MICROMUSE INC, 424B4, 1998-02-13

MICROMUSE INC
424B4, 1998-02-13
PREPACKAGED SOFTWARE

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<PAGE> 1
Filed Pursuant to Rule 424(b)(4)
Registration No. 333-42177

LOGO

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3,200,000 SHARES
COMMON STOCK
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Of the 3,200,000 shares (the "Shares") of Common Stock, par value $0.01 per
share ("Common Stock"), of Micromuse Inc. (the "Company") offered hereby (the
"Offering"), 3,100,000 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." Prior to this Offering, there has been no public market for the
Common Stock. See "Underwriting" for a discussion of the factors considered in
determining the initial public offering price. The Common Stock has been
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 $12.00 $0.84 $11.16 $11.16
Total(3) $38,400,000 $2,688,000 $34,596,000 $1,116,000
</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
480,000 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 $44,160,000, $3,091,200, $36,046,800 and
$5,022,000, 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 February 19, 1998.

DEUTSCHE MORGAN GRENFELL

NATIONSBANC MONTGOMERY SECURITIES LLC

SALOMON SMITH BARNEY

The date of this Prospectus is February 12, 1998.
<PAGE> 2

[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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<PAGE> 3

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................................ 3,200,000 shares (including 3,100,000 shares by the Company
and 100,000 shares by the Selling Stockholders)
Common Stock to be outstanding after the Offering... 14,900,956 shares(1)
Use of proceeds..................................... For working capital and other general corporate purposes.
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 $ 44,179
Working capital.................................................................... 6,801 43,297
Total assets....................................................................... 16,922 53,418
Redeemable convertible preferred stock............................................. 23,755 --
Total stockholders' equity (deficit)............................................... (14,455) 45,796
</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, 980,228 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. Assumes a cash exercise of
an outstanding warrant to purchase 1,500,000 shares of Series A Preferred
Stock at $2.00 per share and the conversion of such shares to Common Stock,
which amount would be reduced by 250,000 shares in the event of a net issue
exercise (at the initial public offering price of $12.00 per share). See
"Capitalization".

(2) Adjusted to reflect the sale of 3,100,000 shares of Common Stock offered by
the Company hereby at the initial public offering price of $12.00 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, and adjusted to reflect the cash exercise of an
outstanding warrant to purchase 1,500,000 shares of Series A Preferred Stock
at $2.00 per share. In the event such warrant is exercised by means of a net
issuance, total stockholders' equity, as adjusted, would decrease by
$3,000,000. See "Capitalization," "Use of Proceeds" and Note 6 of Notes to
Consolidated Financial Statements.

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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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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

9
<PAGE> 10

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

10
<PAGE> 11

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

11
<PAGE> 12

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

12
<PAGE> 13

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."

13
<PAGE> 14

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 was 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

14
<PAGE> 15

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, at the initial public
offering price of $12.00 per share, and without regard to possible regulatory or
contractual restrictions on transfer, will be $140,411,472, 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 the initial public
offering price of $12.00 per share and as a result of the difference between the
acquisition cost for such shares and the 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

15
<PAGE> 16

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 $8.93
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."

16
<PAGE> 17

USE OF PROCEEDS

The net proceeds to the Company from the sale of 3,100,000 shares of Common
Stock to be sold by the Company in this Offering, at the initial public offering
price of $12.00 per share, are estimated to be $33.5 million ($34.9 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> 18

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 (assuming no net issuance), 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 3,100,000
shares of Common Stock offered by the Company hereby and the receipt of the
estimated net proceeds therefrom at the initial public offering price of $12.00
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; 14,900,956 shares issued and
outstanding, pro forma as adjusted................... 67 127 149
Additional paid-in capital............................. 2,400 29,095 57,269
Treasury stock, at cost: 897,605 shares actual and pro
forma; none, pro forma as adjusted................... (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 45,796
------- ------- -------
Total capitalization.............................. $ 9,300 $ 12,300 $45,796
======= ======= =======
</TABLE>

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

(2) Reflects the adjusted 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"). In the
event such warrant is exercised by means of a net issuance, at the initial
public offering of $12.00 per share, total stockholders' equity, pro forma
and pro forma as adjusted would decrease by $3,000,000 and total shares
outstanding would decrease by 250,000 shares. See Note 6 of Notes to
Consolidated Financial Statements.

