UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

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

                                    FORM 10-Q

              |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  For the quarterly period ended June 30, 2000

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

              For the transition period from ________ to ________.

                        Commission file number 000-23783

                                 MICROMUSE INC.
             (Exact name of registrant as specified in its charter)

DELAWARE                                                              94-3288385
-------------------------------                     ----------------------------
(State or other jurisdiction of                (IRS Employer Identification No.)
incorporation or organization)

                               139 TOWNSEND STREET
                         SAN FRANCISCO, CALIFORNIA 94107
                                 (415) 538-9090
               (Address, including ZIP code, and telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                                 Yes |X| No |_|

      34,694,010 shares of Common Stock, $0.01 par value, were outstanding as of
July 31, 2000

<PAGE>

                                 MICROMUSE INC.

                                TABLE OF CONTENTS

                                                                            Page
                                                                            ----

PART I - Financial Information

Item 1. Condensed Consolidated Financial Statements:

          Condensed Consolidated Balance Sheets as of June 30, 2000
            and September 30, 1999                                             3

          Condensed Consolidated Statements of Operations for the
            three and nine months ended June 30, 2000 and 1999                 4

          Condensed Consolidated Statements of Cash Flows for the nine
            months ended June 30, 2000 and 1999                                5

          Notes to Condensed Consolidated Financial Statements                 6

Item 2. Management's Discussion and Analysis of Financial Condition
        and Results of Operations                                             11

Item 3. Quantitative and Qualitative Disclosures about Market Risk            28

PART II - Other Information

Item 1.  Legal Proceedings                                                    29

Item 2.  Changes in Securities and use of Proceeds                            29

Item 3.  Defaults upon Senior Securities                                      29

Item 4.  Submission of Matters to a Vote of Security Holders                  29

Item 5.  Other Information                                                    29

Item 6.  Exhibits and Reports on Form 8-K                                     30

Signature                                                                     31


                                       2
<PAGE>

Part I - FINANCIAL INFORMATION

      Item 1. Condensed Consolidated Financial Statements

                                 MICROMUSE INC.

                      CONDENSED CONSOLIDATED BALANCE SHEETS
                      (In thousands, except per share data)
                                  (Unaudited)

<TABLE>
<CAPTION>
                                     ASSETS

                                                                 June 30,  September 30,
                                                                   2000         1999
                                                                ---------  -------------
<S>                                                             <C>          <C>
Current assets:
   Cash and cash equivalents                                    $  82,083    $  35,058
   Short-term investments                                          18,466       34,689
   Accounts receivable, net                                        14,960        9,613
   Prepaid expenses and other current assets                        4,959        3,871
   Deferred income taxes                                              359          359
                                                                ---------    ---------
     Total current assets                                         120,827       83,590
   Property and equipment, net                                      8,584        5,984
   Deferred income taxes                                            1,031        1,031
   Goodwill and purchased intangible assets, net                   28,516           --
                                                                ---------    ---------
                                                                $ 158,958    $  90,605
                                                                =========    =========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
   Accounts payable                                             $   2,734    $   4,210
   Accrued expenses                                                15,021        4,798
   Income taxes payable                                             2,539        1,919
   Deferred revenue                                                20,924        9,672
                                                                ---------    ---------
     Total current liabilities                                     41,218       20,599

Stockholders' equity
   Preferred stock; $0.01 par value; 5,000 shares authorized
     no shares issued and outstanding                                  --           --
   Common stock; $0.01 par value; 60,000 shares authorized;
     34,600 and 32,326 shares outstanding as of June 30, 2000
     and September 30, 1999, respectively                             346          323
   Additional paid-in capital                                     126,700       73,586
   Deferred compensation                                              (61)        (103)
   Accumulated other comprehensive losses                          (1,110)        (286)
   Accumulated deficit                                             (8,135)      (3,514)
                                                                ---------    ---------
     Total stockholders' equity                                   117,740       70,006
                                                                ---------    ---------
                                                                $ 158,958    $  90,605
                                                                =========    =========
</TABLE>

    See accompanying notes to the condensed consolidated financial statements


                                       3
<PAGE>

                                 MICROMUSE INC.

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                      (In thousands, except per share data)
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                             Three months ended      Nine months ended
                                                                   June 30,               June 30,
                                                             -------------------   --------------------
                                                               2000       1999       2000        1999
                                                             --------   --------   --------    --------
<S>                                                          <C>        <C>        <C>         <C>
Revenues:
  License                                                    $ 24,167   $ 11,568   $ 60,619    $ 29,860
  Maintenance and services                                      8,765      3,854     21,783       9,014
                                                             --------   --------   --------    --------
     Total revenues                                            32,932     15,422     82,402      38,874
                                                             --------   --------   --------    --------

Cost of revenues:
  License                                                       1,362        601      3,272       1,768
  Maintenance and services                                      4,233      1,974     10,739       4,783
                                                             --------   --------   --------    --------
     Total cost of revenues                                     5,595      2,575     14,011       6,551
                                                             --------   --------   --------    --------
        Gross profit                                           27,337     12,847     68,391      32,323
                                                             --------   --------   --------    --------

Operating expenses:
  Sales and marketing                                          14,628      7,450     36,292      18,785
  Research and development                                      4,879      2,583     12,459       6,412
  General and administrative                                    3,050      1,466      7,680       4,284
  Purchased in-process research and development                    --         --     11,066          --
  Amortization of goodwill and purchased intangible assets      1,595         --      3,224          --
  Executive recruiting costs                                       --         --         --         720
                                                             --------   --------   --------    --------
     Total operating expenses                                  24,152     11,499     70,721      30,201
                                                             --------   --------   --------    --------
        Income (loss) from operations                           3,185      1,348     (2,330)      2,122

Other income, net                                               1,628      1,279      3,387       2,987
                                                             --------   --------   --------    --------
  Income before income taxes                                    4,813      2,627      1,057       5,109
Income tax provision (benefit)                                  2,371        250      5,678        (635)
                                                             --------   --------   --------    --------
  Net income (loss)                                          $  2,442   $  2,377   $ (4,621)   $  5,744
                                                             ========   ========   ========    ========

Per share data:
  Basic net income (loss)                                    $   0.07   $   0.07   $  (0.14)   $   0.18
  Diluted net income (loss)                                  $   0.06   $   0.07   $  (0.14)   $   0.17

Weighted average shares used in computing:
  Basic net income (loss) per share                            34,471     31,822     34,057      31,708
  Diluted net income (loss) per share                          39,221     34,902     34,057      34,378
</TABLE>

    See accompanying notes to the condensed consolidated financial statements


                                       4
<PAGE>

                                 MICROMUSE INC.

