material manner. The foregoing definition shall not be deemed
to be inclusive of all the acts or omissions which the Corporation (or any
Parent or Subsidiary) may consider as grounds for the dismissal or discharge of
Optionee or any other individual in the Service of the Corporation (or any
Parent or Subsidiary).

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Q. 1934 ACT shall mean the Securities Exchange Act of 1934, as
amended.

R. NON-STATUTORY OPTION shall mean an option not intended to
satisfy the requirements of Code Section 422.

S. OPTION SHARES shall mean the number of shares of Common Stock
subject to the option.

T. OPTIONEE shall mean the person to whom the option is granted
as specified in the Grant Notice.

U. PARENT shall mean any corporation (other than the Corporation)
in an unbroken chain of corporations ending with the Corporation, provided each
corporation in the unbroken chain (other than the Corporation) owns, at the time
of the determination, stock possessing fifty percent (50%) or more of the total
combined voting power of all classes of stock in one of the other corporations
in such chain.

V. PLAN shall mean the Corporation's 1997 Stock Option/Stock
Issuance Plan.

W. PLAN ADMINISTRATOR shall mean either the Board or a committee
of the Board acting in its capacity as administrator of the Plan.

X. PURCHASE AGREEMENT shall mean the stock purchase agreement in
substantially the form of Exhibit B to the Grant Notice.

Y. SERVICE shall mean the Optionee's performance of services for
the Corporation (or any Parent or Subsidiary) in the capacity of an Employee, a
non-employee member of the board of directors or an independent consultant.

Z. STOCK EXCHANGE shall mean the American Stock Exchange or the
New York Stock Exchange.

AA. SUBSIDIARY shall mean any corporation (other than the
Corporation) in an unbroken chain of corporations beginning with the
Corporation, provided each corporation (other than the last corporation) in the
unbroken chain owns, at the time of the determination, stock possessing fifty
percent (50%) or more of the total combined voting power of all classes of stock
in one of the other corporations in such chain.

BB. VESTING SCHEDULE shall mean the vesting schedule specified in
the Grant Notice pursuant to which the Optionee is to vest in the Option Shares
in a series of installments over his or her period of Service.

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<PAGE> 1
EXHIBIT 10.3

MICROMUSE INC.

1997 EMPLOYEE STOCK PURCHASE PLAN

(AS ADOPTED EFFECTIVE _______ __, 1998)

TABLE OF CONTENTS
Page
----
<S> <C> <C>
SECTION 1. PURPOSE OF THE PLAN..............................................................1

SECTION 2. ADMINISTRATION OF THE PLAN.......................................................1
(a) Committee Composition...........................................................1
(b) Committee Responsibilities......................................................1

SECTION 3. ENROLLMENT AND PARTICIPATION.....................................................1
(a) Offering Periods................................................................1
(b) Accumulation Periods............................................................1
(c) Enrollment......................................................................1
(d) Duration of Participation.......................................................1
(e) Applicable Offering Period......................................................2

SECTION 4. EMPLOYEE CONTRIBUTIONS...........................................................2
(a) Frequency of Payroll Deductions.................................................2
(b) Amount of Payroll Deductions....................................................2
(c) Changing Withholding Rate.......................................................2
(d) Discontinuing Payroll Deductions................................................3
(e) Limit on Number of Elections....................................................3

SECTION 5. WITHDRAWAL FROM THE PLAN.........................................................3
(a) Withdrawal......................................................................3
(b) Re-Enrollment After Withdrawal..................................................3

SECTION 6. CHANGE IN EMPLOYMENT STATUS......................................................3
(a) Termination of Employment.......................................................3
(b) Leave of Absence................................................................3
(c) Death...........................................................................3

SECTION 7. PLAN ACCOUNTS AND PURCHASE OF SHARES.............................................4
(a) Plan Accounts...................................................................4
(b) Purchase Price..................................................................4
(c) Number of Shares Purchased......................................................4
(d) Available Shares Insufficient...................................................4
(e) Issuance of Stock...............................................................4
(f) Unused Cash Balances............................................................5
(g) Stockholder Approval............................................................5

SECTION 8. LIMITATIONS ON STOCK OWNERSHIP...................................................5
(a) Five Percent Limit..............................................................5
</TABLE>

i
<PAGE> 3
<TABLE>
<S> <C> <C>
(b) Dollar Limit....................................................................5

SECTION 9. RIGHTS NOT TRANSFERABLE..........................................................6

SECTION 10. NO RIGHTS AS AN EMPLOYEE........................................................6

SECTION 11. NO RIGHTS AS A STOCKHOLDER......................................................6

SECTION 12. SECURITIES LAW REQUIREMENTS.....................................................6

SECTION 13. STOCK OFFERED UNDER THE PLAN....................................................7
(a) Authorized Shares...............................................................7
(b) Anti-Dilution Adjustments.......................................................7
(c) Reorganizations.................................................................7

SECTION 14. AMENDMENT OR DISCONTINUANCE.....................................................7

SECTION 15. DEFINITIONS.....................................................................7
(a) "Accumulation Period"...........................................................7
(b) "Board".........................................................................7
(c) "Change in Control".............................................................7
(d) "Code"..........................................................................8
(e) "Committee".....................................................................8
(f) "Company".......................................................................8
(g) "Compensation"..................................................................8
(h) "Eligible Employee".............................................................8
(i) "Exchange Act"..................................................................8
(j) "Fair Market Value".............................................................8
(k) "IPO"...........................................................................9
(l) "Offering Period"...............................................................9
(m) "Participant"...................................................................9
(n) "Participating Company".........................................................9
(o) "Plan"..........................................................................9
(p) "Plan Account"..................................................................9
(q) "Purchase Price"................................................................9
(r) "Stock".........................................................................9
(s) "Subsidiary"....................................................................9

SECTION 16. EXECUTION......................................................................10

</TABLE>

<PAGE> 4
MICROMUSE INC.

1997 EMPLOYEE STOCK PURCHASE PLAN

SECTION 1. PURPOSE OF THE PLAN.

The Plan was adopted by the Board on January 20, 1998, effective as of
the date of the IPO. The purpose of the Plan is to provide Eligible Employees
with an opportunity to increase their proprietary interest in the success of the
Company by purchasing Stock from the Company on favorable terms and to pay for
such purchases through payroll deductions. The Plan is intended to qualify under
section 423 of the Code.

SECTION 2. ADMINISTRATION OF THE PLAN.

(a) COMMITTEE COMPOSITION. The Plan shall be administered by the
Committee. The Committee shall consist exclusively of one or more directors of
the Company, who shall be appointed by the Board.

(b) COMMITTEE RESPONSIBILITIES. The Committee shall interpret the Plan
and make all other policy decisions relating to the operation of the Plan. The
Committee may adopt such rules, guidelines and forms as it deems appropriate to
implement the Plan. The Committee's determinations under the Plan shall be final
and binding on all persons.

SECTION 3. ENROLLMENT AND PARTICIPATION.

(a) OFFERING PERIODS. While the Plan is in effect, two overlapping
Offering Periods shall commence in each calendar year. The Offering Periods
shall consist of the 24-month periods commencing on each August 1 and February
1, except that the first Offering Period shall commence on the date of the IPO
and end on January 31, 2000.

(b) ACCUMULATION PERIODS. While the Plan is in effect, two Accumulation
Periods shall commence in each calendar year. The Accumulation Periods shall
consist of the six-month periods commencing on each August 1 and February 1,
except that the first Accumulation Period shall commence on the date of the IPO
and end on July 31, 1998.

(c) ENROLLMENT. Any individual who, on the day preceding the first day
of an Offering Period, qualifies as an Eligible Employee may elect to become a
Participant in the Plan for such Offering Period by executing the enrollment
form prescribed for this purpose by the Committee. The enrollment form shall be
filed with the Company at the prescribed location not later than 10 business
days prior to the commencement of such Offering Period.

(d) DURATION OF PARTICIPATION. Once enrolled in the Plan, a Participant
shall continue to participate in the Plan until he or she ceases to be an
Eligible Employee, withdraws from the Plan under Section 5(a) or reaches the end
of the Accumulation Period in which his or

<PAGE> 5

her employee contributions were discontinued under Section 4(d) or 8(b). A
Participant who discontinued employee contributions under Section 4(d) or
withdrew from the Plan under Section 5(a) may again become a Participant, if he
or she then is an Eligible Employee, by following the procedure described in
Subsection (c) above. A Participant whose employee contributions were
discontinued automatically under Section 8(b) shall automatically resume
participation at the beginning of the earliest Accumulation Period ending in the
next calendar year, if he or she then is an Eligible Employee.

(e) APPLICABLE OFFERING PERIOD. For purposes of calculating the Purchase
Price under Section 7(b), the applicable Offering Period shall be determined as
follows:

(i) Once a Participant is enrolled in the Plan for an Offering
Period, such Offering Period shall continue to apply to him or her until
the earliest of (A) the end of such Offering Period, (B) the end of his
or her participation under Subsection (d) above or (C) re-enrollment in
a subsequent Offering Period under Paragraph (ii) below.

(ii) In the event that the Fair Market Value of Stock on the last
trading day before the commencement of the Offering Period in which the
Participant is enrolled is higher than on the last trading day before
the commencement of any subsequent Offering Period, the Participant
shall automatically be re-enrolled for such subsequent Offering Period.

(iii) When a Participant reaches the end of an Offering Period
but his or her participation is to continue, then such Participant shall
automatically be re-enrolled for the Offering Period that commences
immediately after the end of the prior Offering Period.

SECTION 4. EMPLOYEE CONTRIBUTIONS.

(a) FREQUENCY OF PAYROLL DEDUCTIONS. A Participant may purchase shares
of Stock under the Plan solely by means of payroll deductions. Payroll
deductions, as designated by the Participant pursuant to Subsection (b) below,
shall occur on each payday during participation in the Plan.

(b) AMOUNT OF PAYROLL DEDUCTIONS. An Eligible Employee shall designate
on the enrollment form the portion of his or her Compensation that he or she
elects to have withheld for the purchase of Stock. Such portion shall be a whole
percentage of the Eligible Employee's Compensation, but not less than 1% nor
more than 15%.

(c) CHANGING WITHHOLDING RATE. If a Participant wishes to change the
rate of payroll withholding, he or she may do so by filing a new enrollment form
with the Company at the prescribed location at any time. The new withholding

2
<PAGE> 6

rate shall be effective as soon as reasonably practicable after such form has
been received by the Company. The new withholding rate shall be a whole
percentage of the Eligible Employee's Compensation, but not less than 1% nor
more than 15%.