18
<PAGE> 19

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 the initial public offering price of $12.00 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 $45,796,000, or $3.07 per share. This represents an immediate increase in
net tangible book value of $2.03 per share to existing stockholders and an
immediate dilution in net tangible book value of $8.93 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>
Initial public offering price per share............................ $12.00
Pro forma net tangible book value per share as of December 31,
1997.......................................................... $1.04
Increase per share attributable to new investors................. 2.03
------
Adjusted pro forma net tangible book value per share as of December
31, 1997(1)...................................................... 3.07
------
Dilution per share to new investors................................ $ 8.93
======
</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 the initial public offering price of
$12.00 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......... 11,800,956 79.2% $23,467,000 38.7% $1.99
New investors(2).............. 3,100,000 20.8 37,200,000 61.3 12.00
---------- ----- ----------- -----
Total............... 14,900,956 100.0% $60,667,000 100.0%
========== ===== =========== =====
</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
980,228 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) Reflects the adjusted 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"). In the
event such warrant is exercised by means of a net issuance, at the initial
public offering of $12.00 per share, adjusted pro forma tangible book value
would be decreased to $2.92 per share.

(2) Sales by Selling Stockholders in this Offering will reduce the number of
shares held by existing stockholders to 11,700,956, or approximately 79%
(11,350,956 shares or approximately 76% if the Underwriters' over-allotment
option is exercised in full), and will increase the number of shares held by
new investors to 3,200,000, or approximately 21% (3,680,000 shares or
approximately 24% 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> 20

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
YEAR ENDED SEPTEMBER 30, ENDED DECEMBER 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> 21

<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> 22

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> 23

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> 24

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> 25

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> 26

$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> 27

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> 28

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> 29

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> 30

<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> 31

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> 32

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> 33

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. In the event such warrant is exercised by means of a
net issuance, cash and stockholders' equity each would decrease by $3,000,000.
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> 34

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> 35

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> 36

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> 37

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

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<PAGE> 38

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 and Network
Equipment Technologies, and the Company has entered into distribution agreements
with 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

38
<PAGE> 39

management platforms and devices and then presents user-configurable views of
subsets of 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:

LOGO

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.

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<PAGE> 40

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> 41

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> 42

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.

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<PAGE> 43

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 TRW
Bay Networks
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> 44

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> 45

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
Company believes that a 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> 46

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> 47

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> 48

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
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,

48
<PAGE> 49

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.

In January 1998, the Company received correspondence from counsel to former
noteholders, Meyer, Duffy & Associates, Inc. and affiliated entities ("Meyer
Duffy") asserting rights to purchase shares of capital stock of the Company at a
purchase price significantly lower than the initial public offering price of
$12.00 per share. Meyer Duffy held promissory notes of the Company which were
convertible into shares of the Company's capital stock upon the occurrence of
certain events. The Company repaid the notes in full pursuant to their terms in
December 1996. The Company does not believe such allegations have merit and, if
pursued by Meyer Duffy, the Company intends to vigorously defend such claim and
believes that the resolution of such claim will not have a material adverse
effect on the Company's operating results or financial condition. However, if
commenced, such litigation could be time-consuming and costly, and there can be
no assurance that the Company would necessarily prevail given the inherent
uncertainties in litigation. In the event the Company did not prevail in
litigation, the Company could be required to issue a substantial number of
shares of Common Stock, which would result in significant dilution to existing
stockholders, or to pay monetary damages which could have a material adverse
effect on the Company's operating results and financial condition. In February
1998, the Company and Meyer Duffy entered into a settlement agreement pursuant
to which all claims among the parties were mutually released.

49
<PAGE> 50

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> 51

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.