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (In thousands)
                                  (Unaudited)

<TABLE>
<CAPTION>
                                                                  Nine months ended
                                                                      June 30,
                                                                --------------------
                                                                  2000        1999
                                                                --------    --------
<S>                                                             <C>         <C>
Cash flows from operating activities:
  Net income (loss)                                             $ (4,621)   $  5,744
  Adjustments to reconcile net income (loss) to net cash
    provided by operating activities:
    Depreciation and amortization                                  5,024       1,184
    Amortization of deferred employee compensation                    42          42
    Purchased in-process research and development                 11,066          --
    Compensation expense related to warrant                           --         462
    Tax benefit related to exercise of stock options               4,008          --
    Changes in operating assets and liabilities net of
      acquired accounts:
      Accounts receivable, net                                    (5,347)     (2,620)
      Prepaid expenses and other current assets                   (1,029)     (2,932)
      Accounts payable                                            (1,479)      1,259
      Accrued expenses                                            10,223       2,537
      Income taxes payable                                           620          --
      Deferred revenue                                            11,252         478
                                                                --------    --------
        Net cash provided by operating activities                 29,759       6,154
                                                                --------    --------
Cash flows from investing activities:
  Capital expenditures                                            (4,455)     (3,200)
  Maturity (purchase) of investments, net                         16,223      (7,471)
  Acquisition of CAN net assets, net of cash acquired               (146)         --
                                                                --------    --------
    Cash provided by (used in) investing activities               11,622     (10,671)
                                                                --------    --------
Cash flows from financing activities:
  Proceeds from issuance of common stock                           6,468          --
  Proceeds from issuance of treasury stock                            --       1,805
  Purchase of treasury stock                                          --      (9,540)
                                                                --------    --------
    Net cash provided by (used in) financing activities            6,468      (7,735)
                                                                --------    --------
Effects of exchange rate changes on cash and cash equivalents       (824)       (325)
                                                                --------    --------
Net increase (decrease) in cash and cash equivalents              47,025     (12,577)
Cash and cash equivalents at beginning of period                  35,058      22,798
                                                                --------    --------
Cash and cash equivalents at end of period                      $ 82,083    $ 10,221
                                                                ========    ========
</TABLE>

    See accompanying notes to the condensed consolidated financial statement


                                       5
<PAGE>

                                 MICROMUSE INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

Note 1. Basis of Presentation

The condensed consolidated financial statements are the unaudited historical
financial statements of Micromuse Inc. and subsidiaries (the "Company") and
reflect all adjustments (consisting only of normal recurring adjustments) that,
in the opinion of management, are necessary for a fair presentation of interim
period results. These condensed consolidated financial statements should be read
in conjunction with the financial statements and notes thereto included in our
Registration Statement on Form S-3 and Form 10-K as filed with the Securities
and Exchange Commission on May 5, 2000 and December 28, 1999, respectively. The
September 30, 1999 consolidated balance sheet included herein was derived from
audited financial statements, but does not include all disclosures, including
notes, required by generally accepted accounting principles.

The results of operations for the current interim period are not necessarily
indicative of results to be expected for the entire current year or other future
interim periods.

Use of Estimates

The preparation of condensed 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 condensed 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 maturity at purchase
of 90 days or less to be cash equivalents.

Investments

The Company has invested in certain marketable securities that are categorized
as held-to-maturity. The fair value of these investments, which are accounted
for using the amortized cost-basis of accounting, approximates their respective
carrying value defined as the amount at which the instrument could be exchanged
in a current transaction between willing parties.

Impairment of Long-Lived Assets

The Company evaluates its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of such assets may
not be recoverable. Recoverability of assets to be held and used is measured by
a comparison of the carrying amount of any asset to future net cash flows
expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or fair value less
the costs to sell.

Shareholder's Equity and Stock Split

All share and per-share numbers herein reflect the 2 for 1 stock split of our
common stock that occurred for stockholders of record on February 3, 2000.

Per Share Data

Basic per share amounts are calculated using the weighted-average number of
common shares outstanding during the period. Diluted per share amounts are
calculated using the weighted-average


                                       6
<PAGE>

                                 MICROMUSE INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

number of common shares outstanding during the period and, when dilutive, the
weighted-average number of potential common shares from the assumed conversion
of the redeemable convertible preferred stock and the exercise of outstanding
options to purchase common stock using the treasury stock method. Excluded from
the computation of the net loss per share for the nine-month period ended June
30, 2000 was a warrant to acquire 53,334 shares of common stock at $14.82 per
share, and options to acquire approximately 6.4 million shares of common stock,
with a weighted average exercise price of $18.38 per share, because their effect
would be anti-dilutive. A reconciliation of the numerators and denominators used
in the basic and diluted net income (loss) per share amounts follows (in
thousands):

<TABLE>
<CAPTION>
                                                      Three months ended      Nine months ended
                                                            June 30,               June 30,
                                                      -------------------   --------------------
                                                        2000       1999       2000        1999
                                                      --------   --------   --------    --------
<S>                                                   <C>        <C>        <C>         <C>
Numerator for basic and diluted net income (loss)     $  2,442   $  2,377   $ (4,621)   $  5,744
                                                      ========   ========   ========    ========
Denominator for basic net income (loss) per
  share - weighted-average shares outstanding           34,471     31,822     34,057      31,708
  Dilutive effect of:
    Common stock options                                 4,750      3,027         --       2,646
    Warrant                                                 --         53         --          24
                                                      --------   --------   --------    --------
Denominator for diluted net income (loss) per share     39,221     34,902     34,057      34,378
                                                      ========   ========   ========    ========
</TABLE>

Concentration of Revenues

No one customer accounted for more than 10% of revenues for the quarter ended
June 30, 2000. In the comparable period of the prior year, one customer
accounted for 12% of revenues.

Comprehensive Income (Loss)

Effective October 1, 1998, the Company adopted the Financial Accounting
Standards Board's (the "FASB") Statement of Financial Accounting Standards
("SFAS") No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
establishes new rules for the reporting and display of comprehensive income
(loss) and its components; however, the adoption of SFAS 130 had no impact on
our net income (loss) or stockholders' equity. This Statement requires foreign
currency translation adjustments, which prior to adoption were reported
separately in stockholders' equity (deficit), to be included in other
comprehensive income (loss). Prior year financial statements have been
reclassified to conform to the requirements of SFAS 130.

Geographic and Segment Information

During fiscal 1999 the Company adopted the provisions of SFAS No. 131,
Disclosure about Segments of an Enterprise and Related Information. SFAS No. 131
establishes standards for the reporting by public business enterprises of
information about operating segments, products and services, geographic areas,
and major customers. The method for determining what information to report is
based on the way that management organizes the operating segments within the
Company for making operational decisions and assessments of financial
performance.

The Company's chief operating decision-maker is considered to be the Company's
Chief Executive Officer ("CEO"). The CEO reviews financial information presented
on a consolidated basis


                                       7
<PAGE>

                                 MICROMUSE INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

accompanied by information by geographic region for purposes of making operating
decisions and assessing financial performance.

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

                                      Three months ended      Nine months ended
                                           June 30,               June 30,
                                      -------------------   --------------------
                                        2000       1999       2000        1999
                                      --------   --------   --------    --------
Revenues:
  United States                       $ 19,986   $ 10,912   $ 53,377    $ 26,305
  International                         12,946      4,510     29,025      12,569
                                      --------   --------   --------    --------
    Total                             $ 32,932   $ 15,422   $ 82,402    $ 38,874
                                      ========   ========   ========    ========

Income (loss) from operations:
  United States                       $    270   $    288   $  1,729    $    684
  International                          2,915      1,060     (4,059)      1,438
                                      --------   --------   --------    --------
    Total                             $  3,185   $  1,348   $ (2,330)      2,122
                                      ========   ========   ========    ========

                                      June 30,   September 30,
                                        2000         1999
                                      --------   -------------

Identifiable assets:
  United States                       $127,695      $79,208
  International                         31,263       11,397
                                      --------      -------
    Total                             $158,958      $90,605
                                      ========      =======

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

Recent Pronouncement

In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133, as amended addresses the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts. Under SFAS No. 133, entities are required to carry
all derivative instruments in the balance sheet at fair value. The accounting
for changes in the fair value of a derivative instrument depends on whether it
has been designated and qualifies as part of a hedging relationship and, if so,
the reason for holding it. The Company must adopt SFAS No. 133 by October 1,
2000. The Company does not anticipate that SFAS No. 133 will have an effect on
its financial statements.

