MICROMUSE INC, 424B4, 1998-07-29

MICROMUSE INC
424B4, 1998-07-29
PREPACKAGED SOFTWARE

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Filed Pursuant to Rule 424(b)(4)
Registration No. 333-58975

3,000,000 Shares

LOGO

Common Stock
($.01 par value)

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

Of the shares of Common Stock, $.01 par value per share ("Common Stock"),
offered hereby (the "Offering"), 1,000,000 shares are being sold by Micromuse
Inc. ("Micromuse" or the "Company") and 2,000,000 shares are being sold by the
Selling Stockholders named herein under "Principal and Selling Stockholders."
The Company will not receive any of the proceeds of the shares sold by the
Selling Stockholders. The Company's Common Stock is listed on The Nasdaq Stock
Market's National Market ("NNM") under the symbol "MUSE." On July 28, 1998, the
reported last sale price of the Common Stock on the NNM was $25.00 per share.
See "Price Range of Common Stock."

FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED IN CONNECTION WITH
AN INVESTMENT IN THE COMMON STOCK, SEE "RISK FACTORS" ON PAGE 5 HEREIN.

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>
UNDERWRITING
DISCOUNTS PROCEEDS TO
PRICE TO AND PROCEEDS TO SELLING
PUBLIC COMMISSIONS COMPANY(1) STOCKHOLDERS
----------- ------------ ----------- ------------
<S> <C> <C> <C> <C>
Per Share..................................... $24.875 $1.368 $23.507 $23.507
Total(2)...................................... $74,625,000 $4,104,000 $23,507,000 $47,014,000
</TABLE>

(1) Before deduction of expenses payable by the Company, estimated at $650,000.
(2) Certain of the Selling Stockholders have granted the Underwriters an option,
exercisable for 30 days from the date of this Prospectus, to purchase a
maximum of 450,000 additional shares of Common Stock to cover
over-allotments of shares. If the option is exercised in full, the total
Price to Public will be $85,818,750, Underwriting Discounts and Commissions
will be $4,719,600 and Proceeds to Selling Stockholders will be $57,592,150.

The shares of Common Stock are offered by the several Underwriters when, as
and if delivered to and accepted by the Underwriters and subject to their right
to reject orders in whole or in part. It is expected that the shares of Common
Stock will be ready for delivery on or about August 3, 1998, against payment in
immediately available funds.

CREDIT SUISSE FIRST BOSTON

NATIONSBANC MONTGOMERY SECURITIES LLC

SALOMON SMITH BARNEY

Prospectus dated July 28, 1998.
<PAGE> 2

[ARTWORK]

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING OVERALLOTMENT, STABILIZING TRANSACTIONS, SYNDICATE SHORT COVERING
TRANSACTIONS, PENALTY BIDS AND PASSIVE MARKET MAKING. SUCH ACTIVITIES, IF
COMMENCED, MAY BE DISCONTINUED AT ANY TIME. FOR A DESCRIPTION OF THESE
ACTIVITIES, SEE "UNDERWRITING."
<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. Except as
otherwise noted, all information in this Prospectus, including share and per
share information, assumes no exercise of the Underwriters' over-allotment
option.

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, CTC (Itochu),
Datacraft, Ericsson Data Services, N.E.T., and Vanstar. As of June 30, 1998, the
Company had over 150 customers operating in and serving a variety of industries.
Customers include AirTouch, America Online, AT&T Wireless, British
Telecommunications, Cable and Wireless, Cellular One, Deutsche Telekom, First
Data Resources, Genuity, GE Information Services, Global One, GTE
Internetworking, Merrill Lynch, MindSpring, Morgan Stanley, Netcom, Pacific
Bell, PSINet, Siemens, Southwestern Bell Internet Services, Unisource and
WorldCom/MFS/UUNet.

THE OFFERING

<TABLE>
<S> <C>
Common Stock offered................................ 3,000,000 shares (including 1,000,000 shares by the Company
and 2,000,000 shares by the Selling Stockholders)
Common Stock to be outstanding after the Offering... 15,913,438 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>
NINE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
--------------------------- ------------------
1995 1996 1997 1997 1998
------ ------ ------- ------- -------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues:
License................................................... $1,077 $3,374 $ 6,968 $ 3,991 $14,672
Maintenance and services.................................. 369 1,141 2,324 1,630 3,945
------ ------ ------- ------- -------
Total revenues...................................... 1,446 4,515 9,292 5,621 18,617
Gross profit................................................ 1,181 3,820 7,727 4,648 15,311
Net loss.................................................... $ (234) $ (236) $(7,876) $(5,029) $(1,738)
</TABLE>

<TABLE>
<CAPTION>
JUNE 30, 1998
-------------------------
ACTUAL AS ADJUSTED(2)
------- --------------
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $23,503 $46,403
Working capital............................................. 40,306 63,206
Total assets................................................ 53,267 76,167
Total stockholders' equity.................................. 43,030 65,930
</TABLE>

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

(1) Based on the number of shares outstanding as of June 30, 1998. Assumes the
sale of 21,715 shares of Common Stock offered hereby by certain Selling
Stockholders upon the exercise of outstanding options. Excludes 1,598,709
shares of Common Stock issuable upon exercise of outstanding options as of
June 30, 1998, with a weighted average exercise price of $4.43 and 951,404
shares of Common Stock reserved for issuance under the Company's stock
plans. See "Management -- 1997 Stock Option/Stock Issuance Plan," and
"-- 1997 Employee Stock Purchase Plan".

(2) Adjusted to reflect the sale of 1,000,000 shares of Common Stock offered by
the Company hereby at the public offering price of $24.875 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 exercise of outstanding
options to purchase 21,715 shares of Common Stock by certain Selling
Stockholders. See "Capitalization."

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<PAGE> 4

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 worldwide 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 $7.8 billion in 1997,
and projected to grow to approximately $14.7 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 which 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, CTC (Itochu), Datacraft, Ericsson Data
Services, N.E.T., and Vanstar. As of June 30, 1998, the Company had over 150
customers operating in and serving a variety of industries. Customers include
AirTouch, America Online, AT&T Wireless, British Telecommunications, Cable and
Wireless, Cellular One, Deutsche Telekom, First Data Resources, Genuity, GE
Information Services, Global One, GTE Internetworking, Merrill Lynch,
MindSpring, Morgan Stanley, Netcom, Pacific Bell, PSINet, Siemens, Southwestern
Bell Internet Services, Unisource 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 (including without limitation the following Risk
Factors) contains forward-looking statements (within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934) regarding the Company and its business, financial condition, results of
operations and prospects. Words such as "expects," "anticipates," "intends,"
"plans," "believes," "seeks," "estimates" and similar expressions or variations
of such words are intended to identify forward-looking statements, but are not
the exclusive means of identifying forward-looking statements in this
Prospectus. Additionally, statements concerning future matters such as the
development of new products, enhancements or technologies, possible changes in
legislation and other statements regarding matters that are not historical are
forward-looking statements.

Although forward-looking statements in this Prospectus reflect the good
faith judgment of the Company's management, such statements can only be based on
facts and factors currently known by the Company. Consequently, forward-looking
statements are inherently subject to risks and uncertainties, and actual results
and outcomes may differ materially from the results and outcomes discussed in
the forward-looking statements. Factors that could cause or contribute to such
differences in results and outcomes 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. Readers are urged not to place undue reliance on
these forward-looking statements, which speak only as of the date of the
Prospectus. The Company undertakes no obligation to revise or update any
forward-looking statements in order to reflect any event or circumstance that
may arise after the date of the Prospectus.

LIMITED OPERATING HISTORY AS A SOFTWARE COMPANY; 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. Although the Company did not incur losses in the
fiscal quarter ended June 30, 1998, there can be no assurance that the Company
will be profitable in any period thereafter. 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 substantial additional revenue growth on a quarterly or
annual basis, 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 June
30, 1998, the Company had accumulated net losses of $12.3 million. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

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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;
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 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 92
employees on June 30, 1997 to 164 employees on June 30, 1998 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 Chief Financial Officer, Senior Vice
President, Sales and U.S. Controller have been in their current positions with
the Company for a limited period of time. To

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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 successfully 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 Vice President, Marketing, a human resources director and managers for
research and development projects. Further, the Company will need to continue to
develop 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, 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 continues to hire sales
personnel. Based on the Company's experience, it takes at least six months, if
not longer, for a salesperson to become fully productive. Although the Company
increased the size of its sales organization during the twelve-month period
ended June 30, 1998, the Company experienced difficulty in recruiting a
sufficient number of qualified sales people during the period. There can be no
assurance that the Company will be successful in recruiting additional sales
personnel or 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 and the release of the
Company's Netcool/Reporter and Netcool/Internet Service Monitors, the demands on
the Company's technical services and customer support resources have grown
rapidly. See "-- Product Defects; Product Liability." 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 or sales of
Netcool/Reporter or Netcool/Internet Service Monitors 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 22% of the Company's total revenues in fiscal 1997 and
the nine-month period ended June 30, 1998, 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
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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 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 15% 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
45% of the Company's software revenues to date have been derived from the sale
of its products to telecommunications carriers 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

(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 applications 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."

PRODUCT DEFECTS; PRODUCT LIABILITY

Software products as internally complex as Netcool/OMNIbus,
Netcool/Reporter and Netcool/Internet Service Monitors 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 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. Netcool/Reporter, currently in its initial
release, has features and performance characteristics that have had limited
market appeal. Although the Company is currently devoting significant management
and technical resources to improve the features and performance of
Netcool/Reporter, the Company does not expect significant revenue contribution
from Netcool/Reporter for the foreseeable future. To the extent such efforts
continue to require the allocation of a significant portion of the Company's
technical personnel resources, or if the performance and features of
Netcool/Reporter are not improved, the Company could continue to experience
delays in or failure of market acceptance of Netcool/Reporter, or damage to the
Company's reputation or relationships with its customers, any of which could
have a material adverse effect on the Company's business, operating results or
financial condition. 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 of the Company's products after commencement of commercial
shipments which could have a material adverse effect upon the Company's
business, operating results or financial condition.

9
<PAGE> 10

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, any 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. Although the
Company maintains product liability insurance, there can be no assurance that
such insurance will adequately cover, if at all, any such claims. Further,
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."

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
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. 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

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 June 30, 1998, WorldCom B.V., entities affiliated with WorldCom
and entities affiliated with British Telecommunications, accounted for
approximately 17%, 3% and 8%, respectively, of the Company's total revenues.
During the quarter ended March 31, 1998, the Company did not have any customers
that contributed over 10% of total revenues. In addition, during the quarter
ended December 31, 1997, Deutsche Bank AG, an entity affiliated with Deutsche
Bank Securities, an underwriter in the Company's initial public offering,
accounted for approximately 30% of the Company's total revenues. 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
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."

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. 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. Currency exchange fluctuations in countries in
which the Company licenses its products or conducts operations historically have
had, and in the future could continue to 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. 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
11
<PAGE> 12

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. 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."

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,

12
<PAGE> 13

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 modifying 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."

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

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."

YEAR 2000 COMPLIANCE

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.

VOLATILITY OF STOCK PRICE

The market price of the Common Stock has been and is likely to continue 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 stock 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 "Price Range of Common
Stock."

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, approximately 43% of the
outstanding Common Stock will be held by the directors and executive officers of
the Company, together with certain entities affiliated with 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."

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
14
<PAGE> 15

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 the Board of Directors is 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 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 $20.74
from the assumed 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."

15
<PAGE> 16

USE OF PROCEEDS

The net proceeds to the Company from the sale of 1,000,000 shares of Common
Stock to be sold by the Company in this Offering, at the public offering price
of $24.875 per share, are estimated to be $22,857,000, 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 and to provide liquidity for certain of the Company's existing
stockholders.

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.

PRICE RANGE OF COMMON STOCK

The Company's Common Stock has traded publicly on the Nasdaq National
Market since February 13, 1998 under the symbol "MUSE." The Company's initial
public offering price was $12.00 per share. The following table sets forth for
the periods indicated the high and low closing prices of the Common Stock. Prior
to the Company's initial public offering, there was no established public
trading market for the Common Stock.

