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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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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, 2003                                               
|                                                                                           
|o 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 incorporation or organization) |  | (IRS Employer Identification No.)
|                                                               |  |                                  

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 o
|----- | ----

Indicate by check mark whether the registrant is
an accelerated filer (as defined in rule 12b-2 of the Exchange Act).

|Yes o | No x
|----- | ----

77,420,383  shares of Common
Stock, $0.01 par value, were outstanding as of July 31, 2003

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##### Table of Contents

MICROMUSE INC.

TABLE OF CONTENTS

|                               |                                                                                                            | Page
|------------------------------ | ---------------------------------------------------------------------------------------------------------- | ----
|                               |                                                                                                            |     
|PART I - Financial Information |                                                                                                           
|                               |                                                                                                           
|Item 1.                        | Condensed Consolidated Financial Statements (Unaudited):                                                   |     
|                               |                                                                                                            |     
|                               | Condensed Consolidated Balance Sheets as of June 30, 2003 and September 30, 2002                           | 3   
|                               |                                                                                                            |     
|                               | Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2003 and 2002 | 4   
|                               |                                                                                                            |     
|                               | Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2003 and 2002           | 5   
|                               |                                                                                                            |     
|                               | Notes to Condensed Consolidated Financial Statements                                                       | 6   
|                               |                                                                                                            |     
|Item 2.                        | Managements Discussion and Analysis of Financial Condition and Results of Operations                      | 14  
|                               |                                                                                                            |     
|Item 3.                        | Quantitative and Qualitative Disclosures about Market Risk                                                 | 31  
|                               |                                                                                                            |     
|Item 4.                        | Controls and Procedures                                                                                    | 32  
|                               |                                                                                                            |     
|PART II -
Other Information    |                                                                                                           
|                               |                                                                                                           
|Item 1.                        | Legal Proceedings                                                                                          | 33  
|                               |                                                                                                            |     
|Item 2.                        | Changes in Securities and Use of Proceeds                                                                  | 33  
|                               |                                                                                                            |     
|Item 3.                        | Defaults upon Senior Securities                                                                            | 33  
|                               |                                                                                                            |     
|Item 4.                        | Submission of Matters to a Vote of Security Holders                                                        | 33  
|                               |                                                                                                            |     
|Item 5.                        | Other Information                                                                                          | 33  
|                               |                                                                                                            |     
|Item 6.                        | Exhibits and Reports on Form 8-K                                                                           | 34  
|                               |                                                                                                            |     
|Signatures                     | 35                                                                                                        

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MICROMUSE INC.

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

|                                                                                                                                                        |  | June 30, 2003 |         | September 30, 2002 |  
|------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------- | ------------------ | -
|                                                                                                                                                        |  |               |         |                    |  
|ASSETS                                                                                                                                                  |  |               |         |                    |  
|Current assets:                                                                                                                                         |  |               |         |                    |  
|Cash and cash equivalents                                                                                                                               |  | $             | 88,971  |                    | $
|Short-term investments                                                                                                                                  |  |               | 45,957  |                    |  
|Billed receivables, net                                                                                                                                 |  |               | 7,255   |                    |  
|Prepaid expenses and other current assets                                                                                                               |  |               | 5,632   |                    |  
|                                                                                                                                                        |  |               |         |                    |  
|Total current assets                                                                                                                                    |  |               | 147,815 |                    |  
|Property and equipment, net                                                                                                                             |  |               | 6,240   |                    |  
|Long-term investments                                                                                                                                   |  |               | 77,344  |                    |  
|Goodwill and other intangible assets, net                                                                                                               |  |               | 39,196  |                    |  
|                                                                                                                                                        |  |               |         |                    |  
|                                                                                                                                                        |  | $             | 270,595 |                    | $
|                                                                                                                                                        |  |               |         |                    |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                    |  |               |         |                    |  
|Current liabilities:                                                                                                                                    |  |               |         |                    |  
|Accounts payable                                                                                                                                        |  | $             | 4,538   |                    | $
|Accrued expenses                                                                                                                                        |  |               | 21,990  |                    |  
|Income taxes payable                                                                                                                                    |  |               | 6,171   |                    |  
|Deferred revenue                                                                                                                                        |  |               | 46,350  |                    |  
|                                                                                                                                                        |  |               |         |                    |  
|Total current liabilities                                                                                                                               |  |               | 79,049  |                    |  
|Stockholders equity                                                                                                                                    |  |               |         |                    |  
|Preferred stock; $0.01 par value; 5,000 shares authorized no shares issued and outstanding                                                              |  |               |        |                    |  
|Common stock; $0.01 par value; 200,000 shares authorized; 77,174 and 75,194 shares outstanding as of June 30, 2003 and September 30, 2002,
respectively |  |               | 772     |                    |  
|Additional paid-in capital                                                                                                                              |  |               | 204,228 |                    |  
|Treasury stock                                                                                                                                          |  |               | (2,657  | )                  |  
|Accumulated other comprehensive loss                                                                                                                    |  |               | (2,876  | )                  |  
|Accumulated deficit                                                                                                                                     |  |               | (7,921  | )                  |  
|                                                                                                                                                        |  |               |         |                    |  
|Total stockholders equity                                                                                                                              |  |               | 191,546 |                    |  
|                                                                                                                                                        |  |               |         |                    |  
|                                                                                                                                                        |  | $             | 270,595 |                    | $
|                                                                                                                                                        |  |               |         |                    |  

See accompanying notes to the condensed consolidated financial statements

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MICROMUSE INC.

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

|                                                     |  | Three months ended June 30, |        | Nine months ended June 30, |  
|---------------------------------------------------- |  | --------------------------- | ------ | -------------------------- | -
|                                                     |  |                             |        |                            |  
|                                                     |  | 2003                        |        | 2002                       |  
|                                                     |  |                             |        |                            |  
|Revenues:                                            |  |                             |        |                            |  
|License                                              |  | $                           | 18,443 |                            | $
|Maintenance and services                             |  |                             | 14,567 |                            |  
|                                                     |  |                             |        |                            |  
|Total revenues                                       |  |                             | 33,010 |                            |  
|                                                     |  |                             |        |                            |  
|Cost of revenues:                                    |  |                             |        |                            |  
|License                                              |  |                             | 1,476  |                            |  
|Maintenance and services                             |  |                             | 3,160  |                            |  
|                                                     |  |                             |        |                            |  
|Total cost of revenues                               |  |                             | 4,636  |                            |  
|                                                     |  |                             |        |                            |  
|Gross profit                                         |  |                             | 28,374 |                            |  
|                                                     |  |                             |        |                            |  
|Operating expenses:                                  |  |                             |        |                            |  
|Sales and marketing                                  |  |                             | 14,565 |                            |  
|Research and development                             |  |                             | 7,553  |                            |  
|General and administrative                           |  |                             | 4,003  |                            |  
|Amortization of goodwill and other intangible assets |  |                             | 1,311  |                            |  
|Purchased in process research and development        |  |                             |       |                            |  
|Restructuring costs                                  |  |                             | 1,686  |                            |  
|Executive recruiting costs                           |  |                             |       |                            |  
|                                                     |  |                             |        |                            |  
|Total operating expenses                             |  |                             | 29,118 |                            |  
|                                                     |  |                             |        |                            |  
|Loss from operations                                 |  |                             | (744   | )                          |  
|Other income, net                                    |  |                             | 1,023  |                            |  
|                                                     |  |                             |        |                            |  
|Income (loss) before income taxes                    |  |                             | 279    |                            |  
|Income tax provision (benefit)                       |  |                             | (150   | )                          |  
|                                                     |  |                             |        |                            |  
|Net income (loss)                                    |  | $                           | 429    |                            | $
|                                                     |  |                             |        |                            |  
|Per share data:                                      |  |                             |        |                            |  
|Basic net income (loss)                              |  | $                           | 0.01   |                            | $
|Diluted net income (loss)                            |  | $                           | 0.01   |                            | $
|Weighted average shares used in computing:           |  |                             |        |                            |  
|Basic net income (loss) per share                    |  |                             | 76,635 |                            |  
|Diluted net income (loss) per share                  |  |                             | 80,087 |                            |  

See accompanying notes to the condensed consolidated financial
statements

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MICROMUSE INC.