In December 1998, the American Institute of Certified Public Accountants issued
Statement of Position No. 98-9, Software Revenue Recognition, with Respect to
Certain Arrangements ("SOP 98-9"), which requires the recognition of revenue
using the "residual method" in a multiple element arrangement when fair value
does not exist for one or more of the delivered elements in the arrangement.
Under the "residual method", the total fair value of the undelivered elements is
deferred and subsequently recognized in accordance with SOP 97-2. The Company
adopted SOP 98-9 on October 1, 1999 and did not incur a material change to its
accounting for revenues as a result of the provisions of SOP 98-9.


                                       8
<PAGE>

                                 MICROMUSE INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial
Statements. SAB 101 provides guidance on applying generally accepted accounting
principles to revenue recognition issues in financial statements. In March 2000,
the SEC issued Staff Accounting Bulletin No. 101A (SAB 101A), Amendment: Revenue
Recognition in Financial Statements. SAB 101A delays the implementation date of
SAB 101 until the Company's first fiscal quarter of 2001. SAB 101B "Second
Amendment: Revenue Recognition in Financial Statements" delays the
implementation of SAB 101 until the Company's fourth fiscal quarter of 2001. The
Company will adopt SAB 101 and is evaluating the effect that such adoption may
have on its financial statements.

In March 2000, the FASB issued interpretation No. 44 (FIN 44), Accounting for
Certain Transactions Involving Stock Compensation - an Interpretation of APB 25.
This Interpretation clarifies (a) the definition of an employee for purposes of
applying Opinion 25, (b) the criteria for determining whether a plan qualifies
as a noncompensatory plan, (c) the accounting consequences of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. This Interpretation is effective July 1, 2000. The Company does not
anticipate that FIN 44 will have a material effect on its financial statements.

Note 2. Acquisition of Calvin Alexander Networking, Inc.

On November 2, 1999, the Company entered into and, on December 28, 1999, it
closed an agreement to acquire all of the outstanding common and preferred
shares of Calvin Alexander Networking, Inc. ("CAN"), a privately-held company
that develops leading-edge network auto-discovery technology. Under the terms of
the acquisition agreement, the Company issued approximately 143,000 shares of
its common stock, or approximately $43 million, to acquire CAN. The transaction
was accounted for under the purchase method of accounting and was treated as a
tax-free reorganization for federal income tax purposes. Certain agreements have
been made to promote the retention and motivation of CAN employees. A portion of
the consideration for the transaction is subject to a one-year lock-up agreement
and a one-year price guarantee.

A summary of the allocation of the purchase price is as follows (in millions):

      In-process research and development                 $11.1
      Total tangible assets                                 0.2
      Intangible assets:
          Assembled workforce                               0.3
          Core technology                                   5.7
          Goodwill                                         25.7
                                                          -----
             Total intangible assets                       31.7

                                                          -----
          Total                                           $43.0
                                                          -----

At the time of the acquisition, the estimated aggregate fair value of CAN's
research and development efforts that had not reached technological feasibility
as of the acquisition date and had no alternative future uses was estimated by
the Company's management to be $11.1 million, and was expensed at the
acquisition date. Goodwill, which represents the excess of the purchase price
over the fair value of identifiable tangible and intangible assets acquired less
liabilities assumed, is being amortized over the estimated life of five years.


                                       9
<PAGE>

                                 MICROMUSE INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  (Unaudited)

The following summary, which was prepared on a pro forma basis, combines the
Company's consolidated results of operations with CAN's results of operations
for the three and nine months ended June 30, 2000 and 1999, as if the
combination had occurred at the beginning of the periods presented. The table
includes the impact of certain adjustments including the elimination of the
charge for acquired in-process research and development, and the additional
amortization relating to intangible assets acquired (in thousands, except per
share data):

                                          Three months ended   Nine months ended
                                                June 30,           June 30,
                                          ------------------   -----------------
                                            2000      1999      2000      1999
                                           -------   -------   -------   -------

Revenues                                   $32,932   $15,422   $82,402   $38,874
                                           =======   =======   =======   =======
Net income                                 $ 2,442   $   622   $ 4,693   $   730
                                           =======   =======   =======   =======

Net income per share:
  Basic                                    $  0.07   $  0.02   $  0.14   $  0.02
  Diluted                                  $  0.06   $  0.02   $  0.12   $  0.02

Shares used in per share
computation:
  Basic                                     34,471    32,261    34,201    32,147
  Diluted                                   39,221    35,341    39,202    34,817

A reconciliation of the numerators and denominators used in the above pro forma
basic and diluted net income per share amounts follows:

<TABLE>
<CAPTION>
                                               Three months ended   Nine months ended
                                                     June 30,           June 30,
                                               ------------------   -----------------
                                                   2000      1999      2000      1999
                                                -------   -------   -------   -------
<S>                                             <C>       <C>       <C>       <C>
Numerator for basic and diluted net income      $ 2,442   $   622   $ 4,693   $   730
                                                =======   =======   =======   =======
Denominator for basic net income per
  share - weighted-average shares outstanding    34,471    32,261    34,201    32,147
  Dilutive effect of:
    Common stock options                          4,750     3,027     4,974     2,646
    Warrant                                          --        53        27        24
                                                -------   -------   -------   -------
Denominator for diluted net income per share     39,221    35,341    39,202    34,817
                                                =======   =======   =======   =======
</TABLE>

Note 3. Subsequent Event

On June 20, 2000 and July 20, 2000, the Company entered into and subsequently
closed, respectively, an agreement to acquire all of the outstanding common and
preferred shares of NetOps Corp. ("NetOps"), a privately held software company
headquartered in Pleasantville, N.Y. Under the terms of the acquisition
agreement, the Company issued common stock and cash worth approximately $24
million to acquire NetOps. The transaction was accounted for under the purchase
method of accounting and was treated as a tax-free reorganization for federal
income tax purposes. Certain agreements have been made to promote the retention
and motivation of NetOps employees.


                                       10
<PAGE>

                                 MICROMUSE INC.

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations

The following information should be read in conjunction with the condensed
consolidated historical financial information and the notes thereto included in
Item 1 of this Quarterly Report on Form 10-Q and Management's Discussion and
Analysis of Financial Condition and Results of Operations contained in our
Registration Statement on Form S-3 and Form 10-K as filed with the Securities
and Exchange Commission on May 5, 2000 and December 28, 1999, respectively.

The statements contained in this Form 10-Q that are not purely historical are
forward-looking statements within the meaning of Section 21E of the Securities
Exchange Act of 1934, including statements regarding our expectations, beliefs,
hopes, intentions or strategies regarding the future. All forward-looking
statements in this Form 10-Q are based upon information available to us as of
the date hereof, and we assume no obligation to update any such forward-looking
statements. Actual results could differ materially from our current
expectations. Factors that could cause or contribute to such differences
include, but are not limited to: variation in demand for our software products
and services; the level and timing of sales; the extent of product and price
competition; introductions or enhancements of products or delays in
introductions or enhancements of products; hiring and retention of personnel;
changes in the mix of products and services sold; general domestic and
international economic and political conditions; and other factors and risks
discussed in "Risk Factors" in our Registration Statement on Form S-3 and Form
10-K as filed with the Securities and Exchange Commission on May 5, 2000 and
December 28, 1999, respectively, and elsewhere in this Quarterly Report.

Overview

Micromuse develops, markets and supports a family of scalable, highly
configurable, rapidly deployable software solutions that enable Fault and
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.

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. 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. Our
principal executive offices are located at 139 Townsend Street, San Francisco,
California 94107, and our telephone number at that address is (415) 538-9090.


                                       11
<PAGE>

                                 MICROMUSE INC.