<TABLE>
<CAPTION>
HIGH LOW
---- ----
<S> <C> <C>
Year ending September 30, 1998
Fourth Quarter (through July 28, 1998).................... $ 41 1/8 $ 25
Third Quarter............................................. 40 13/16 21 1/2
Second Quarter (from February 13, 1998, the first trading
date).................................................. 26 5/8 18 7/8
</TABLE>

On July 28, 1998, the closing price of the Common Stock on the Nasdaq
National Market was $25.00 per share. As of June 30, 1998, there were
approximately 57 holders of record of the Common Stock.

16
<PAGE> 17

CAPITALIZATION

The following table sets forth the capitalization of the Company as of June
30, 1998: (i) on an actual basis, (ii) on a pro forma basis to reflect the
exercise of outstanding options to purchase 21,715 shares of Common Stock by
certain Selling Shareholders immediately prior to the closing of this offering,
and (iii) on a pro forma basis as adjusted to reflect the sale of 1,000,000
shares of Common Stock offered by the Company hereby and the receipt of the
estimated net proceeds therefrom at the public offering price of $24.875 per
share and after deducting underwriting discounts and commissions and estimated
offering expenses payable by the Company. 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>
JUNE 30, 1998(1)
----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
-------- --------- -----------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
Stockholders' equity:
Preferred stock, $0.01 par value, 5,000,000 shares
authorized; no shares issued and outstanding........... $ -- $ -- $ --
Common stock, $0.01 par value, 60,000,000 shares
authorized, 14,891,723 shares issued and outstanding,
actual; 14,913,438 shares issued and outstanding, pro
forma; 15,913,438 shares issued and outstanding, pro
forma as adjusted...................................... 148 149 159
Additional paid-in capital................................ 55,455 55,497 78,344
Deferred compensation..................................... (173) (173) (173)
Cumulative translation adjustment......................... (100) (100) (100)
Accumulated deficit....................................... (12,300) (12,300) (12,300)
-------- ------- --------
Total stockholders' equity............................. $ 43,030 43,073 $ 65,930
-------- ------- --------
Total capitalization................................. $ 43,030 43,073 $ 65,930
======== ======= ========
</TABLE>

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

(1) Excludes (i) 1,598,709 shares of Common Stock issuable upon exercise of
outstanding options as of June 30, 1998 with a weighted average exercise
price of $4.43 per share; and (ii) 951,404 shares reserved for issuance
under the Company's stock plans. See "Management -- 1997 Stock Option/Stock
Issuance Plan," and "-- 1997 Employee Stock Purchase Plan".

17
<PAGE> 18

DILUTION

The pro forma net tangible book value of the Company on June 30, 1998,
after giving effect to the exercise of outstanding options to purchase 21,715
shares of Common Stock by certain Selling Stockholders, was $43,073,000, or
approximately $2.89 per share of 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 June 30,
1998, 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 public offering price of $24.875 per share and after deducting
underwriting discounts and estimated offering expenses payable by the Company,
the net tangible book value of the Company as of June 30, 1998 would have been
$65,930,000, or $4.14 per share. This represents an immediate increase in net
tangible book value of $1.25 per share to existing stockholders and an immediate
dilution in net tangible book value of $20.74 per share to purchasers of Common
Stock in the Offering. The per share dilution is illustrated in the following
table:

<TABLE>
<S> <C> <C>
Public offering price per share............................. $24.88
Pro forma net tangible book value per share as of June 30,
1998................................................... $2.89
Increase per share attributable to new investors.......... 1.25
-----
Adjusted net tangible book value per share as of June 30,
1998(1)................................................... 4.14
------
Dilution per share to new investors......................... $20.74
======
</TABLE>

The following table summarizes as of June 30, 1998, the difference between
the existing stockholders and the purchasers of shares in the Offering (at the
public offering price of $24.875 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................. 14,913,438 93.7% $ 62,297,000 71.5% $ 4.18
New investors(1)...................... 1,000,000 6.3 24,875,000 28.5 24.875
---------- ----- ------------ -----
Total....................... 15,913,438 100.0% $ 87,172,000 100.0%
========== ===== ============ =====
</TABLE>

The foregoing computations are based on the number of shares outstanding as
of June 30, 1998, and assume no exercise of the Underwriters' over-allotment
option or any exercise of outstanding stock options after June 30, 1998, except
the foregoing calculations give effect to the exercise of outstanding options to
purchase 21,715 shares of Common Stock by certain Selling Stockholders. As of
June 30, 1998, there were 1,598,709 shares of Common Stock issuable upon
exercise of outstanding options with a weighted average exercise price of $4.43
per share, and an additional 951,404 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," and "-- 1997 Employee Stock Purchase Plan".
- ---------------
(1) Sales by Selling Stockholders in this Offering will reduce the number of
shares held by existing stockholders to 12,913,438, or approximately 81.1%
(12,463,438 shares or approximately 78.3% if the Underwriters'
over-allotment option is exercised in full), and will increase the number of
shares held by new investors to 3,000,000, or approximately 18.9% (3,450,000
shares or approximately 21.7% 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.

18
<PAGE> 19

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 auditors, 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 nine months ended June 30,
1997 and 1998 and the consolidated balance sheet data at June 30, 1998 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>
NINE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
------------------------------------------ ------------------
1993 1994 1995 1996 1997 1997 1998
----- ----- ------ ------ -------- ------- --------
(IN THOUSANDS, EXCEPT 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 $ 3,991 $ 14,672
Maintenance and services.................................. -- 3 369 1,141 2,324 1,630 3,945
----- ----- ------ ------ -------- ------- --------
Total revenues...................................... -- 114 1,446 4,515 9,292 5,621 18,617
----- ----- ------ ------ -------- ------- --------
Cost of revenues:
License................................................... -- 61 163 311 523 324 945
Maintenance and services.................................. -- -- 102 384 1,042 649 2,361
----- ----- ------ ------ -------- ------- --------
Total cost of revenues.............................. -- 61 265 695 1,565 973 3,306
----- ----- ------ ------ -------- ------- --------
Gross profit................................................ -- 53 1,181 3,820 7,727 4,648 15,311
Operating expenses:
Sales and marketing....................................... -- 30 728 1,768 8,970 4,669 10,819
Research and development ................................. 224 318 708 1,582 2,042 1,282 3,804
General and administrative................................ 78 236 584 996 4,244 2,734 3,154
----- ----- ------ ------ -------- ------- --------
Total operating expenses............................ 302 584 2,020 4,346 15,256 8,685 17,777
----- ----- ------ ------ -------- ------- --------
Loss from operations........................................ (302) (531) (839) (526) (7,529) (4,037) (2,466)
Other income (expense):
Interest income........................................... -- -- -- 8 64 8 992
Interest expense.......................................... (17) (68) (106) (212) (1,268) (717) (4)
Other..................................................... -- -- -- 25 (200) (179) (210)
----- ----- ------ ------ -------- ------- --------
Loss before income taxes.................................... (319) (599) (945) (705) (8,933) (4,925) (1,688)
Income taxes................................................ -- -- -- 100 -- -- 50
----- ----- ------ ------ -------- ------- --------
Loss from continuing operations............................. (319) (599) (945) (805) (8,933) (4,925) (1,738)
Discontinued operations:
Income (loss) from discontinued operations................ 633 335 711 569 (104) (104) --
Gain on disposal of discontinued operations(1)............ -- -- -- -- 1,161 -- --
----- ----- ------ ------ -------- ------- --------
Net income (loss)........................................... $ 314 $(264) $ (234) $ (236) $ (7,876) $(5,029) $ (1,738)
Accretion on redeemable convertible preferred stock......... -- -- -- -- (755) (353) (1,334)
----- ----- ------ ------ -------- ------- --------
Net income (loss) applicable to holders of common stock..... $ 314 $(264) $ (234) $ (236) $ (8,631) $(5,382) $ (3,072)
===== ===== ====== ====== ======== ======= ========
Basic and diluted per share data:
Loss from continuing operations applicable to holders of
common stock............................................ $(0.11) (0.20) (0.17) (0.14) (1.52) (0.84) (0.29)
Net income (loss) applicable to holders of common stock... $0.11 (0.09) (0.04) (0.04) (1.35) (0.86) (0.29)
Shares used in per share calculations..................... 2,969 2,969 5,498 5,954 6,373 6,250 10,487
Cash dividends per share.................................... $ -- $ -- $ 0.01 $ -- $ -- $ -- $ --
===== ===== ====== ====== ======== ======= ========
</TABLE>

<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
------------------------------------------------ ---------
1993 1994 1995 1996 1997 1998
------ ----- ------- ------- ------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $ -- $ 18 $ 12 $ 594 $13,741 $ 23,503
Working capital (deficiency)................................ (259) (453) (383) (847) 13,181 40,306
Total assets................................................ 4,375 4,492 5,767 9,107 22,740 53,267
Redeemable convertible preferred stock...................... -- -- -- -- 22,865 --
Total stockholders' equity (deficit)........................ 351 93 (203) (222) (7,234) 43,030
</TABLE>

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

19
<PAGE> 20

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. In order to further the growth of the Netcool business, the Company
engaged in an initial public offering of Common Stock on February 12, 1998,
raising approximately $34.2 million, net of fees and expenses. 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 during the twelve month period
ended June 30, 1998, growing from 92 to 164 employees. 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. On March 31, 1998, the
Company announced the first customer shipment of Netcool/Reporter and
Netcool/Internet Service Monitors. Netcool/Reporter, currently in its initial
commercial release, has feature and performance characteristics that have had
limited market appeal. 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 "-- Product Defects; Product Liability."

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 June 30, 1998, Micromuse had licensed its Netcool products to more
than 150 customers worldwide. Micromuse licenses its software through its direct
sales force, OEMs and value added resellers. License revenues from OEMs and
resellers accounted for approximately 12%, 8%, 11% and 22% of the

20
<PAGE> 21

Company's total license revenues for fiscal 1995, 1996, 1997 and the first nine
months 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
June 30, 1998, the Company had sold in excess of 65% of its software products to
telecommunications carriers 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 six
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 June 30, 1998, with the
exception of the quarters ended September 30, 1996 and June 30, 1998, and had an
accumulated deficit of $12.3 million as of June 30, 1998. 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."

21
<PAGE> 22

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>
NINE MONTHS
YEAR ENDED ENDED
SEPTEMBER 30, JUNE 30,
----------------------- ---------------
1995 1996 1997 1997 1998
AS A PERCENTAGE OF TOTAL REVENUES ----- ----- ----- ------ -----
<S> <C> <C> <C> <C> <C>
Revenues:
License......................................... 74.5% 74.7% 75.0% 71.0% 78.8%
Maintenance and services........................ 25.5 25.3 25.0 29.0 21.2
----- ----- ----- ------ -----
Total revenues............................... 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ------ -----
Cost of revenues:
License......................................... 11.3 6.9 5.6 5.8 5.1
Maintenance and services........................ 7.0 8.5 11.2 11.5 12.7
----- ----- ----- ------ -----
Total cost of revenues....................... 18.3 15.4 16.8 17.3 17.8
----- ----- ----- ------ -----
Gross profit................................. 81.7 84.6 83.2 82.7 82.2
Operating expenses:
Sales and marketing............................. 50.3 39.2 96.5 83.0 58.1
Research and development........................ 49.0 35.0 22.0 22.8 20.4
General and administrative...................... 40.4 22.1 45.7 48.6 17.0
----- ----- ----- ------ -----
Total operating expenses..................... 139.7 96.3 164.2 154.4 95.5
----- ----- ----- ------ -----
Loss from operations......................... (58.0) (11.7) (81.0) (71.7) (13.3)
Other income (expense)............................ (7.4) (3.9) (15.1) (15.8) 4.2
Loss before income taxes..................... (65.4) (15.6) (96.1) (87.5) (9.1)
Income taxes...................................... -- 2.2 -- -- 0.2
----- ----- ----- ------ -----
Loss from continuing operations.............. (65.4) (17.8) (96.1) (87.5) (9.3)
Income (loss) from discontinued operations........ 49.2 12.6 (1.1) (1.9) --
Gain on disposal of discontinued operations....... -- -- 12.4 -- --
Net loss..................................... (16.2) (5.2) (84.8) (89.4) (9.3)
----- ----- ----- ------ -----
Accretion on redeemable convertible preferred
stock........................................... -- -- (8.1) (6.3) (7.2)
----- ----- ----- ------ -----
Net loss applicable to holders of common stock.... (16.2)% (5.2)% (92.9)% (95.7)% (16.5)%
===== ===== ===== ====== =====
AS A PERCENTAGE OF RELATED REVENUES
Cost of license revenues.......................... 15.1 9.2 7.5 8.1 6.4
Cost of maintenance and services revenues......... 27.6 33.7 44.8 39.8 59.8
</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 to and including September 30, 1997,
in accordance with American Institute of Certified Public Accountants ("AICPA")
Statement of Position ("SOP") No. 91-1 entitled Software Revenue Recognition.
For the nine months ended June 30, 1998, the Company has recognized revenue in
accordance with AICPA SOP No. 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 AICPA SOP No. 97-2.