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

|                                                                                         |  | Nine months ended June 30, |        
|---------------------------------------------------------------------------------------- |  | -------------------------- | -------
|                                                                                         |  |                            |        
|                                                                                         |  | 2003                       |        
|                                                                                         |  |                            |        
|Cash flows from operating activities:                                                    |  |                            |        
|Net income (loss)                                                                        |  | $                          | (5,905 
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |  |                            |        
|Depreciation and amortization                                                            |  |                            | 9,330  
|Purchased in process research & development                                              |  |                            | 142    
|Non-cash compensation expense related to restructuring                                   |  |                            | 54     
|Non-cash compensation expense related to issuance of warrant                             |  |                            |       
|Tax benefit related to exercise of stock options                                         |  |                            | 427    
|Changes in operating assets and liabilities net of acquired amounts:                     |  |                            |        
|Billed receivables, net                                                                  |  |                            | 11,465 
|Prepaid expenses and other current assets                                                |  |                            | 335    
|Accounts payable                                                                         |  |                            | 2,075  
|Accrued expenses                                                                         |  |                            | (3,883 
|Income taxes payable                                                                     |  |                            | (493   
|Deferred revenue                                                                         |  |                            | 8,867  
|                                                                                         |  |                            |        
|Net cash provided by operating activities                                                |  |                            | 22,414 
|                                                                                         |  |                            |        
|Cash flows from investing activities:                                                    |  |                            |        
|Capital expenditures                                                                     |  |                            | (1,004 
|Investment purchases, net                                                                |  |                            | (52,880
|Acquisition of net assets, net of cash acquired                                          |  |                            | (2,597 
|                                                                                         |  |                            |        
|Cash used in investing activities                                                        |  |                            | (56,481
|                                                                                         |  |                            |        
|Cash flows from financing activities:                                                    |  |                            |        
|Proceeds from issuance of common stock                                                   |  |                            | 7,719  
|                                                                                         |  |                            |        
|Net cash provided by financing activities                                                |  |                            | 7,719  
|                                                                                         |  |                            |        
|Effects of exchange rate changes on cash and cash equivalents                            |  |                            | (1,899 
|                                                                                         |  |                            |        
|Net decrease in cash and cash equivalents                                                |  |                            | (28,247
|Cash and cash equivalents at beginning of period                                         |  |                            | 117,218
|                                                                                         |  |                            |        
|Cash and cash equivalents at end of period                                               |  | $                          | 88,971 
|                                                                                         |  |                            |        

See accompanying notes to the condensed consolidated financial statements

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MICROMUSE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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 consolidated financial statements and notes
thereto included in the Companys Form 10-K as filed with the Securities and Exchange Commission on December 23, 2002.  The September 30, 2002, condensed 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 EstimatesThe preparation of condensed consolidated financial
statements in conformity with accounting principles generally accepted in the United States of America 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 EquivalentsThe Company considers all highly liquid instruments with an original maturity of three months or less to be cash equivalents.

Earnings Per
ShareBasic 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 number of common shares outstanding during the
period and, when dilutive, the weighted-average number of potential common shares from the exercise of outstanding options and warrants to purchase common stock using the treasury stock method. Excluded from the computation of diluted loss per share
for the quarter ended June 30, 2002, and the nine months ended June 30, 2003, were options to acquire 12.6 million and 12.4 million shares of common stock, respectively, and a warrant to acquire 54,321 shares of common stock at $5.42 per share
because their effect would be anti-dilutive. Excluded from the computation of diluted earnings per share for the quarter ended June 30, 2003, and the nine months ended June 30, 2002, were options to acquire 3.7 million and 5.5 million shares of
common stock, respectively. A reconciliation of the numerators and denominators used in the basic and diluted net income per share amounts follows (in thousands):

|                                                                                        |  | Three months ended June 30, |        | Nine months ended June 30, |  
|--------------------------------------------------------------------------------------- |  | --------------------------- | ------ | -------------------------- | -
|                                                                                        |  |                             |        |                            |  
|                                                                                        |  | 2003                        |        | 2002                       |  
|                                                                                        |  |                             |        |                            |  
|Numerator for basic and diluted net income (loss)                                       |  | $                           | 429    |                            | $
|                                                                                        |  |                             |        |                            |  
|Denominator for basic net income (loss) per share  weighted-average shares outstanding |  |                             | 76,635 |                            |  
|Dilutive effect of:                                                                     |  |                             |        |                            |  
|Common stock options                                                                    |  |                             | 3,398  |                            |  
|Warrants                                                                                |  |                             | 54     |                            |  
|                                                                                        |  |                             |        |                            |  
|Denominator for diluted net income (loss) per share                                     |  |                             | 80,087 |                            |  
|                                                                                        |  |                             |        |                            |  

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MICROMUSE INC.

Concentration of RevenuesOne third-party distributor customer accounted
for approximately 19% and 29% of revenues for the quarter and nine months ended June 30, 2003, and 16% for the nine months ended June 30, 2002. Another third party distributor customer accounted for 13% of revenue for the quarter ended June 30,
2002.  One end-user customer accounted for 13% of revenues for the nine months ended June 30, 2003.  No one end-user customer accounted for greater than 10% of revenues for the quarters ended June 30, 2003 and 2002 and the nine months
ended June 30, 2002.

Billed ReceivablesBilled receivables includes an allowance for doubtful accounts of $2.4 million and $3.7 million as of June 30, 2003 and September 30, 2002,
respectively.

Accumulated Other Comprehensive LossThe only component of accumulated other comprehensive loss is net foreign currency translation adjustments. Other comprehensive loss,
net of tax, for the quarter ended June 30, 2003, was $1.0 million, as compared to income of $0.1 million for the quarter ended June 30, 2002. Other comprehensive loss, net of tax, for the nine months ended June 30, 2003 and 2002, was $2.0 million
and $0.9 million, respectively.

Stock-Based CompensationAt June 30, 2003, the Company had two stock-based employee compensation plans, which are described more fully in the notes
included in the Form 10-K as filed with the Securities Exchange Commission on December 23, 2002.  The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of
the grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based
employee compensation.

|                                        |  | Three months endedJune 30, |        | Nine months ended  June 30, |     
|--------------------------------------- |  | -------------------------- | ------ | --------------------------- | ----
|                                        |  |                            |        |                             |     
|                                        |  | 2003                       |        |                             | 2002
|                                        |  |                            |        |                             |     
|Net income (loss), as reported          |  | $                          | 429    |                             | $   
|Less:  Compensation expense, net of tax |  |                            | 7,371  |                             |     
|                                        |  |                            |        |                             |     
|Adjusted net loss                       |  | $                          | (6,942 | )                           | $   
|                                        |  |                            |        |                             |     
|Net income (loss) per share:            |  |                            |        |                             |     
|Basic  as reported                     |  | $                          | 0.01   |                             | $   
|Basic  as adjusted                     |  | $                          | (0.09  | )                           | $   
|Diluted  as reported                   |  | $                          | 0.01   |                             | $   
|Diluted  as adjusted                   |  | $                          | (0.09  | )                           | $   

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MICROMUSE INC.

Geographic and Segment InformationThe 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 accompanied by certain geographic information for purposes of making
operating decisions and assessing financial performance.  Therefore, the Company operates as a single operating segment: service and business assurance software.

The Company markets its
products primarily from the United States. International sales are primarily to customers in the United Kingdom and continental Europe. Information regarding regional revenues, which are based on the location of the end-user, and operations in
different geographic regions is as follows (in thousands):

|                     |  | Three months ended June 30, |        | Nine months ended June 30, |  
|-------------------- |  | --------------------------- | ------ | -------------------------- | -
|                     |  |                             |        |                            |  
|                     |  | 2003                        |        | 2002                       |  
|                     |  |                             |        |                            |  
|Revenues:            |  |                             |        |                            |  
|United States        |  | $                           | 19,386 |                            | $
|United Kingdom       |  |                             | 2,892  |                            |  
|Other international  |  |                             | 10,732 |                            |  
|                     |  |                             |        |                            |  
|Total                |  | $                           | 33,010 |                            | $
|                     |  |                             |        |                            |  
|                     |  |                             |        |                            |  
|                     |  | June 30, 2003               |        | September 30, 2002         |  
|                     |  |                             |        |                            |  
|Long - lived assets: |  |                             |        |                            |  
|United States        |  | $                           | 28,302 |                            | $
|International        |  |                             | 17,134 |                            |  
|                     |  |                             |        |                            |  
|Total                |  | $                           | 45,436 |                            | $
|                     |  |                             |        |                            |  

Recent Accounting PronouncementsIn July 2001, the Financial Accounting Standards Board (FASB)
issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 addresses financial accounting and reporting for acquired goodwill and other intangible assets. SFAS No. 142 changes the accounting for goodwill from an amortization
method to an impairment-only approach. Goodwill is now tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. Amortization of goodwill recorded for business combinations consummated prior to July 1,
2001 ceased, and intangible assets acquired prior to July 1, 2001 that do not meet the criteria for recognition under SFAS No. 141, Business Combinations, were reclassified to goodwill. The Company adopted SFAS No. 142 on October 1, 2002.
Upon adoption, approximately $16.3 million of goodwill was no longer amortized but is tested annually for impairment. In the quarter ended March 31, 2003, the Company performed its transitional goodwill impairment test required under SFAS No. 142
and concluded no goodwill was impaired on adoption.