Results of Operations

The following table sets forth certain items in our consolidated statement of
operations as a percentage of total revenues, except as indicated:

<TABLE>
<CAPTION>
                                               Three months ended   Nine months ended
                                                     June 30,            June 30,
                                               ------------------   -----------------
As a Percentage of Total Revenues:               2000      1999      2000      1999
                                                ------    ------    ------    ------
<S>                                              <C>       <C>       <C>       <C>
Revenues:
  License                                         73.4%     75.0%     73.6%     76.8%
  Maintenance and services                        26.6%     25.0%     26.4%     23.2%
                                                ------    ------    ------    ------
    Total revenues                               100.0%    100.0%    100.0%    100.0%
                                                ------    ------    ------    ------

Cost of revenues:
  License                                          4.1%      3.9%      4.0%      4.5%
  Maintenance and services                        12.9%     12.8%     13.0%     12.3%
                                                ------    ------    ------    ------
    Total cost of revenues                        17.0%     16.7%     17.0%     16.8%
                                                ------    ------    ------    ------
      Gross profit                                83.0%     83.3%     83.0%     83.2%
                                                ------    ------    ------    ------

Operating expenses:
  Sales and marketing                             44.4%     48.3%     44.0%     48.3%
  Research and development                        14.8%     16.7%     15.1%     16.5%
  General and administrative                       9.3%      9.5%      9.3%     11.0%
  Purchased in-process research & development      0.0%      0.0%     13.4%      0.0%
  Amortization of goodwill and purchased
    intangible assets                              4.8%      0.0%      3.9%      0.0%
  Executive recruiting costs                       0.0%      0.0%      0.0%      1.9%
                                                ------    ------    ------    ------
    Total operating expenses                      73.3%     74.6%     85.8%     77.7%
                                                ------    ------    ------    ------
      Income (loss) from operations                9.7%      8.7%     -2.8%      5.5%

Other income, net                                  4.9%      8.3%      4.1%      7.7%
                                                ------    ------    ------    ------
  Income before income taxes                      14.6%     17.0%      1.3%     13.1%
Income tax provision (benefit)                     7.2%      1.6%      6.9%     -1.6%
                                                ------    ------    ------    ------
  Net income (loss)                                7.4%     15.4%     -5.6%     14.8%
                                                ======    ======    ======    ======

As a Percentage of Related Revenues:
Cost of license revenues                           5.6%      5.2%      5.4%      5.9%
Cost of maintenance and services revenues         48.3%     51.2%     49.3%     53.1%
</TABLE>


                                       12
<PAGE>

                                 MICROMUSE INC.

Revenues. Revenues increased to $32.9 million and $82.4 million in the quarter
and nine months ended June 30, 2000, respectively, from $15.4 million and $38.9
million in the comparable periods of the prior year. License revenues increased
to $24.2 million and $60.6 million in the quarter and nine months ended June 30,
2000, respectively, from $11.6 million and $29.9 million in the comparable
periods of the prior year. The growth of license revenues was primarily due to
the expansion of our sales organization, an increase in the number of product
licenses sold and the increased sales of the other elements of the Netcool suite
of products reflecting the increased demand for Netcool(R)/OMNIbus and other
products. Maintenance and services revenues increased to $8.8 million and $21.8
million in the quarter and nine months ended June 30, 2000, respectively, from
$3.9 million and $9.0 million in the comparable periods of the prior year. The
increase in maintenance and services revenues was a result of providing
maintenance and services to a larger installed customer base. License revenues
as a percentage of total revenues decreased to 73% and 74% in the quarter and
nine months ended June 30, 2000, respectively, from 75% and 77% in the
comparable periods of the prior year, due primarily to services revenues
returning to historic levels.

Cost of Revenues. The cost of license revenues consists primarily of technology
license fees paid to third-party software vendors and production costs. Cost of
license revenues as a percentage of license revenues increased to 6% in the
quarter ended June 30, 2000, from 5% in the comparable period of the prior year
primarily due to an increase in third-party royalty costs, partially offset by
economies of scale. Cost of license revenues as a percentage of license revenues
decreased to 5% in the nine months ended June 30, 2000, from 6% in the
comparable period of the prior year primarily due to the increase economies of
scale. The 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 as a percentage
of maintenance and services revenues decreased to 48% and 49% in the quarter and
nine months ended June 30, 2000, respectively, from 52% and 53% in the
comparable periods of the prior year. This improvement, which was principally
due to a proportionally greater percentage of higher-margin maintenance
revenues, was partially offset by increased personnel, facilities, and travel
costs associated with expanding the customer support and technical service
organizations.

Sales and Marketing Expenses. Sales and marketing expenses increased to $14.6
million and $36.3 million in the quarter and nine months ended June 30, 2000,
respectively, from $7.5 million and $18.8 million in the comparable periods of
the prior year. These changes were primarily due to the increased personnel
costs associated with the expansion of the sales and technical services
departments and increased facilities costs. Sales and marketing expenses as a
percentage of total revenues declined to 44% in the quarter and nine months
ended June 30, 2000, from 48% in both of the comparable periods of the prior
year. These reductions were primarily due to the increased scale of operations.

Research and Development Expenses. Research and development expenses increased
to $4.9 million and $12.5 million in the quarter and nine months ended June 30,
2000, respectively, from $2.6 million and $6.4 million in the comparable periods
of the prior year. These increases were the 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 to 15% in both the
quarter and nine months ended June 30, 2000, from 17% in both of the comparable
periods of the prior year. These reductions were primarily due to the increased
scale of operations.

General and Administrative Expenses. General and administrative expenses
increased to $3.1 million and $7.7 million in the quarter and nine months ended
June 30, 2000, respectively, from $1.5 million


                                       13
<PAGE>

                                 MICROMUSE INC.

and $4.3 million in the comparable periods of the prior year. These increases
were primarily due to increased personnel costs, professional fees, facilities
costs and associated expenses to support the increased scale of operations.
General and administrative expenses as a percentage of revenues declined to 9%
in both the quarter and nine months ended June 30, 2000, from 10% and 11% in the
comparable periods of the prior year. These reductions were primarily due to the
increased scale of operations.

Purchased In-Process Research and Development Expense. The $11.1 million charge
in the nine months ended June 30, 2000, reflects the portion of Calvin Alexander
Networking, Inc.'s research and development efforts that, at the time of
acquisition, had not reached technological feasibility and had no alternative
future uses.

Amortization of Goodwill and Purchased Intangible Assets. The charge of $1.6
million and $3.2 million in the quarter and nine months ended June 30, 2000,
respectively, reflects the amortization of the goodwill and purchased intangible
assets over estimated useful lives of three to five years.

Executive Recruiting Costs. The prior year executive recruiting costs of $0.7
million included a charge related to the fair value of the warrant issued to the
executive search firm to purchase 53,334 shares of the Company's common stock at
a price of $14.82 per share, cash fees paid to the executive search firm and
certain relocation costs.

Other Income, Net. Other income increased to $1.6 million and $3.4 million in
the quarter and nine months ended June 30, 2000, respectively, from $1.3 million
and $3.0 million in comparable periods of the prior year. This net increase was
primarily due to the interest income related to the increase in cash, cash
equivalents and short-term investments.

Liquidity and Capital Resources

As of June 30, 2000, we had $82.1 million in cash and cash equivalents and $18.5
million in marketable securities. The net increase of $47.0 million in cash and
cash equivalents in the nine months ended June 30, 2000 was due primarily to the
net maturities of $16.2 million in marketable securities, increase in accrued
expenses and deferred revenue and proceeds from the issuance of common stock.
These sources of cash were partially offset by a net loss, the increase in
accounts receivable and the purchase of capital equipment. The increase in
accrued expenses was due primarily to the timing of payroll tax payments related
to exercised stock options and, to a lesser extent, the growth in the business.
The increase in deferred revenue was due primarily to an increase in maintenance
renewals, the growth in the business, and orders where the revenue recognition
criteria had not been met as of June 30, 2000. The increase in accounts
receivable reflects the growth in related revenues offset partially by improved
collections.