22
<PAGE> 23

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 $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.

23
<PAGE> 24

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 expenses 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 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
24
<PAGE> 25

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.

Nine Months Ended June 30, 1997 and 1998

Revenues. Net revenues increased from $5.6 million for the nine month
period ended June 30, 1997 to $18.6 million for the nine month period ended June
30, 1998. License revenues increased from $4.0 million for the nine month period
ended June 30, 1997 to $14.7 million for the nine month period ended June 30,
1998, 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 $1.6 million for
the nine month period ended June 30, 1997 to $3.9 million for the nine month
period ended June 30, 1998, 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 approximately 71% in the
nine month period ended June 30, 1997 to approximately 79% in the nine month
period ended June 30, 1998, due primarily to an increased focus by the Company
in generating license revenues.

Cost of Revenues. Cost of license revenues as a percentage of license
revenues decreased to 6% for the nine month period ended June 30, 1998 from 8%
for the nine month period ended June 30, 1997 due to economies of scale. Cost of
maintenance and services revenues increased as a percentage of maintenance and
services revenues to 60% for the nine month period ended June 30, 1998 from 40%
for the nine month period ended June 30, 1997 principally due to increased
personnel, facilities and travel costs associated with expanding the customer
support and technical services organizations.

Sales and Marketing Expenses. Sales and marketing expenses increased from
$4.7 million for the nine month period ended June 30, 1997 to $10.8 million for
the nine month period ended June 30, 1998, primarily due to the increased
personnel costs associated with the expansion of the Company's sales and
technical services departments and increased facilities costs. Sales and
marketing expenses as a percentage of total revenues declined from 83% for the
nine month period ended June 30, 1997 to 58% for the nine month period ended
June 30, 1998 primarily due to net revenues increasing at a faster rate than
sales and marketing expenses and a decrease in compensation expense related to
the issuance of stock options in the later period.

Research and Development Expenses. Research and development expenses
increased from $1.3 million for the nine month period ended June 30, 1997 to
$3.8 million for the nine month period ended June 30, 1998 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 as a percentage of total revenues
declined from 23% for the nine month period ended June 30, 1997 to 20% for the
nine month period ended June 30, 1998.

General and Administrative Expenses. General and administrative expenses
increased from $2.7 million for the nine month period ended June 30, 1997 to
$3.2 million for the nine month period ended June 30, 1998 primarily due to
increased personnel costs, professional fees and facilities costs associated
with the Company's increased scale of operations. General and administrative
expenses as a percentage of revenues declined from 49% for the nine month period
ended June 30, 1997 to 17% for the nine month period ended June 30, 1998 due to
the increase in total revenues.

Other Income (Expense). Other expense for the nine month period ended June
30, 1997 was $888,000 as compared with other income of $778,000 for the nine
month period ended June 30, 1998, primarily due to interest earned on the
proceeds from the Company's initial public offering during the period ended June
30, 1998 which offset imputed interest related to the issuance of a warrant to
purchase 1,500,000 shares of Series A Preferred Stock at a per share exercise
price of $2.00 (the "Series A Warrant").

25
<PAGE> 26

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 June 30, 1998, 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
--------------------------------------------------------------------------------------------------
JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30,
1996 1996 1996 1997 1997 1997 1997 1998 1998
-------- --------- -------- -------- -------- --------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
License.................... $ 684 $1,720 $ 802 $ 1,095 $ 2,094 $ 2,977 $ 3,735 $ 4,914 $6,023
Maintenance and services... 322 518 424 616 590 694 1,094 1,281 1,570
------ ------ ------ ------- ------- ------- ------- ------- ------
Total revenues........... 1,006 2,238 1,226 1,711 2,684 3,671 4,829 6,195 7,593
------ ------ ------ ------- ------- ------- ------- ------- ------
Cost of revenues:
License.................... 54 132 61 108 155 199 315 312 318
Maintenance and services... 115 149 166 180 303 393 762 802 797
------ ------ ------ ------- ------- ------- ------- ------- ------
Total cost of revenues... 169 281 227 288 458 592 1,077 1,114 1,115
------ ------ ------ ------- ------- ------- ------- ------- ------
Gross profit................. 837 1,957 999 1,423 2,226 3,079 3,752 5,081 6,478
Operating expenses:
Sales and marketing........ 528 705 1,004 1,951 1,714 4,301 3,144 3,489 4,186
Research and development... 410 534 303 383 596 760 1,069 1,337 1,398
General and
administrative........... 272 439 467 1,553 714 1,510 892 1,011 1,251
------ ------ ------ ------- ------- ------- ------- ------- ------
Total operating
expenses............... 1,210 1,678 1,774 3,887 3,024 6,571 5,105 5,837 6,835
------ ------ ------ ------- ------- ------- ------- ------- ------
Income (loss) from
operations................. (373) 279 (775) (2,464) (798) (3,492) (1,353) (756) (357)
Other income (expense)....... (53) (31) 26 (450) (464) (516) 50 160 568
------ ------ ------ ------- ------- ------- ------- ------- ------
Income (loss) before income
taxes...................... (426) 248 (749) (2,914) (1,262) (4,008) (1,303) (596) 211
Income taxes................. 30 11 -- -- -- -- -- -- 50
------ ------ ------ ------- ------- ------- ------- ------- ------
Income (loss) from continuing
operations................. (456) 237 (749) (2,914) (1,262) (4,008) (1,303) (596) 161
Discontinued operations:
Income (loss) from
discontinued
operations............... 197 (57) (120) 18 (2) -- -- -- --
Gain on disposal of
discontinued
operations............... -- -- -- -- -- 1,161 -- -- --
------ ------ ------ ------- ------- ------- ------- ------- ------
Net income (loss)............ $ (259) $ 180 $ (869) $(2,896) $(1,264) $(2,847) $(1,303) $ (596) $ 161
Accretion on redeemable
convertible preferred
stock...................... -- -- -- (89) (264) (402) (890) (444) --
------ ------ ------ ------- ------- ------- ------- ------- ------
Net income (loss) applicable
to holders of common
stock...................... $ (259) $ 180 $ (869) $(2,985) $(1,528) $(3,249) $(2,193) $(1,040) $ 161
====== ====== ====== ======= ======= ======= ======= ======= ======
</TABLE>

26
<PAGE> 27

<TABLE>
<CAPTION>
AS A PERCENTAGE OF TOTAL REVENUES
--------------------------------------------------------------------------------------------------
JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30,
1996 1996 1996 1997 1997 1997 1997 1998 1998
-------- --------- -------- -------- -------- --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues:
License.................... 68.0% 76.9% 65.4% 64.0% 78.0% 81.1% 77.3% 79.3% 79.3%
Maintenance and services... 32.0 23.1 34.6 36.0 22.0 18.9 22.7 20.7 20.7
----- ----- ----- ------ ----- ------ ----- ------ -----
Total revenues........... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0
----- ----- ----- ------ ----- ------ ----- ------ -----
Cost of revenues:
License.................... 5.4 5.9 5.0 6.3 5.8 5.4 6.5 5.0 4.2
Maintenance and services... 11.4 6.7 13.5 10.5 11.3 10.7 15.8 13.0 10.5
----- ----- ----- ------ ----- ------ ----- ------ -----
Total cost of revenues....... 16.8 12.6 18.5 16.8 17.1 16.1 22.3 18.0 14.7
----- ----- ----- ------ ----- ------ ----- ------ -----
Gross profit................. 83.2 87.4 81.5 83.2 82.9 83.9 77.7 82.0 85.3
Operating expenses:
Sales and marketing........ 52.5 31.5 81.9 114.0 63.8 117.2 65.1 56.3 55.1
Research and development... 40.8 23.8 24.7 22.4 22.2 20.7 22.1 21.6 18.4
General and
administrative........... 27.0 19.6 38.1 90.8 26.6 41.1 18.5 16.3 16.5
----- ----- ----- ------ ----- ------ ----- ------ -----
Total operating
expenses............... 120.3 74.9 144.7 227.2 112.6 179.0 105.7 94.2 90.0
----- ----- ----- ------ ----- ------ ----- ------ -----
Income (loss) from
operations................. (37.1) 12.5 (63.2) (144.0) (29.7) (95.1) (28.0) (12.2) (4.7)
Other income (expense)....... (5.2) (1.4) 2.1 (26.3) (17.3) (14.1) 1.0 2.6 7.5
----- ----- ----- ------ ----- ------ ----- ------ -----
Income (loss) before income
taxes...................... (42.3) 11.1 (61.1) (170.3) (47.0) (109.2) (27.0) (9.6) 2.8
----- ----- ----- ------ ----- ------ ----- ------ -----
Income taxes................. 3.0 0.5 -- -- -- -- -- -- 0.7
----- ----- ----- ------ ----- ------ ----- ------ -----
Income (loss) from continuing
operations................. (45.3) 10.6 (61.1) (170.3) (47.0) (109.2) (27.0) (9.6) 2.1
Discontinued operations:
Income (loss) from
discontinued
operations............... 19.6 (2.6) (9.8) 1.0 (0.1) -- -- -- --
Gain on sale of
discontinued
operations............... -- -- -- -- -- 31.7 -- -- --
----- ----- ----- ------ ----- ------ ----- ------ -----
Net income (loss)............ (25.7) 8.0 (70.9) (169.3) (47.1) (77.5) (27.0) (9.6) 2.1
----- ----- ----- ------ ----- ------ ----- ------ -----
Accretion on redeemable
convertible preferred
stock...................... -- -- (5.2) (9.8) (11.0) (18.4) (7.2) --
----- ----- ----- ------ ----- ------ ----- ------ -----
Net income (loss) applicable
to holders of common
stock...................... (25.7)% 8.0% (70.9)% (174.5)% (56.9)% (88.5)% (45.4)% (16.8)% 2.1%
===== ===== ===== ====== ===== ====== ===== ====== =====
</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
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,
fluctuations in quarterly results for the final quarter of each fiscal year 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. Cost of revenues for maintenance and services decreased in absolute
dollars from $802,000 in the quarter ended March 31, 1998 to $797,000 for the
quarter ended June 30, 1998, due to improved productivity of technical service
personnel. In the quarter ended March 31, 1997, sales and marketing expenses
increased from the prior quarter due to compensation expenses 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 expenses related to bonus shares issued and

27
<PAGE> 28

professional fees associated with the Reorganization. In the quarter ended
September 30, 1997, sales and marketing expenses 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 quarters ended December
31, 1997, March 31, 1998, and June 30, 1998, sales and marketing expenses were
less in absolute dollar amounts than those in the quarter ended September 30,
1997 due to reduced expenses associated with reduced rates of hiring. General
and administrative expenses in the same three quarters fell in absolute dollar
amounts due to a reduction in 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 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.

28
<PAGE> 29

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 an initial
public offering of its Common Stock, 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 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 terminated upon the closing of the Company's initial
public offering. 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 was exercised by means of a net issuance immediately
prior to the closing of the Company's initial public offering. 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 June 30,
1998. 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. In February 1998, the Company sold shares of
Common Stock in its initial public offering generating net proceeds of $34.2
million. As of June 30, 1998, the Company had $23.5 million in cash and cash
equivalents and $20.3 million in marketable securities. 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 generated by operating activities in the nine months
ended June 30, 1998 was primarily attributable to an increase in accrued
expenses and deferred

29
<PAGE> 30

expenses as well as a decrease in accounts receivable and the related party
loan, offset by a net loss of $1.7 million.

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 nine months
ended June 30, 1998, net cash generated by financing activities was attributable
to the Company's sale of Common Stock in its initial public offering with net
proceeds of $34.2 million.

As of June 30, 1998, 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.