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MICROMUSE INC.

The following table sets forth the carrying amount of goodwill as of June 30,
2003.  Goodwill also includes amounts originally allocated to assembled workforce (in thousands):

|         |  | June 30, 2003         |       
|-------- |  | --------------------- | ------
|         |  |                       |       
|         |  | Gross Carrying Amount |       
|         |  |                       |       
|Goodwill |  | $                     | 49,262
|         |  |                       |       

The following tables set forth the carrying amount of other intangibles assets that will continue to be
amortized (in thousands):

|                                             |  | June 30, 2003         |       
|-------------------------------------------- |  | --------------------- | ------
|                                             |  |                       |       
|                                             |  | Gross Carrying Amount |       
|                                             |  |                       |       
|Developed technology                         |  | $                     | 18,013
|Customer Contracts                           |  |                       | 1,076 
|Trademarks                                   |  |                       | 807   
|Other intangible assets                      |  |                       | 809   
|                                             |  |                       |       
|Intangibles related to business acquisitions |  | $                     | 20,705
|                                             |  |                       |       

The total amortization expense related to goodwill and other intangible assets is set forth in the table
below (in thousands):

|                        |  | Three months ended June 30, |       | Nine months ended June 30, |  
|----------------------- |  | --------------------------- | ----- | -------------------------- | -
|                        |  |                             |       |                            |  
|                        |  | 2003                        |       | 2002                       |  
|                        |  |                             |       |                            |  
|Goodwill                |  | $                           |      |                            | $
|Developed technology    |  |                             | 1,123 |                            |  
|Customer contracts      |  |                             | 82    |                            |  
|Trademarks              |  |                             | 42    |                            |  
|Other intangible assets |  |                             | 64    |                            |  
|                        |  |                             |       |                            |  
|Total amortization      |  |                             | 1,311 |                            |  
|                        |  |                             |       |                            |  

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MICROMUSE INC.

The total expected future amortization related to other intangible assets is set
forth in the table below (in thousands):

|Year  |  | Future Amortizations |      
|----- |  | -------------------- | -----
|      |  |                      |      
|2003  |  | $                    | 1,161
|2004  |  |                      | 4,518
|2005  |  |                      | 2,174
|      |  |                      |      
|Total |  | $                    | 7,853
|      |  |                      |      

Summarized below are the effects on net income (loss) and net income (loss) per share data, if the
Company had followed the provisions of SFAS No. 142 for all periods presented (in thousands, except per share amounts):

|                                                                                                  |  | Three months ended  June 30, |        | Nine months ended  June 30, |  
|------------------------------------------------------------------------------------------------- |  | ---------------------------- | ------ | --------------------------- | -
|                                                                                                  |  |                              |        |                             |  
|                                                                                                  |  | 2003                         |        | 2002                        |  
|                                                                                                  |  |                              |        |                             |  
|Net income (loss)  as reported                                                                   |  | $                            | 429    |                             | $
|Adjustments:                                                                                      |  |                              |        |                             |  
|Amortization of goodwill                                                                          |  |                              |       |                             |  
|Amortization of assembled workforce                                                               |  |                              |       |                             |  
|                                                                                                  |  |                              |        |                             |  
|Net adjustments                                                                                   |  |                              |       |                             |  
|                                                                                                  |  |                              |        |                             |  
|Net income (loss)  as adjusted                                                                   |  | $                            | 429    |                             | $
|                                                                                                  |  |                              |        |                             |  
|Basic and diluted net income (loss) per common share  as reported                                |  | $                            | 0.01   |                             | $
|Basic net income (loss) per common share  as adjusted                                            |  | $                            | 0.01   |                             | $
|Diluted net income (loss) per common share  as adjusted                                          |  | $                            | 0.01   |                             | $
|Weighted average common shares outstanding used in calculating net income (loss) per common share |  |                              |        |                             |  
|Basic                                                                                             |  |                              | 76,635 |                             |  
|Diluted                                                                                           |  |                              | 80,087 |                             |  

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
Activities. This statement addresses financial accounting and reporting costs associated with exit or disposal activities. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The effect
of adopting SFAS No. 146 is that it may affect the timing of recognizing any future restructuring costs as well as amounts recognized. As of June 30, 2003, the Company does not have any exit or disposal activities as defined under SFAS No. 146 that
were initiated after the effective date.

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MICROMUSE INC.

In November 2002, the FASB issued FASB Interpretation No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which clarifies disclosure and recognition/measurement requirements related to certain guarantees. The disclosure requirements are
effective for financial statements issued after December 15, 2002 and the recognition/measurement requirements are effective on a prospective basis for guarantees issued or modified after December 31, 2002. As of June 30, 2003, the Company does not
have any guarantees as defined under FASB Interpretation No. 45.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities(FIN No. 46).  A
variable interest entity is a corporation, partnership, trust, or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient
financial resources for the entity to support its activities.  FIN No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entitys
activities or is entitled to receive a majority of the entitys residual returns or both.  The consolidation requirements of FIN No. 46 apply immediately to variable interest entities created after January 31, 2003.  The consolidation
requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003.  Disclosure requirements apply to any financial statements issued after January 31, 2003.  The adoption of FIN No. 46 did not
have an effect on its consolidated financial position, results of operations, or cash flows.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative
Instruments and Hedging Activities, which amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 149 is generally effective for derivative instruments, including derivative instruments embedded in certain contracts, entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003.  The Company does not expect the adoption of SFAS No. 149 to have a material impact on its consolidated financial position, results of operations, or cash flows.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, which establishes standards on how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.  Disclosure requirements are effective for financial instruments entered into or modified after May 31, 2003, and otherwise shall be effective at the beginning of the
first interim period beginning after June 15, 2003.  As of June 30, 2003, the Company does not have any financial instruments as defined under SFAS No. 150.

Note 2. 
Acquisitions

On December 19, 2002, the Company acquired all of the outstanding common stock of Lumos Technologies Inc. (Lumos), a privately-held developer of sophisticated
technology for managing Layer 1 networks. By integrating their capabilities with existing Netcool applications, the Company will be able to deliver comprehensive Layer 1 network visibility, event correlation, and problem resolution to current and
future users of the Netcool suite. Under the terms of the acquisition agreement, the Company will pay up to $2.7 million in cash and has assumed $0.9 million in outstanding debt. Approximately $1.0 million of the cash purchase price was paid at
closing, with the remainder payable in connection with certain earnouts in relation to revenue, development and employee retention goals, until the quarter ending December 31, 2003. The transaction was accounted for under the purchase method of
accounting with Lumos results of operations included from the acquisition date.

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A summary of the allocation of the initial purchase price plus the earnouts to date
is as follows (in millions):

|Total tangible liabilities, net     |  | $ | (1.3 | )
|----------------------------------- |  | - | ---- | -
|Intangible assets:                  |  |   |      |  
|In process research and development |  |   | 0.1  |  
|Developed technology                |  |   | 1.2  |  
|Customer contracts                  |  |   | 0.2  |  
|Goodwill                            |  |   | 1.3  |  
|                                    |  |   |      |  
|Total intangible assets             |  |   | 2.8  |  
|                                    |  |   |      |  
|Total                               |  | $ | 1.5  |  
|                                    |  |   |      |  

At the time of the acquisition, the estimated aggregate fair value of Lumos 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 $0.1 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, will be tested annually for impairment or whenever events or circumstances occur indicating the
goodwill might be impaired. Identifiable intangible assets will be amortized on a straight line basis over a period ranging from six months to two years.

The following summary, unaudited and
prepared on a pro forma basis, combines the Companys consolidated results of operations with Lumos results of operations, 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 amounts):

|                                      |  | Three months ended  June 30, |        | Nine months ended  June 30, |  
|------------------------------------- |  | ---------------------------- | ------ | --------------------------- | -
|                                      |  |                              |        |                             |  
|                                      |  | 2003                         |        | 2002                        |  
|                                      |  |                              |        |                             |  
|Revenues                              |  | $                            | 33,010 |                             | $
|Net income (loss)                     |  | $                            | 726    |                             | $
|Net income (loss) per share:          |  |                              |        |                             |  
|Basic                                 |  | $                            | 0.01   |                             | $
|Diluted                               |  | $                            | 0.01   |                             | $
|Shares used in per share computation: |  |                              |        |                             |  
|Basic                                 |  |                              | 76,635 |                             |  
|Diluted                               |  |                              | 80,087 |                             |  

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Note 3. Restructuring Costs

As a result of the Companys change in strategy and its desire to improve its cost structure and profitability, the Company announced and implemented two separate restructuring plans.