The net use of cash and cash equivalents in the nine months ended June 30, 1999
was due primarily to the purchase of treasury stock, marketable securities,
capital expenditures, the increase in accounts receivable and prepaid expenses
and other current assets. These uses were partially offset by net income of $5.7
million, the proceeds from the issuance of treasury stock, and the increase in
accounts payable and accrued expenses. The increase in accounts receivable,
accounts payable and accrued expenses reflects the growth in the business while
the increase in prepaid expense and other current assets includes a prepayment
of technology license fees to a third-party software vendor, rental deposits and
prepaid value added taxes.

We believe that our current cash balances and the cash flows generated by
operations, if any, will be sufficient to meet our anticipated cash needs for
working capital and capital expenditures for the next


                                       14
<PAGE>

                                 MICROMUSE INC.

12 months. A portion of our 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, we evaluate
potential acquisitions of such businesses, products or technologies. We 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 our stockholders.

Year 2000 Compliance and Euro Conversion

We have designed and tested our products to be Year 2000 compliant. Our
evaluation of Year 2000-related risks and corrective actions in connection with
such third-party applications, internally developed products and local operating
systems is ongoing. We continue to believe that our products performed well
during the roll-over from 1999 to 2000 and February 29, 2000. Any undetected or
unreported errors or defects associated with Year 2000 date functions could
result in material costs to us. In addition, certain components of our products
process timestamp information from third-party applications or local operating
systems. If such third-party applications or local operating systems are not
Year 2000 compliant, our products that process such timestamp information may
not be Year 2000 compliant.

In our standard license agreements, we provide certain warranties to licensees
that our software routines and programs are Year 2000 compliant. If any of our
licensees experience Year 2000 problems, such licensees could assert claims for
damages against us. Any such claims or litigation could result in substantial
costs and diversion of our resources even if ultimately decided in our favor.
Based on work done to date and our best estimates, we have not incurred material
costs and do not expect to incur future material costs in addressing the Year
2000 issue in our systems and products.

Our Year 2000 internal readiness program primarily covers: information
technology-based office facilities, data and voice communications, building
management and security systems, taking inventory of hardware, software and
embedded systems, assessing business and customer satisfaction risks associated
with such systems, creating action plans to address known risks, executing and
monitoring action plans, and contingency planning. We have not experienced
material disruptions in our business associated or our internal systems, but
there can be no assurances that we will not experience serious unanticipated
negative consequences and/or material costs caused by undetected errors or
defects in the technology used in our internal systems. The most reasonably
likely worst case scenarios would include: (i) corruption of data contained in
our internal information systems, (ii) hardware failure and (iii) the failure of
infrastructure services provided by government agencies and other third parties
(e.g., electricity, phone service, water transport, internet services, etc.).
Contingency plans to include, among other things, manual "work-arounds" for
software and hardware failures, as well as substitution of systems, if
necessary.

Various European countries introduced a single currency (known as the Euro) in
January 1999. We have conducted a review of our internal information systems to
identify the systems that could be affected by such Year 2000 and Euro
conversion requirements. Further, to accommodate our recent growth, we 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, we will be required to improve our 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.


                                       15
<PAGE>

                                 MICROMUSE INC.

                                  RISK FACTORS

In addition to the other information in this Report, the following risk factors
should be considered carefully in evaluating our business and us. This Form 10-Q
(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 us
and our 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 Form 10-Q. 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 Form 10-Q reflect the good faith
judgment of our management, such statements can only be based on facts and
factors we currently know about. 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" as well as those discussed elsewhere in
this Form 10-Q. Readers are urged not to place undue reliance on these
forward-looking statements, which speak only as of the date of the this Form
10-Q. We undertake 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 Form 10-Q.

Because we have a limited operating history in a dynamic market, it is difficult
to predict our future operating results.

Because we have a limited operating history, it is difficult to predict our
future operating results. We first shipped our Netcool/OMNIbus product in
January of 1995 and therefore have a limited operating history of developing and
providing service level management software. Our limited operating history and
rapidly changing product development, installation, maintenance and market
dynamics make the prediction of future results of operations difficult. Our
prospects must be considered in light of the risks, costs and difficulties
frequently encountered by emerging companies, particularly companies in the
competitive software industry. We intend to increase our operating expenses to
hire experienced senior managers, develop new distribution channels, increase
our sales and marketing efforts, implement and improve operational, financial
and management information systems, broaden technical services and customer
support capabilities, fund higher levels of research and development and expand
administrative resources in anticipation of future growth. Our operating results
will be harmed if these increased expenditures do not result in increased
revenues.

Our operating results may vary from quarter to quarter, causing our stock price
to fluctuate.

Our quarterly revenues and operating results in business segments that we track
fluctuate and are difficult to predict. It is possible that in some quarter or
quarters our operating results will be below the expectations of public market
analysts or investors. In such event, or in the event adverse conditions
prevail, or are perceived to prevail, with respect to our business or financial
markets generally, the market price of our common stock may decline
significantly.


                                       16
<PAGE>

                                 MICROMUSE INC.

We realize a significant portion of our license revenues in the last month of a
quarter, frequently in the last weeks or even days of a quarter. As a result,
license revenues in any quarter are difficult to forecast because it is
substantially dependent on orders booked and shipped in that quarter. Moreover,
our sales cycle, from initial evaluation to delivery of software, vary
substantially from customer to customer. Further, we base our expense levels in
part on forecasts of future orders and sales, which are extremely difficult to
predict. A substantial portion of our operating expenses is 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. Accordingly, our operating results will be harmed if revenues
fall below our expectations in a particular quarter. In addition, the number and
timing of large individual sales has been difficult for us to predict, and large
individual sales have, in some cases, occurred in quarters subsequent to those
we anticipated, or have not occurred at all. The loss or deferral of one or more
significant sales in a quarter could harm our operating results.

Because of these fluctuations we believe that quarter-to-quarter comparisons of
our operating results are not necessarily meaningful or indicative of our future
performance. A number of other factors are likely to cause these variations,
including:

o     changes in the demand for our software products and services and the level
      of product and price competition that we encounter;

o     the timing of new hires and our ability to attract, retain and motivate
      qualified personnel, including changes in our sales incentives;

o     the mix of products and services sold, including the mix of sales to new
      and existing customers and through third-party distributors and our direct
      sales force;

o     changes in the mix of, and lack of demand from, distribution channels
      through which our products are sold;

o     the length of our sales cycles and the success of our new customer
      generation activities;

o     spending patterns and budgetary resources of our customers on network
      management software solutions;

o     product life-cycles and the timing of introductions or enhancements of
      products, or delays in the introductions or enhancements of our products
      and those of our competitors;

o     market acceptance of new products;

o     changes in the renewal rate of support agreements;

o     seasonal variation in revenues because a disproportionate amount of our
      annual revenues have historically been generated by sales of our products
      during our fourth fiscal quarter and this trend may or may not continue;

o     expansion of international operations, including gains and losses on the
      conversion to United States dollars of accounts receivable and accounts
      payable arising from international operations and the mix of international
      and domestic revenue;


                                       17
<PAGE>

                                 MICROMUSE INC.

o     the extent of market consolidation; and

o     software defects and other product quality problems.

Failure to manage our growth may adversely affect our business.

We have grown rapidly, adding customers, personnel and expanding the scope and
geographic area of our operations. Our growth has resulted in new and increased
responsibilities for our management personnel and has placed and will continue
to place a significant strain upon our management and our operating and
financial systems and resources. We have grown from 321 employees on September
30, 1999 to 425 employees on June 30, 2000 and currently plan to recruit more
staff.

Failure to improve our infrastructure may adversely affect our business.