(d) DISCONTINUING PAYROLL DEDUCTIONS. If a Participant wishes to
discontinue employee contributions entirely, he or she may do so by filing a new
enrollment form with the Company at the prescribed location at any time. Payroll
withholding shall cease as soon as reasonably practicable after such form has
been received by the Company. (In addition, employee contributions may be
discontinued automatically pursuant to Section 8(b).) A Participant who has
discontinued employee contributions may resume such contributions by filing a
new enrollment form with the Company at the prescribed location. Payroll
withholding shall resume as soon as reasonably practicable after such form has
been received by the Company.

(e) LIMIT ON NUMBER OF ELECTIONS. No Participant shall make more than
two elections under Subsection (c) or (d) above during any Accumulation Period.

SECTION 5. WITHDRAWAL FROM THE PLAN.

(a) WITHDRAWAL. A Participant may elect to withdraw from the Plan by
filing the prescribed form with the Company at the prescribed location at any
time before the last day of an Accumulation Period. As soon as reasonably
practicable thereafter, payroll deductions shall cease and the entire amount
credited to the Participant's Plan Account shall be refunded to him or her in
cash, without interest. No partial withdrawals shall be permitted.

(b) RE-ENROLLMENT AFTER WITHDRAWAL. A former Participant who has
withdrawn from the Plan shall not be a Participant until he or she re-enrolls in
the Plan under Section 3(c). Re-enrollment may be effective only at the
commencement of an Offering Period.

SECTION 6. CHANGE IN EMPLOYMENT STATUS.

(a) TERMINATION OF EMPLOYMENT. Termination of employment as an Eligible
Employee for any reason, including death, shall be treated as an automatic
withdrawal from the Plan under Section 5(a). (A transfer from one Participating
Company to another shall not be treated as a termination of employment.)

(b) LEAVE OF ABSENCE. For purposes of the Plan, employment shall not be
deemed to terminate when the Participant goes on a military leave, a sick leave
or another bona fide leave of absence, if the leave was approved by the Company
in writing. Employment, however, shall be deemed to terminate 90 days after the
Participant goes on a leave, unless a contract or statute guarantees his or her
right to return to work. Employment shall be deemed to terminate in any event
when the approved leave ends, unless the Participant immediately returns to
work.

(c) DEATH. In the event of the Participant's death, the amount credited
to his or her Plan Account shall be paid to a beneficiary designated by him or
her for this purpose on the

3
<PAGE> 7

prescribed form or, if none, to the Participant's estate. Such form shall be
valid only if it was filed with the Company at the prescribed location before
the Participant's death.

SECTION 7. PLAN ACCOUNTS AND PURCHASE OF SHARES.

(a) PLAN ACCOUNTS. The Company shall maintain a Plan Account on its
books in the name of each Participant. Whenever an amount is deducted from the
Participant's Compensation under the Plan, such amount shall be credited to the
Participant's Plan Account. Amounts credited to Plan Accounts shall not be trust
funds and may be commingled with the Company's general assets and applied to
general corporate purposes. No interest shall be credited to Plan Accounts.

(b) PURCHASE PRICE. The Purchase Price for each share of Stock purchased
at the close of an Accumulation Period shall be the lower of:

(i) 85% of the Fair Market Value of such share on the last
trading day in such Accumulation Period; or

(ii) 85% of the Fair Market Value of such share on the last
trading day before the commencement of the applicable Offering Period
(as determined under Section 3(e)) or, in the case of the first Offering
Period under the Plan, 85% of the price at which one share of Stock is
offered to the public in the IPO.

(c) NUMBER OF SHARES PURCHASED. As of the last day of each Accumulation
Period, each Participant shall be deemed to have elected to purchase the number
of shares of Stock calculated in accordance with this Subsection (c), unless the
Participant has previously elected to withdraw from the Plan in accordance with
Section 5(a). The amount then in the Participant's Plan Account shall be divided
by the Purchase Price, and the number of shares that results shall be purchased
from the Company with the funds in the Participant's Plan Account. The foregoing
notwithstanding, no Participant shall purchase more than 1,250 shares of Stock
with respect to any Accumulation Period nor more than the amounts of Stock set
forth in Sections 8(b) and 13(a). The Committee may determine with respect to
all Participants that any fractional share, as calculated under this Subsection
(c), shall be (i) rounded down to the next lower whole share or (ii) credited as
a fractional share.

(d) AVAILABLE SHARES INSUFFICIENT. In the event that the aggregate
number of shares that all Participants elect to purchase during an Accumulation
Period exceeds the maximum number of shares remaining available for issuance
under Section 13(a), then the number of shares to which each Participant is
entitled shall be determined by multiplying the number of shares available for
issuance by a fraction, the numerator of which is the number of shares that such
Participant has elected to purchase and the denominator of which is the number
of shares that all Participants have elected to purchase.

(e) ISSUANCE OF STOCK. Certificates representing the shares of Stock
purchased by a Participant under the Plan shall be issued to him or her as soon
as reasonably practicable after the

4
<PAGE> 8

close of the applicable Accumulation Period, except that the Committee may
determine that such shares shall be held for each Participant's benefit by a
broker designated by the Committee (unless the Participant has elected that
certificates be issued to him or her). Shares may be registered in the name of
the Participant or jointly in the name of the Participant and his or her spouse
as joint tenants with right of survivorship or as community property.

(f) UNUSED CASH BALANCES. An amount remaining in the Participant's Plan
Account that represents the Purchase Price for any fractional share shall be
carried over in the Participant's Plan Account to the next Accumulation Period.
Any amount remaining in the Participant's Plan Account that represents the
Purchase Price for whole shares that could not be purchased by reason of
Subsection (c) above, Section 8(b) or Section 13(a) shall be refunded to the
Participant in cash, without interest.

(g) STOCKHOLDER APPROVAL. Any other provision of the Plan
notwithstanding, no shares of Stock shall be purchased under the Plan unless and
until the Company's stockholders have approved the adoption of the Plan.

SECTION 8. LIMITATIONS ON STOCK OWNERSHIP.

(a) FIVE PERCENT LIMIT. Any other provision of the Plan notwithstanding,
no Participant shall be granted a right to purchase Stock under the Plan if such
Participant, immediately after his or her election to purchase such Stock, would
own stock possessing more than 5% of the total combined voting power or value of
all classes of stock of the Company or any parent or Subsidiary of the Company.
For purposes of this Subsection (a), the following rules shall apply:

(i) Ownership of stock shall be determined after applying the
attribution rules of section 424(d) of the Code;

(ii) Each Participant shall be deemed to own any stock that he or
she has a right or option to purchase under this or any other plan; and

(iii) Each Participant shall be deemed to have the right to
purchase 1,250 shares of Stock under this Plan with respect to each
Accumulation Period.

(b) DOLLAR LIMIT. Any other provision of the Plan notwithstanding, no
Participant shall purchase Stock with a Fair Market Value in excess of the
following limit:

(i) In the case of Stock purchased during an Offering Period that
commenced in the current calendar year, the limit shall be equal to (A)
$25,000 minus (B) the Fair Market Value of the Stock that the
Participant previously purchased in the current calendar year (under
this Plan and all other employee stock purchase plans of the Company or
any parent or Subsidiary of the Company).

5
<PAGE> 9

(ii) In the case of Stock purchased during an Offering Period
that commenced in the immediately preceding calendar year, the limit
shall be equal to (A) $50,000 minus (B) the Fair Market Value of the
Stock that the Participant previously purchased (under this Plan and all
other employee stock purchase plans of the Company or any parent or
Subsidiary of the Company) in the current calendar year and in the
immediately preceding calendar year.

(iii) In the case of Stock purchased during an Offering Period
that commenced in the second preceding calendar year, the limit shall be
equal to (A) $75,000 minus (B) the Fair Market Value of the Stock that
the Participant previously purchased (under this Plan and all other
employee stock purchase plans of the Company or any parent or Subsidiary
of the Company) in the current calendar year and in the two preceding
calendar years.

For purposes of this Subsection (b), the Fair Market Value of Stock shall be
determined in each case as of the beginning of the Offering Period in which such
Stock is purchased. Employee stock purchase plans not described in section 423
of the Code shall be disregarded. If a Participant is precluded by this
Subsection (b) from purchasing additional Stock under the Plan, then his or her
employee contributions shall automatically be discontinued and shall resume at
the beginning of the earliest Accumulation Period ending in the next calendar
year (if he or she then is an Eligible Employee).

SECTION 9. RIGHTS NOT TRANSFERABLE.

The rights of any Participant under the Plan, or any Participant's
interest in any Stock or moneys to which he or she may be entitled under the
Plan, shall not be transferable by voluntary or involuntary assignment or by
operation of law, or in any other manner other than by beneficiary designation
or the laws of descent and distribution. If a Participant in any manner attempts
to transfer, assign or otherwise encumber his or her rights or interest under
the Plan, other than by beneficiary designation or the laws of descent and
distribution, then such act shall be treated as an election by the Participant
to withdraw from the Plan under Section 5(a).

SECTION 10. NO RIGHTS AS AN EMPLOYEE.

Nothing in the Plan or in any right granted under the Plan shall confer
upon the Participant any right to continue in the employ of a Participating
Company for any period of specific duration or interfere with or otherwise
restrict in any way the rights of the Participating Companies or of the
Participant, which rights are hereby expressly reserved by each, to terminate
his or her employment at any time and for any reason, with or without cause.

SECTION 11. NO RIGHTS AS A STOCKHOLDER.

A Participant shall have no rights as a stockholder with respect to any
shares of Stock that he or she may have a right to purchase under the Plan until
such shares have been purchased on the last day of the applicable Accumulation
Period.

6
<PAGE> 10

SECTION 12. SECURITIES LAW REQUIREMENTS.

Shares of Stock shall not be issued under the Plan unless the issuance
and delivery of such shares comply with (or are exempt from) all applicable
requirements of law, including (without limitation) the Securities Act of 1933,
as amended, the rules and regulations promulgated thereunder, state securities
laws and regulations, and the regulations of any stock exchange or other
securities market on which the Company's securities may then be traded.

SECTION 13. STOCK OFFERED UNDER THE PLAN.

(a) AUTHORIZED SHARES. The aggregate number of shares of Stock available
for purchase under the Plan shall be 300,000, subject to adjustment pursuant to
this Section 13.

(b) ANTI-DILUTION ADJUSTMENTS. The aggregate number of shares of Stock
offered under the Plan, the 1,250-share limitation described in Section 7(c) and
the price of shares that any Participant has elected to purchase shall be
adjusted proportionately by the Committee for any increase or decrease in the
number of outstanding shares of Stock resulting from a subdivision or
consolidation of shares or the payment of a stock dividend, any other increase
or decrease in such shares effected without receipt or payment of consideration
by the Company, the distribution of the shares of a Subsidiary to the Company's
stockholders or a similar event.