YEAR 2000 COMPLIANCE AND EURO CONVERSION

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, computer systems and/or software used by many
companies may need to be upgraded to comply with such "Year 2000" requirements.
Further, various European states have planned the introduction of a single
currency (known as the Euro) in January 1999. The introduction of the Euro may
result in complex conversion calculations. The Company is currently in the
process of conducting a review of its internal information systems to identify
systems that could be affected by such Year 2000 and Euro conversion
requirements. Further, to accommodate its recent growth, 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. In particular, the Company will be required to improve its
accounting and financial reporting systems, which currently require substantial
management effort and will be required to implement a U.S.-based financial and
accounting system. The Company expects to incur internal staff costs as well as
consulting and other expenses related to these requirements, including Year 2000
and Euro conversion requirements. The Company cannot estimate the amount of
costs that will be associated with implementing these improvements and changes.
While the Company currently expects that such improvements and changes will not
pose significant operational problems, delays in the implementation or
modification of the Company's information systems could have a material adverse
effect on the Company's business, results of operations and financial condition.

30
<PAGE> 31

BUSINESS

The Company's initial target market has been organizations with large,
technically complex and heterogeneous networks, the majority of which 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, CTC (Itochu), Datacraft, Ericsson Data Services, N.E.T., and Vanstar.
As of June 30, 1998, the Company had over 150 customers operating in and serving
a variety of industries. Customers include AirTouch, America Online, AT&T
Wireless, British Telecommunications, Cable and Wireless, Cellular One, Deutsche
Telekom, First Data Resources, Genuity, GE Information Services, Global One, GTE
Internetworking, Merrill Lynch, MindSpring, Morgan Stanley, Netcom, Pacific
Bell, PSINet, Siemens, Southwestern Bell Internet Services, Unisource 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 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.
31
<PAGE> 32

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 worldwide 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 $7.8 billion in 1997, and projected to grow to approximately $14.7
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
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.

32
<PAGE> 33

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
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, 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.

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<PAGE> 34

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 which focuses on distribution relationships with selected OEMs,
value added resellers, and systems integrators and intends to expand
these channels. The Company has entered into distribution agreements with
Bay Networks, Cisco Systems, CTC (Itochu), Datacraft, Ericsson Data
Services, N.E.T. and Vanstar Corporation. In addition, the Company
intends to expand its direct sales force, currently located in San
Francisco; Atlanta; Boston; Chicago; Dallas; Los Angeles; New York;
Scottsdale, Arizona; Vienna, Virginia; 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.

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<PAGE> 35

- 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 helpdesk systems from Remedy and Peregrine, 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, Netcool/Internet
Service Monitors for the proactive management of internet services, and
associated related technical services. Netcool/OMNIbus collects, consolidates,
de-duplicates and correlates information from a wide range of network management
platforms and devices and then presents user-configurable views of subsets of
network data. Netcool/Reporter uses this data to provide real-time and
historical reporting. Netcool/Internet Service Monitors collect response and
availability data from several frequently implemented Internet/Intranet services
and forward this information to Netcool/OMNIbus for integration with other
service data. 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. Netcool/Reporter, currently in its initial commercial release,
has features and performance characteristics that have had limited market
appeal. See "Risk Factors -- Product Defects; Product Liability."

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<PAGE> 36

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

[DIAGRAM OF NETCOOL ARCHITECTURE]
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> 37

The Company has developed 41 pre-built Probes, and a Probe 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 IT/Operations IBM NetView/6000 V3.31 RoboMon Element
Management Center v.3.x Informix Table Manager Probe
Ascom TimePlex HP OpenView KBU Fivemere Sun Solstice Enterprise
TimeView/2000 IT/Operations Microsoft Windows NT Manager
BMC Patrol Probe Center v.4.x Event Log Sun Solstice SNM 2.3
Cabletron SPECTRUM HP OpenView NNM Modular Probe Sybase Table
Cisco StrataView v8.x v.3.31 NET IDNX Telematics Switch
DEC VAX OPCOM HP OpenView NNM NET Open/5000 TN-MS
DEC VAX VCS v.4.x Netlabs (DiMONS 2G) Trapd (SNMP) Probe
Ericsson ACP1000 HP OpenView NNM Newbridge 46020 Unix Multiplex
Ericsson MD110 v.5.x Nortel DMS Probe Server
Fibermux LightWatch HTTPD Common Oracle Table Unix Syslog Probe
Generic Probe Log Format Ping Probe
GPT EM-OS HTTPD Server Error Log
Heartbeat Probe
- -------------------------------------------------------------------------------------------------------------------
</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

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<PAGE> 38

ObjectServer and the operator's 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 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). Netcool/Reporter is designed to leverage archived data
from service profiles created within Netcool/OMNIbus, and to allow 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, currently in its initial commercial
release, has features and performance characteristics that have had limited
market appeal. Although the Company is currently devoting significant management
and technical resources to improve the features and performance of
Netcool/Reporter, the Company does not expect significant revenue contribution
from Netcool/Reporter for the foreseeable future. To the extent such efforts
continue to require the allocation of a significant portion of the Company's
technical personnel resources, or if the performance and features of
Netcool/Reporter are not improved, the Company could continue to experience
delay in or failure of market acceptance of Netcool/Reporter, or damage to the
Company's reputation or relationships with its customers, any of which could
have a material adverse effect on the Company's business, operating results and
financial condition. See "Risk Factors -- Product Defects, Product Liability."

Netcool/Internet Service Monitors

Netcool/Internet Service Monitors, which became available on March 31,
1998, are software applications that collect and analyze real-time response and
availability data about internet services including HTTP (Web servers), FTP
(file transfer), SMTP and POP3 (e-mail), NNTP (news), DNS (directory services),
and RADIUS (dial-in security and accounting). Netcool/Internet Service Monitors
collect response and availability data, compare it with user-defined threshold
levels, and then forward fault information to Netcool/OMNIbus when thresholds
are exceeded. The resulting information can be combined with other network fault
data to provide companies with detailed information about services that
incorporate Internet-based elements. Netcool/Internet Service Monitors can be
configured through the World Wide Web through an HTML interface and are designed
to integrate easily with networks managed by Netcool/OMNIbus.

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<PAGE> 39

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,
ObjectServer Solaris 2.x 1994 memory-resident, active database system
ObjectServer HP-UX9.x 1994 that stores and manages all collected
ObjectServer HP-UX10.x 1995 network events.
ObjectServer AIX 4.x PowerPC 1997
ObjectServer Microsoft 1998*
Windows NT
- --------------------------------------------------------------------------------------------------------
NETCOOL/OMNIBUS DESKTOPS

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 GATEWAYS

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
Peregrine ServiceCenter 1998
- --------------------------------------------------------------------------------------------------------
NETCOOL/OMNIBUS PROBES

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. See "Risk
Factors -- Product Defects; Product
Liability."
- --------------------------------------------------------------------------------------------------------
NETCOOL/INTERNET SERVICE MONITORS 1998 Software that collects and analyzes
real-time response and availability data
about Internet services.
- --------------------------------------------------------------------------------------------------------
</TABLE>

* Expected to become commercially available in the fourth quarter of fiscal
1998.

Product Pricing

At least one Probe, ObjectServer, and Desktop are required for
Netcool/OMNIbus to operate. Netcool/ Reporter is 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 is $15,000. Netcool/Internet Service Monitors are priced at
$20,000 for the suite of seven monitors or $7,500 per monitor. Fees for
implementations of Netcool/OMNIbus typically range from $40,000 to $1.0 million.

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<PAGE> 40

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 June 30,
1998, the Company had over 150 customers in the following 9 countries: the
United States, Canada, the United Kingdom, Australia, Germany, Italy, Mexico,
the Netherlands and South Africa.

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
BT MNS Big Planet Deutsche Bank
BT Australia Genuity Merrill Lynch
BT Labs GTE Internetworking Morgan Stanley
BT North America INSL Salomon Smith Barney
BT Syncordia MindSpring
Cable and Wireless Netcom
CableTel (NTL) PSINet Commercial
Concert Southwestern Bell Internet
Deutsche Telekom Services Automobile Association (U.K.)
GEIS UUNet Chrysler
Infonet City of Edmonton
Ionica Cellular First Data Resources
MFS Communications First Union Bank
Multisys AT&T Wireless Instinet
Pacific Bell AirTouch J.C. Penney
Primus Cellular One Kaiser Permanente
Racal Communications Hutchinson Orange PCS Kohl's
TCI Xypoint LSI Logic
TMI National Institute of Health
Vyvx Communications Equipment Nationwide Building Society
WorldCom Royal Automobile Club
Ascom Timeplex Tenneco
Bay Networks TRW
Cisco
Ericsson
Motorola
N.E.T.
Siemens
- ----------------------------------------------------------------------------------------------
</TABLE>

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<PAGE> 41

SELECTED CUSTOMER APPLICATIONS

<TABLE>
<S> <C>
- --------------------------------------------------------------------------------------------------
CUSTOMER APPLICATION
- --------------------------------------------------------------------------------------------------
MANAGED NETWORK SERVICE PROVIDER GEIS is a managed network services provider that maintains a
(GEIS) chain of support centers in locations around the world,
including 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 360 locations throughout the United
States and has over 350,000 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
30,000 modems, 500 terminal servers, 100 UNIX servers of
various types, 75 hubs and switches, and 75 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
30,000) and the customers it serves (100,000 to over
350,000) without increasing the network operations staff.
The entire operation is efficiently managed by only 6
network administrators.
- --------------------------------------------------------------------------------------------------
</TABLE>

SALES AND MARKETING

The Company markets its software and services primarily through its direct
sales organization in San Francisco; Atlanta; Boston; Chicago; Dallas; Los
Angeles; New York; Scottsdale, Arizona; Vienna, Virginia; 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 June 30, 1998, the
Company's sales organization consisted of 35 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 June 30, 1998,
the Company's marketing organization employed 7 people.

Although the Company increased the size of its sales organization during
the twelve-month period ended June 30, 1998, 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

41
<PAGE> 42

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, CTC (Itochu), Datacraft, Ericsson Data Services,
N.E.T., and Vanstar Corporation. 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 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 June 30, 1998, there were 43 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.

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<PAGE> 43

- 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."

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 June
30, 1998, the Company employed 17 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 43 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 nine months ended
June 30, 1998 were $708,000, $1.6 million, $2.0 million and $3.8 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 June 30, 1998, the Company's
research and development organization consisted of 35 people.

43
<PAGE> 44

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 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.
For example, Netcool/Reporter, currently in its initial commercial release, has
features and performance characteristics that have had limited market appeal.
Although the Company is currently devoting significant management and technical
resources to improve the features and performance of Netcool/Reporter, the
Company does not expect significant revenue contribution from Netcool/Reporter
for the foreseeable future. To the extent such efforts continue to require the
allocation of a significant portion of the Company's technical personnel
resources, or if the performance and features of Netcool/Reporter are not
improved, the Company could continue to experience delay in or failure of market
acceptance of Netcool/Reporter, or damage to the Company's reputation or
relationships with its customers, any of which could have a material adverse
effect on the Company's business, operating results and financial condition. See
"Risk Factors -- 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 & 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.

44
<PAGE> 45

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

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

INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS

45
<PAGE> 46

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 "Risk
Factors -- Dependence upon Proprietary Technology; Risk of Third-Party Claims of
Infringement."

EMPLOYEES

As of June 30, 1998, the Company had 164 employees, including 35 engaged in
research and development activities, 42 in sales and marketing, 43 in technical
services, 27 in administration and finance and 17 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. 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,
Chicago, 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 July 1998, the Company received correspondence from counsel to a
stockholder and former officer of the Company asserting claims relating to
ownership of intellectual property related to the Company's Netcool/Omnibus
product and claims regarding his ownership of stock in the Company.
Specifically, the letter alleges that the former officer's transfer of
intellectual property rights to the Company was invalid, that he was improperly
denied the necessary time in which to evaluate whether to participate in this
Offering and that his lock-up agreement may not be valid with respect to the
170,316 shares of the Company's Common Stock beneficially owned by him. The
Company has reviewed the claims set forth in the correspondence and based upon
such review does not believe such allegations have merit and, if pursued by such
stockholder, the Company intends to vigorously defend any such claims and
believes that the resolution of such claims will not have a material adverse
effect on the Company's business, 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 does not prevail
in litigation, the Company could be prevented from selling its Netcool/Omnibus
product or required to enter into royalty or licensing agreements or pay
monetary damages. 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 against the Company, the Company's business, operating results
or financial condition could be materially adversely affected.