We need to continue to implement and improve a variety of operational, financial
and management information systems, procedures and controls. In particular, we
need to improve our 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
require the addition of new management personnel, and we are currently in the
process of recruiting individuals to fill important management positions.
Further, we need to continue to develop a U.S.-based financial and accounting
system. Our business will be harmed if we are unable to recruit and retain these
key personnel, if our current and future executive officers do not operate
effectively, both independently and as a group, or if we fail to implement
improved operational, financial and management systems.

We need to continue to expand and improve the productivity of our sales force
and our technical services and customer support organization.

We need to continue to hire additional sales personnel. Based on our experience,
such personnel are in high demand, are difficult to recruit and retain and
require nine months, or longer, to become fully productive. Although we
increased the size of our sales organization during fiscal 1999, we experienced
difficulty in recruiting a sufficient number of qualified sales personnel during
the period. Our business will be harmed if we are unable to recruit additional
sales personnel or increase the productivity of our current sales personnel.
Further, because of the recent expansion of the installed base of
Netcool/OMNIbus and the release of our Netcool/Reporter(TM), Netcool/Internet
Service Monitors(TM), Netcool/FireWall-1(TM), Netcool/Fusion(TM),
Netcool/NTSM(TM), Netcool/Impact(TM), and Netcool/Wave(TM) and other software
products, the demands on our technical services and customer support resources
have grown rapidly. We need to significantly expand our technical services and
customer support organizations and similar third-party capabilities if we are to
achieve significant additional revenue growth. Competition for additional
qualified technical personnel to perform the required functions is intense and
such personnel may not be available. If our technical services and customer
support resources are insufficient to support our growth our business will be
harmed.

We need to continue to expand our distribution channels and retain our existing
third-party distributors.

We need to continue to develop relationships with leading network equipment and
telecommunications providers and to expand our third-party channel of
distribution. We are currently investing, and plan to continue to invest,
significant resources to develop these relationships and channels of
distribution, which could reduce our ability to generate profits. Third-party
distributors accounted for approximately 35%, 36% and 26% of our total revenues
in the nine months ended June 30, 2000, fiscal 1999 and 1998,


                                       18
<PAGE>

                                 MICROMUSE INC.

respectively. Our business will be harmed if we are not able to attract
additional distributors that market our products effectively. Further, many of
our agreements with third-party distributors are nonexclusive, and many of the
companies with which we have agreements also have similar agreements with our
competitors or potential competitors. Our third-party distributors have
significantly greater sales and marketing resources than we do, and their sales
and marketing efforts may conflict with our direct sales efforts. In addition,
although sales through third-party distributors result in reduced sales and
marketing expense with respect to such sales, we sell our products to
third-party distributors at reduced prices, resulting in lower gross margins on
such third-party sales. We believe that our success in penetrating markets for
our fault and service level management applications depends substantially on our
ability to maintain our current distribution relationships, in particular, those
with Cisco Systems, Lucent Technologies, Unisphere (Siemens) and others. Our
business will be harmed if network equipment and telecommunications providers
and distributors discontinue their relationships with us, compete directly with
us or form additional competing arrangements with our competitors.

We are dependent on the market for software designed for use with advanced
communications services, and the size of this market is unproven.

The market for our products is in an early stage of development and is very
dynamic. Although the rapid expansion and increasing complexity of computer
networks in recent years and the resulting emergence of service level management
has increased the demand for fault and service level management 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.

We are substantially dependent upon telecommunications carriers and internet
service providers continuing to purchase our products.

Telecommunications carriers, including internet service providers, that deliver
advanced communications services to their customers have accounted for
approximately 82%, 79% and 68% of our total revenues in the nine months ended
June 30, 2000, fiscal 1999 and 1998, respectively. In addition, these providers
are the central focus of our sales strategy. If these customers cease to deploy
advanced communications services for any reason, the market for our products
will be harmed. Also, delays in the introduction of advanced services, such as
network management outsourcing, or the failure of such services to gain
widespread market acceptance or the decision of telecommunications carriers and
other service providers not to use our products in the deployment of these
services would harm our business.

We face intense competition, including from larger competitors with greater
resources than our own, which could result in our losing market share or
experiencing a decline in gross margins.

We face intense competition in our markets. As we enter new markets, we
encounter additional, market-specific competitors. In addition, because the
software market has relatively low barriers to entry, we are aware of new and
potential entrants in portions of our market space. Increased competition is
likely to result in price reductions and may result in reduced gross margins and
loss of market share.

Further, many of our 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
we do. 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


                                       19
<PAGE>

                                 MICROMUSE INC.

emerging technologies and changes in customer requirements than we can. Existing
competitors could also increase their market share by bundling products having
functionality offered by our products with their current applications. Moreover,
our current and potential competitors may increase their share of the fault and
service level management 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 functionality offered by our products, which could render our
products obsolete and unmarketable.

Our current and prospective competitors offer a variety of solutions to address
the fault and service level and enterprise network management markets and
generally fall within the following five categories:

o     customer's internal design and development organizations that produce
      service level management and network management applications for their
      particular needs, in some cases using multiple instances of products from
      hardware and software vendors such as Compaq, Sun Microsystems, Inc.,
      Hewlett-Packard Company and Cabletron Systems, Inc.;

o     vendors of network and systems management frameworks including Computer
      Associates International, Inc. and International Business Machines
      Corporation;

o     vendors of network and systems management applications including
      Hewlett-Packard Company, BMC Software, Inc, Sun Microsystems, Inc. and
      International Business Machines Corporation;

o     providers of specific market applications; and

o     systems integrators serving the telecommunications industry which
      primarily provide programming services to develop customer specific
      applications including TCSI Corporation (formerly Teknekron Communications
      Systems, Inc.) and Objective Systems Integrators, Inc.

Many of our existing and potential customers and distributors 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 ours. As a result, we must continuously educate
existing and prospective customers as to the advantages of our products versus
internally developed network operations support and management applications.

If we ship products that contain defects or limitations, the market acceptance
or our products and our reputation will be harmed, and our customers could seek
to recover their damages from us.

If we ship products that contain defects, the market acceptance or our products
and our reputation will be harmed, and our customers could seek to recover their
damages from us. Complex software products frequently contain errors, defects or
limitations, especially when first introduced or when new versions or
enhancements are released. Despite our extensive product testing, we have in the
past released versions of Netcool/OMNIbus with defects and have discovered
software errors in certain of our products after their introduction. For
example, version 3.0 of Netcool/OMNIbus, released in 1996, had a number of
material defects. Version 1.0 of Netcool/Reporter, released in 1998, had
features and performance characteristics that limited market acceptance.
Significant portions of our technical personnel resources were required to
address these defects and limitations. Because of these defects and


                                       20
<PAGE>

                                 MICROMUSE INC.

limitations, we could continue to experience delays in or failure of market
acceptance of products, or damage to our reputation or relationships with our
customers. Any defects, errors or limitations in new versions or enhancements of
our products after commencement of commercial shipments would harm our business.

In addition, because our products are used to monitor and address network
problems and avoid failures of the network to support critical business
functions, any design defects, software errors, misuse of our products,
incorrect data from network elements or other potential problems within or out
of our control that may arise from the use of our products could result in
financial or other damages to our customers. Our customers could seek to have us
pay for these losses. Although we maintain product liability insurance, it may
not be adequate. Further, although our license agreements with our customers
typically contain provisions designed to limit our exposure to potential claims
as well as any liabilities arising from such claims, such provisions may not
effectively protect us against such claims and the liability and costs
associated therewith.

The sales cycle for our software products is long, and the delay or failure to
complete one or more large license transactions in a quarter could cause our
operating results to fall below our expectations.