The fiscal 2002 restructuring plan, which was announced during the quarter ended September 30, 2002, resulted in a decrease of the Companys workforce by 85 employees and the elimination of excess facilities. In
connection with implementation of the restructuring plan, the Company incurred restructuring charges of $4.2 million in the quarter ended September 30, 2002. In the quarter ended June 30, 2003, an additional restructuring charge of $1.7 million was
incurred due to an adjustment of assumptions on property leases relating to the fiscal 2002 restructuring plan. The Company determined that it would not be able to sub-lease some of the excess facilities that it had expected to sub-lease when
calculating the original restructuring charge.

The fiscal 2003 restructuring plan, which was announced during the quarter ended December 31, 2002, resulted in a decrease of the
Companys workforce by 117 employees and total restructuring charges of $3.3 million, relating to severance and employment related charges.

Severance and employment-related charges consist
primarily of severance, health benefits, other termination costs and legal expenses as a result of the termination of employees. Severance and employment related charges could be higher than the Company has estimated should there be additional
arbitration and legal proceedings. The total severance accrual balance of $1.0 million as of June 30, 2003 is expected to be paid by December 31, 2003.

Facility costs primarily represent closure
and downsizing costs related to offices in Europe and North America that were vacated as part of the fiscal 2002 restructuring program. Closure and downsizing costs include payments required under lease contracts, after the properties were
abandoned, less any applicable estimated sublease income during the period after abandonment. To determine the lease loss portion of the closure and downsizing costs, certain estimates were made related to the (1) time period over which the relevant
building would remain vacant, (2) sublease terms, and (3) sublease rates, including common area charges. The lease loss accrual is an estimate and will be adjusted in the future upon triggering events (such as changes in estimates of time to
sublease and actual sublease rates). As of June 30, 2003, the remaining $1.9 million accrual of lease termination costs, net of estimated sublease income, is expected to be paid on various dates through December 2005.

The following table sets forth the restructuring activity for the nine months ended June 30, 2003 (in thousands):

|                                                      |  | Fiscal 2002 Restructuring Plan |       | Fiscal 2003 Restructuring Plan |   |          
|----------------------------------------------------- |  | ------------------------------ | ----- | ------------------------------ | - | ---------
|                                                      |  |                                |       |                                |   |          
|                                                      |  | Facility                       |       | Severance                      |   | Severance
|                                                      |  |                                |       |                                |   |          
|Accrual balance at September 30, 2002                 |  | $                              | 971   |                                | $ | 1,447    
|Restructuring charges                                 |  |                                | 1,655 |                                |   |         
|Cash paid during the nine months ended June 30, 2003: |  |                                | 713   |                                |   | 1,037    
|                                                      |  |                                |       |                                |   |          
|Accrual balance at June 30, 2003                      |  | $                              | 1,913 |                                | $ | 410      
|                                                      |  |                                |       |                                |   |          

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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 Form 10-K as filed with the Securities and Exchange Commission on December 23, 2002.

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 below and elsewhere in this Quarterly Report, and other Micromuse filings with the Securities and Exchange Commission.

OverviewMicromuse Inc. develops, markets and supports a family of scalable, highly configurable, rapidly deployable software solutions that enable realtime fault management and service assurance  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 Limited (formerly known as 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 Ltd, 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.

Recent EventsOn July 29, 2003, the Company announced that Lloyd A. Carney was appointed Chairman of the Board of Directors and Chief Executive Officer of the Company.  Coincident with
this announcement, it was announced that David Schwab, an independent member of the Board of Directors since prior to the Companys Initial Public Offering, would function as the lead independent director on the Board of Directors, and Michael
Luetkemeyer will continue as a member of the Board and the Companys Senior Vice President and Chief Financial Officer.

Critical Accounting Policies and EstimatesOur
discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.
The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an
on-going basis, we evaluate our estimates, including, but not limited to, revenue recognition, bad debts, warranty obligations, investments, intangible assets, income taxes, contingencies and litigation. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following are the critical accounting policies and estimates that are used in
the preparation of our consolidated financial statements:

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Revenue Recognition. Our revenues are derived from license revenues for our
Netcool family of products, as well as associated maintenance, consulting and training services revenues.  We recognize revenue in accordance with Statement of Position 97-2, Software Revenue Recognition (SOP 97-2), as amended by SOP
98-9, and recognize revenue using the residual method. Under the residual method, revenue is recognized when vendor specific objective evidence of fair value exists for all of the undelivered elements in the arrangement (i.e., maintenance and
professional services), but does not exist for one or more of the delivered elements in the arrangement (i.e., the software product). We allocate revenue to each undelivered element based on its respective fair value, with the fair value determined
by the price charged when that element is sold separately. We determine the fair value of the maintenance portion of the arrangement to be based on the renewal price charged to the customer when maintenance is sold separately or the option price for
annual maintenance renewals included in the underlying customer contracts. The fair value of the professional services portion of the arrangement is based on the daily rates that we charge for these services when sold independently from a software
license. At the outset of the arrangement with the customer, we defer revenue for the fair value of the undelivered elements and recognize revenue for the delivered elements when the basic criteria of SOP 97-2 have been met. If evidence of fair
value cannot be established for the undelivered elements of a license agreement, the entire amount of revenue from the arrangement is deferred and recognized over the period that these elements are delivered.

For all of our software arrangements, we defer revenue for the fair value of the undelivered elements and recognize revenue for the delivered elements when the basic criteria of SOP 97-2 have been met - (1) persuasive evidence
of an arrangement exists, (2) delivery has occurred, (3) the vendors fee is fixed or determinable and (4) collectibility is probable.  We evaluate each as follows:

| | Persuasive evidence of an arrangement exists:  For license arrangements with end-users, an arrangement is evidenced by a written contract, which is signed by both the
customer and us, or a purchase order from those customers who have previously negotiated a standard license arrangement with us.  Sales to our resellers are evidenced by a master agreement governing the relationship together with a purchase
order on a transaction-by-transaction basis. For certain of our OEM arrangements, an arrangement is evidenced on receipt of a delivery notification to the end user.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Delivery has occurred: Delivery is considered to have occurred when media containing the licensed programs is provided to a common carrier or, in the case of electronic delivery, the
customer is given access to the licensed programs.  In the case of arrangements with resellers and OEMs, revenue is recognized upon sell-through.  Evidence of sell-through usually comes in the form of a purchase order or contract
identifying the end-user and sell-through shipping reports, usually identifying the ship to location.                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Fixed or determinable fee: We consider the fee to be fixed or determinable if the fee is not subject to refund or adjustment. If the arrangement fee is not fixed or determinable, we
recognize the revenue as amounts become due and payable.                                                                                                                                                                                                                                                                                                                                              
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | Collection is probable: We conduct a credit review for all significant transactions at the time of the arrangement to determine the creditworthiness of the customer. Collection is deemed
probable if we expect that the customer will be able to pay amounts under the arrangement as payments become due. If we determine that collection is not probable, we defer the revenue and recognize the revenue upon cash collection.                                                                                                                                                          

Maintenance revenues from ongoing customer support and product upgrades are deferred and recognized ratably over the term of the maintenance agreement, typically 12 months. Payments for
maintenance fees (on initial order or on renewal) are generally made in advance and are nonrefundable. Revenues for professional services are recognized as the services are performed. Professional services generally are not essential to the
functionality of the software.  Our software products are fully functional upon delivery and do not require any significant modification or alteration.

Deferred revenue includes revenue not
yet recognized as a result of deferred maintenance, professional services not yet rendered and license revenue deferred until all the requirements of SOP 97-2 are met.

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Allowance for Doubtful Accounts.We regularly review the adequacy of our
allowance for doubtful accounts after considering the components of the accounts receivable aging, the age of each invoice, each customers expected ability to pay and our collection history with each customer. We review any invoice greater
than 30 days past due to determine if an allowance is appropriate based on its risk category. In addition, we maintain a general reserve for all invoices by applying a percentage based on each 30-day aged category. In determining these percentages,
we analyze our historical collection experience by region and current economic trends. If the historical data we use to calculate the allowance provided for doubtful accounts does not accurately reflect the future ability to collect outstanding
receivables, additional provisions for doubtful accounts may be needed and the future results of operations could be materially affected. However, historically the reserve has proven to be adequate.