46
<PAGE> 47

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth certain information regarding the executive
officers and directors of the Company as of June 30, 1998:

<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 Chief Financial Officer
David N. Dorrance...................... 37 Senior Vice President, Sales
Peter Shearan.......................... 34 Senior Vice President, Technical Services
Timothy J. Tokarsky.................... 34 Vice President, Application Development
Mark J. Peach.......................... 39 Vice President, Core Technology
Helen M. Fairclough.................... 36 Vice President, Operations
Angela Dawes(3)........................ 36 Director of Sales, Western Region; Director
Michael E.W. Jackson(1)(2)............. 48 Director
David C. Schwab(1)(2).................. 40 Director
</TABLE>

- ---------------
(1) Member of Audit Committee
(2) Member of Compensation Committee
(3) Member of Stock Option Committee

Christopher J. Dawes has served as President, Chief Executive Officer and
Chairman of the Board of Directors of the Company since its inception. Mr. Dawes
has also been a director of Micromuse plc, a subsidiary of the Company
("Micromuse plc") 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 has served as the Company's Chief Financial Officer since
July 1998. Mr. Allott served as the Company's Senior Vice President, Finance
from September 1997 to July 1998. 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. Mr.
Allott has also been a director of Micromuse plc since March 1996. 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.

David N. 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.

Peter Shearan has served as the Company's Senior Vice President, Technical
Services since April 1998. From February 1996 to March 1998, Mr. Shearan served
as the Company's Vice President, Technical Services. 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.

47
<PAGE> 48

Timothy J. 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 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 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.

Angela 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. Ms. Dawes has also been a director of Micromuse plc
since its inception. Prior to joining the Company, Mrs. Dawes served at Computer
Associates in various capacities.

Michael E.W. Jackson has been a director of the Company since July 1998.
Mr. Jackson has also been a director of Micromuse plc since March 1994. Mr.
Jackson has been Chairman of Elderstreet Investments, a venture capital and
investment house since 1990. Since January 1998, Mr. Jackson has served as
Deputy Chairman of British Thornton Holdings plc. Mr. Jackson has also served as
a non-executive director for Hat Pin plc since June 1996 and Spargo Consulting
plc since May 1994. Mr. Jackson has also served as a director of Sage Group plc,
an accounting software company, since July 1984 and as non-executive chairman
since September 1997. Mr. Jackson received his LLB in Law from Cambridge
University.

David C. Schwab has been a director of the Company since December 1996. Mr.
Schwab has been a venture 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.

BOARD COMPOSITION

The Board of Directors is currently comprised of four directors. The terms
of office of the Board of Directors are 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 Michael E.W. Jackson. At each annual meeting of
stockholders 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

48
<PAGE> 49

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 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.

The Stock Option Committee has the authority to grant up to 7,000 options
to new, non-officer employees 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, a former director of the
Company, 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 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 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.

49
<PAGE> 50

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
ANNUAL COMPENSATION COMPENSATION
--------------------------------------- ------------
AWARDS
------------
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 --
Chief Financial Officer
Mark J. Peach................................. 108,614 -- 10,541(3) 15,320 --
Vice President, Core Technology
Peter Shearan................................. 110,597 -- 12,123(4) 44,440 --
Senior 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.

50
<PAGE> 51

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
INDIVIDUAL GRANT REALIZABLE
---------------------------------------- VALUE AT ASSUMED
NUMBER OF ANNUAL RATES OF
SECURITIES % OF TOTAL STOCK
UNDERLYING OPTIONS PRICE APPRECIATION
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 910,848 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.

51
<PAGE> 52

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>
VALUE OF
NUMBER OF UNEXERCISED
SECURITIES 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 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.

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

52
<PAGE> 53

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 June 30, 1998, options to purchase an aggregate of 1,598,709 shares
of Common Stock were outstanding under the Stock Option Plan at a weighted
average exercise price of $4.43. As of June 30, 1998, a total of 951,404 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. Under the ESPP
300,000 shares of Common Stock have been reserved for issuance. The ESPP became
effective at the time of the Company's initial public offering. All full-time
regular employees who are employed by the Company 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> 54

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
INVESTOR(1) STOCK(2) STOCK(3) STOCK(4) STOCK CONVERTED(5)
----------- --------- --------- --------- ------- ------------
<S> <C> <C> <C> <C> <C>
Sierra Ventures V, L.P.(6)......... 1,341,059 2,000,000 295,490 -- 3,636,549
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 and Selling Stockholders" for more detail on shares held by
these purchasers.

(2) Reflects shares purchased through the net exercise of a warrant to purchase
shares of Series A Preferred Stock at a per share exercise price of $2.00.

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

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

(5) Reflects the conversion to Common Stock of each share of Series A, Series B
and Series C Preferred Stock that was effective upon the closing of the
Company's initial public offering.

(6) Jeffrey M. Drazan and David C. Schwab, a general partner and venture
partner, respectively, of SV Associates V, LP, the general partner of Sierra
Ventures V, L.P., is a former director and director, respectively, 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 Series A
Warrant; 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 June 30, 1998 there was no
outstanding balance under the Credit Agreement. The Credit Agreement terminated
upon the closing of the Company's initial public 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.

54
<PAGE> 55

STOCK PURCHASES BY CURRENT AND FORMER DIRECTORS

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

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.

55
<PAGE> 56

PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth certain information regarding the beneficial
ownership of the Company's outstanding Common Stock as of June 30, 1998 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(3) NUMBER PERCENT(1)(2)(3)
---------- ---------------- ---------- ---------- ----------------
<S> <C> <C> <C> <C> <C>
NAMED EXECUTIVE OFFICERS AND
DIRECTORS
Christopher J. Dawes........... 2,486,726 16.7% 461,701 2,025,025 12.7%
Mark J. Peach(4)............... 93,020 * -- 93,020 *
Stephen A. Allott(5)........... 84,637 * -- 84,637 *
Timothy J. Tokarsky(6)......... 77,000 * -- 77,000 *
Peter Shearan(7)............... 87,484 * -- 87,484 *
Angela Dawes................... 1,751,636 11.8 328,723 1,422,913 8.9
Michael E.W. Jackson........... 68,126 * 12,785 55,341 *
David C. Schwab(8)............. 3,867,101 26.0 725,726 3,141,375 19.7
3000 Sand Hill Road
Building 4, Suite 210
Menlo Park, CA 94025
OTHER 5% STOCKHOLDERS
Jeffrey M. Drazan(9)........... 3,704,325 24.9 695,178 3,009,147 18.9
3000 Sand Hill Road
Building 4, Suite 210
Menlo Park, CA 94025
Sierra Ventures V, L.P.(10).... 3,636,549 24.4 682,459 2,954,090 18.6
3000 Sand Hill Road
Building 4, Suite 210
Menlo Park, CA 94025
CITICORP(11)................... 777,605 5.2 116,641 660,964 4.2
155 East 53rd Street
1 CITICORP Center
New York, NY 10043

OTHER SELLING STOCKHOLDERS
East River Ventures, L.P....... 311,042 2.1 58,372 252,670 1.6
Network Equipment Technologies,
Inc. ........................ 311,042 2.1 58,372 252,670 1.6
Victory Ventures LLC........... 279,938 1.9 52,535 227,403 1.4
Ken Barth...................... 187,347 1.3 35,158 152,189 1.0
William B. Ayer(12)............ 168,750 1.1 30,027 138,723 *
DMG Technology Ventures LLC.... 155,521 1.0 29,186 126,335 *
David N. Dorrance(13).......... 120,552 * 6,500 114,052 *
Robert Witty(14)............... 85,000 * 3,050 81,950 *
Charles M. Silvey(15).......... 45,200 * 8,886 36,314 *
Audrey Strout(16).............. 40,474 * 4,903 35,571 *
John Richard Whitehead(17)..... 34,349 * 3,000 31,349 *
Robert Loughan................. 33,500 * 32,900 600 *
Andrew C. Mitchell(18)......... 30,000 * 1,876 28,124 *
</TABLE>

56
<PAGE> 57

<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED BEFORE THE OFFERING SHARES OWNED AFTER THE OFFERING
----------------------------- BEING -----------------------------
NUMBER PERCENT(1)(2) OFFERED(3) NUMBER PERCENT(1)(2)(3)
---------- ---------------- ---------- ---------- ----------------
<S> <C> <C> <C> <C> <C>
Peter A. Flaherty.............. 20,000 * 3,400 16,600 *
Arjun Gupta.................... 15,552 * 2,919 12,633 *
M3 Partners, LC................ 12,041 * 2,260 9,781 *
Robert Denman.................. 7,776 * 1,459 6,317 *
Sandra Drazan Living Trust..... 7,776 * 1,459 6,317 *
Bert L. Zaccaria............... 7,776 * 1,459 6,317 *
ZD. Air, Inc................... 7,776 * 1,459 6,317 *
Clarke H. Bailey............... 3,855 * 655 3,200 *
Robert L. Egan................. 3,855 * 723 3,132 *
Stanley R. Rawn, Jr............ 3,855 * 723 3,132 *
Gerald Shaltz (SEP IRA)........ 3,329 * 500 2,829 *
Colleen Devenish............... 2,939 * 551 2,388 *
Alicia B. Lindgren............. 1,442 * 245 1,197 *
Donald T. Pascal............... 1,442 * 271 1,171 *
Michael W. Chorske............. 577 * 108 469 *
James J. Doykos II............. 577 * 100 477 *
Jonathan M. Lowenberg.......... 577 * 108 469 *

ALL DIRECTORS AND EXECUTIVE
OFFICERS AS A GROUP (10
PERSONS)(19)................. 8,670,731 56.5 1,535,435 7,135,296 43.6
</TABLE>

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

* Less than 1%

(1) Assumes no exercise of the Underwriters' over-allotment option. In the
event that the Underwriters' over-allotment option is exercised, up to an
additional 450,000 shares may be sold by certain selling stockholders as
follows: Christopher J. Dawes 124,310, Angela Dawes 88,507, Sierra Ventures
V, L.P. 183,748, East River Ventures, L.P. 15,716, DMG Technology Ventures
LLC, 7,858, Network Equipment Technologies, Inc. 15,716 and Victory
Ventures LLC 14,145.

(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 June 30, 1998 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) Each stockholder of the Company who was subject to a 180 day lock-up
agreement with the underwriters in the Company's initial public offering,
and each optionee of the Company with vested options, was granted an
opportunity to sell such holder's pro rata portion of the 2,000,000 shares
offered by the Selling Stockholders hereby.

(4) Includes 93,020 shares subject to options which are exercisable within 60
days of June 30, 1998.

(5) Includes 84,637 shares subject to options which are exercisable within 60
days of June 30, 1998.

(6) Includes 77,000 shares subject to options which are exercisable within 60
days of June 30, 1998.

(7) Includes 87,484 shares subject to options which are exercisable within 60
days of June 30, 1998.

(8) Shares beneficially owned before the Offering includes 3,636,549 shares
held by Sierra Ventures V, L.P. Shares beneficially owned after the
Offering includes 2,954,091 shares held by Sierra Ventures V, L.P. Mr.
Schwab, a director of the Company, is a venture partner of SV Associates V,
LP, which is the

57
<PAGE> 58

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 interest in SV
Associates V, LP.

(9) Shares beneficially owned before the Offering includes 3,636,549 shares
held by Sierra Ventures V, L.P. and 7,776 shares held by ZD. Air, Inc., a
corporation. Shares beneficially owned after the Offering includes
2,954,091 shares held by Sierra Ventures V, L.P. and 6,317 shares held by
ZD. Air, Inc. Mr. Drazan, a former 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.

(10) Messrs. Drazan and Schwab, a former director and director, respectively, of
the Company are a general partner and venture partner, respectively, of SV
Associates V, LP. SV Associates V, LP 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 interest in SV
Associates V, LP.

(11) 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.

(12) Includes 8,750 shares subject to options which are exercisable within 60
days of June 30, 1998.

(13) Includes 85,000 shares subject to options which are exercisable within 60
days of June 30, 1998. Mr. Dorrance serves as the Company's Senior Vice
President, Sales.

(14) Includes 85,000 shares subject to options which are exercisable within 60
days of June 30, 1998.