(c) REORGANIZATIONS. Any other provision of the Plan notwithstanding,
immediately prior to the effective time of a Change in Control, the Offering
Period and Accumulation Period then in progress shall terminate and shares shall
be purchased pursuant to Section 7. In the event of a merger or consolidation to
which the Company is a constituent corporation and which does not constitute a
Change in Control, the Plan shall continue unless the plan of merger or
consolidation provides otherwise. The Plan shall in no event be construed to
restrict in any way the Company's right to undertake a dissolution, liquidation,
merger, consolidation or other reorganization.

SECTION 14. AMENDMENT OR DISCONTINUANCE.

The Board shall have the right to amend, suspend or terminate the Plan
at any time and without notice. Except as provided in Section 13, any increase
in the aggregate number of shares of Stock to be issued under the Plan shall be
subject to approval by a vote of the stockholders of the Company. In addition,
any other amendment of the Plan shall be subject to approval by a vote of the
stockholders of the Company to the extent required by an applicable law or
regulation.

SECTION 15. DEFINITIONS.

(a) "ACCUMULATION PERIOD" means a six-month period during which
contributions may be made toward the purchase of Stock under the Plan, as
determined pursuant to Section 3(b).

7
<PAGE> 11

(b) "BOARD" means the Board of Directors of the Company, as constituted
from time to time.

(i) The consummation of a merger or consolidation of the Company
with or into another entity or any other corporate reorganization, if
more than 50% of the combined voting power of the continuing or
surviving entity's securities outstanding immediately after such merger,
consolidation or other reorganization is owned by persons who were not
stockholders of the Company immediately prior to such merger,
consolidation or other reorganization; or

(ii) The sale, transfer or other disposition of all or
substantially all of the Company's assets or the complete liquidation or
dissolution of the Company.

A transaction shall not constitute a Change in Control if its sole purpose is to
change the state of the Company's incorporation or to create a holding company
that will be owned in substantially the same proportions by the persons who held
the Company's securities immediately before such transaction.

(d) "CODE" means the Internal Revenue Code of 1986, as amended.

(e) "COMMITTEE" means a committee of the Board, as described in Section
2.

(f) "COMPANY" means Micromuse Inc., a Delaware corporation.

(g) "COMPENSATION" means (i) the total compensation paid in cash to a
Participant by a Participating Company, including salaries, wages, bonuses,
incentive compensation, commissions, overtime pay and shift premiums, plus (ii)
any pre-tax contributions made by the Participant under section 401(k) or 125 of
the Code. "Compensation" shall exclude all non-cash items, moving or relocation
allowances, cost-of-living equalization payments, car allowances, tuition
reimbursements, imputed income attributable to cars or life insurance, severance
pay, fringe benefits, contributions or benefits received under employee benefit
plans, income attributable to the exercise of stock options, and similar items.
The Committee shall determine whether a particular item is included in
Compensation.

(h) "ELIGIBLE EMPLOYEE" means any employee of a Participating Company
who meets both of the following requirements:

(i) His or her customary employment is for more than five months
per calendar year and for more than 20 hours per week; and

(ii) He or she has been an employee of a Participating Company
for not less than three consecutive months.

The foregoing notwithstanding, an individual shall not be considered an Eligible
Employee if his or her participation in the Plan is prohibited by the law of any
country which has jurisdiction

8
<PAGE> 12

over him or her or if he or she is subject to a collective bargaining agreement
that does not provide for participation in the Plan.

(i) "EXCHANGE ACT" means the Securities Exchange Act of 1934, as
amended.

(j) "FAIR MARKET VALUE" means the market price of Stock, determined by
the Committee as follows:

(i) If Stock was traded over-the-counter on the date in question
but was not traded on The Nasdaq Stock Market or The Nasdaq National
Market, then the Fair Market Value shall be equal to the mean between
the last reported representative bid and asked prices quoted for such
date by the principal automated inter-dealer quotation system on which
Stock is quoted or, if the Stock is not quoted on any such system, by
the "Pink Sheets" published by the National Quotation Bureau, Inc.;

(ii) If Stock was traded over-the-counter on the date in question
and was traded on The Nasdaq Stock Market or The Nasdaq National Market,
then the Fair Market Value shall be equal to the last-transaction price
quoted for such date by The Nasdaq Stock Market or The Nasdaq National
Market;

(iii) If the Stock was traded on a stock exchange on the date in
question, then the Fair Market Value shall be equal to the closing price
reported by the applicable composite transactions report for such date;
and

(iv) If none of the foregoing provisions is applicable, then the
Fair Market Value shall be determined by the Committee in good faith on
such basis as it deems appropriate.

Whenever possible, the determination of Fair Market Value by the Committee shall
be based on the prices reported in The Wall Street Journal or as reported
directly to the Company by Nasdaq or a comparable exchange. Such determination
shall be conclusive and binding on all persons.

(k) "IPO" means the initial offering of Stock to the public pursuant to
a registration statement filed by the Company with the Securities and Exchange
Commission.

(l) "OFFERING PERIOD" means a 24-month period with respect to which the
right to purchase Stock may be granted under the Plan, as determined pursuant to
Section 3(a).

(m) "PARTICIPANT" means an Eligible Employee who elects to participate
in the Plan, as provided in Section 3(c).

(n) "PARTICIPATING COMPANY" means (i) the Company and (ii) each present
or future Subsidiary designated by the Committee as a Participating Company.

(o) "PLAN" means this Micromuse Inc. 1997 Employee Stock Purchase Plan,
as it may be amended from time to time.

9
<PAGE> 13

(p) "PLAN ACCOUNT" means the account established for each Participant
pursuant to Section 7(a).

(q) "PURCHASE PRICE" means the price at which Participants may purchase
Stock under the Plan, as determined pursuant to Section 7(b).

(r) "STOCK" means the Common Stock of the Company.

(s) "SUBSIDIARY" means any corporation (other than the Company) in an
unbroken chain of corporations beginning with the Company, if each of the
corporations other than the last corporation in the unbroken chain owns stock
possessing 50% or more of the total combined voting power of all classes of
stock in one of the other corporations in such chain.

SECTION 16. EXECUTION.

To record the adoption of the Plan by the Board on January 20, 1997,
the Company has caused its authorized officer to execute the same.

MICROMUSE INC.

By: /s/ CHRISTOPHER J. DAWES
----------------------------------
Title: President and CEO
-------------------------------

<PAGE> 1
EXECUTION COPY

EXHIBIT 10.4

MICROMUSE INC.

AMENDED AND RESTATED

INVESTORS' RIGHTS AGREEMENT

---------

September 8, 1997

TABLE OF CONTENTS

Page
----
<S> <C> <C>
1. Registration Rights..................................................................2
1.1 Definitions...................................................................2
1.2 Request for Registration......................................................3
1.3 Company Registration..........................................................5
1.4 Obligations of the Company....................................................6
1.5 Furnish Information...........................................................8
1.6 Expenses of Demand Registration...............................................8
1.7 Expenses of Company Registration..............................................8
1.8 Underwriting Requirements.....................................................9
1.9 Delay of Registration.........................................................9
1.10 Indemnification...............................................................9
1.11 Reports Under Securities Exchange Act of 1934................................11
1.12 Form S-3 Registration........................................................12
1.13 Assignment of Registration Rights............................................13
1.14 Market Stand-Off" Agreement..................................................13
1.15 Termination of Registration Rights...........................................14

2. Covenants of the Company............................................................15
2.1 Delivery of Financial Statements.............................................15
2.2 Inspection...................................................................16
2.3 Termination of Information and Inspection Covenants..........................16
2.4 Right of First Refusal.......................................................16

3. Miscellaneous.......................................................................17
3.1 Successors and Assigns.......................................................17
3.2 Governing Law................................................................18
3.3 Counterparts.................................................................18
3.4 Titles and Subtitles.........................................................18
3.5 Notices......................................................................18
3.6 Expenses.....................................................................18
3.7 Amendments and Waivers.......................................................18
3.8 Severability.................................................................18
3.9 Aggregation of Stock.........................................................19
3.10 Entire Agreement.............................................................19
3.11 Amendment and Waiver.........................................................19

Schedule A Schedule of Investors
Schedule B Schedule of Founders
</TABLE>

i
<PAGE> 3
AMENDED AND RESTATED INVESTORS' RIGHTS AGREEMENT

THIS AMENDED AND RESTATED INVESTORS' RIGHTS AGREEMENT (the
"Restated Investors' Rights Agreement") is made as of the 8th day of September,
1997, by and between Micromuse Inc., a Delaware corporation (the "Company"), and
the investors listed on Schedule A hereto and the founders listed on Schedule B
hereto, each of which is herein referred to as an "Investor." All terms used and
not otherwise defined herein shall have the meaning ascribed to such terms in
the Purchase Agreement (as defined below).

RECITALS

WHEREAS, the Company and certain Investors entered into an
Investors' Rights Agreement, dated as of March 7, 1997, as amended as of June
19, 1997 (as amended, the "Investors' Rights Agreement"), under which such
Investors were granted certain rights, including registration rights;

WHEREAS, contemporaneously herewith, the Company and certain
Investors have entered into the Series C Preferred Stock Purchase Agreement of
even date herewith (the "Purchase Agreement"), which provides, among other
things, for the sale and issuance of up to 2,488,336 shares of Series C
Convertible Preferred Stock, $.01 par value per share, of the Company (the
"Additional Shares") to certain Investors, for a purchase price of $6.43 per
share;

WHEREAS, pursuant to Section 3.7 of the Investors' Rights
Agreement, the Company must obtain the approval of the holders of at least a
majority of the Investor Registrable Securities (as defined as Section 1.1(f) of
the Investors' Rights Agreement), and the holders of at least a majority of the
Founder Registrable Securities (as defined in Section 1.1(g) of the Investors'
Rights Agreement in order to amend or waive any provision of the Investors'
Rights Agreement;

WHEREAS, the Company and the Investors who are party to the
Investors' Rights Agreement desire to waive the Investors' right of first
refusal pursuant to Section 2.4 of the Investors' Rights Agreement in connection
with the issuance of the Additional Shares (and conversion of the Additional
Shares into Common Stock);

WHEREAS, in connection with the transactions contemplated by the
Purchase Agreement, the Investors' Rights Agreement is being amended and
restated in its entirety by the parties hereto to grant certain registration and
other rights to certain of the Investors with respect to the Additional Shares
and the Common Stock issuable upon conversion of the Additional Shares;

NOW, THEREFORE, in consideration of good and valuable
consideration, the receipt of which is hereby acknowledged, the undersigned
parties hereby agree as follows:

<PAGE> 4

1. Registration Rights. The Company covenants and agrees as follows:

1.1 Definitions. For purposes of this Section 1:

(a) The term "Act" means the Securities Act of 1933, as
amended.