51
<PAGE> 52

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> 53

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=$1.62, 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> 54

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.

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<PAGE> 55

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.

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<PAGE> 56

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.

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<PAGE> 57

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. In the
event such warrant is exercised by means of a net issuance, at the initial
public offering price of $12.00 per share, total shares issued would
decrease by 250,000 shares.

(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 (or which can be exercised on a net issuance
basis); 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

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<PAGE> 58

Company's 1997 Stock Option/Stock Issuance Plan. See "Management -- Employee
Benefit Plans."

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 = $1.62, 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.

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<PAGE> 59

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 18.6%
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 12.0
Jeffrey M. Drazan(7)............ 3,863,266 32.7 -- 3,863,266 25.9
3000 Sand Hill Road
Building 4, Suite 210
Menlo Park, CA 94025
David C. Schwab(8).............. 4,026,042 34.1 -- 4,026,042 27.0
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 25.5
3000 Sand Hill Road
Building 4, Suite 210
Menlo Park, CA 94025
CITICORP(10).................... 777,605 6.6 -- 777,605 5.2
155 East 53rd Street
1 CITICORP Center
New York, NY 10043

ALL DIRECTORS AND EXECUTIVE
OFFICERS AS A GROUP (11
PERSONS)(11).................. 9,245,205 75.2 100,000 9,145,205 59.4
</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> 60

(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. (the "Series A Warrant") and the conversion of such shares into
Common Stock (which amount would be decreased by 250,000 shares in the
event of an exercise of the Series A Warrant by net issuance at the initial
public offering price of $12.00 per share), 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 the Series A Warrant and the
conversion of such shares into Common Stock (which amount would be
decreased by 250,000 shares in the event of an exercise of the Series A
Warrant by net issuance at the initial public offering price of $12.00 per
share). 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 the Series A
Warrant and the conversion of such shares into Common Stock (which amount
would be decreased by 250,000 shares in the event of an exercise of the
Series A Warrant by net issuance at the initial public offering price of
$12.00 per share). 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 (which
amount would be decreased by 250,000 shares in the event of an exercise of
the Series A Warrant by net issuance at the initial public offering price
of $12.00 per share).

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<PAGE> 61

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 42 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). In the event
such warrant is exercised by means of net issuance, such amount would be reduced
by 250,000 shares (at the initial public offering price of $12.00 per share).
There will be 14,900,956 shares of Common Stock outstanding (assuming no
exercise of the Underwriters' over-allotment option, assuming no exercise after
December 31, 1997 of outstanding options and assuming a cash exercise of the
Series A Warrant) 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

61
<PAGE> 62

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 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.

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<PAGE> 63

REGISTRATION RIGHTS

After this Offering, the holders of 11,430,540 shares of Common Stock will
be entitled to certain rights with respect to the registration of such shares
under the Securities Act. Such amount would be reduced by 250,000 shares in the
event of an exercise of the Series A Warrant by means of net issuance (at the
initial public offering price of $12.00 per share). Under the 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> 64

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this Offering, the Company will have approximately
14,900,956 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, provided such amount would be reduced by
250,000 shares in the event of an exercise of such warrant by means of net
issuance (at the initial public offering price of $12.00 per share)). All of the
3,200,000 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) 5,000 shares will be available for immediate
sale in the public market in accordance with Rule 144(k) and (ii) approximately
9,127,138 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 149,010 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

64
<PAGE> 65

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 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 11,430,540 shares of
outstanding Common Stock will, under certain circumstances, have rights to
require the Company to register their shares for future sale. Such amount would
be reduced by 250,000 shares in the event of an exercise of the Series A Warrant
by means of net issuance (at the initial public offering price of $12.00 per
share). See "Description of Capital Stock -- Registration Rights."