(15) Includes 25,491 shares subject to options which are exercisable within 60
days of June 30, 1998. Mr. Silvey served as the Company's Senior Vice
President, Marketing, from July 1997 to May 1998.

(16) Includes 20,474 shares subject to options which are exercisable within 60
days of June 30, 1998.

(17) Includes 34,349 shares subject to options which are exercisable within 60
days of June 30, 1998.

(18) Includes 30,000 shares subject to options which are exercisable within 60
days of June 30, 1998.

(19) Shares beneficially owned before the Offering includes 461,590 shares of
Common Stock issuable upon exercise of immediately exercisable options held
by certain officers and 3,636,549 shares held by entities affiliated with
Mr. Schwab. Shares beneficially owned after the Offering includes 455,090
shares of Common Stock issuable upon exercise of immediately exercisable
options held by certain officers and 2,954,090 shares held by entities
affiliated with Mr. Schwab.

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<PAGE> 59

DESCRIPTION OF CAPITAL STOCK

The authorized capital stock of the Company consists 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 June 30, 1998, there were 14,891,723 shares of Common Stock
outstanding that were held of record by 57 stockholders. There will be
15,913,438 shares of Common Stock outstanding (assuming no exercise of the
Underwriters' over-allotment option and no exercise after June 30, 1998 of
outstanding options except for the sale of 21,715 shares of Common Stock
issuable upon exercise of outstanding options by certain of the Selling
Stockholders) after giving effect to the sale of the shares of Common Stock to
the public offered hereby.

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 the Board
of Directors is 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 all stockholder actions must be effected at a
duly called meeting and not by consent in writing. Provisions of the Bylaws and
the Restated Certificate of Incorporation provide that the stockholders may
amend the Bylaws or certain provisions of the Restated 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

59
<PAGE> 60

Company. These provisions are designed to reduce the vulnerability of the
Company to an unsolicited acquisition proposal. The provisions also are intended
to discourage certain tactics that may be used in proxy fights. However, such
provisions could have the effect of discouraging others from making tender
offers for the Company's shares and, as a consequence, they also may inhibit
fluctuations in the market price of the Company's shares that could result from
actual or rumored takeover attempts. Such provisions also may have the effect of
preventing changes in the management of the Company. See "Risk
Factors -- Anti-takeover Effects of Certificate of Incorporation, Bylaws and
Delaware Law."

Delaware Takeover Statute

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

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

REGISTRATION RIGHTS

After this Offering, the holders of 8,965,741 shares of Common Stock will
be entitled to certain rights with respect to the registration of such shares
under the Securities Act. 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> 61

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this Offering, the Company will have 15,913,438 shares
of Common Stock outstanding (assuming no exercise of options or issuance of
Common Stock subsequent to June 30, 1998 except for the sale of 21,715 shares of
Common Stock issuable upon exercise of outstanding options by certain of the
Selling Stockholders and based upon 14,891,723 shares of the Company's Common
Stock outstanding as of June 30, 1998). All of the 3,000,000 shares sold in this
Offering, the 3,680,000 shares sold in the Company's initial public offering and
1,000 shares publicly resold by stockholders of the Company 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 9,232,438 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. 252,833 shares will be available for immediate sale in the
public market in accordance with Rules 144 and, upon the expiration of transfer
restrictions specified in preexisting agreements or in lock-up agreements with
Credit Suisse First Boston Corporation, 8,774,490 shares will be available for
sale in the public market beginning 90 days after the date of this Prospectus 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
205,116 shares are eligible for sale in the public market more than 90 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 90 days
after the date of this Prospectus, without the prior written consent of Credit
Suisse First Boston Corporation.

In general, under Rule 144, beginning on May 13, 1998, 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
159,134 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 May 13, 1998,
may be sold by stockholders other than Affiliates of the Company subject only to
the manner of sale provisions of Rule 144 and by an Affiliate under Rule 144
without compliance with its one-year holding period requirement. As of June 30,
1998, the holders of options exercisable into approximately 1,598,709 shares of
Common Stock will be eligible to sell their shares upon the expiration of
transfer restrictions specified in the Stock Option Plan 90 days after the date
of this Prospectus, subject in certain cases to vesting of such options.

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
61
<PAGE> 62

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.

In addition, following this Offering, the holders of 8,965,741 shares of
outstanding Common Stock will, under certain circumstances, have rights to
require the Company to register their shares for future sale. See "Description
of Capital Stock -- Registration Rights."

62
<PAGE> 63

UNDERWRITING

Under the terms and subject to the conditions contained in an Underwriting
Agreement, dated the date of this Prospectus (the "Underwriting Agreement")
among the Company, the Selling Stockholders and the underwriters named below
(the "Underwriters"), for whom CSFBC, NationsBanc Montgomery Securities LLC and
Smith Barney Inc. are acting as the representatives (the "Representatives"), the
Underwriters have severally, but not jointly, agreed to purchase from the
Company and the Selling Stockholders, the following respective numbers of shares
of Common Stock:

<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
----------- ---------
<S> <C>
Credit Suisse First Boston Corporation...................... 1,650,000
NationsBanc Montgomery Securities LLC....................... 450,000
Smith Barney Inc............................................ 900,000
---------
Total............................................. 3,000,000
=========
</TABLE>

The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent and that the
Underwriters will be obligated to purchase all of the shares of Common Stock
offered hereby (other than those shares covered by the over-allotment option
described below) if any are purchased. The Underwriting Agreement provides,
that, in the event of a default by an Underwriter, in certain circumstances the
purchase commitments of non-defaulting Underwriters may be increased or the
Underwriting Agreement may be terminated.

The Selling Stockholders have granted to the Underwriters an option
exercisable by CSFBC, expiring at the close of business on the 30th day after
the date of this Prospectus, to purchase up to 450,000 additional shares of
Common Stock at the offering price, less the underwriting discounts and
commissions, all as set forth on the cover page of this Prospectus. Such option
may be exercised only to cover over-allotments in the sale of the shares of
Common Stock. To the extent that the option is exercised, each Underwriter will
become obligated, subject to certain conditions, to purchase approximately the
same percentage of such additional shares of Common Stock as it was obligated to
purchase pursuant to the Underwriting Agreement.

The Company and the Selling Stockholders have been advised by the
Representatives that the Underwriters propose to offer the shares of Common
Stock to the public initially at the public offering price set forth on the
cover page of this Prospectus and, through the Underwriters, to certain dealers
at such price less a concession of $0.82 per share and the Underwriters and such
dealers may allow a discount of $0.10 per share on sales to certain other
dealers. After the Offering, the public offering price and concession and
discount to dealers may be changed by the Representatives.

The Company and certain of its directors, officers and shareholders have
agreed that they will not offer, sell, contract to sell, announce their
intention to sell, pledge or otherwise dispose of, directly or indirectly, or,
in the case of the Company file with the Securities and Exchange Commission (the
"Commission") a registration statement under the Securities Act relating to any
additional shares of the Common Stock or securities convertible into or
exchangeable or exercisable for any shares of the Common Stock, without the
prior written consent of CSFBC for a period of 90 days after the date of this
Prospectus.

The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including civil liabilities under the
Securities Act, or contribute to payments that the Underwriters may be required
to make in respect thereof.

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.

The Representatives, on behalf of the Underwriters, may engage in
over-allotment, stabilizing transactions, syndicate covering transactions,
penalty bids and "passive" market making in accordance with

63
<PAGE> 64

Regulation M under the Securities Exchange Act of 1934 (the "Exchange Act").
Over-allotment involves syndicate sales in excess of the offering size, which
creates a syndicate short position. Stabilizing transactions permit bids to
purchase the underlying security so long as the stabilizing bids do not exceed a
specified maximum. Syndicate covering transactions involve purchases of the
shares of Common Stock in the open market after the distribution has been
completed in order to cover syndicate short positions. Penalty bids permit the
Representatives to reclaim a selling concession from a syndicate member when the
shares of Common Stock originally sold by such syndicate member are purchased in
a syndicate covering transaction to cover syndicate short positions. In
"passive" market making, market makers in the Securities who are Underwriters or
prospective Underwriters may, subject to certain limitations, make bids for or
purchases of the Securities until the time, if any, at which a stabilizing bid
is made. Such stabilizing transactions, syndicate covering transactions and
penalty bids may cause the price of the Common Stock to be higher than it would
otherwise be in the absence of such transactions. These transactions may be
effected on the Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.

NOTICE TO CANADIAN RESIDENTS

RESALE RESTRICTIONS

The distribution of the Common Stock in Canada is being made only on a
private placement basis exempt from the requirement that the Company and the
Selling Stockholders prepare and file a prospectus with the securities
regulatory authorities in each province where trades of the Common Stock are
effected. Accordingly, any resale of the Common Stock in Canada must be made in
accordance with applicable securities laws which will vary depending on the
relevant jurisdiction, and which may require resales to be made in accordance
with available statutory exemptions or pursuant to a discretionary exemption
granted by the applicable Canadian securities regulatory authority. Purchasers
are advised to seek legal advice prior to any resale of the Common Stock.

REPRESENTATIONS OF PURCHASERS

Each purchaser of the Common Stock in Canada who receives a purchase
confirmation will be deemed to represent to the Company, the Selling
Stockholders and the dealer from whom such purchase confirmation is received
that (i) such purchaser is entitled under applicable provincial securities laws
to purchase such Common Stock without the benefit of a prospectus qualified
under such securities laws, (ii) where required by law, that such purchaser is
purchasing as principal and not as agent, and (iii) such purchaser has reviewed
the text above under "-- Resale Restrictions."

RIGHTS OF ACTION (ONTARIO PURCHASERS)

The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
section 32 of the Regulation under the Securities Act (Ontario). As a result,
Ontario purchasers must rely on other remedies that may be available, including
common law rights of action for damages or rescission or rights of action under
the civil liability provisions of the U.S. federal securities laws.

ENFORCEMENT OF LEGAL RIGHTS

All of the Company's directors and officers as well as the experts named
herein and the Selling Stockholders may be located outside of Canada, and, as a
result, it may not be possible for Canadian purchasers to effect service of
process within Canada upon the Company or such persons. All or a substantial
portion of the assets of the Company and such persons may be located outside of
Canada and, as a result, it may not be possible to satisfy a judgment against
the Company or such persons in Canada or to enforce a judgment obtained in
Canadian courts against the Company or such persons outside of Canada.

64
<PAGE> 65

NOTICE TO BRITISH COLUMBIA RESIDENTS

A purchaser of Common Stock to whom the Securities Act (British Columbia)
applies is advised that such purchaser is required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
Common Stock acquired by such purchaser pursuant to the Offering. Such report
must be in the form attached to British Columbia Securities Commission Blanket
Order BOR #95/17, a copy of which may be obtained from the Company. Only one
such report must be filed in respect of Common Stock acquired on the same date
and under the same prospectus exemption.

TAXATION AND ELIGIBILITY FOR INVESTMENT

Canadian purchasers of Common Stock should consult their own legal and tax
advisors with respect to the tax consequences of an investment in the Common
Stock in their particular circumstances and with respect to the eligibility of
the Common Stock for investment by the purchaser under relevant Canadian
legislation.

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 June 30, 1998, an
investment partnership comprised of members of that firm beneficially owned
15,552 shares of the Company's Common 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
auditors, appearing elsewhere herein, and upon the authority of said firm as
experts in accounting and auditing.

65
<PAGE> 66

AVAILABLE INFORMATION

The Company is subject to the reporting requirements of the Exchange Act,
and, in accordance therewith, files reports, proxy statements and other
information with the Securities and Exchange Commission (the "Commission"). Such
reports, proxy statements and other information can be inspected and copied at
the public reference facilities maintained by the Commission at Room 1024, 450
Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549, and at the
Commission's following Regional Offices: 500 West Madison Street, Suite 1400,
Chicago, Illinois 60661 and Seven World Trade Center, 13th Floor, New York, New
York 10048. Copies of such material can be obtained at prescribed rates from the
Public Reference Section of the Commission at 450 Fifth Street, N.W., Judiciary
Plaza, Washington, D.C. 20549. The Commission maintains a World Wide Web site
that contains reports, proxy statements and other information regarding
registrants that file electronically with the Commission. The address of the
site is http://www.sec.gov. The Company's Common Stock is quoted on the Nasdaq
National Market and reports, proxy statements and other information concerning
the Company also may be inspected at the offices of Nasdaq Operations, 1735 K
Street, N.W., Washington, D.C. 20006.

