UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

                                   ----------

                                    FORM 10-Q

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

                For the quarterly period ended December 31, 2000

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

              For the transition period from ________ to ________ .

                        Commission file number 000-23783

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

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

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

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

                                 Yes |X| No |_|

      72,134,596 shares of Common Stock, $0.01 par value, were outstanding as of
January 31, 2001

<PAGE>

                                 MICROMUSE INC.

                                TABLE OF CONTENTS

                                                                            Page
                                                                            ----

PART I - Financial Information

Item 1. Condensed Consolidated Financial Statements:

          Condensed Consolidated Balance Sheets as of December 31 and
              September 30, 2000                                               3

          Condensed Consolidated Statements of Operations for the three
              months ended December 31, 2000 and 1999                          4

          Condensed Consolidated Statements of Cash Flows for the three
              months ended December 31, 2000 and 1999                          5

          Notes to Condensed Consolidated Financial Statements                 6

Item 2. Management's Discussion and Analysis of Financial Condition
          and Results of Operations                                           10

Item 3. Quantitative and Qualitative Disclosures about Market Risk            25

PART II - Other Information

Item 1. Legal Proceedings                                                     27

Item 2. Changes in Securities and Use of Proceeds                             27

Item 3. Defaults upon Senior Securities                                       27

Item 4. Submission of Matters to a Vote of Security Holders                   27

Item 5. Other Information                                                     27

Item 6. Exhibits and Reports on Form 8-K                                      28

Signature                                                                     29


                                       2
<PAGE>

Part I - FINANCIAL INFORMATION

      Item 1. Condensed Consolidated Financial Statements

                                 MICROMUSE INC.

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

<TABLE>
<CAPTION>
                                     ASSETS
                                                                 December 31,   September 30,
                                                                     2000           2000
                                                                 ------------   -------------
<S>                                                                <C>            <C>
Current assets:
     Cash and cash equivalents                                     $  89,607      $  83,679
     Short-term investments                                           47,120         31,614
                                                                   ---------      ---------
           Total cash, cash equivalents and investments              136,727        115,293

     Accounts receivable, net                                         21,264         17,898
     Prepaid expenses and other current assets                         5,233          6,044

     Deferred income taxes                                             2,100          2,100
                                                                   ---------      ---------
        Total current assets                                         165,324        141,335

     Property and equipment, net                                      10,147          8,495
     Goodwill and purchased intangible assets, net                    44,414         47,181
                                                                   ---------      ---------
                                                                   $ 219,885      $ 197,011
                                                                   =========      =========

                      LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
     Accounts payable                                              $   2,215      $   2,919
     Accrued expenses                                                 23,370         18,900
     Income taxes payable                                                712            712

     Deferred revenue                                                 28,655         21,957
                                                                   ---------      ---------
        Total current liabilities                                     54,952         44,488

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;
        71,057 and 70,520 shares outstanding as of December 31
        and September 30, 2000, respectively                             711            705
     Additional paid-in capital                                      166,037        159,061
     Deferred compensation                                               (33)           (47)
     Accumulated other comprehensive losses                           (1,643)        (1,588)
     Accumulated deficit                                                (139)        (5,608)
                                                                   ---------      ---------
        Total stockholders' equity                                   164,933        152,523
                                                                   ---------      ---------
                                                                   $ 219,885      $ 197,011
                                                                   =========      =========
</TABLE>

    See accompanying notes to the condensed consolidated financial statements


                                       3
<PAGE>

                                 MICROMUSE INC.

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

<TABLE>
<CAPTION>
                                                                  Three months ended
                                                                     December 31,
                                                                 ---------------------
                                                                   2000         1999
                                                                 --------     --------
<S>                                                              <C>          <C>
Revenues:
    License                                                      $ 36,368     $ 16,313
    Maintenance and services                                       13,452        6,018
                                                                 --------     --------
        Total revenues                                             49,820       22,331
                                                                 --------     --------

Cost of revenues:
    License                                                         2,068          848
    Maintenance and services                                        5,228        2,994
                                                                 --------     --------
        Total cost of revenues                                      7,296        3,842
                                                                 --------     --------
            Gross profit                                           42,524       18,489
                                                                 --------     --------