(b) The term "Form S-3" means such form under the Act as
in effect on the date hereof or any registration form under the
Act subsequently adopted by the SEC which permits inclusion or
incorporation of substantial information by reference to other
documents filed by the Company with the SEC.

(c) The term "Holder" means any person owning or
having the right to acquire Registrable Securities or any assignee thereof in
accordance with Section 1.13 hereof.

(d) The term "1934 Act" shall mean the Securities
Exchange Act of 1934, as amended.

(e) The term "register," "registered," and
"registration" refer to a registration effected by preparing and filing a
registration statement or similar document in compliance with the Act, and the
declaration or ordering of effectiveness of such registration statement or
document.
(f) The term "Series A/B Registrable Securities"
means (i) the Common Stock issuable or issued upon conversion of the Series A
Preferred Stock which is issuable upon exercise of the Series A Warrant, (ii)
the Common Stock issuable upon conversion of the Series B Preferred Stock, and
(iii) any Common Stock of the Company issued as (or issuable upon the conversion
or exercise of any warrant, right or other security which is issued as) a
dividend or other distribution with respect to, or in exchange for or in
replacement of the shares referenced in (i) and (ii) above, excluding in all
cases, however, any Series A/B Registrable Securities sold by a person in a
transaction in which his rights under this Section 1 are not assigned.

(g) The term "Founder Registrable Securities" means
the shares of Common Stock held by the individuals as set forth on Schedule B to
this Agreement, excluding in all cases, however, any Founder Registrable
Securities sold by a person in a transaction in which his rights under this
Section 1 are not assigned.

(h) The term "Series C Registrable Securities"
means the Common Stock issuable upon conversion of the Series C Convertible
Preferred Stock and any Common Stock issued as (or issuable upon the conversion
or exercise of any warrant, right or other security which is issued as) a
dividend or other distribution with respect to, or in exchange for or in
replacement of any shares referenced above, excluding in all cases however, any
Series C Registrable Securities sold by a person in a transaction in which his
rights under this Section 1 are not assigned.

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<PAGE> 5

(i) The term "Registrable Securities" shall mean
the Series A/B Registrable Securities, the Series C Registrable Securities and
the Founder Registrable Securities.

(j) The number of shares of "Registrable Securities
then outstanding" shall be determined by the number of shares of Common Stock
outstanding which are, and the number of shares of Common Stock issuable
pursuant to then exercisable or convertible securities which are, Registrable
Securities.

(k) The term "SEC" shall mean the Securities and
Exchange Commission.

(l) The term "PLC Optionee" shall mean any option
holders of Micromuse Plc, a subsidiary of the Company, that agree to exchange
options to purchase shares of Micromuse Plc for options to purchase shares of
Common Stock of the Company granted by the Founders pursuant to the terms of a
certain Stock Option Exchange Agreement (the "Stock Option Exchange Agreement")
among such PLC Optionees, the Company (as escrow agent) and the Founders.

1.2 Request for Registration.

(a) If the Company shall receive at any time (but not
within six (6) months after the effective date of a registration statement for a
public offering of securities of the Company (other than a registration
statement relating either to the sale of securities to employees of the Company
pursuant to a stock option, stock purchase or similar plan or an SEC Rule 145
transaction))

(i) after June 1, 1998 (x) a written
request from the Holders of at least forty percent (40%) of the Series A/B
Registrable Securities then outstanding that the Company file a registration
statement under the Act covering the registration of such Series A/B Registrable
Securities, or (y) in connection with the Company's first registered public
offering, a written request from the Holders of at least twenty percent (20%) of
the Founder Registrable Securities then outstanding (or such lesser percentage
from Holders proposing to register Founder Registrable Securities with
anticipated aggregate offering price, net of underwriting discounts and
commissions, in excess of $5,000,000), or (z) subsequent to the Company's first
registered public offering, a written request from any Holder of Founder
Registrable Securities that the Company file a registration statement under the
Act covering the registration of Founder Registrable Securities, or

(ii) after August 1, 1999, a written request
from the Holders of at least fifty percent (50%) of the Series C Registrable
Securities then outstanding that the Company file a registration statement under
the Act covering the registration of such Series C Registrable Securities;
provided, that with respect to a written request for the Company's first
registered public offering, such Series C Registrable Securities Holders request
that at least twenty percent (20%) of such Series C Registrable Securities held
by such requesting Holders be registered in connection with such registration
(or such lesser percentage from Holders proposing

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<PAGE> 6

to register Series C Registrable Securities with an anticipated aggregate
offering price, net of underwriting discounts and commissions, in excess of
$5,000,000),

then the Company shall, within ten (10) days of the receipt thereof, give
written notice of such request to all Holders and shall use its reasonable best
efforts to effect as soon as practicable, and in any event within 60 days of the
receipt of such request, the registration under the Act of all Series A/B
Registrable Securities, Series C Registrable Securities and Founder Registrable
Securities, as applicable, which the Holders request to be registered, subject
to the limitations of subsection 1.2(c), within twenty (20) days of the mailing
of such notice by the Company in accordance with Section 3.5. All requests for
registration hereunder by the Holders of the Founder Registrable Securities
shall be made by Christopher Dawes as representative of the Holders of Founder
Registrable Securities.

(b) If a Holder of either the Series A/B
Registrable Securities, Series C Registrable Securities or Founder Registrable
Securities shall demand registration pursuant to Section 1.2(a) hereof, then the
Company shall, at such time, promptly give each Holder of Series A/B Registrable
Securities, Series C Registrable Securities and Founder Registrable Securities
written notice of such registration. Upon the written request of each such
Holder given within twenty (20) days after mailing of such notice by the Company
in accordance with Section 3.5, the Company shall, subject to the provisions of
Section 1.2(c), cause to be registered under the Act all of the Registrable
Securities that each such Holder has requested to be registered.

(c) If the Holders initiating the registration
request hereunder ("Initiating Holders") intend to distribute the Registrable
Securities covered by their request by means of an underwriting, they shall so
advise the Company as a part of their request made pursuant to subsection 1.2(a)
and the Company shall include such information in the written notice referred to
in subsection 1.2(a). The underwriter will be selected by the Company and shall
be reasonably acceptable to a majority in interest of the Initiating Holders. In
such event, the right of any Holder to include his Registrable Securities in
such registration shall be conditioned upon such Holder's participation in such
underwriting and the inclusion of such Holder's Registrable Securities in the
underwriting (unless otherwise mutually agreed by a majority in interest of the
Initiating Holders and such Holder) to the extent provided herein. All Holders
proposing to distribute their securities through such underwriting shall
(together with the Company as provided in subsection 1.4(e)) enter into an
underwriting agreement in customary form with the underwriter or underwriters
selected for such underwriting. Notwithstanding any other provision of this
Section 1.2, if the underwriter advises the Company in writing, a copy of such
writing shall be provided by the Company to the Initiating Holders, that
marketing factors require a limitation of the number of shares to be
underwritten, then the Company shall so advise all Holders of Registrable
Securities which would otherwise be underwritten pursuant hereto, and the number
of shares of Registrable Securities that may be included in the underwriting
shall be allocated one-third among the holders of the Series A/B Registrable
Securities, one-third among the holders of Series C Registrable Securities and
one-third among the holders of Founder Registrable Securities, and within each
group such number of shares shall be allocated among all Holders thereof,
including the Initiating Holders, in proportion (as nearly as practicable) to
the

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<PAGE> 7

amount of Registrable Securities owned by each Holder; provided, however, that
the number of shares of Registrable Securities to be included in such
underwriting shall not be reduced unless all other securities are first entirely
excluded from the underwriting.

(d) Notwithstanding the foregoing, if the
Company shall furnish to the Initiating Holders a certificate signed by the
Chief Executive Officer of the Company stating that in the good faith judgment
of the Board of Directors of the Company, it would be seriously detrimental to
the Company and its shareholders for such registration statement to be filed and
it is therefore essential to defer the filing of such registration statement,
the Company shall have the right to defer taking action with respect to such
filing for a period of not more than 120 days after receipt of the request of
the Initiating Holders; provided, however, that the Company may not utilize this
right more than once in any twelve-month period.

(e) In addition, the Company shall not be
obligated to effect, or to take any action to effect, any registration pursuant
to this Section 1.2:

(i) With respect to the holders of
Series A/B Registrable Securities, after the Company has effected two
registrations pursuant to this Section 1.2 and such registrations have been
declared or ordered effective;

(ii) With respect to the holders of
Founder Registrable Securities, after the Company has effected one registration
pursuant to this Section 1.2 and such registration has been declared or ordered
effective;

(iii) With respect to the holders of Series
C Registrable Securities, after the Company has effected one registration
pursuant to this Section 1.2 and such registration has been declared or ordered
effective;

(iv) During the period starting with the
date sixty (60) days prior to the Company's good faith estimate of the date of
filing of, and ending on a date one hundred eighty (180) days after the
effective date of, a registration subject to Section 1.3 hereof; provided that
the Company is actively employing in good faith all reasonable efforts to cause
such registration statement to become effective; or

(v) If the Initiating Holders propose to
dispose of shares of Registrable Securities that may be immediately registered
on Form S-3 pursuant to a request made pursuant to Section 1.12 below.

1.3 Company Registration. If (but without any obligation to do
so) the Company proposes to register (including for this purpose a registration
effected by the Company for shareholders other than the Holders) any of its
stock or other securities under the Act in connection with the public offering
of such securities solely for cash (other than a registration relating solely to
the sale of securities to participants in a Company stock plan, a registration
on any form which does not include substantially the same information as would
be required to be included in a registration statement covering the sale of the
Registrable Securities or a registration in which the only Common Stock being
registered is Common Stock issuable upon

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<PAGE> 8

conversion of debt securities which are also being registered), the Company
shall, at such time, promptly give each Holder written notice of such
registration. Upon the written request of each Holder given within twenty (20)
days after mailing of such notice by the Company in accordance with Section 3.5,
the Company shall, subject to the provisions of Section 1.8, cause to be
registered under the Act all of the Registrable Securities that each such Holder
has requested to be registered.