Circumstances that have caused revisions to the allowance calculation have been primarily due to the contraction of the overall economy. Continued deterioration in the economy may result in more customers being placed in the
specific account reserve category, thereby increasing our reserve estimate and negatively impacting operating results.

Impairment Assessments. We perform an impairment assessment of
goodwill and other intangible assets whenever events or changes in circumstances indicate that the carrying value of goodwill and other intangible assets may not be recoverable. Significant changes in circumstances can be both internal to our
strategic and financial direction, as well as changes to the competitive and economic landscape. Changes in circumstances that are considered important for asset impairment include, but are not limited to, decrease in our market capitalization,
contraction of the telecommunications industry, reduction or elimination of geographic economic growth, reductions in our forecasted growth and significant changes to operating costs.

As part of
our impairment assessment, we examine economic conditions, products, customer base and geography. Based on these criteria, we determine which products we will continue to support and sell and, thereby, determine which assets will continue to have
future strategic value and benefit. We then estimate the value of the goodwill based on the sum of the expected future cash flows expected to result from the use of the assets and their eventual disposition.

Restructuring-related Assessments. Our critical accounting policy and judgment as it relates to restructuring-related assessments includes our estimate of facility costs and severance-related costs. To determine the
facility costs, which is the loss after our cost recovery efforts from subleasing a building, certain estimates were made related to the (1) time period over which the relevant building would remain vacant, (2) sublease terms, and (3) sublease
rates, including common area charges.  The lease loss is an estimate and represents the low end of the range.  In the quarter ended September 30, 2002, the fiscal 2002 restucturing plan resulted in the elimination of excess
facilities.  In the quarter ended June 30, 2003, an additional restructuring charge of $1.7 million was incurred due to an adjustment of assumptions on property leases relating to the fiscal 2002 restructuring plan.  To determine the
severance and employment-related charges, we have made certain estimates as they relate to severance benefits including the remaining time employees will be retained, the estimated severance period, health benefits and other termination costs as
well as the estimated legal costs. Severance and employment-related charges for the fiscal 2003 restructuring plan could be higher than we have estimated should there be additional arbitration and legal proceedings.

Pro Forma Financial ResultsWe prepare and release quarterly unaudited financial statements prepared in accordance with generally accepted accounting principles (GAAP). We also disclose and discuss
certain pro forma financial information in the related earnings release and investor conference call. This pro forma financial information excludes certain non-cash and special charges, consisting primarily of the amortization and impairment of
goodwill and other intangible assets, purchased in process research and development, restructuring costs and executive recruiting costs. However, we urge investors to carefully review the GAAP financial information included as part of our Quarterly
Reports on Form 10-Q, our Annual Reports on Form 10-K, and our quarterly earnings releases.

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

|                                                     |  | Three months ended June 30, |       | Nine months ended June 30, | 
|---------------------------------------------------- |  | --------------------------- | ----- | -------------------------- | 
|                                                     |  |                             |       |                            | 
|                                                     |  | 2003                        |       | 2002                       | 
|                                                     |  |                             |       |                            | 
|As a Percentage of Total Revenues:                   |  |                             |       |                            | 
|Revenues:                                            |  |                             |       |                            | 
|License                                              |  |                             | 55.9  | %                          | 
|Maintenance and services                             |  |                             | 44.1  | %                          | 
|                                                     |  |                             |       |                            | 
|Total revenues                                       |  |                             | 100.0 | %                          | 
|                                                     |  |                             |       |                            | 
|Cost of revenues:                                    |  |                             |       |                            | 
|License                                              |  |                             | 4.5   | %                          | 
|Maintenance and services                             |  |                             | 9.6   | %                          | 
|                                                     |  |                             |       |                            | 
|Total cost of revenues                               |  |                             | 14.1  | %                          | 
|                                                     |  |                             |       |                            | 
|Gross profit                                         |  |                             | 85.9  | %                          | 
|                                                     |  |                             |       |                            | 
|Operating expenses:                                  |  |                             |       |                            | 
|Sales and marketing                                  |  |                             | 44.1  | %                          | 
|Research and development                             |  |                             | 22.9  | %                          | 
|General and administrative                           |  |                             | 12.1  | %                          | 
|Amortization of goodwill and other intangible assets |  |                             | 4.0   | %                          | 
|Purchased in process research and development        |  |                             | 0.0   | %                          | 
|Restructuring costs                                  |  |                             | 5.1   | %                          | 
|Executive recruiting costs                           |  |                             | 0.0   | %                          | 
|                                                     |  |                             |       |                            | 
|Total operating expenses                             |  |                             | 88.2  | %                          | 
|                                                     |  |                             |       |                            | 
|Loss from operations                                 |  |                             | (2.3  | )%                         | 
|Other income, net                                    |  |                             | 3.1   | %                          | 
|                                                     |  |                             |       |                            | 
|Income (loss) before income taxes                    |  |                             | 0.8   | %                          | 
|Income tax provision (benefit)                       |  |                             | (0.5  | )%                         | 
|                                                     |  |                             |       |                            | 
|Net income (loss)                                    |  |                             | 1.3   | %                          | 
|                                                     |  |                             |       |                            | 
|As a Percentage of Related Revenues:                 |  |                             |       |                            | 
|Cost of license revenues                             |  |                             | 8.0   | %                          | 
|Cost of maintenance and services revenues            |  |                             | 21.7  | %                          | 

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Revenues.Revenues decreased to $33.0 million and $92.1 million in the quarter
and nine months ended June 30, 2003, from $35.0 million and $114.1 million in the comparable periods of the prior year. License revenues decreased to $18.4 million and $50.5 million in the quarter and nine months ended June 30, 2003, from $20.1
million and $67.9 million in the comparable periods of the prior year. The decline in license revenues was primarily due to the current economic slowdown that is limiting the overall capital spending of our existing and potential customers.
Maintenance and services revenues decreased to $14.6 million and $41.7 million in the quarter and nine months ended June 30, 2003, from $15.0 million and $46.2 million in the comparable periods of the prior year. The decrease in maintenance and
services revenues was a result of the related decrease in license revenue and lower overall services revenue. License revenues as a percentage of total revenues was 55.9% and 54.8% in the quarter and nine months ended June 30, 2003, as compared to
57.3% and 59.5% in the comparable periods of the prior year.

One third-party distributor customer accounted for approximately 19% and 29% of revenues for the quarter and nine months ended June 30,
2003, and 16% for the nine months ended June 30, 2002. Another third party distributor customer accounted for 13% of revenue for the quarter ended June 30, 2002.  One end-user customer accounted for 13% of revenues for the nine months ended
June 30, 2003.  No one end-user customer accounted for greater than 10% of revenues for the quarters ended June 30, 2003 and 2002 and the nine months ended June 30, 2002.

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 8.0% and 8.5% in the
quarter and nine months ended June 30, 2003, as compared to 7.8% and 6.9% in the comparable periods of the prior year. The increase was mainly due to a change in the mix of license revenue in the current quarter and nine months ended June 30, 2003.
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 21.7% and 22.5% in the quarter and nine months ended June 30, 2003, from 27.6% and 30.2% in the comparable periods of the prior year. This improvement was principally due to a proportionally greater percentage of
higher-margin maintenance revenues over services revenue in addition to economies of scale, and the decrease in headcount, facilities, and travel costs.

Sales and Marketing Expenses. Sales
and marketing expenses decreased to $14.6 million and $43.5 million in the quarter and nine months ended June 30, 2003, from $17.9 million and $54.0 million in the comparable periods of the prior year. This decrease was primarily due to the decrease
in sales commission as a result of the related decrease in revenue and a decrease in personnel related costs as a result of lower headcount and travel expenditures. Sales and marketing expenses as a percentage of total revenues decreased to 44.1%
from 51.0% in the quarter ended June 30, 2003 and 2002, respectively, and decreased to 47.2% from 47.4% in the nine months ended June 30, 2003 and 2002, respectively.

Research and Development
Expenses. Research and development expenses decreased to $7.6 million and $22.1 million in the quarter and nine months ended June 30, 2003, from $8.3 million and $23.9 million in the comparable periods of the prior year. The decrease was
primarily due to the decrease in headcount and travel related expenditures. Research and development costs as a percentage of total revenues decreased to 22.9% and 23.6% in the quarter ended June 30, 2003 and 2002, respectively, and increased to
24.0% from 20.9% in the nine months ended June 30, 2003 and 2002, respectively.

General and Administrative Expenses. General and administrative expenses decreased to $4.0 million and $12.1
million in the quarter and nine months ended June 30, 2003, from $4.1 million and $13.1 million in the comparable periods of the prior year. The decrease in general and administrative expenses was primarily due to lower bad debt expense and a
decrease in headcount, which were partially offset by an increase in professional fees. General and administrative expenses as a percentage of revenues increased to 12.1% and 13.1% in the quarter and nine months ended June 30, 2003, from 11.7% and
11.5% in the comparable periods of the prior year.