Operating expenses:
    Sales and marketing                                            21,613        9,803
    Research and development                                        7,966        3,295
    General and administrative                                      4,187        2,226
    Purchased in-process research and development                      --       11,066
    Amortization of goodwill and purchased intangible assets        2,767           34
                                                                 --------     --------
        Total operating expenses                                   36,533       26,424
                                                                 --------     --------
            Income (loss) from operations                           5,991       (7,935)

Other income, net                                                   2,052          815
                                                                 --------     --------
    Income (loss) before income taxes                               8,043       (7,120)
Income tax provision                                                2,574        1,472
                                                                 --------     --------
    Net income (loss)                                            $  5,469     $ (8,592)
                                                                 ========     ========

Per share data:
    Basic net income (loss)                                      $   0.08     $  (0.13)
    Diluted net income (loss)                                    $   0.07     $  (0.13)

Weighted average shares used in computing:
    Basic net income per share (loss)                              70,951       65,128
    Diluted net income per share (loss)                            80,021       65,128
</TABLE>

    See accompanying notes to the condensed consolidated financial statements


                                       4
<PAGE>

                                 MICROMUSE INC.

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

<TABLE>
<CAPTION>
                                                                                Three months ended
                                                                                   December 31,
                                                                              ----------------------
                                                                                2000          1999
                                                                              --------      --------
<S>                                                                           <C>           <C>
Cash flows from operating activities:
  Net income (loss)                                                           $  5,469      $ (8,592)
  Adjustments to reconcile net income (loss) to net cash
     provided by operating activities:
     Depreciation and amortization                                               3,994           544
     Amortization of deferred employee compensation                                 14            14
     Purchased in-process research and development                                  --        11,066
     Tax  benefit related to exercise of stock options                           2,574         1,472
     Changes in operating assets and liabilities net of acquired amounts:
         Accounts receivable, net                                               (3,366)       (1,888)

         Prepaid expenses and other current assets                                 811           974

         Accounts payable                                                         (704)         (913)

         Accrued expenses                                                        4,470         6,202

         Income taxes payable                                                       --          (557)

         Deferred revenue                                                        6,698           169
                                                                              --------      --------
            Net cash provided by operating activities                           19,960         8,491
                                                                              --------      --------
Cash flows from investing activities:
  Capital expenditures                                                          (2,879)       (1,270)
  Maturity (purchase) of investments, net                                      (15,506)       15,963

  Acquisition of business, net of cash acquired                                     --          (146)
                                                                              --------      --------
     Cash provided by (used in) investing activities                           (18,385)       14,547
                                                                              --------      --------
Cash flows from financing activities:
  Proceeds from issuance of common stock                                         4,408         1,650
                                                                              --------      --------
     Net cash provided by financing activities                                   4,408         1,650
                                                                              --------      --------
Effects of exchange rate changes on cash and cash equivalents                      (55)          (65)
                                                                              --------      --------
Net increase in cash and cash equivalents                                        5,928        24,623

Cash and cash equivalents at beginning of period                                83,679        35,058
                                                                              --------      --------
Cash and cash equivalents at end of period                                    $ 89,607      $ 59,681
                                                                              ========      ========
</TABLE>

    See accompanying notes to the condensed consolidated financial statement


                                       5
<PAGE>

                                 MICROMUSE INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)

Note 1. Basis of Presentation

The condensed consolidated financial statements are the unaudited historical
financial statements of Micromuse Inc. and subsidiaries (the "Company") and
reflect all adjustments (consisting only of normal recurring adjustments) that,
in the opinion of management, are necessary for a fair presentation of interim
period results. These condensed consolidated financial statements should be read
in conjunction with the financial statements and notes thereto included in our
Form 10-K as filed with the Securities and Exchange Commission on December 29,
2000. The September 30, 2000 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.

Reclassifications

Certain reclassifications, none of which effected net income, have been made to
prior amounts to conform to the current period presentation.

Use of Estimates

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

Cash Equivalents

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

Investments

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

Impairment of Long-Lived Assets

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

Shareholder's Equity and Stock Split

All share and per-share numbers herein reflect the 2 for 1 stock split of our
common stock that occurred for stockholders of record on December 5, 2000.