1.4 Obligations of the Company. Whenever required under this Section 1
to effect the registration of any Registrable Securities, the Company shall, as
expeditiously as reasonably possible:

(a) Prepare and file with the SEC a registration statement with
respect to such Registrable Securities and use its best efforts to cause such
registration statement to become effective, and, upon the request of the Holders
of a majority of the Registrable Securities registered thereunder, keep such
registration statement effective for a period of up to one hundred twenty (120)
days or until the distribution contemplated in the Registration Statement has
been completed; provided, however, that (i) such 120-day period shall be
extended for a period of time equal to the period the Holder refrains from
selling any securities included in such registration at the request of an
underwriter of Common Stock (or other securities) of the Company; and (ii) in
the case of any registration of Registrable Securities on Form S-3 which are
intended to be offered on a continuous or delayed basis, such 120-day period
shall be extended, if necessary, to keep the registration statement effective
until all such Registrable Securities are sold, provided that Rule 415, or any
successor rule under the Act, permits an offering on a continuous or delayed
basis, and provided further that applicable rules under the Act governing the
obligation to file a post-effective amendment permit, in lieu of filing a
post-effective amendment which (I) includes any prospectus required by Section
10(a)(3) of the Act or (II) reflects facts or events representing a material or
fundamental change in the information set forth in the registration statement,
the incorporation by reference of information required to be included in (I) and
(II) above to be contained in periodic reports filed pursuant to Section 13 or
15(d) of the 1934 Act in the registration statement.

(b) Prepare and file with the SEC such amendments and
supplements to such registration statement and the prospectus used in connection
with such registration statement as may be necessary to comply with the
provisions of the Act with respect to the disposition of all securities covered
by such registration statement.

(c) Furnish to the Holders such numbers of copies of a
prospectus, including a preliminary prospectus, in conformity with the
requirements of the Act, and such other documents as they may reasonably request
in order to facilitate the disposition of Registrable Securities owned by them.

(d) Use its best efforts to register and qualify the securities
covered by such registration statement under such other securities or Blue Sky
laws of such jurisdictions as shall be reasonably requested by the Holders;
provided that the Company shall not be required in connection therewith or as a
condition thereto to qualify to do business or to

6
<PAGE> 9

file a general consent to service of process in any such states or
jurisdictions, unless the Company is already subject to service in such
jurisdiction and except as may be required by the Act.

(e) In the event of any underwritten public
offering, enter into and perform its obligations under an underwriting
agreement, in usual and customary form, with the managing underwriter of such
offering. Each Holder participating in such underwriting shall also enter into
and perform its obligations under such an agreement.

(f) Notify each Holder of Registrable Securities
covered by such registration statement at any time when a prospectus relating
thereto is required to be delivered under the Act of the happening of any event
as a result of which the prospectus included in such registration statement, as
then in effect, includes an untrue statement of a material fact or omits to
state a material fact required to be stated therein or necessary to make the
statements therein not misleading in the light of the circumstances then
existing.

(g) No indemnifying party, in the defense of any
such claim or litigation, shall, except with the consent of each indemnified
party, consent to entry to any judgment or enter into any settlement which does
not include as an unconditional term thereof the giving by the claimant or
plaintiff to such indemnified party of a release from all liability in respect
to such claim or litigation.

(h) Cause all such Registrable Securities
registered pursuant hereunder to be listed on each securities exchange on which
similar securities issued by the Company are then listed.

(i) Provide a transfer agent and registrar for
all Registrable Securities registered pursuant hereunder and a CUSIP number for
all such Registrable Securities, in each case not later than the effective date
of such registration.

(j) Use its best efforts to furnish, at the
request of any Holder requesting registration of Registrable Securities pursuant
to this Section 1, on the date that such Registrable Securities are delivered to
the underwriters for sale in connection with a registration pursuant to this
Section 1, if such securities are being sold through underwriters, or, if such
securities are not being sold through underwriters, on the date that the
registration statement with respect to such securities becomes effective, (i) an
opinion, dated such date, of the counsel representing the Company for the
purposes of such registration, in form and substance as is customarily given to
underwriters in an underwritten public offering, addressed to the underwriters,
if any, and to the Holders requesting registration of Registrable Securities and
(ii) a letter dated such date, from the independent certified public accountants
of the Company, in form and substance as is customarily given by independent
certified public accountants to underwriters in an underwritten public offering,
addressed to the underwriters, if any, and to the Holders requesting
registration of Registrable Securities.

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<PAGE> 10

1.5 Furnish Information.

(a) It shall be a condition precedent to the obligations of the
Company to take any action pursuant to this Section 1 with respect to the
Registrable Securities of any selling Holder that such Holder shall furnish to
the Company such information regarding itself, the Registrable Securities held
by it, and the intended method of disposition of such securities as shall be
required to effect the registration of such Holder's Registrable Securities.

(b) The Company shall have no obligation with respect to any
registration requested pursuant to Section 1.2 or Section 1.12 if, due to the
operation of subsection 1.5(a), the number of shares or the anticipated
aggregate offering price of the Registrable Securities to be included in the
registration does not equal or exceed the number of shares or the anticipated
aggregate offering price required to originally trigger the Company's obligation
to initiate such registration as specified in subsection 1.2(a) or Section 1.12,
whichever is applicable.

1.6 Expenses of Demand Registration. All expenses other than
underwriting discounts and commissions and fees of special counsel to a Holder
incurred in connection with registrations, filings or qualifications pursuant to
Section 1.2, including (without limitation) all registration, filing and
qualification fees, printers' and accounting fees, fees and disbursements of
counsel for the Company shall be borne by the Company; provided, however, that
the Company shall not be required to pay for any expenses of any registration
proceeding begun pursuant to Section 1.2 if the registration request is
subsequently withdrawn at the request of the Holders of a majority of the
Registrable Securities to be registered (in which case all participating holders
shall bear such expenses), unless the Holders of a majority of the Registrable
Securities held by the Initiating Holders agree to forfeit their respective
right to one demand registration pursuant to Section 1.2; provided further,
however, that if at the time of such withdrawal, the Holders have learned of a
material adverse change in the condition, business, or prospects of the Company
from that known to the Holders at the time of their request and have withdrawn
the request with reasonable promptness following disclosure by the Company of
such material adverse change, then the Holders shall not be required to pay any
of such expenses and shall retain their rights pursuant to Section 1.2. All
expenses borne by the Holders of Registrable Securities shall be apportioned
based on the number of shares of Registrable Securities included in such
registration.

1.7 Expenses of Company Registration. The Company shall bear and pay all
expenses incurred in connection with any registration, filing or qualification
of Registrable Securities with respect to the registrations pursuant to Section
1.3 for each Holder (which right may be assigned as provided in Section 1.13),
including (without limitation) all registration, filing, and qualification fees,
printers and accounting fees relating or apportionable thereto and the fees and
disbursements of counsel for the Company in its capacity as counsel to the
selling Holders hereunder, but excluding underwriting discounts and commissions
relating to Registrable Securities and fees of special counsel to the Holders of
Registrable Securities.

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<PAGE> 11

1.8 Underwriting Requirements. In connection with any offering involving
an underwriting of shares of the Company's capital stock, the Company shall not
be required under Section 1.3 to include any of the Holders' securities in such
underwriting unless they accept the terms of the underwriting as agreed upon
between the Company and the underwriters selected by it (or by other persons
entitled to select the underwriters), and then only in such quantity as the
underwriters determine in their sole discretion will not jeopardize the success
of the offering by the Company. If the total amount of securities, including
Registrable Securities, requested by shareholders to be included in such
offering exceeds the amount of securities sold other than by the Company that
the underwriters determine in their sole discretion is compatible with the
success of the offering, then the Company shall be required to include in the
offering only that number of such securities, including Registrable Securities,
which the underwriters determine in their sole discretion will not jeopardize
the success of the offering (the securities so included to be apportioned pro
rata among the selling stockholders according to the total amount of securities
entitled to be included therein owned by each selling stockholder or in such
other proportions as shall mutually be agreed to by such selling stockholders)
but in no event shall any shares being sold by a stockholder exercising a demand
registration right similar to that granted in Section 1.2 be excluded from such
offering. For purposes of the preceding parenthetical concerning apportionment,
for any selling stockholder which is a holder of Registrable Securities and
which is a partnership or corporation, the partners, retired partners and
stockholders of such holder, or the estates and family members of any such
partners and retired partners and any trusts for the benefit of any of the
foregoing persons shall be deemed to be a single "selling stockholder", and any
pro-rata reduction with respect to such "selling stockholder" shall be based
upon the aggregate amount of shares carrying registration rights owned by all
entities and individuals included in such "selling stockholder," as defined in
this sentence.

1.9 Delay of Registration. No Holder shall have any right to obtain or
seek an injunction restraining or otherwise delaying any such registration as
the result of any controversy that might arise with respect to the
interpretation or implementation of this Section 1.

1.10 Indemnification. In the event any Registrable Securities are
included in a registration statement under this Section 1:

(a) To the extent permitted by law, the Company will
indemnify and hold harmless each Holder, any underwriter (as defined in the Act)
for such Holder and each person, if any, who controls such Holder or underwriter
within the meaning of the Act or the 1934 Act, against any losses, claims,
damages, or liabilities (joint or several) to which they may become subject
under the Act, or the 1934 Act or other federal or state law, insofar as such
losses, claims, damages, or liabilities (or actions in respect thereof) arise
out of or are based upon any of the following statements, omissions or
violations (collectively a "Violation"): (i) any untrue statement or alleged
untrue statement of a material fact contained in such registration statement,
including any preliminary prospectus or final prospectus contained therein or
any amendments or supplements thereto, (ii) the omission or alleged omission to
state therein a material fact required to be stated therein, or necessary to
make the statements therein

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<PAGE> 12
not misleading, or (iii) any violation or alleged violation by the Company of
the Act, the 1934 Act, any state securities law or any rule or regulation
promulgated under the Act, or the 1934 Act or any state securities law; and the
Company will pay to each such Holder, underwriter or controlling person, as
incurred, any legal or other expenses reasonably incurred by them in connection
with investigating or defending any such loss, claim, damage, liability, or
action; provided, however, that the indemnity agreement contained in this
subsection 1.10(a) shall not apply to amounts paid in settlement of any such
loss, claim, damage, liability, or action if such settlement is effected without
the consent of the Company (which consent shall not be unreasonably withheld),
nor shall the Company be liable in any such case for any such loss, claim,
damage, liability, or action to the extent that it arises out of or is based
upon a Violation which occurs in reliance upon and in conformity with written
information furnished expressly for use in connection with such registration by
any such Holder, underwriter or controlling person.