The sales cycle for our software products can be as long as three to nine
months, and our delay or failure to complete one or more large license
transactions in a quarter could harm our operating results. Our software is
generally used for division-wide 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 us to expend substantial time, effort and money educating
them about the value of our solutions. Licensing of our 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 we have little or no control, may cause potential customers to favor a
particular supplier or to delay or forego a purchase.

We depend on our key personnel, and the loss of any of our key personnel could
harm our business.

Our 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 harm our
business. We do not generally have employment contracts with key personnel. In
addition, we are dependent upon our continuing ability to attract, train and
retain additional highly qualified management, sales, product development,
technical services and customer support personnel. We have at times and continue
to experience difficulty in recruiting qualified personnel. Because we face
intense competition in our recruiting activities, we may be unable to attract
and/or retain qualified personnel.

We have acquired other businesses and we may make additional acquisitions in the
future, which will complicate our management tasks and could result in
substantial expenditures.

We have acquired other businesses and we may make additional acquisitions in the
future, which will complicate our management tasks and could result in
substantial expenditures. For example, on November 2, 1999, we entered into and
on December 28, 1999 we completed an agreement to acquire Calvin Alexander
Networking, Inc., a small developer of network auto-discovery software. On June
20, 2000 and July 20, 2000, the Company entered into and subsequently closed,
respectively, an agreement to


                                       21
<PAGE>

                                 MICROMUSE INC.

acquire all of the outstanding common and preferred shares of NetOps Corp., a
privately held software company headquartered in Pleasantville, N.Y. Because of
these past and potential future acquisitions, we will need to integrate distinct
products, customers and corporate cultures into our own. These past and
potential future acquisitions create numerous risks for us, including:

o     failure to successfully assimilate acquired operations and products;

o     diversion of our management's attention from other matters;

o     loss of key employees of acquired companies;

o     substantial transaction costs;

o     substantial liabilities or exposures in the acquired entity that were not
      known or accurately evaluated or forecast by us; and

o     substantial additional costs charged to operations as a result of the
      failure to consummate a potential acquisition.

Further, some of the products we may acquire would require significant
additional development before they can be marketed and may not generate revenue
at levels we anticipate. Moreover, our future acquisitions, if any, may result
in issuances of our equity securities which dilute our stockholders, the
incurrence of debt, large one-time write-offs and creation of goodwill or other
intangible assets that could result in amortization expense. It is possible that
our efforts to consummate or integrate acquisitions will not be successful,
which would harm our business.

We have relied and expect to continue to rely on a limited number of products
for a significant portion of our revenues.

All of our revenues have been derived from licenses for our Netcool family of
products and related maintenance, training and consulting services. We currently
expect that Netcool/OMNIbus-related revenues will continue to account for a
substantial percentage of our revenues in fiscal 2000 and for the foreseeable
future thereafter. Although we have introduced Netcool/Reporter,
Netcool/Internet Service Monitors, Netcool/FireWall-1, Netcool/Fusion,
Netcool/NTSM, Netcool/Impact, Netcool/Wave and other products, our 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. Our business
will be harmed if Netcool/OMNIbus does not continue to achieve market acceptance
or if we fail to develop and market improvements to Netcool/OMNIbus or new or
enhanced products. 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 our 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 harm our
business.

We have relied and expect to continue to rely on a limited number of customers
for a significant portion of our revenues.

We derive a significant portion of our revenues in any particular period from a
limited number of customers. No customers accounted for more than 10% of
revenues for the quarter ended June 30, 2000. In the comparable period of the
prior year, one customer accounted for 12% of revenues. We


                                       22
<PAGE>

                                 MICROMUSE INC.

expect to continue to derive a significant portion of our revenues from a
limited number of customers in the future. If a significant customer, or group
of customers, cancels or delays orders for our products, or does not continue to
purchase our products at or above historical levels, our business will be
harmed. For example, pre-existing customers may be part of, or become part of,
large organizations that standardize using a competitive product. The terms of
our agreements with our 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, we
generally do not have long-term customer contracts upon which we can rely for
future revenues.

Our international sales and operations expose us to currency fluctuation risks
and other inherent risks.

We license our products in foreign countries. In addition, we maintain a
significant portion of our operations, including the bulk of our software
development operations, in the United Kingdom. Fluctuations in the value of
these currencies relative of the United States dollar have adversely impacted
our results in the past and may do so in the future. These fluctuations can
cause our prices to not be competitive or raise our expenses and reduce our
profitability. License, maintenance and service revenues outside of the United
States accounted for 38%, 36% and 39% of our total revenues in the nine months
ended June 30, 2000, fiscal 1999 and 1998, respectively. We expect that
international license, maintenance and consulting revenues will continue to
account for a significant portion of our total revenues in the future. We pay
the expenses of our international operations in local currencies and do not
currently engage in hedging transactions with respect to such obligations.

Our international operations and revenues involve a number of other inherent
risks, including:

o     longer receivables collection periods and greater difficulty in accounts
      receivable collection;

o     difficulty in staffing and generally higher costs associated with managing
      foreign operations;

o     an even lengthier sales cycle than with domestic customers;

o     the impact of possible recessionary environments in economies outside the
      United States;

o     sales in Europe and certain other parts of the world generally are
      adversely affected in the quarter ending September 30, as many customers
      reduce their business activities during the summer months. If our
      international sales become a greater component of total revenue, these
      seasonal factors may have a more pronounced effect on our operating
      results; and

o     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.

o     Changes in payroll, stock option, employee stock purchase and business
      related taxation.

We intend to enter into additional international markets and to continue to
expand our operations outside of the United States by expanding our direct sales
force and pursuing additional strategic relationships. Such expansion will
require significant management attention and expenditure of significant
financial resources and could adversely affect our ability to generate profits.
If we are


                                       23
<PAGE>

                                 MICROMUSE INC.

unable to establish additional foreign operations in a timely manner, our growth
in international sales will be limited, and our business could be harmed.

Rapid technological change, including evolving industry standards and
regulations and new product introductions by our competitors, could render our
products obsolete.

Rapid technological change, including evolving industry standards and
regulations and new product introductions by our competitors, could render our
products obsolete. As a result, the life cycles of our products are difficult to
estimate and we must constantly develop, market and sell new and enhanced
products. If we fail to do so, our business will be harmed. For example, the
widespread adoption of a new architecture for managing telecommunications
networks (for example TMN architecture) would force us to adapt our products to
such standard, which we may be unable to do on a timely basis or 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 our products. Further, the introduction or
announcement of new product offerings by us or one or more of our competitors
may cause our customers to defer licensing of our existing products.

Our products operate on third-party software platforms, and we could lose market
share if our products do not operate on the hardware and software operating
platforms employed by our customers.

Our products operate on third-party software platforms and we could lose market
share if our products do not operate on the hardware and software operating
platforms employed by our customers. Our products are designed to operate on a
variety of hardware and software platforms employed by our customers in their
networks. We must continually modify and enhance our products to keep pace with
changes in hardware and software platforms and database technology. As a result,
uncertainties related to the timing and nature of new product announcements,
introductions or modifications by systems vendors, particularly Sun
Microsystems, Inc., International Business Machines Corporation, Hewlett-Packard
Company, Cabletron Systems, Inc. and Cisco Systems, Inc. and by vendors of
relational database software, particularly Oracle Corporation and Sybase, Inc.,
could harm our business. For example, we are modifying certain of our products
to operate with the Linux operating system.

Our efforts to protect our intellectual property may not be adequate, or a
third-party could claim that we are infringing its proprietary rights.