                                       6
<PAGE>

                                 MICROMUSE INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)

Per Share Data

Basic per share amounts are calculated using the weighted-average number of
common shares outstanding during the period. Diluted per share amounts are
calculated using the weighted-average number of common shares outstanding during
the period and, when dilutive, the weighted-average number of potential common
shares from the assumed conversion of the redeemable convertible preferred stock
and the exercise of outstanding options to purchase common stock using the
treasury stock method. Excluded from the computation of the net loss per share
for the three months ended December 31, 1999, was a warrant to acquire 106,668
shares of common stock at $7.41 per share, and options to acquire approximately
9.6 million shares of common stock, with a weighted average exercise price of
$6.41 per share, because their effect would be anti-dilutive. A reconciliation
of the numerators and denominators used in the basic and diluted net income
(loss) per share amounts follows (in thousands):

                                                           Three months ended
                                                              December 31,
                                                          ---------------------
                                                            2000         1999
                                                          --------     --------
Numerator for basic and diluted net income (loss)         $  5,469     $ (8,592)
                                                          =====================
Denominator for basic net income (loss) per
     share - weighted-average shares outstanding            70,951       65,128
     Dilutive effect of common stock options                 9,070           --
                                                          --------     --------
Denominator for diluted net income (loss) per share         80,021       65,128
                                                          ========     ========

Concentration of Revenues

No one customer accounted for more than 10% of revenues for the quarters ended
December 31, 2000 and 1999, respectively.

Accumulated Other Comprehensive Income (Loss)

The only component of accumulated other comprehensive loss is net foreign
currency translation adjustments. Other comprehenisive loss for the three months
ended December 31, 2000 was $55,000 and $65,000 for the three months ended
December 31, 1999.

Geographic and Segment Information

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

The Company's chief operating decision-maker is considered to be the Company's
Chief Executive Officer ("CEO"). The CEO reviews financial information presented
on a consolidated basis accompanied by geographic information for purposes of
making operating decisions and assessing financial performance.


                                       7
<PAGE>

                                 MICROMUSE INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)

Therefore, the Company operates as a single operating segment: fault management
and service assurance software.

The Company markets its products primarily from the United States. International
sales are primarily to customers in France, Germany and the United Kingdom.
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
                                                           December 31,
                                                  -----------------------------
                                                    2000                1999
                                                  ---------           ---------
Revenues:
     United States                                $  36,581           $  14,319
     Other International                             13,239               8,012
                                                  ---------           ---------
        Total                                     $  49,820           $  22,331
                                                  =========           =========

Net income (loss):
     United States                                $   1,829           $     587
     International                                    3,640              (9,179)
                                                  ---------           ---------
        Total                                     $   5,469           $  (8,592)
                                                  =========           =========

Identifiable assets:
    United States                                 $ 163,157           $  84,690
    International                                    56,728              16,398
                                                  ---------           ---------
       Total                                      $ 219,885           $ 101,088
                                                  =========           =========

Net assets:
     United States                                $ 155,668           $ 102,619
     International                                    9,265               2,679
                                                  ---------           ---------
        Total                                     $ 164,933           $ 105,298
                                                  =========           =========

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

Recent Pronouncement

In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities. SFAS No. 133, as amended addresses the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts. Under SFAS No. 133, entities are required to carry
all derivative instruments in the balance sheet at fair value. The accounting
for changes in the fair value of a derivative instrument depends on whether it
has been designated and qualifies as part of a hedging relationship and, if so,
the reason for holding it. The Company adopted SFAS No. 133 on October 1, 2000.
The adoption did not have a material effect on the Company's consolidated
financial position or results of operations.

In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial
Statements. SAB 101 provides guidance on applying


                                       8
<PAGE>

                                 MICROMUSE INC.

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

                                   (Unaudited)

generally accepted accounting principles to revenue recognition issues in
financial statements. SAB 101, as amended, is required to be implemented in the
Company's fourth fiscal quarter of 2001. The Company will adopt SAB 101 in its
fourth fiscal quarter of 2001 and is evaluating the effect that such adoption
may have on its financial statements.


                                       9
<PAGE>

                                 MICROMUSE INC.

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

The following information should be read in conjunction with the condensed
consolidated historical financial information and the notes thereto included in
Item 1 of this Quarterly Report on Form 10-Q and Management's Discussion and
Analysis of Financial Condition and Results of Operations contained in our Form
10-K as filed with the Securities and Exchange Commission on December 29, 2000.

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.

Overview

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


                                       10
<PAGE>

                                 MICROMUSE INC.