(b) To the extent permitted by law, each selling
Holder will indemnify and hold harmless the Company, each of its directors, each
of its officers who has signed the registration statement, each person, if any,
who controls the Company within the meaning of the Act, any underwriter, any
other Holder selling securities in such registration statement and any
controlling person of any such underwriter or other Holder, against any losses,
claims, damages, or liabilities (joint or several) to which any of the foregoing
persons may become subject, under the Act, or the 1934 Act or other federal or
state law, insofar as such losses, claims, damages, or liabilities (or actions
in respect thereto) arise out of or are based upon any Violation, in each case
to the extent (and only to the extent) that such Violation occurs in reliance
upon and in conformity with written information furnished by such Holder
expressly for use in connection with such registration; and each such Holder
will pay, as incurred, any legal or other expenses reasonably incurred by any
person intended to be indemnified pursuant to this subsection 1.10(b), in
connection with investigating or defending any such loss, claim, damage,
liability, or action; provided, however, that the indemnity agreement contained
in this subsection 1.10(b) shall not apply to amounts paid in settlement of any
such loss, claim, damage, liability or action if such settlement is effected
without the consent of the Holder, which consent shall not be unreasonably
withheld; provided, that, in no event shall any indemnity under this subsection
1.10(b) exceed the gross proceeds from the offering received by such Holder.

(c) Promptly after receipt by an indemnified party
under this Section 1.10 of notice of the commencement of any action (including
any governmental action), such indemnified party will, if a claim in respect
thereof is to be made against any indemnifying party under this Section 1.10,
deliver to the indemnifying party a written notice of the commencement thereof
and the indemnifying party shall have the right to participate in, and, to the
extent the indemnifying party so desires, jointly with any other indemnifying
party similarly noticed, to assume the defense thereof with counsel mutually
satisfactory to the parties; provided, however, that an indemnified party
(together with all other indemnified parties which may be represented without
conflict by one counsel) shall have the right to retain one separate counsel,
with the fees and expenses to be paid by the indemnifying party, if
representation of such indemnified party by the counsel retained by the
indemnifying party would be inappropriate due to actual or potential differing
interests between such indemnified party and any other party represented by such
counsel in such proceeding. The failure to deliver written notice to the

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<PAGE> 13

indemnifying party within a reasonable time of the commencement of any such
action, if prejudicial to its ability to defend such action, shall relieve such
indemnifying party of any liability to the indemnified party under this Section
1.10, but the omission so to deliver written notice to the indemnifying party
will not relieve it of any liability that it may have to any indemnified party
otherwise than under this Section 1.10.

(d) If the indemnification provided for in this Section
1.10 is held by a court of competent jurisdiction to be unavailable to an
indemnified party with respect to any loss, liability, claim, damage, or expense
referred to therein, then the indemnifying party, in lieu of indemnifying such
indemnified party hereunder, shall contribute to the amount paid or payable by
such indemnified party as a result of such loss, liability, claim, damage, or
expense in such proportion as is appropriate to reflect the relative fault of
the indemnifying party on the one hand and of the indemnified party on the other
in connection with the statements or omissions that resulted in such loss,
liability, claim, damage, or expense as well as any other relevant equitable
considerations. The relative fault of the indemnifying party and of the
indemnified party shall be determined by reference to, among other things,
whether the untrue or alleged untrue statement of a material fact or the
omission to state a material fact relates to information supplied by the
indemnifying party or by the indemnified party and the parties' relative intent,
knowledge, access to information, and opportunity to correct or prevent such
statement or omission.

(e) Notwithstanding the foregoing, to the extent that
the provisions on indemnification and contribution contained in the underwriting
agreement entered into in connection with the underwritten public offering are
in conflict with the foregoing provisions, the provisions in the underwriting
agreement shall control.

(f) The obligations of the Company and Holders under
this Section 1.10 shall survive the completion of any offering of Registrable
Securities in a registration statement under this Section 1, and otherwise.

1.11 Reports Under Securities Exchange Act of 1934. With a view to
making available to the Holders the benefits of Rule 144 promulgated under the
Act and any other rule or regulation of the SEC that may at any time permit a
Holder to sell securities of the Company to the public without registration or
pursuant to a registration on Form S-3, the Company agrees to:

(a) make and keep public information available, as those terms
are understood and defined in SEC Rule 144, at all times after ninety (90) days
after the effective date of the first registration statement filed by the
Company for the offering of its securities to the general public;

(b) take such action, including the voluntary registration of
its Common Stock under Section 12 of the 1934 Act, as is necessary to enable the
Holders to utilize Form S-3 for the sale of their Registrable Securities, such
action to be taken as soon as practicable after the end of the fiscal year in
which the first registration statement filed by the Company for the offering of
its securities to the general public is declared effective;

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<PAGE> 14

(c) file with the SEC in a timely manner all reports and other
documents required of the Company under the Act and the 1934 Act; and

(d) furnish to any Holder, so long as the Holder owns any
Registrable Securities, forthwith upon request (i) a written statement by the
Company that it has complied with the reporting requirements of SEC Rule 144 (at
any time after ninety (90) days after the effective date of the first
registration statement filed by the Company), the Act and the 1934 Act (at any
time after it has become subject to such reporting requirements), or that it
qualifies as a registrant whose securities may be resold pursuant to Form S-3
(at any time after it so qualifies), (ii) a copy of the most recent annual or
quarterly report of the Company and such other reports and documents so filed by
the Company, and (iii) such other information as may be reasonably requested in
availing any Holder of any rule or regulation of the SEC which permits the
selling of any such securities without registration or pursuant to such form.

1.12 Form S-3 Registration. In case the Company shall receive (i) from
any Holder of Series A/B Registrable Securities, (ii) any Founders Registrable
Securities Holders of at least two percent (2%) of the Common Stock then
outstanding or (iii) any Series C Registrable Securities Holders of at least
five percent (5%) of the Common Stock then outstanding (on a fully diluted
basis), a written request or requests that the Company effect a registration on
Form S-3 and any related qualification or compliance with respect to all or a
part of the Registrable Securities owned by such Holder or Holders, the Company
will:

(a) promptly give written notice of the proposed registration,
and any related qualification or compliance, to all other Holders; and

(b) as soon as practicable, effect such registration and all
such qualifications and compliances as may be so requested and as would permit
or facilitate the sale and distribution of all or such portion of such Holder's
or Holders' Registrable Securities as are specified in such request, together
with all or such portion of the Registrable Securities of any other Holder or
Holders joining in such request as are specified in a written request given
within 15 days after receipt of such written notice from the Company; provided,
however, that the Company shall not be obligated to effect any such
registration, qualification or compliance, pursuant to this section 1.12: (1) if
Form S-3 is not available for such offering by the Holders; (2) if the Holders,
together with the holders of any other securities of the Company entitled to
inclusion in such registration, propose to sell Registrable Securities and such
other securities (if any) at an aggregate price to the public (net of any
underwriters' discounts or commissions) of less than $1,000,000; (3) if the
Company shall furnish to the Holders a certificate signed by the President of
the Company stating that in the good faith judgment of the Board of Directors of
the Company, it would be seriously detrimental to the Company and its
shareholders for such Form S-3 Registration to be effected at such time, in
which event the Company shall have the right to defer the filing of the Form S-3
registration statement for a period of not more than 60 days after receipt of
the request of the Holder or Holders under this Section 1.12; provided, however,
that the Company shall not utilize this right more than once in any twelve month
period; (4) if the Company has, within the twelve (12) month period preceding
the date of such request, already effected two registrations on Form S-3 for the
Holders pursuant to this Section 1.12; or (5) in any

12
<PAGE> 15

particular jurisdiction in which the Company would be required to qualify to do
business or to execute a general consent to service of process in effecting such
registration, qualification or compliance.

(c) subject to the foregoing, the Company shall file a
registration statement covering the Registrable Securities and other securities
so requested to be registered as soon as practicable after receipt of the
request or requests of the Holders. All expenses incurred in connection with a
registration requested pursuant to Section 1.12, including (without limitation)
all registration, filing, qualification, printer's and accounting fees and the
reasonable fees and disbursements of counsel for the Company, but excluding any
underwriters' discounts or commissions associated with Registrable Securities
and the fees of special counsel to the Holders of Registrable Securities, shall
be borne by the Company. Registrations effected pursuant to this Section 1.12
shall not be counted as demands for registration or registrations effected
pursuant to Sections 1.2 or 1.3, respectively. All expenses borne by the Holders
of Registrable Securities shall be apportioned based on the number of shares of
Registrable Securities included in such registration.

1.13 Assignment of Registration Rights. The rights to cause the Company
to register Registrable Securities pursuant to this Section 1 may be assigned
(but only with all related obligations) by a Holder to a transferee or assignee
of such securities, provided:

(a) The rights may be assigned only to an assignee or transferee
who acquires or receives (i) either twenty percent (20%) of the Series A/B
Registrable Securities, or Founder Registrable Securities representing at least
two percent (2%) of the Company's total outstanding Common Stock or Series C
Registrable Securities representing at least twenty percent (20%) of such
assigning Investor's Series C Registrable Securities, and (ii) the assignee or
transferee is reasonably acceptable to the Company; provided that no rights
pursuant to this Section 1 may be transferred to a PLC Optionee who exercises
its option to purchase Founder Registrable Securities; and

(b) (i) the Company is, within a reasonable time after such
transfer, furnished with written notice of the name and address of such
transferee or assignee and the securities with respect to which such
registration rights are being assigned; (ii) such transferee or assignee agrees
in writing to be bound by and subject to the terms and conditions of this
Agreement, including without limitation the provisions of Sections 1.14 and 1.15
below; and (iii) such assignment shall be effective only if immediately
following such transfer the further disposition of such securities by the
transferee or assignee is restricted under the Act;

provided, further, that any distribution or transfer of such rights to the
partner of a Holder that is a partnership may be accomplished without
restriction.

1.14 "Market Stand-Off" Agreement. Each Investor hereby agrees that,
during the period of duration specified by the Company or an underwriter of
Common Stock or other securities of the Company, following the date of the first
sale to the public pursuant to a registration statement of the Company filed
under the Act, it shall not, to the extent requested by the Company and such
underwriter, directly or indirectly sell, offer to sell, contract to sell

13
<PAGE> 16

(including, without limitation, any short sale), grant any option to purchase or
otherwise transfer or dispose of (other than to donees who agree to be similarly
bound) any securities of the Company held by it at any time during such period
except Common Stock included in such registration; provided, however, that

(a) all officers and directors and greater than five percent
(5%) stockholders of the Company enter into similar agreements; and

(b) such market stand-off time period for the Company's initial
public offering shall not exceed one hundred eighty (180) days and for any
subsequent public offering shall not exceed ninety (90) days;

provided, further, that with respect to any public offering subsequent to the
Company's initial public offering, the Series C Registrable Securities held by
Holders will not be subject to the foregoing restrictions.

In order to enforce the foregoing covenant, the Company may
impose stop-transfer instructions with respect to the Registrable Securities of
each Investor (and the shares or securities of every other person subject to the
foregoing restriction) until the end of such period.

Notwithstanding the foregoing, the obligations described in this
Section 1.14 shall not apply to a registration relating solely to employee
benefit plans on Form S-l or Form S-8 or similar forms which may be promulgated
in the future, or a registration relating solely to a Commission Rule 145
transaction on Form S-14 or Form S-15 or similar forms which may be promulgated
in the future.