We cannot guarantee that the steps we have taken to protect our proprietary
rights will be adequate to deter misappropriation of our intellectual property.
In addition, we may not be able to detect unauthorized use or our intellectual
property and take appropriate steps to enforce our rights. If third parties
infringe or misappropriate our trade secrets, copyrights, trademarks or other
proprietary information or intellectual property, our business could be harmed.
In addition, protection of intellectual property in many foreign countries is
weaker and less reliable than in the United States, so as our international
operations expand, the risk that we will fail to adequately protect our
intellectual property increases. Further, while we believe that our products and
trademarks do not infringe upon the proprietary rights of third parties, other
parties may assert that our products infringe, or may infringe, their
proprietary rights. 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 us 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 us or at all. We expect that software product developers will be
increasingly subject to infringement claims as the number of products and
competitors in our industry segment grows and the functionality of products in
different industry segments overlaps.


                                       24
<PAGE>

                                 MICROMUSE INC.

We rely on software that we have licensed from third-party developers to perform
key functions in our products.

We rely on software that we license from third parties, including software that
is integrated with internally developed software and used in our products to
perform key functions. We could lose the right to use this software or it could
be made available to us only on commercially unreasonable terms. Although we
believe 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 us until equivalent software could be developed internally or
identified, licensed and integrated, which would harm our business.

Our stock price is volatile.

The market price of our common stock has been and is likely to continue to be
highly volatile. The market price may vary in response to many factors, some of
which are outside our control, including:

o     actual or anticipated fluctuations in our operating results;

o     announcements of technological innovations, new products or new contracts
      by us or our competitors;

o     developments with respect to copyrights or proprietary rights;

o     adoption of new accounting standards affecting the software industry; and

o     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 our 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 our management's attention and resources that could harm our business.

General economic and market conditions may impair our business.

Segments of the software industry have experienced significant economic
downturns characterized by decreased product demand, price erosion, work
slowdowns and layoffs. Our operation may in the future experience substantial
fluctuations as a consequence of general economic conditions affecting the
timing of orders from major customers and other factors affecting capital
spending. Although we have a diverse client base, we target certain market
segments. Therefore, any economic downturns in general or in the targeted
segments in particular would harm our business.

We have various mechanisms in place to discourage takeover attempts.


                                       25
<PAGE>

                                 MICROMUSE INC.

Certain provisions of our certificate of incorporation and bylaws and certain
provisions of Delaware law could delay or make difficult a change in control of
Micromuse that a stockholder may consider favorable. The provisions include:

o     "blank check: preferred stock that could be used by our board of directors
      to increase the number of outstanding shares and thwart a takeover
      attempt; and

o     a classified board of directors with staggered, two-year, terms, which may
      lengthen the time required to gain control of the board of directors

In addition, Section 203 of the General Corporation Law of the State of
Delaware, which is applicable to us, and our stock incentive plans, may
discourage, delay or prevent a change of control of Micromuse.

Year 2000 and Euro conversion issues could impair our business.

We have designed and tested our products to be Year 2000 compliant. Our
evaluation of Year 2000-related risks and corrective actions in connection with
such third-party applications, internally developed products and local operating
systems is ongoing. We believe that our products performed well during the
roll-over from 1999 to 2000 and February 29, 2000. We incorporate herein by
reference the Year 2000 Compliance and Euro Conversion discussion included
earlier in this Form 10-Q.


                                       26
<PAGE>

                                 MICROMUSE INC.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Foreign Currency Hedging Instruments

We transact business in various foreign currencies. Accordingly, we are subject
to exposure from adverse movements in foreign currency exchange rates. This
exposure is primarily related to local currency denominated revenues and
operating expenses in the U.K. However, as of June 30, 2000, no hedging
contracts were outstanding.

We currently do not use financial instruments to hedge local currency
denominated operating expenses in the U.K. Instead, we believe that a natural
hedge exists, in that local currency revenues will substantially offset the
local currency denominated operating expenses. We assess the need to utilize
financial instruments to hedge currency exposures on an ongoing basis.

We do not use derivative financial instruments for speculative trading purposes,
nor do we hedge our foreign currency exposure in a manner that entirely offsets
the effects of changes in foreign exchange rates. We regularly review our
hedging program and may as part of this review determine at any time to change
our hedging program.

Fixed Income Investments

Our exposure to market risks for changes in interest rates relate primarily to
investments in debt securities issued by U.S. government agencies and corporate
debt securities. We place our investments with high credit quality issuers and,
by policy, limits the amount of the credit exposure to any one issuer.

Our general policy is to limit the risk of principal loss and ensure the safety
of invested funds by limiting market and credit risk. All highly liquid
investments with a maturity of three months or less at the date of purchase are
considered to be cash equivalents; investments with maturities between three
months or less are considered cash equivalents; investments with maturities
between three and twelve months are considered to be short-term investments;
investments with maturities in excess of twelve months are considered to be
long-term investments. The weighted average pre-tax interest rate on the
investment portfolio is approximately 5.6%. We do not expect any material loss
with respect to our investment portfolio.


                                       27
<PAGE>

                                 MICROMUSE INC.

Part II - OTHER INFORMATION

Item 1. Legal Proceedings.

The Company is routinely involved in legal and administrative proceedings in the
ordinary course of its business. Management does not regard any of those
proceedings to be material.

Item 2. Changes in Securities and Use of Proceeds.

The Board of Directors approved a two-for-one split of its common stock for each
share of record held at close of business on February 3, 2000. The shares
resulting from the split have been distributed by our transfer agent.

Item 3. Defaults upon Senior Securities.

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders.

Not applicable.

Item 5. Other Information.

Not applicable.


                                       28
<PAGE>

                                 MICROMUSE INC.

Item 6. Exhibits and Reports on Form 8-K:

      (a) Exhibits

Exhibit
Number      Description
--------    --------------------------------------------------------------------
  2.1+      Agreement and Plan of Reorganization, dated November 2, 1999, by and
            among Micromuse Inc., CAN Acquisition Corp., Calvin Alexander
            Networking, Inc., Adam Forbes and Michael Wood.
  2.2++     Amendment to Agreement and Plan of Reorganization
  3.1++     Restated Certificate of Incorporation of the Registrant, as amended
            to date.
  3.2++     Amended and Restated Bylaws of the Registrant.
  4.1++     Reference is made to Exhibits 3.1, 3.2 and 10.4.
  4.2++     Specimen Common Stock certificate.
  5.1       Opinion of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian,
            LLP
 10.4++     Amended and Restated Investors' Rights Agreement by and among the
            Registrant and certain stockholders of the Registrant, dated as of
            September 8, 1997.
 23.1       Consent of Independent Auditors
 23.2       Consent of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian,
            LLP (included in the opinion filed as Exhibit 5.1)
 24.1       Power of Attorney (reference is made to the signature page of this
            Registration Statement
 27.1       Financial Data Schedule

            +     Incorporated by reference from the exhibit 10.11 to
                  Registrant's annual report on Form 10-K for the year ended
                  September 30, 1999, filed on December 28, 1999.

            ++    Incorporated by reference from the exhibit of the same number
                  in the Registrant's Registration Statement on Form S-1
                  (Registration No. 333-95939) as filed with the SEC on February
                  1, 2000.

      (b) Reports on Form 8-K

            The company filed one report on Form 8-K during the quarter ended
      June 30, 2000. Information on the item reported on is as follows:

      Date                      Item reported on

      February 25, 2000         Acquisition of Calvin Alexander Networking "CAN"


                                       29
<PAGE>

                                 MICROMUSE INC.

                                    SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, on August 14, 2000.

                                       MICROMUSE INC.
                                       (Registrant)


                                       By: /s/ STEPHEN A. ALLOTT
                                       -----------------------------------------
                                       Stephen A. Allott

                                       Director, President and Chief Financial
                                       Officer (Principal Financial Officer and
                                       Duly Authorized Officer)


                                       30