Results of Operations

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

                                                             Three months ended
                                                                December 31,
                                                             ------------------
As a Percentage of Total Revenues:                            2000        1999
                                                             ------      ------
Revenues:
   License                                                     73.0%       73.0%
   Maintenance and services                                    27.0        27.0
                                                             ------      ------
       Total revenues                                         100.0       100.0
                                                             ------      ------

Cost of  revenues:
   License                                                      4.2         3.8
   Maintenance and services                                    10.5        13.4
                                                             ------      ------
       Total cost of revenues                                  14.7        17.2
                                                             ------      ------
            Gross profit                                       85.3        82.8
                                                             ------      ------

Operating expenses:
   Sales and marketing                                         43.4        43.9
   Research and development                                    16.0        14.8
   General and administrative                                   8.4        10.0
   Purchased in-process research & development                   --        49.6
   Amortization of goodwill and purchased intangible assets     5.5         0.1
                                                             ------      ------
       Total operating expenses                                73.3       118.4
                                                             ------      ------
            Income (loss) from operations                      12.0       (35.6)

Other income, net                                               4.1         3.6
                                                             ------      ------
   Income (loss) before income taxes                           16.1       (32.0)
Income tax provision                                            5.1         6.6
                                                             ------      ------
   Net income (loss)                                           11.0       (38.6)
                                                             ======      ======

As a Percentage of Related Revenues:
Cost of license revenues                                        5.7%        5.2%
Cost of maintenance and services revenues                      38.9%       49.8%


                                       11
<PAGE>

                                 MICROMUSE INC.

Revenues. Revenues increased to $49.8 million in the quarter ended December 31,
2000, from $22.3 million in the comparable period of the prior year. License
revenues increased to $36.4 million in the quarter ended December 31, 2000, from
$16.3 million in the comparable period of the prior year. The growth in license
revenues was primarily due to an increase in the number of product licenses
sold, reflecting the increased acceptance of Netcool(R)/OMNIbus and the
expansion of our sales organization and product offerings. Maintenance and
services revenues increased to $13.5 million in the quarter ended December 31,
2000, from $6.0 million in the comparable period of the prior year The increase
in maintenance and services revenues was a result of providing maintenance and
services to a larger installed base of customers. License revenues as a
percentage of total revenues were 73% in the quarters ended December 31, 2000
and 1999.

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 5.7% in the
quarter December 31, 2000, from 5.2% in the comparable period of the prior year
primarily due to higher third-party royalty costs offset partially by economies
of scale. The cost of maintenance and services revenues consists primarily of
personnel-related costs incurred in providing maintenance, consulting and
training to customers. Cost of maintenance and services revenues as a percentage
of maintenance and services revenues decreased to 38.9% in the quarter ended
December 31, 2000, from 49.8% in the comparable period of the prior year. This
improvement, which was principally due to a proportionally greater percentage of
higher-margin maintenance revenues, was partially offset by increased personnel,
facilities, and travel costs associated with expanding the customer support and
technical service organizations.

Sales and Marketing Expenses. Sales and marketing expenses increased to $21.6
million in the quarter ended December 31, 2000, from $9.8 million in the
comparable period of the prior year. This increase was primarily due to the
increased personnel costs associated with the expansion of the sales and
technical services departments and increased facilities costs. Sales and
marketing expenses as a percentage of total revenues declined to 43% in the
quarter ended December 31, 2000, from 44% in the comparable period of the prior
year. This reduction was primarily due to the increased scale of operations.

Research and Development Expenses. Research and development expenses increased
to $8.0 million in the quarter ended December 31, 2000, from $3.3 million in the
comparable period of the prior year. This increase was the result of increased
personnel, additional facilities costs, and an increase in the computer systems
and software development tools required by the additional personnel. Research
and development costs as a percentage of total revenues increased to 16% in the
quarter ended December 31, 2000, from 15% in the same period of the prior year.
This increase is primarily due to the acceleration of hiring research and
development staff offset partially by the increased scale of operations.

General and Administrative Expenses. General and administrative expenses
increased to $4.2 million in the quarter ended December 31, 2000, from $2.2
million in the comparable period of the prior year. This increase was primarily
due to increased personnel costs, professional fees, facilities costs and
associated expenses to support the increased scale of operations. General and
administrative expenses as a percentage of revenues declined to 8% in the
quarter ended December 31, 2000, from 10% in the comparable period of the prior
year. This reduction was primarily due to the increased scale of operations.