1.15 Termination of Registration Rights.

(a) No Holder shall be entitled to exercise any right
provided for in this Section 1 after five (5) years following the consummation
of the sale of securities pursuant to a registration statement filed by the
Company under the Act in connection with the initial firm commitment
underwritten offering of its securities to the general public.

(b) In addition, the right of any Holder to request
registration or inclusion in any registration pursuant to Section 1.3 shall
terminate on the closing of the first Company-initiated registered public
offering of Common Stock of the Company if all shares of Registrable Securities
held or entitled to be held upon conversion by such Holder may immediately be
sold under Rule 144 during any 90-day period, or on such date after the closing
of the first Company-initiated registered public offering of Common Stock of the
Company as all shares of Registrable Securities held or entitled to be held upon
conversion by such Holder may immediately be sold under Rule 144 during any
90-day period; provided, however, that the provisions of this Section 1.15(b)
shall not apply to any Holder who owns more than two percent (2%) of the
Company's outstanding stock until such time as such Holder owns less than two
percent (2%) of the outstanding stock of the Company.

14
<PAGE> 17

2. Covenants of the Company.

2.1 Delivery of Financial Statements. The Company shall
deliver to

(a) each Investor that holds in the aggregate
100,000 shares or more of the then outstanding Series A and Series B Preferred
Stock (or Common Stock issuable upon conversion of Series A and Series B
Preferred Stock) or 50,000 shares or more of the then outstanding Series C
Preferred Stock (or Common Stock issuable upon conversion of Series C Preferred
Stock), as soon as practicable, but in any event within ninety (90) days after
the end of each fiscal year of the Company, an income statement for such fiscal
year, a balance sheet of the Company and statement of shareholder's equity as of
the end of such year, and a schedule as to the sources and applications of funds
for such year, such year-end financial reports to be in reasonable detail,
prepared in accordance with U.S. generally accepted accounting principles
("GAAP"), and audited and certified by independent public accountants of
nationally recognized standing selected by the Company;

(b) each Investor that holds in the aggregate
100,000 shares or more of the then outstanding Series A and Series B Preferred
Stock (or Common Stock issuable upon conversion of Series A and Series B
Preferred Stock) or 50,000 shares or more of the then outstanding Series C
Preferred Stock (or Common Stock issuable upon conversion of Series C Preferred
Stock), as soon as practicable, but in any event within forty-five (45) days
after the end of each of the first three (3) quarters of each fiscal year of the
Company, an unaudited income statement, statement of cash flows, a statement of
stockholder's equity for such fiscal quarter and an unaudited balance sheet as
of the end of such fiscal quarter;

(c) each Investor that holds in aggregate twenty
percent (20%) or more of the total then outstanding Series A and Series B
Preferred Stock (including Common Stock issuable upon conversion of the
Preferred Stock) or in aggregate fifteen percent (15%) or more of the total then
outstanding Series C Preferred Stock (including Common Stock issued upon
conversion of the Series C Preferred Stock, within thirty (30) days of the end
of each month, upon request, an unaudited income statement, statement of cash
flows and balance sheet for and as of the end of such month, in reasonable
detail;

(d) each Investor that holds in aggregate twenty
percent (20%) or more of the total then outstanding Series A and Series B
Preferred Stock (including Common Stock issuable upon conversion of the Series C
Preferred Stock) or in aggregate fifteen percent (15%) or more of the total then
outstanding Series C Preferred Stock (including Common Stock issued upon
conversion of the Preferred Stock), as soon as practicable, but in any event
thirty (30) days prior to the end of each fiscal year, upon request, a budget
and business plan for the next fiscal year, prepared on a monthly basis,
including balance sheets and statement of cash flows for such months and, as
soon as prepared, any other budgets or revised budgets prepared by the Company
or, if prepared by the Company, any standard variance analysis or any comparison
to budget or plan;

(e) with respect to the financial statements
called for in subsections (b) and (c) of this Section 2.1, an instrument
executed by the Chief Financial Officer

15
<PAGE> 18

or President of the Company and certifying that such financials were prepared in
accordance with GAAP consistently applied with prior practice for earlier
periods (with the exception of footnotes that may be required by GAAP) and
fairly present the financial condition of the Company and its results of
operation for the period specified, subject to year-end audit adjustment;

(f) The Company shall not be obligated under
Section 2.1 to provide information which it deems in good faith to be a trade
secret or similar confidential information.

2.2 Inspection. The Company shall permit each Investor that holds in the
aggregate twenty percent (20%) or more of the then outstanding Preferred Stock
(including Common Stock issuable upon exchange of the Preferred), at such
Investor's expense, to visit and inspect the Company's properties, to examine
its books of account and records and to discuss the Company's affairs, finances
and accounts with its officers, all at such reasonable times as may be requested
by the Investor; provided, however, that the Company shall not be obligated
pursuant to this Section 2.2 to provide access to any information which it
reasonably considers to be a trade secret or similar confidential information.

2.3 Termination of Information and Inspection Covenants. The covenants
set forth in subsections 2.1(c) and (d) and Section 2.2 shall terminate as to
Investors and be of no further force or effect when the sale of securities
pursuant to a registration statement filed by the Company under the Act in
connection with the firm commitment underwritten offering of its securities to
the general public is consummated or when the Company first becomes subject to
the periodic reporting requirements of Sections 12(g) or 15(d) of the 1934 Act,
whichever event shall first occur.

2.4 Right of First Refusal. Subject to the terms and conditions
specified in this paragraph 2.4, the Company hereby grants to each Investor a
right of first refusal with respect to future sales by the Company of its Shares
(as hereinafter defined).

Each time the Company or its wholly-owned subsidiary, Micromuse PLC, a
company formed in the United Kingdom, proposes to offer any shares of, or
securities convertible into or exercisable for any shares of, any class of their
capital stock ("Shares"), the Company shall first make an offering of such
Shares to each Investor in accordance with the following provisions:

(a) The Company shall deliver a notice ("Notice") to the
Investors stating (i) its bona fide intention to offer such Shares, (ii) the
number of such Shares to be offered, and (iii) the price and terms, if any, upon
which it proposes to offer such Shares.

(b) Within 10 calendar days after giving of the Notice, the
Investor may elect to purchase or obtain, at the price and on the terms
specified in the Notice, up to that portion of such Shares which equals the
proportion that the number of shares of Common Stock issued and held, or
issuable upon conversion of the Series A Preferred Stock, Series B Preferred
Stock or Series C Preferred Stock then held, by such Investor bears to the total
number of shares of Common Stock of the Company then outstanding (assuming full
conversion and

16
<PAGE> 19

exercise of all convertible or exercisable securities with the exception of any
options outstanding under any Company Stock Option Plan).

(c) If all Shares which Investors are entitled to obtain
pursuant to subsection 2.4(b) are not elected to be obtained as provided in
subsection 2.4(b) hereof, the Company may, during the 20-day period following
the expiration of the period provided in subsection 2.4(b) hereof, offer the
remaining unsubscribed portion of such Shares to any person or persons at a
price not less than, and upon terms no more favorable to the offeree than those
specified in the Notice. If the Company does not enter into an agreement for the
sale of the Shares within such period, or if such agreement is not consummated
within 20 days of the execution thereof, the right provided hereunder shall be
deemed to be revived and such Shares shall not be offered unless first reoffered
to the Investors in accordance herewith.

(d) The right of first refusal in this paragraph 2.4 shall not
be applicable (i) to the issuance or sale of shares of Common Stock (or options
therefor) to employees for the primary purpose of soliciting or retaining their
employment pursuant to the Company's Stock Option Plan, (ii) with respect to the
Holders of Series A/B Registrable Securities and Founder Registrable Securities,
to or after consummation of a bona fide, firmly underwritten public offering of
shares of Common Stock, registered under the Act, at an offering price of at
least $6.86 per share (appropriately adjusted for any stock split, dividend,
combination or other recapitalization) with aggregate gross proceeds of at least
$10,000,000, (iii) with respect to the Holders of Series C Registrable
Securities, to or after consummation of a bona fide, firmly underwritten public
offering of shares of Common Stock, registered under the Act, at an offering
price of at least $9.65 per share if such offering is consummated on or prior to
September 8, 1998, and $12.86 per share thereafter (in each such case, the price
per share shall be appropriately adjusted for any stock split, dividend,
combination or other recapitalization) with aggregate gross proceeds of at least
$10,000,000 (iv) the issuance of securities pursuant to the conversion or
exercise of convertible or exercisable securities, (v) the issuance of
securities in connection with a bona fide business acquisition of or by the
Company, whether by merger, consolidation, sale of assets, sale or exchange of
stock or otherwise or (vi) the issuance of stock, warrants or other securities
or rights to employees, directors, customers, suppliers, OEM's, or consultants,
provided such issuances are for other than primarily equity financing purposes.

(e) The right of first refusal set forth in this Section 2.4 may
not be assigned or transferred, except that (i) such right is assignable by each
Holder to any wholly owned subsidiary or parent of, or to any corporation or
entity that is, within the meaning of the Act, controlling, controlled by or
under common control with, any such Holder, and (ii) such right is assignable
between and among any of the Holders.

3. Miscellaneous.

3.1 Successors and Assigns. Except as otherwise provided
herein, the terms and conditions of this Agreement shall inure to the benefit of
and be binding upon the respective successors and assigns of the parties
(including transferees of any shares of Registrable Securities), with the
exception that the terms and conditions of this Agreement shall

17
<PAGE> 20
not apply to a PLC Optionee who exercises its rights to purchase shares of
Founder Registrable Securities. Nothing in this Agreement, express or implied,
is intended to confer upon any party other than the parties hereto or their
respective successors and assigns any rights, remedies, obligations, or
liabilities under or by reason of this Agreement, except as expressly provided
in this Agreement.

3.2 Governing Law. This Agreement shall be governed by and
construed under the laws of the State of California as applied to agreements
among California residents entered into and to be performed entirely within
California.

3.3 Counterparts. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.

3.4 Titles and Subtitles. The titles and subtitles used in this
Agreement are used for convenience only and are not to be considered in
construing or interpreting this Agreement.

3.5 Notices. Unless otherwise provided, any notice required or
permitted under this Agreement shall be given in writing and shall be deemed
effectively given upon personal delivery to the party to be notified (including,
but not limited to, by nationally recognized courier or overnight delivery
service) or upon deposit with the United States Post Office, by registered or
certified mail, postage prepaid and addressed to the party to be notified at the
address indicated for such party on the signature page hereof, or at such other
address as such party may designate by ten (10) days' advance written notice to
the other parties.