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Amortization of Goodwill and Other Intangible Assets.Amortization of goodwill
and other intangible assets decreased to $1.3 million and $4.3 million in the quarter and nine months ended June 30, 2003, from $2.8 million and $8.3 million in the comparable periods of the prior year.  The charges reflect the amortization of
the goodwill and other intangible assets over estimated useful lives of three to five years. The decrease was mainly due to the adoption of SFAS No. 142, which changed the accounting for goodwill from an amortization method to an impairment-only
approach.  If the Company had followed the provisions of SFAS No. 142 in the prior year, the expense would have decreased by $1.9 million and $5.6 million for the quarter and nine months ended June 30, 2002, respectively.

Purchased In Process Research and Development. For each of our acquisitions, we allocated part of the purchase price to developed technology and in process research and development (IPR&D). This allocation
was based on whether or not technological feasibility had been achieved and whether there was an alternative future use for the technology. Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for Costs of Computer Software to be
Sold, Leased or Otherwise Marketed, sets guidelines for establishing technological feasibility. Technological feasibility is determined when a product reaches the working model stage, which is generally when a product is classified
as a beta version release. For the acquisition of Lumos Technologies Inc. in December 2002, we concluded that the purchased IPR&D of $0.1 million had not yet reached technological feasibility and had no alternative use. Therefore, we expensed
these costs at the time of the purchase, according to the provisions of FASB Interpretation No. 4, Applicability of SFAS No. 2 to Business Combinations Accounted for by the Purchase Method.

Restructuring Costs. During the quarter and nine months ended June 30, 2003, we incurred $1.7 million and $5.0 million, respectively, in restructuring costs. (See Restructuring-related Assessment under
Critical Accounting Policies and also Note 3 of Notes to Condensed Consolidated Financial Statements.)

Executive Recruiting Costs. The executive recruiting costs of $0.4 million in the nine
months ended June 30, 2002 are primarily costs incurred in the recruitment of a new Chief Financial Officer. The costs relate to the fair value of a warrant issued to an executive recruiting firm, fees paid to the recruiting firm and certain
relocation costs.

Other Income, Net. Other income decreased to $1.0 million and $3.7 million in the quarter and nine months ended June 30, 2003 and 2002, respectively, from $1.5 million and
$4.4 million in the nine months ended June 30, 2003 and 2002, respectively.  This net decrease was primarily due to the decline in interest rates over the past year.

Provision for Income
Taxes.Income taxes showed a benefit of $0.2 million and a charge of $0.9 million in the quarter and nine months ended June 30, 2003, as compared to a benefit of $1.2 million and a charge of $0.0 million in the comparable periods of the
prior year. The decrease was mainly due to the related decline in taxable income and a decline in projected taxes in fiscal year 2003 from fiscal year 2002.

Liquidity and Capital
ResourcesAs of June 30, 2003, we had $89.0 million in cash and cash equivalents and $123.3 million in marketable securities, as compared to $117.2 million in cash and cash equivalents and $70.4 million in marketable securities as of
September 30, 2002. The net decrease in cash and cash equivalents in the nine months ended June 30, 2003, was due primarily to net loss adjusted for non-cash expenses, the decrease in billed receivables, the decrease in prepaid expenses and other
current assets, the increase in accounts payable, the increase in deferred revenue, and the proceeds from the issuance of common stock. These sources of cash and cash equivalents were partially offset by the purchase of marketable securities,
capital expenditures, the acquisition of Lumos Technologies Inc., the decrease in accrued expenses and the decrease in taxes payable.

As of June 30, 2003, the Companys principal commitments
consisted of obligations under operating leases.

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We believe that our current cash balances and the cash flows generated by operations
will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for the next 12 months. Thereafter, if cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell
additional equity or convertible debt securities or obtain credit facilities. The decision to sell additional equity or debt securities could be made at any time and would likely result in additional dilution to our stockholders. 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.

RISK FACTORS

The following factors, in addition to the other information contained in this
report, should be considered carefully in evaluating the Company and our prospects. This report (including without limitation the following Risk Factors) contains forward-looking statements (within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934) regarding the Company and 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 report. 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 report 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 report. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. 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 report.

Our operating results may vary as a result of the current economic slowdown.

We face uncertainty in the degree to which the current economic slowdown will negatively affect growth and capital spending by our existing and potential customers. We continue to
experience instances of customers delaying or deferring licenses of our software and maintenance agreement, and longer lead times needed to close our customer sales.  In addition, recent political turmoil in many parts of the world, including
terrorist and military actions, may continue to put pressure on global economic conditions. If the economic conditions in the United States and globally do not improve, or if we experience a worsening in the global economic slowdown, we may continue
to experience material adverse impacts on our business, operating results, and financial condition. We may not be able to accurately anticipate the magnitude of these impacts on future quarterly and annual results.

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

Our operating results have in the past, and will continue to be,
subject to quarterly and annual fluctuations. Our quarterly revenues and operating results in geographic 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.

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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, varies 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:

| | changes in the demand for our software products and services and the level of product and price competition that we encounter;                                                                                                                   
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                  
| | the timing of new hires and our ability to attract, retain and motivate qualified personnel, including changes in our sales incentives;                                                                                                          
|  |                                                                                                                                                                                                                                                  
| | 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;                                                                                 
|  |                                                                                                                                                                                                                                                  
| | changes in the mix of, and lack of demand from, distribution channels through which our products are sold;                                                                                                                                       
|  |                                                                                                                                                                                                                                                  
| | the length of our sales cycles and the success of our new customer generation activities;                                                                                                                                                        
|  |                                                                                                                                                                                                                                                  
| | spending patterns and budgetary resources of our customers on network management software solutions;                                                                                                                                             
|  |                                                                                                                                                                                                                                                  
| | 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;                                                                    
|  |                                                                                                                                                                                                                                                  
| | market acceptance of new products;                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                  
| | changes in the renewal rate of maintenance agreements;                                                                                                                                                                                           
|  |                                                                                                                                                                                                                                                  
| | fluctuations in our gross margins;                                                                                                                                                                                                               
|  |                                                                                                                                                                                                                                                  
| | our ability to achieve targeted cost reductions;                                                                                                                                                                                                 
|  |                                                                                                                                                                                                                                                  
| | actual events, circumstances, outcomes and amounts differing from judgments, assumptions and estimates used in determining the value of certain assets, liabilities and other items reflected
in our financial statements;                       
|  |                                                                                                                                                                                                                                                  
| | 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;
|  |                                                                                                                                                                                                                                                  
| | the extent of market consolidation; and                                                                                                                                                                                                          
|  |                                                                                                                                                                                                                                                  
| | software defects and other product quality problems.                                                                                                                                                                                             

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Therefore, operating results for a particular future period are difficult to predict
and prior results are not necessarily indicative of results to be expected in future periods.  Any of the foregoing factors, or others discussed elsewhere herein, could have a material adverse effect on our business, operating results,
financial condition and stock price.

Failure to manage our business may adversely affect our operations.

Over the past few
years, we have added customers, personnel and expanded the scope and geographic area of our operations that has placed and will continue to place a significant strain upon our management and our operating and financial systems and resources.
However, we have reduced our headcount from 660 employees on September 30, 2002 to 538 employees on June 30, 2003, mainly as a result of planned reductions and attrition. Given the uncertainties discussed in this Risk Factors section, together with
factors that might affect our ability to quickly expand or contract our work force around the world, it is difficult to predict future requirements for the number and type of employees in the fields and geographies in which we operate. Failure to
align employee skills and populations with revenue and market requirements would have a material adverse impact on our business and its operating results.

Our restructuring of operations may
not achieve the results we intend and may harm our business.

In the quarters ended September 30, 2002 and December 31, 2002, we initiated plans to streamline operations and reduce
expenses, which included cuts in discretionary spending, reductions in capital expenditures, reductions in the work force and consolidation of certain office locations, as well as other steps to reduce expenses. The implementation of our
restructuring plans has placed, and may continue to place, a significant strain on our managerial, operational, financial, employee and other resources. Additionally, the restructurings may negatively affect our employee turnover as well as
recruiting and retention of important employees. It is possible that these reductions could impair our marketing, sales and customer support efforts or alter our product development plans. If we experience difficulties in carrying out the
restructuring plans, our expenses could increase more quickly than we expect. If we find that our planned restructurings do not achieve our objectives, it may be necessary to implement further reduction of our expenses, to perform additional
reductions in our headcount, or to undertake additional restructurings of our business.