65
<PAGE> 66

UNDERWRITING

The Underwriters named below, for whom Deutsche Morgan Grenfell Inc.,
NationsBanc Montgomery Securities LLC 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............................................... 1,296,000
NationsBanc Montgomery Securities LLC...................................... 792,000
Smith Barney Inc........................................................... 792,000
CIBC Oppenheimer Corp. .................................................... 160,000
Soundview Financial Group.................................................. 160,000
---------
Total............................................................ 3,200,000
=========
</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 $0.50 per
share. The selected dealers may reallow a concession of not more than $0.10 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 the Selling Stockholders have granted an option to the
Underwriters to purchase up to maximum of 480,000 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 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

66
<PAGE> 67

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 was determined by negotiation between
the Company and the Representatives. The principal factors 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.

The Underwriters have reserved for sale, at the initial public offering
price, up to 200,000 shares of the Common Stock offered hereby for certain
individuals designated by the Company who have expressed an interest in
purchasing such shares of Common Stock in the offering. The number of shares
available for sale to the general public will be reduced to the extent such
persons purchase such reserved shares. Any reserved shares not so purchased will
be offered by the Underwriters to the general public on the same basis as other
shares offered hereby.

67
<PAGE> 68

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> 69

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> 70

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, except as to
Note 12 which is as of
February 11, 1998

F-2
<PAGE> 71

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 67 67
Additional paid-in capital.......................... 264 2,390 2,400
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> 72

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> 73

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 1 419 -- -- -- -- -- 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 67 2,390 (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 $ 67 $2,400 (898) $(5,300) $ (201) $ -- $ (11,421) $ (14,455)
===== ==== ====== ==== ====== ====== ======== ======== =======
</TABLE>

See accompanying notes to consolidated financial statements.

F-5
<PAGE> 74

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> 75

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> 76

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> 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)

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> 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)

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> 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)

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> 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)

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> 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)

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 2,513,000 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 and
non-statutory options that must be granted at an exercise price not less than
100% and 85% of the fair market value of the common stock on the date of grant,
respectively, (110% if the person to whom the option is granted is a 10%
stockholder). Incentive options may only be granted to employees. 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> 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)

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> 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)

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 would have increased by $47,000 and $10,000 for fiscal
1997 and the three months ended December 31, 1997, respectively and the loss per
share would have remained unchanged 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> 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 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> 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)

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> 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)

11. PRO FORMA INFORMATION (UNAUDITED)

The following table reflects the exercise for cash 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(1)
----------- ----------- ------------
(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....................... 67 60 127
Additional paid-in capital......... 2,400 26,695 29,095
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>

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

(1) In the event that the Series A preferred stock warrant is exercised by means
of a net issuance, pro forma cash and stockholders' equity would both
decrease by $3 million.

12. LITIGATION

In January 1998, the Company received correspondence from counsel to former
noteholders, Meyer, Duffy & Associates, Inc. and affiliated entities ("Meyer
Duffy") asserting rights to purchase shares of capital stock of the Company at a
purchase price significantly lower than the assumed initial public offering
price of $11.00 per share. Meyer Duffy held promissory notes of the Company
which were convertible into shares of the Company's capital stock upon the
occurrence of certain events. The Company repaid the notes in full pursuant to
their terms in December 1996. The Company does not believe such allegations have
merit and, if pursued by Meyer Duffy, the Company intends to vigorously defend
such claim and believes that the resolution of such claim will not have a
material adverse effect on the Company's operating results or financial
condition. However, if commenced, such litigation could be time-consuming and
costly, and there can be no assurance that the Company would necessarily prevail
given the inherent uncertainties in litigation. In the event the Company did not
prevail in litigation, the Company could be required to issue a substantial
number of shares of Common stock, which would result in substantial dilution to
existing stockholders, or to pay monetary damages which could have a material
adverse effect on the Company's operating results and financial condition.

F-18
<PAGE> 87

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> 88

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> 89

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

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 MARCH 9, 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

3,200,000 SHARES

COMMON STOCK
DEUTSCHE MORGAN GRENFELL

NATIONSBANC MONTGOMERY
SECURITIES LLC

SALOMON SMITH BARNEY

PROSPECTUS

FEBRUARY 12, 1998