The Company has filed with the Commission a Registration Statement on Form
S-1 (the "Registration Statement") under the Securities Act of 1933, as amended
(the "Securities Act"), with respect to the securities offered by this
Prospectus. This Prospectus, which forms a part of the Registration Statement,
does not contain all of the information set forth in the Registration Statement,
certain parts of which have been omitted in accordance with the rules and
regulations of the Commission. For further information with respect to the
Company and the securities offered hereby, reference is made to the Registration
Statement, including the exhibits filed or incorporated by reference in the
Registration Statement. Statements made in this Prospectus about any contract or
other document are not necessarily complete and in each instance in which a copy
of such contract is filed with, or incorporated by reference in, the
Registration Statement as an exhibit, reference is made to such copy, and each
such statement shall be deemed qualified in all respects by such reference.
Copies of the Registration Statement may be inspected, without charge, at the
offices of the Commission, or obtained at prescribed rates from the Public
Reference Section of the Commission at the address set forth above.

66
<PAGE> 67

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 June 30, 1998......................................... F-3
Consolidated Statements of Operations for the Years Ended
September 30, 1995, 1996, and 1997 and the Nine Months
Ended June 30, 1997 and 1998.............................. F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the Years Ended September 30, 1995, 1996, and 1997 and
the Nine Months Ended June 30, 1998....................... F-5
Consolidated Statements of Cash Flows for the Years Ended
September 30, 1995, 1996, and 1997 and Nine Months Ended
June 30, 1997 and 1998.................................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>

F-1
<PAGE> 68

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

Mountain View, California
December 10, 1997

F-2
<PAGE> 69

MICROMUSE INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

ASSETS

<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
----------------- -------------
1996 1997 1998
------ ------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 594 $13,741 23,503
Short-term investments.................................... -- -- 20,254
Accounts receivable....................................... 5,682 4,461 5,386
Inventories............................................... 399 -- --
Prepaid expenses and other current assets................. 1,250 935 1,400
Related party loan........................................ 159 1,153 --
------ ------- --------
Total current assets.............................. 8,084 20,290 50,543
Property and equipment, net................................. 1,023 2,450 2,724
------ ------- --------
$9,107 $22,740 $ 53,267
====== ======= ========

Current liabilities:
Accounts payable.......................................... $4,048 $ 2,654 1,670
Bank overdraft............................................ 1,351 -- --
Current portion of capital lease obligations.............. 114 -- --
Accrued expenses.......................................... 971 3,133 3,918
Short-term notes.......................................... 1,275 -- --
Deferred revenue.......................................... 1,172 1,322 4,649
------ ------- --------
Total current liabilities......................... 8,931 7,109 10,237
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 in 1996, 1997 and 1998 respectively;
none, 4,488,336 and none issued and outstanding, in
1996, 1997 and 1998, respectively (aggregate
liquidation preference of $21,000,000 in 1997)......... -- 22,865 --
Stockholders' equity (deficit):
Preferred stock, $0.01 par value, 5,000,000 shares
authorized; no shares issued and outstanding........... -- -- --
Common stock, $0.01 par value; 60,000,000 shares
authorized; 6,099,753, 6,705,853 and 14,891,723 shares
issued and outstanding in 1996, 1997 and 1998,
respectively........................................... 61 67 148
Additional paid-in capital................................ 264 2,390 55,455
Treasury stock, at cost: 120,000 shares in 1997........... -- (300) --
Deferred compensation..................................... -- (215) (173)
Cumulative translation adjustment......................... 50 52 (100)
Accumulated deficit....................................... (597) (9,228) (12,300)
------ ------- --------
Total stockholders' equity (deficit).............. (222) (7,234) 43,030
------ ------- --------
$9,107 $22,740 $ 53,267
====== ======= ========
</TABLE>

See accompanying notes to consolidated financial statements.
F-3
<PAGE> 70

MICROMUSE INC. AND SUBSIDIARIES

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

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
------------------------- -------------------
1995 1996 1997 1997 1998
------ ------ ------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
License............................................. $1,077 $3,374 $ 6,968 3,991 14,672
Maintenance and services............................ 369 1,141 2,324 1,630 3,945
------ ------ ------- -------- --------
Total revenues.............................. 1,446 4,515 9,292 5,621 18,617
------ ------ ------- -------- --------
Cost of revenues:
License............................................. 163 311 523 324 945
Maintenance and services............................ 102 384 1,042 649 2,361
------ ------ ------- -------- --------
Total cost of revenues...................... 265 695 1,565 973 3,306
------ ------ ------- -------- --------
Gross profit................................ 1,181 3,820 7,727 4,648 15,311
------ ------ ------- -------- --------
Operating expenses:
Sales and marketing................................. 728 1,768 8,970 4,669 10,819
Research and development............................ 708 1,582 2,042 1,282 3,804
General and administrative.......................... 584 996 4,244 2,734 3,154
------ ------ ------- -------- --------
Total operating expenses.................... 2,020 4,346 15,256 8,685 17,777
------ ------ ------- -------- --------
Loss from operations........................ (839) (526) (7,529) (4,037) (2,466)
Other income (expense):
Interest income..................................... -- 8 64 8 992
Interest expense.................................... (106) (212) (1,268) (717) (4)
Other............................................... -- 25 (200) (179) (210)
------ ------ ------- -------- --------
Loss before income taxes.................... (945) (705) (8,933) (4,925) (1,688)
Income taxes.......................................... -- 100 -- -- 50
------ ------ ------- -------- --------
Loss from continuing operations............. (945) (805) (8,933) (4,925) (1,738)
Discontinued operations:
Income (loss) from discontinued operations.......... 711 569 (104) (104) --
Gain on disposal of discontinued operations......... -- -- 1,161 -- --
------ ------ ------- -------- --------
Net loss.................................... (234) (236) (7,876) (5,029) (1,738)
Accretion on redeemable convertible preferred stock... -- -- (755) (353) (1,334)
------ ------ ------- -------- --------
Net loss applicable to holders of common
stock..................................... $ (234) $ (236) $(8,631) $ (5,382) (3,072)
====== ====== ======= ======== ========
Basic and diluted per share data:
Loss from continuing operations applicable to
holders of common stock.......................... $(0.17) (0.14) (1.52) (0.84) (0.29)
Income (loss) from discontinued operations.......... .13 .10 (.02) (.02) --
Gain on disposal of discontinued operations......... -- -- .18 -- --
Net loss applicable to holders of common stock...... $(0.04) (0.04) (1.35) (0.86) (0.29)
Shares used in per share calculations................. 5,498 5,954 6,373 6,250 10,487
====== ====== ======= ======== ========
</TABLE>

See accompanying notes to consolidated financial statements.
F-4
<PAGE> 71

MICROMUSE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>

COMMON STOCK ADDITIONAL TREASURY STOCK DEFERRED CUMULATIVE
---------------- PAID-IN ---------------- STOCK TRANSLATION
SHARES AMOUNT CAPITAL SHARES AMOUNT COMPENSATION ADJUSTMENT
------- ------ ---------- ------ ------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances as of September 30, 1994............ 2,969 $ 30 $ 47 -- $ -- $ -- $ --
Issuance of common stock..................... 2,968 29 48 -- -- -- --
Foreign currency translation adjustment...... -- -- -- -- -- -- 4
Net loss..................................... -- -- -- -- -- -- --
Dividend..................................... -- -- -- -- -- -- --
------- ---- ------- ---- ------- ----- -----
Balances as of September 30, 1995............ 5,937 59 95 -- -- -- 4
Issuance of common stock..................... 163 2 2 -- -- -- --
Deferred compensation related to grants of
stock options............................... -- -- 167 -- -- (167) --
Amortization of deferred employee
compensation................................ -- -- -- -- -- 167 --
Foreign currency translation adjustment...... -- -- -- -- -- -- 46
Net loss..................................... -- -- -- -- -- -- --
------- ---- ------- ---- ------- ----- -----
Balances as of September 30, 1996............ 6,100 61 264 -- -- -- 50
Bonus shares issued.......................... 450 5 1,138 -- -- -- --
Stock options exercised...................... 36 -- 130 -- -- -- --
Compensation expense related to stock
transfers................................... -- -- 210 -- -- -- --
Treasury stock purchased..................... -- -- -- (120) (300) -- --
Issuance of common stock..................... 120 1 419 -- -- -- --
Deferred compensation related to grants of
stock options............................... -- -- 229 -- -- (229) --
Amortization of deferred employee
compensation................................ -- -- -- -- -- 14 --
Foreign currency translation adjustment...... -- -- -- -- -- -- 2
Net loss..................................... -- -- -- -- -- -- --
Accretion on redeemable convertible preferred
stock....................................... -- -- -- -- -- -- --
------- ---- ------- ---- ------- ----- -----
Balances as of September 30, 1997............ 6,706 67 2,390 (120) (300) (215) 52
Treasury stock purchased (unaudited)......... -- -- -- (778) (5,000) -- --
Stock options exercised (unaudited).......... 25 -- 37 -- -- -- --
Issuance of common stock upon initial public
offering, net of related costs
(unaudited)................................. 2,332 23 28,889 898 5,300 -- --
Conversion of Series B and C preferred stock
(unaudited)................................. 4,488 45 22,566 -- -- -- --
Exercise of Series A warrants (unaudited).... 1,341 13 1,575 -- -- -- --
Amortization of deferred employee
compensation (unaudited).................... -- -- -- -- -- 42 --
Foreign currency translation adjustment
(unaudited)................................. -- -- -- -- -- -- (152)
Net loss (unaudited)......................... -- -- -- -- -- -- --
Accretion on redeemable convertible preferred
stock (unaudited)........................... -- -- -- -- -- -- --
------- ---- ------- ---- ------- ----- -----
Balances as of June 30, 1998 (unaudited)..... 14,892 $148 $55,455 -0- $ -0- $(173) $(100)
======= ==== ======= ==== ======= ===== =====

<CAPTION>
TOTAL
STOCKHOLDERS'
ACCUMULATED EQUITY
DEFICIT (DEFICIT)
----------- -------------
<S> <C> <C>
Balances as of September 30, 1994............ $ 13 $ 90
Issuance of common stock..................... (77) --
Foreign currency translation adjustment...... -- 4
Net loss..................................... (234) (234)
Dividend..................................... (63) (63)
-------- --------
Balances as of September 30, 1995............ (361) (203)
Issuance of common stock..................... -- 4
Deferred compensation related to grants of
stock options............................... -- --
Amortization of deferred employee
compensation................................ -- 167
Foreign currency translation adjustment...... -- 46
Net loss..................................... (236) (236)
-------- --------
Balances as of September 30, 1996............ (597) (222)
Bonus shares issued.......................... -- 1,143
Stock options exercised...................... -- 130
Compensation expense related to stock
transfers................................... -- 210
Treasury stock purchased..................... -- (300)
Issuance of common stock..................... -- 420
Deferred compensation related to grants of
stock options............................... -- --
Amortization of deferred employee
compensation................................ -- 14
Foreign currency translation adjustment...... -- 2
Net loss..................................... (7,876) (7,876)
Accretion on redeemable convertible preferred
stock....................................... (755) (755)
-------- --------
Balances as of September 30, 1997............ (9,228) (7,234)
Treasury stock purchased (unaudited)......... -- (5,000)
Stock options exercised (unaudited).......... -- 37
Issuance of common stock upon initial public
offering, net of related costs
(unaudited)................................. -- 34,210
Conversion of Series B and C preferred stock
(unaudited)................................. -- 22,611
Exercise of Series A warrants (unaudited).... -- 1,588
Amortization of deferred employee
compensation (unaudited).................... -- 42
Foreign currency translation adjustment
(unaudited)................................. -- (152)
Net loss (unaudited)......................... (1,738) (1,738)
Accretion on redeemable convertible preferred
stock (unaudited)........................... (1,334) (1,334)
-------- --------
Balances as of June 30, 1998 (unaudited)..... $(12,300) $ 43,030
======== ========
</TABLE>