We may fail to support our operations.

To
succeed in the implementation of our business strategy, we must execute our sales strategy and further develop products and expand service capabilities, while managing future operations by implementing effective planning and operating
processes.  If we fail to manage effectively, our business could suffer.  To manage, we must:

| | successfully manage the business with fewer employees due to the restructuring plans;              
|- | ---------------------------------------------------------------------------------------------------
|  |                                                                                                    
| | continue to implement and improve our operational, financial and management information systems;   
|  |                                                                                                    
| | hire, train and retain qualified personnel, especially if the business climate improves;           
|  |                                                                                                    
| | continue to expand and upgrade core technologies;                                                  
|  |                                                                                                    
| | effectively manage multiple relationships with various OEMs, resellers and system integrators; and
|  |                                                                                                    
| | successfully integrate the businesses of our acquired companies.                                   

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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 channels of
distribution through OEMs, resellers and systems integrators. We currently 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 51%, 48% and 42% of our total revenues in the nine months ended June 30, 2003, fiscal 2002 and fiscal 2001, respectively. Our business will be harmed if we are not able to retain and 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, IBM, Ericsson, Accenture, Cap Gemini Ernst & Young 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 or is developed but not highly penetrated. Although the rapid expansion and increasing complexity of computer networks in recent years and the resulting emergence of service level
agreements has increased, the demand for fault and service level management software products, and the awareness of and the need for such products is a recent development. Therefore, 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 other service providers continuing to purchase our products.

Telecommunications carriers, including Internet service providers, that deliver advanced
communications services to their customers accounted for approximately 57%, 74% and 79% of our total revenues in the nine months ended June 30, 2003, fiscal 2002 and fiscal 2001, respectively. In addition, these providers are an important 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 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.

Consolidations in, or a continued slowdown in, the telecommunications industry could harm our business.

We have derived a substantial amount of our revenues
from sales of products and related services to the telecommunications industry.  The telecommunications industry has experienced significant growth and consolidation in the past few years, although, over recent years, trends indicate that
capital spending by this industry has decreased and may continue to decrease in the future as a result of a general decline in economic growth in local and international markets.  Our business is highly dependent on the telecommunications
industry and on continued capital spending by our customers in that industry.  In the event of further significant slowdown in capital spending of the telecommunications industry, our business would be adversely affected.  Furthermore, as
a result of industry consolidation, there may be fewer potential customers requiring our software in the future.  Larger, consolidated telecommunications companies may also use their purchasing power to create pressure on the prices and the
margins we could realize.  We cannot be certain that consolidations in, or a slowdown in the growth of, the telecommunication industry will not harm our business.

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Our business depends on the continued growth in use and improvement of the
Internet.

A significant portion of our revenues comes from telecommunications carriers, Internet service providers and other customers that rely upon or are driven by the Internet. 
As a result, our future results of operations substantially depend on the continued acceptance and use of the Internet as a medium for commerce and communication. Our business could be harmed if this growth does not continue or if the rate of
technological innovation, deployment or use of the Internet slows or declines. Recent data and reports indicate that both the growth of significant portions of the Internet and technological innovations have slowed.  If these trends continue,
they will likely have an adverse impact on our business.

Furthermore, the growth and development of the market for Internet-based services may prompt the introduction of new laws and
regulations.  Laws, which impose additional burdens on those companies that conduct business online, could decrease the expansion of the use of the Internet.  A decline in the growth of the Internet could decrease demand for our products
and services and increase our cost of doing business, or otherwise harm our business, which could result in a material adverse effect on the market price of our common stock.

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 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:

| | 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 and Hewlett-Packard;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                         
| | vendors of network and systems management frameworks including Computer Associates International, Inc.;                                                                                                                                                                                 
|  |                                                                                                                                                                                                                                                                                         
| | vendors of network and systems management applications including Hewlett-Packard Company and BMC Software, Inc;                                                                                                                                                                         
|  |                                                                                                                                                                                                                                                                                         
| | providers of specific market applications; and                                                                                                                                                                                                                                          
|  |                                                                                                                                                                                                                                                                                         
| | systems integrators serving the telecommunications industry which primarily provide programming services to develop customer specific applications including Team Telecom International Ltd.
and Agilent Technologies, 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.

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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, the market acceptance of 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 or defects, especially when
first introduced or when new versions or enhancements are released. Because of defects, 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 and errors 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 is highly customer specific and can vary from a few weeks to many months. The software
requirements of customers is highly dependent on many factors, including but not limited to their projections of business growth, capital budgets and anticipated cost savings from implementation of our software. 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
requires 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 experienced and continue to experience difficulty in recruiting qualified personnel. Also, the volatility or lack of positive performance in our stock price may also adversely affect our
ability to attract and retain key employees, who often expect to realize value from stock options.  Because we face intense competition in our recruiting activities, we may be unable to attract and/or retain qualified personnel.

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On December 13, 2002, we announced that Gregory Q. Brown resigned as Chairman and
Chief Executive Officer of the Company. On July 29, 2003, the Company announced that Lloyd A. Carney was appointed Chairman of the Board of Directors and Chief Executive Officer of the Company. Coincident with this announcement, it was announced
that David Schwab, an independent member of the Board of Directors since prior to the Companys Initial Public Offering, would function as the lead independent director on the Board of Directors, and Michael Luetkemeyer will continue as the
Companys Senior Vice President and Chief Financial Officer.  Our success depends upon the performance of our executive officers and other key employees and the ability of our management team to work together effectively. There can be no
assurance that the management team will be able to work together effectively, and the effective execution of our business strategy will depend in large part on how well key management and other personnel perform in their positions and are integrated
within our company.

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. In August 2002, we completed the acquisition of RiverSoft plc, a developer of flexible object modeling and root-cause analysis software.  In December 2002, we completed the acquisition of Lumos Technologies Inc., a developer of
sophisticated technology for managing Layer 1 networks. Because of these acquisitions, we are integrating distinct products, customers and corporate cultures into our own. These past and potential future acquisitions create numerous risks for us,
including:

| | failure to successfully assimilate acquired operations and products;                                                          
|- | ------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                               
| | diversion of our managements attention from other matters;                                                                   
|  |                                                                                                                               
| | loss of key employees of acquired companies;                                                                                  
|  |                                                                                                                               
| | substantial transaction costs;                                                                                                
|  |                                                                                                                               
| | substantial liabilities or exposures in the acquired entity that were not known or accurately evaluated or forecast by us; and
|  |                                                                                                                               
| | substantial additional costs charged to operations as a result of the failure to consummate a potential acquisition.          

Further, some of the products we 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 and impairment expense. It is possible that
our efforts to consummate or integrate acquisitions will not be successful, which would harm our business.

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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 beyond fiscal 2002 and for the foreseeable future thereafter. Although we have Netcool/Impact, Netcool/Precision,
Netcool/Visionary and other products, our future operating results, particularly in the near term, are significantly dependent upon the continued market acceptance and continuing improvements of Netcool/OMNIbus. 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 and other Netcool 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.  See Concentration of Revenues in Notes to Condensed Consolidated Financial Statements. We expect 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 business is subject to risks from global operations and
we are exposed to fluctuations in currency exchange rates.

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 to the United States dollar have adversely impacted our results in the past and may do so in the future. See Geographic
and Segment Information in Notes to Condensed Consolidated Financial Statements for information concerning revenues outside the United States. 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:

| | longer receivables collection periods and greater difficulty in accounts receivable collection;                                                                                                                                                                                                                                                                  
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                  
| | difficulty in staffing and generally higher costs associated with managing foreign operations;                                                                                                                                                                                                                                                                   
|  |                                                                                                                                                                                                                                                                                                                                                                  
| | an even lengthier sales cycle than with domestic customers;                                                                                                                                                                                                                                                                                                      
|  |                                                                                                                                                                                                                                                                                                                                                                  
| | the impact of possible recessionary environments in economies outside the United States;                                                                                                                                                                                                                                                                         
|  |                                                                                                                                                                                                                                                                                                                                                                  
| | 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;

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| | 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;
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                           
| | changes in or failure to be aware of or to account for payroll, stock option, employee stock purchase and  business related taxation;                                                                                                     
|  |                                                                                                                                                                                                                                           
| | political, economic or terrorism induced instability;                                                                                                                                                                                     
|  |                                                                                                                                                                                                                                           
| | lack of acceptance of non-localized products;                                                                                                                                                                                             
|  |                                                                                                                                                                                                                                           
| | legal and cultural differences in the conduct of business; and                                                                                                                                                                            
|  |                                                                                                                                                                                                                                           
| | immigration regulations that limit our ability to deploy our employees.                                                                                                                                                                   

We intend to enter into additional
international markets and to continue to expand our operations outside of the United States. 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 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 new architecture standards for managing telecommunications networks 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 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, and Cisco Systems, Inc. and by vendors of relational database software, particularly Oracle Corporation and Sybase, Inc., could harm our business.