3.6 Expenses. If any action at law or in equity is necessary to
enforce or interpret the terms of this Agreement, the prevailing party shall be
entitled to reasonable attorneys' fees, costs and necessary disbursements in
addition to any other relief to which such party may be entitled.

3.7 Amendments and Waivers. Any term of this Agreement may be
amended and the observance of any term of this Agreement may be waived (either
generally or in a particular instance and either retroactively or
prospectively), only with the written consent of the Company and the holders of
a majority of the Series A/B Registrable Securities, the Founder Registrable
Securities and the Series C Investor Registrable Securities then outstanding,
each voting separately. Any amendment or waiver effected in accordance with this
paragraph shall be binding upon each holder of any Registrable Securities then
outstanding, each future holder of all such Registrable Securities, and the
Company.

3.8 Severability. If one or more provisions of this Agreement
are held to be unenforceable under applicable law, such provision shall be
excluded from this Agreement and the balance of the Agreement shall be
interpreted as if such provision were so excluded and shall be enforceable in
accordance with its terms.

18
<PAGE> 21

3.9 Aggregation of Stock. All shares of Registrable Securities
held or acquired by affiliated entities or persons shall be aggregated together
for the purpose of determining the availability of any rights under this
Agreement.

3.10 Entire Agreement. This Agreement (including the Exhibits
hereto, if any) constitutes the full and entire understanding and agreement
between the parties with regard to the subjects hereof and thereof.

3.11 Amendment and Waiver. The Investors who are party to the
Investors' Rights Agreement and being the holders of at least a majority of the
currently outstanding Investor Registrable Securities (as defined in Section
1.1(f) of the Investors' Rights Agreement) and a majority of the currently
outstanding Founder Registrable Securities (as defined in Section 1.1(g) of the
Investors' Rights Agreement), in connection with the issuance by the Company of
the Additional Shares (and conversion of the Additional Shares into Common
Stock) hereby (i) waive the right of first refusal set forth in Section 2.4 of
the Investors' Rights Agreement, (ii) consent to the amendments to the
Investors' Rights Agreement and agree that the Investors' Rights Agreement shall
be terminated and of no further force and effect and (iii) the Investors agree
to be bound by the provisions of this Restated Investors' Rights Agreement.

19
<PAGE> 22

IN WITNESS WHEREOF, the parties have executed this Agreement as
of the date first above written.

MICROMUSE INC.

By: /s/ CHRISTOPHER J. DAWES
-----------------------------------------
President and Chief Executive Officer

Address: 139 Townsend Street
Mezzanine Floor
San Francisco, California 94107

INVESTORS:

SIERRA VENTURES V, L.P.

By its General Partner SV Associates V, L.P.

By: /s/ Peter L. Wendell
-----------------------------------------
Its:
----------------------------------------
Address: 3000 Sand Hill Road
Building 4, Suite 210
Menlo Park, CA 94025

CITICORP

By: /s/ RONALD DeSALTO
----------------------------------------
Its: Vice President
----------------------------------------
Address: 155 East 53rd Street
1 Citicorp Center
New York, New York 10043

<PAGE> 23

NETWORK EQUIPMENT TECHNOLOGIES, INC.

By: /s/ Dan Lane
-----------------------------------------
Its: Vice President
----------------------------------------

Address: 800 Saginaw Drive
Redwood City, California 94063

VICTORY VENTURES LLC

By: /s/ WALTER A. CAROZZA
-----------------------------------------
Name: Walter A. Carozza
---------------------------------------
Title: President
--------------------------------------
Address: 645 Madison Avenue, 22nd Floor
New York, New York 10022

EAST RIVER VENTURES, L.P.

By: /s/ WALTER A. CAROZZA
-----------------------------------------
Name: Walter A. Carozza
---------------------------------------
Title: General Partner
--------------------------------------

Address: 645 Madison Avenue, 22nd Floor
New York, New York 10022

DMG TECHNOLOGY VENTURES L.L.C.

By: /s/ G. Boutros
-----------------------------------------
Name:
---------------------------------------
Title:
--------------------------------------

Address: 1550 El Camino Real, Suite 100
Menlo Park, California 94025

<PAGE> 24

COMDISCO, INC.

By: /s/ JAMES P. LABE
-----------------------------------------
Name: James P. Labe
---------------------------------------
Title: President, Compisco Ventures Division
--------------------------------------

Address: 3000 Sand Hill Road
Building 1, Suite 155
Menlo Park, California 74025

SANDRA DRAZAN LIVING TRUST

By: /s/ ARTHUR DRAZAN
-----------------------------------------
Name: Arthur Drazan
---------------------------------------
Title:
--------------------------------------

By:
-----------------------------------------
Name:
---------------------------------------
Title:
--------------------------------------

Address: 3000 Sand Hill Road
Building Four, Suite 210
Menlo Park, California 94025

/s/ LAWRENCE FLINN, JR.
-------------------------------------------
Lawrence Flinn, Jr.

Address: 411 West Putnam Avenue
Suite 305
Greenwich, Connecticut 06831

/s/ PETER A. FLAHERTY
-------------------------------------------
Peter A. Flaherty

Address: 130 East 95th Street
New York, New York 10128

<PAGE> 25

------------------------------------
Marshall Lux

Address: c/o McKinsey & Company
55 East 52nd Street
New York, New York 10022

/s/ ROBERT DENMAN
------------------------------------
Robert Denman

Address: 6 Margate Terrace
Pueblo, Colorado 81001

/s/ BERT ZACCARIA
------------------------------------
Bert Zaccaria

Address: 3000 Sand Hill Road
Building Four, Suite 210
Menlo Park, California 94025

ZD. AIR, INC.

By: /s/ BERT ZACCARIA
-----------------------------------
Name: /s/ Bert Zaccaria
---------------------------------
Title: President
--------------------------------

Address: 3000 Sand Hill Road
Building Four, Suite 210
Menlo Park, California 94025

<PAGE> 26
/s/ CHRISTOPHER J. DAWES
------------------------------------
Christopher Dawes

Address: 650 Second Street
Apartment 501
San Francisco, CA 44107

/s/ ANGELA DAWES
------------------------------------
Angela Dawes

Address: 650 Second Street
Apartment 501
San Francisco, CA 44107

------------------------------------
Philip Tee

Address:

------------------------------------
Trevor Robinson

Address: Tancreds
South Road
St. George's Hill
Weybridge, Surrey, England
KT13 ONA

------------------------------------
Kenneth Barth

Address: 10456 Countess Drive
Dallas, TX 75229

<PAGE> 27
/s/ MICHAEL JACKSON
------------------------------------
Michael Jackson

Address: 2 Castello Avenue
London, England
SW15

/s/ DAVID C. SCHWAB
------------------------------------
David Schwab

Address: c/o Sierra Ventures
3000 Sand Hill Road
Building 4, Suite 210
Menlo Park, CA 94025

------------------------------------
Dale Rossi

Address: c/o Micromuse Inc.
139 Townsend Street
Mezzanine Floor
San Francisco, CA 94107

------------------------------------
Robert Loughan

Address: c/o Micromuse Inc.
139 Townsend Street
Mezzanine Floor
San Francisco, CA 94107

------------------------------------
Will Ayer

Address: c/o Micromuse Inc.
139 Townsend Street
Mezzanine Floor
San Francisco, CA 94107

<PAGE> 28
/s/ STEVEN M. FRANKLIN
------------------------------------
G & H PARTNERS

By:__________________________________
Name:________________________________
Partner______________________________

Address: 155 Constitution Drive
Menlo Park, California 94025

------------------------------------
Harold J. Newman

Address: 605 3rd Avenue, 38th Floor
New York, New York 10158

BROOKHAVEN CAPITAL MANAGEMENT

By: /s/ VINCENT LARRINE
--------------------------------
Name: Vincent Larrine
--------------------------------
Title: President
--------------------------------
Address: 3000 Sand Hill Road
Building 2, Suite 1051
Menlo Park, California 94025

GERALD SCHALTZ SEP IRA DTD 12/26/95

By: /s/ GERALD SHALTZ
--------------------------------
Name:
Title:

Address: 120 Willowbrook Drive
Portola Valley, California 94028

<PAGE> 29
SCHEDULE A

Schedule of Investors

Name and Address
- ----------------

Citicorp

Sierra Ventures V, LP

Network Equipment Technologies, Inc.

Victory Ventures LLC

East River Ventures, L.P.

Lawrence Flinn, Jr.

DMG Technology Ventures L.L.C.

Peter A. Flaherty

Comdisco, Inc.

Sandra Drazan Living Trust

Robert Denman

Bert Zaccaria

ZD. Air, Inc.

Harold J. Newman

G&H Partners

Gerald Schaltz SEP IRA DTD 12/26/95

Brookhaven Capital Management

S-1
<PAGE> 30
SCHEDULE B

Schedule of Founders

Founders
- --------

Christopher Dawes
Angela Dawes
Philip Tee
Trevor Robinson
Ken Barth
Michael Jackson
David Schwab
Dale Rossi
Robert Loughan
Will Ayer

S-2

<PAGE> 1

EXHIBIT 11

MICROMUSE INC. AND SUBSIDIARIES

STATEMENT REGARDING COMPUTATION
OF PROFORMA NET LOSS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS ENDED
SEPTEMBER 30, DECEMBER 31,
1997 1997
------------- ------------------
(UNAUDITED)
<S> <C> <C>
Net loss applicable to holders of common stock......... $(8,631) $ (1,303)
-------- --------
Weighted average shares outstanding during the period.. 6,329 6,152
Preferred stock on an "as if" converted basis.......... 1,290 4,488
Common shares issued and stock options granted in
accordance with Staff Accounting Bulletin No. 83:....
Common stock option.................................... 577 577
Preferred stock........................................ 1,454 --
Preferred stock warrant................................ 1,167 1,167
-------- --------
Shares used in per share calculation................... 10,817 12,384
-------- --------
Pro forma loss from continuing operations per share.... $ (0.83) $ (0.11)
-------- --------
Pro forma loss from discontinued operations per
share................................................ $ (0.01) $ 0.00
Pro forma gain on disposal of discontinued operations
per share............................................ $ .11 $ 0.00
Pro forma net loss applicable to holders of common
stock per share\..................................... $ (0.80) $ (0.11)
</TABLE>

<PAGE> 1

EXHIBIT 23.1

CONSENT OF KPMG PEAT MARWICK LLP, INDEPENDENT AUDITORS

The Board of Directors
Micromuse Inc.:

We consent to the use of our report included herein and to the references
to our firm under the headings "Selected Consolidated Financial Data" and
"Experts" in the prospectus.

/s/ KPMG PEAT MARWICK LLP

Palo Alto, California

January 20, 1998