See accompanying notes to consolidated financial statements.
F-5
<PAGE> 72

MICROMUSE INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, JUNE 30,
------------------------------ ------------------
1995 1996 1997 1997 1998
-------- -------- -------- ------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss............................................. $ (234) $ (236) $ (7,876) $(5,029) $ (1,738)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization...................... 489 603 669 615 903
Loss on disposal of assets......................... 484 242 51 -- --
Debt issuance costs................................ -- -- 1,350 -- --
Amortization of deferred employee compensation..... -- 167 14 -- 42
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 1,702 (925)
Inventories...................................... 747 (53) 399 (94) --
Prepaid expenses and other current assets........ (618) (294) 315 (189) (465)
Related party loan............................... (25) (127) (994) (738) 1,153
Accounts payable................................. 85 1,806 (1,394) (231) (984)
Accrued expenses................................. 255 149 2,162 (40) 785
Deferred revenue................................. 111 548 150 941 3,327
Long-term taxes payable.......................... 17 (22) -- -- --
-------- -------- -------- ------- --------
Net cash provided by (used in) operating
activities.................................. (61) 288 (2,460) (3,063) 2,098
-------- -------- -------- ------- --------
Cash flows used in investing activities:
Capital expenditures................................. (397) (602) (2,147) (907) (1,177)
Purchase of short-term investments................... -- -- -- -- (20,254)
-------- -------- -------- ------- --------
Net cash used in investing activities......... (397) (602) (2,147) (907) (21,431)
-------- -------- -------- ------- --------
Cash flows from financing activities:
Bank overdraft....................................... 309 677 (1,351) (814) --
Proceeds from short-term notes....................... 324 951 1,000 2,500 --
Payment of short-term notes.......................... -- -- (2,275) (3,611) --
Proceeds from long-term notes payable................ 414 -- -- -- --
Payments on long-term notes payable.................. (204) (205) (268) (68) --
Payments on capital lease obligations................ (332) (577) (244) -- --
Proceeds from issuance of common stock............... -- 4 430 -- 34,247
Purchase of treasury stock........................... -- -- (300) -- (5,000)
Proceeds from issuance of redeemable convertible
preferred stock.................................... -- -- 20,760 6,730 --
Payment of dividends................................. (63) -- -- -- --
-------- -------- -------- ------- --------
Net cash provided by (used in) financing
activities.................................. 448 850 17,752 4,737 29,247
-------- -------- -------- ------- --------
Effect of exchange rate changes on cash and cash
equivalents.......................................... 4 46 2 47 (152)
-------- -------- -------- ------- --------
Net increase (decrease) in cash and cash equivalents... (6) 582 13,147 814 9,762
Cash and cash equivalents at beginning of period....... 18 12 594 594 13,741
-------- -------- -------- ------- --------
Cash and cash equivalents at end of period............. $ 12 $ 594 $ 13,741 $ 1,408 $ 23,503
======== ======== ======== ======= ========
Supplemental disclosures of cash flow information:
Cash paid during the period -- interest.............. $ 79 $ 159 $ 154 $ 125 $ --
======== ======== ======== ======= ========
Noncash financing activities:
Accretion on redeemable convertible preferred
stock............................................ $ -- $ -- $ 755 $ 353 $ 1,334
======== ======== ======== ======= ========
Exercise of warrant to purchase redeemable
convertible Series A preferred stock for common
stock............................................ $ -- $ -- $ -- $ -- $ 1,588
======== ======== ======== ======= ========
Conversion of redeemable convertible Series B and C
preferred stock to common stock.................. $ -- $ -- $ -- $ -- $ 22,611
======== ======== ======== ======= ========
</TABLE>

See accompanying notes to consolidated financial statements.
F-6
<PAGE> 73

MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 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.

Initial Public Offering of Common Stock

In February 1998, the Company completed an offering of its capital stock
pursuant to a Registration Statement on Form S-1 ("IPO"), whereby the Company
sold 3,230,000 shares of Common Stock to the public at a price of $12.00 per
share. The net proceeds to the Company from the IPO were $34.2 million.

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.

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.

F-7
<PAGE> 74
MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)

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

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. In October 1997, the
American Institute of Certified Public Accountants issued Statement of Position
No. 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 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.

F-8
<PAGE> 75
MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)

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. The measurement of deferred
tax assets is reduced, if necessary, by a valuation allowance for any tax
benefits that are not expected to be realized.

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.

Per Share Data

In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, Earnings Per Share. SFAS No. 128 establishes standards for the computation,
presentation and disclosure of earnings per share (EPS) and also requires dual
presentation of basic EPS and diluted EPS for entities with complex capital
structures. SFAS No. 128 became effective for the Company's consolidated
financial statements for quarterly and annual periods beginning October 1, 1997,
and requires restatement of EPS for periods prior to the effective date.

SFAS No. 128 requires the presentation of basic and diluted EPS for both
loss from continuing operations applicable to holders of common stock and net
loss applicable to holders of common stock. Loss from continuing operations and
net loss are increased by the amount of accretion on redeemable convertible
preferred stock during each period in arriving at the respective amounts
applicable to holders of common stock. Under SFAS No. 128, basic EPS is computed
as net loss applicable to common shareholders divided by the weighted-average
number of common shares outstanding during the period. Diluted EPS is computed
based on the weighted-average number of common shares outstanding during the
period and, when dilutive, the weighted average number of potential common
shares from the assumed exercise of outstanding options and warrants to purchase
common stock using the treasury stock method and from the assumed conversion of
convertible debt and convertible preferred stock using the as if converted
method.

Potential common shares have been excluded from the computation of EPS for
all periods presented since their effect on EPS is antidilutive due to the
losses incurred in each period. Consequently, the number of shares in the
computations of basic and diluted EPS is the same for each period. Potential
common shares

F-9
<PAGE> 76
MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)

which were excluded from the computations of EPS but which could potentially
dilute basic EPS in the future consisted of options to purchase common stock
totaling 476,083 shares in fiscal 1995, 575,379 shares in fiscal 1996, 1,312,086
shares in fiscal 1997, and 1,132,928 shares and 1,597,753 shares in the
nine-month periods ended June 30, 1997 and 1998, respectively. Also excluded
from the computations of EPS were common shares resulting from the assumed
conversion of Series B and Series C redeemable convertible preferred stock
because the effects of these securities were antidilutive prior to their
conversion into 2,000,000 and 2,488,336 shares, respectively, of common stock
upon the closing of the Company's initial public offering on February 13, 1998.

Unaudited Interim Financial Information

The consolidated financial information as of June 30, 1998 and for the nine
months ended June 30, 1997 and 1998 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 nine months ended June 30, 1998 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.

In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position No. 98-1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use ("SOP 98-1"). This SOP applies
to software that is acquired or developed solely for an entity's internal use
and requires the capitalization of qualifying costs in software application
development activities, which include design, coding, installation hardware and
testing. Capitalization of qualifying costs incurred in development stage
activities begins when the entity has committed to fund a particular internal
computer software project and the entity considers it probable that the
committed software will be used to perform the intended function, provided that
the entity has completed the preliminary project stage activities. Preliminary
project stage activities include the conceptual formulation and evaluation of
alternatives and the determination of the existence of needed technology.
Qualifying capitalizable computer software costs include the external direct
costs of materials and services and the payroll related costs of employees who
are directly involved with the internal project. All other costs related to the
project are expensed as incurred.

SOP 98-1 will be effective for internal use computer software costs
incurred in future years commencing with the Company's fiscal year beginning
October 1, 1999. The Company has followed an accounting policy of expensing as
incurred all costs related to software developed for internal use and intends to
continue this policy until the effective date of SOP 98-1. The Company has not
yet determined whether the adoption of SOP 98-1

F-10
<PAGE> 77
MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)

will have a material effect on the Company's financial position or results of
operations after the effective date of SOP 98-1.

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 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
March 31, 1998, the Company has not recorded either of these amounts.

F-11
<PAGE> 78
MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)

3. BALANCE SHEET COMPONENTS

Property and equipment

<TABLE>
<CAPTION>
SEPTEMBER 30,
----------------- JUNE 30
1996 1997 1998
------- ------ -----------
(UNAUDITED)
<S> <C> <C> <C>
In thousands:
Computer equipment........................... $ 1,583 $2,819 $ 3,883
Furniture and fixtures....................... 196 959 1,000
Other........................................ 591 597 479
------- ------ -------
2,370 4,375 5,362
Less accumulated depreciation................ (1,347) (1,925) (2,638)
------- ------ -------
$ 1,023 $2,450 $ 2,724
======= ====== =======
</TABLE>

Accrued expenses

<TABLE>
<S> <C> <C> <C>
In thousands:
Payroll and commission related............... $ 125 $ 996 $ 1,903
Other........................................ 846 2,137 2,015
------- ------ -------
$ 971 $3,133 $ 3,918
======= ====== =======
</TABLE>

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.

F-12
<PAGE> 79
MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)

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
AND OUTSTANDING CARRYING 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 were permitted to 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 was
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 occurred 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 were 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 were 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.

The Company was required to 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 were 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 accrued the 15%
rate of return to the redemption date. The amount accrued as of September 30,
1997 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 expired 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 allowed 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 was amortized to
interest expense over

F-13
<PAGE> 80
MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)

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.
Because the warrant to purchase 1,500,000 shares of Series A was exercised upon
the IPO, options to purchase an additional 166,666 shares of common stock were
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.

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

<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
-------------------------------------
WEIGHTED-
AVERAGE WEIGHTED-
NUMBER EXERCISE AVERAGE
OF SHARES PRICE FAIR 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 --
==========
Balances as of September 30, 1997......... 1,312,086 2.38 --
==========
</TABLE>

As of September 30, 1996 and 1997, 338,083 and 267,687 shares, with
weighted-average exercise prices of $2.43 and $1.97, were fully vested and
exercisable, respectively. As of September 30, 1997, 100,000 shares are
available for grant.

F-14
<PAGE> 81
MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)

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

<TABLE>
<CAPTION>
OUTSTANDING
----------------------------------- EXERCISABLE
WEIGHTED- --------------------
AVERAGE WEIGHTED- WEIGHTED-
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE OF LIFE EXERCISE OF EXERCISE
PRICES SHARES (IN YEARS) PRICE SHARES PRICE
------------ --------- ---------- ---------- ------- ----------
<S> <C> <C> <C> <C> <C>
$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 $2.38 267,737 $1.97
========= ==== ===== ======= =====
</TABLE>

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 and $42,000 of the $229,000
was amortized in fiscal 1997 and in the nine month period ended June 30, 1998,
respectively, 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 for fiscal 1997 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 and 1997 was $0.57 and $0.67, 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.

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.

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. Under the ESPP
300,000 shares of Common Stock have been reserved for issuance. The ESPP became
effective at the time of the IPO. All full-time regular employees who are
employed by the Company will be eligible to participate in the ESPP after
completing a three-month waiting period.

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.

F-15
<PAGE> 82
MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)

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.

The tax effects of temporary differences that give rise to significant
portions of deferred tax assets are presented below (in thousands):

<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------
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.

F-16
<PAGE> 83
MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)

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>

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>

F-17
<PAGE> 84
MICROMUSE INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1995, 1996, AND 1997
(INFORMATION AS OF JUNE 30, 1998 AND FOR THE NINE MONTHS ENDED
JUNE 30, 1997 AND 1998 IS UNAUDITED)

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.

11. SUBSEQUENT EVENT (UNAUDITED)

F-18
<PAGE> 85

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> 86

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.
<PAGE> 87

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

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

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
The Company........................... 4
Risk Factors.......................... 5
Use of Proceeds....................... 16
Dividend Policy....................... 16
Price Range of Common Stock........... 16
Capitalization........................ 17
Dilution.............................. 18
Selected Consolidated Financial
Data................................ 19
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 20
Business.............................. 31
Management............................ 47
Certain Transactions.................. 54
Principal and Selling Stockholders.... 56
Description of Capital Stock.......... 59
Shares Eligible for Future Sale....... 61
Underwriting.......................... 63
Notice to Canadian Residents.......... 64
Legal Matters......................... 65
Experts............................... 65
Available Information................. 66
Index to Financial Statements......... F-1
</TABLE>

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

LOGO

Micromuse Inc.

3,000,000 Shares
Common Stock
($.01 par value)
PROSPECTUS
CREDIT SUISSE FIRST BOSTON

NATIONSBANC MONTGOMERY
SECURITIES LLC

SALOMON SMITH BARNEY

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