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 of our intellectual property and take
appropriate steps to enforce our rights. If third parties infringe or misappropriate our trade secrets, copyrights, patents, 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.

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MICROMUSE INC.

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 or we have not fulfilled the terms of agreements with them. On December 9, 2002, Aprisma Management Technologies,
Inc. filed a complaint against Micromuse in the U.S. District Court for the District of New Hampshire.  See Part II, Item 1, Legal Proceedings, for additional information relating to this matter.

The Aprisma matter is in a preliminary stage and we cannot predict its outcome with certainty. Management believes that the Company has strong defenses to Aprismas claims including non-infringement of the patents by
Micromuses products and invalidity of Aprismas patents.  However, management is aware that the litigation process is inherently uncertain on any individual claims.   Additionally, patent litigation can become complex and
extend for a protracted time, which may increase the cost of such litigation. Protracted litigation may also divert the efforts and attention of some of our key management and technical personnel. Should the outcome of this litigation be adverse to
us, we may be required to pay monetary damages to Aprisma, and we could be enjoined from selling any of our products found to infringe Aprismas patents without a license from Aprisma, which may not be available on acceptable terms or at
all.  If we are required to pay significant monetary damages, are enjoined from selling any of our products or are required to make substantial royalty payments, our business would be harmed.

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 or internal developments, 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, exposing us to possible risks of costly and time-consuming securities class
action litigation.

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:

| | actual or anticipated fluctuations in our operating results;                                       
|- | ---------------------------------------------------------------------------------------------------
|  |                                                                                                    
| | announcements of technological innovations, new products or new contracts by us or our competitors;
|  |                                                                                                    
| | developments with respect to intellectual property rights;                                         
|  |                                                                                                    
| | adoption of new accounting standards affecting the software industry; and                          
|  |                                                                                                    
| | 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.

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Our goodwill and other intangible assets may become impaired.

Due to rapidly changing market conditions, our goodwill and other intangible assets may become impaired such that their carrying amounts may not be recoverable, and we may be required to
record an impairment charge impacting our financial position. As of June 30, 2003, we  had approximately $39.2 million of goodwill and other intangible assets, which relate to the acquisitions of CAN, NetOps, RiverSoft and Lumos. We regularly
perform reviews to determine if the carrying value of assets is impaired. As part of our impairment assessment, we examine economic conditions, products, customer base and geography. Based on these criteria, we determine which products we will
continue to support and sell and, thereby, determine which assets will continue to have future strategic value and benefit. No such impairment has been indicated to date. Asset impairment charges of this nature could be large and could have a
material adverse effect on our financial condition and reported results of operations. In the quarter ended March 31, 2003, the Company performed its transitional goodwill impairment test required under SFAS No. 142 and concluded that no goodwill
was impaired.

Future sales of our common stock may affect the market price of our common stock.

As of June 30, 2003, we had
approximately 77.2 million shares of common stock outstanding, excluding approximately 9.0 million shares subject to options outstanding as of such date under our stock option plans that are exercisable at prices ranging from approximately $0.58 to
$106.22 per share. We cannot predict the effect, if any, that future sales of common stock or the availability of shares of common stock for future sale, will have on the market price of common stock prevailing from time to time. Sales of
substantial amounts of common stock (including shares issued upon the exercise of stock options), or the perception such sales could occur, may materially and adversely affect prevailing market prices for common stock. In addition, tax charges
resulting from the exercise of stock options could adversely affect the reported results of operations.

We have various mechanisms in place to discourage takeover attempts.

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:

| | 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
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                           
| | 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.

Changes in effective tax rates could affect our results.

Our future effective tax rates could be adversely affected by earnings being lower
than anticipated in countries where we have lower statutory rates, changes in the valuation of our deferred tax assets and liabilities, or by changes in tax laws or interpretations thereof.

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Our business is especially subject to the risks of earthquakes, floods and
other natural catastrophic events, and to interruption by man-made problems such as computer viruses or terrorism.

Our corporate headquarters are located in San Francisco, a region known
for seismic activity.  A significant natural disaster, such as an earthquake or a flood, could have a material adverse impact on our business, operating results and financial condition.  In addition, our servers are vulnerable to computer
viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems.  Any such event could have a material adverse effect on our business, operating results and financial condition.  In addition, the effects of
war or acts of terrorism could have a material adverse effect on our business, operating results and financial condition.  The terrorist attacks in New York and Washington, D.C. on September 11, 2001 disrupted commerce throughout the world and
intensified the uncertainty of the U.S. and other economies.  The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to these
economies and create further uncertainties.  To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders, or the manufacture or shipment of our products, our business, operating results and
financial condition could be materially and adversely affected.

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, 2003, no hedging contracts were outstanding.

We have entered into foreign
exchange forward contracts to reduce our exposure to foreign currency rate changes on receivables, payables and intercompany balances denominated in a nonfunctional currency. The objective of these contracts is to neutralize the impact of foreign
currency exchange rate movements on our operating results. These contracts require us to exchange currencies at rates agreed upon at the inception of the contracts. These contracts reduce the exposure to fluctuations in exchange rate movements
because the gains and losses associated with foreign currency balances and transactions are generally offset with the gains and losses of the foreign exchange forward contracts. Because the impact of movements in currency exchange rates on forward
contracts offsets the related impact on the underlying items being hedged, these financial instruments help alleviate the risk that might otherwise result from changes in currency exchange rates. We do not designate our foreign exchange forward
contracts as accounting hedges and, accordingly, we adjust these instruments to fair value through earnings in the period of change in their fair value.

Fixed Income
Investments

The primary objective of our investment activities is to preserve principal while maximizing yields without significantly increasing risk. 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, limit 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 investments with three months
or less to maturity at the date of purchase are considered to be cash equivalents; investments with maturities at the date of purchase 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 1.6%.

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Item 4. Controls and Procedures

Based on their evaluation as of the end of the period covered by this Quarterly Report on Form
10-Q, our companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange
Act), are effective to ensure that information required to be disclosed by our company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in
Securities and Exchange Commissions rules and forms.

In connection with the evaluation described above, we identified no change in our internal control over financial reporting that occurred
during our fiscal quarter ended June 30, 2003, and that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Part II 
OTHER INFORMATION

Item 1.
Legal Proceedings.

On December 9, 2002, Aprisma Management Technologies, Inc. filed a complaint against Micromuse Inc. in the U.S. District Court for the District of
New Hampshire.  The complaint alleges that Micromuses network and systems management products, including our Netcool products, infringe six patents held by Aprisma.  The complaint seeks preliminary and permanent injunctive relief as
well as unspecified compensatory and enhanced damages, attorneys fees, interest, costs and expenses.    The complaint was served on Micromuses counsel on February 20, 2003. Micromuse filed its answer to the complaint on April
11, 2003, in which Micromuse alleged affirmative defenses of patent invalidity and non-infringement of the patents by Micromuses products, as well as other equitable defenses.  The answer also contains Micromuses counterclaims
against Aprisma regarding patent invalidity, non-infringement and patent unenforceability on the grounds that Aprisma failed to disclose material prior art to the Patent Office.  Micromuse will continue to vigorously defend its position and
pursue the counterclaims against Aprisma.  Given that litigation matters are inherently unpredictable and this matter is at a preliminary stage, we cannot predict the outcome of this matter with certainty.  See Risk Factor entitled 
Our efforts to protect our intellectual property may not be adequate, or a third-party could claim that we are infringing its proprietary rights.

Item 2.   
Changes in Securities and Use of Proceeds.

Not applicable.

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.

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

(a) Exhibits

|Exhibit Number |      | Description
|-------------- | ---- | -----------
|               |      |            
|               |      |            
|               | 3.1  |            
|               |      |            
|               | 3.2  |            
|               |      |            
|               | 10.2 |            
|               |      |            
|               | 31   |            
|               |      |            
|               | 32   |            

(b) Reports on Form 8-K

A current report on Form 8-K was filed with the Securities and Exchange Commission by Micromuse Inc. on April 23, 2003, to report the results
of operations and financial condition for its fiscal quarter ended March 31, 2003.

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MICROMUSE INC.

SIGNATURES

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 13, 2003.

| | MICROMUSE INC.
| | --------------
| | (Registrant)  
| |               
| | By:           
| |               
| |               
| |               
| |               
| | By:           
| |               
| |               

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