Purchased In-Process Research and Development Expense. The $11.1 million charge
in the quarter ended December 31, 1999, reflects the portion of Calvin Alexander
Networking, Inc.'s research and


                                       12
<PAGE>

                                 MICROMUSE INC.

development efforts that, at the time of acquisition, had not reached
technological feasibility and had no alternative future uses. Research and
development costs to bring the products from the acquired companies to
technological feasibility are not expected to have a material impact on the
Company's future results of operations or financial condition

Amortization of Goodwill and Purchased Intangible Assets. The charge of $2.8
million in the quarter ended December 31, 2000, reflects the amortization of the
goodwill and purchased intangible assets over estimated useful lives of three to
five years.

Other Income, Net. Other income increased to $2.1 million in the quarter ended
December 31, 2000, from $0.8 million in comparable period of the prior year.
This net increase was primarily due to the interest income related to the
increase in cash, cash equivalents and short-term investments.

Liquidity and Capital Resources

As of December 30, 2000, we had $89.6 million in cash and cash equivalents and
$47.1 million in marketable securities, up from $83.7 million in cash and cash
equivalents and $31.6 million in marketable securities as of September 30, 2000.
The net increase in cash and cash equivalents in the three months ended December
31, 2000, was due primarily to the net income adjusted for non-cash expenses,
the increase in accrued expenses and deferred revenues and the proceeds from the
issuance of common stock. These sources of cash and cash equivalents were
partially offset by capital expenditures, the purchase of marketable securities
and the increase in accounts receivable. The increase in accrued expense,
deferred revenue and accounts receivable reflects the growth in the business.
Additionally, the favorable timing of maintenance renewals contributed to the
increase in deferred revenues.

The net increase in cash and cash equivalents in the three months ended December
31, 1999, was due primarily to the net income adjusted for non-cash expenses,
the increase in accrued expenses, and the proceeds from the sale of marketable
securities and from the issuance of common stock. These sources of cash were
partially offset by the increase in accounts receivable and the purchase of
capital equipment. The increase in accrued expenses is due primarily to the
timing of a payroll tax payment related to exercised stock options and, to a
lesser extent, the growth in the business. The increase in accounts receivable
reflects the growth in related revenues.

As of December 31, 2000, the Company's principal commitments consisted of
obligations under operating leases.

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


                                       13
<PAGE>

                                 MICROMUSE INC.

                                  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 the 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.

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

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

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

Our quarterly revenues and operating results in 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.


                                       14
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                                 MICROMUSE INC.

We realize a significant portion of our license revenues in the last month of a
quarter, frequently in the last weeks or even days of a quarter. As a result,
license revenues in any quarter are difficult to forecast because it is
substantially dependent on orders booked and shipped in that quarter. Moreover,
our sales cycle, from initial evaluation to delivery of software, 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:

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

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

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

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

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

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

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

o     market acceptance of new products;

o     changes in the renewal rate of support agreements;

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

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


                                       15
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                                 MICROMUSE INC.

o     the extent of market consolidation; and

o     software defects and other product quality problems.

Failure to manage our growth may adversely affect our business.

We have grown rapidly, adding customers, personnel and expanding the scope and
geographic area of our operations. Our growth has resulted in new and increased
responsibilities for our management personnel and has placed and will continue
to place a significant strain upon our management and our operating and
financial systems and resources. We have grown to 612 employees on December 31,
2000, from 514 employees on September 30, 2000, and currently plan to recruit
more staff.

Failure to improve our infrastructure may adversely affect our business.

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

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

We need to continue to hire additional sales personnel. Based on our experience,
such personnel are in high demand, are difficult to recruit and retain and
require nine months, or longer, to become fully productive. Although we
increased the size of our sales organization during fiscal 2000, we experienced
difficulty in recruiting a sufficient number of qualified sales personnel during
that period. Our business will be harmed if we are unable to recruit additional
sales personnel or increase the productivity of our current sales personnel.
Further, because of the recent expansion of the installed base of
Netcool/OMNIbus, Netcool/Reporter, Netcool/Internet Service Monitors,
Netcool/Firewall, Netcool/Fusion, Netcool/NTSMs, and Netcool/Impact, and the
release of our Netcool/OMNIbus for Voice Networks, Netcool/Precision and
Netcool/Visionary, the demands on our technical services and customer support
resources have grown rapidly. We need to significantly expand our technical
services and customer support organizations and similar third-party capabilities
if we are to achieve significant additional revenue growth. Competition for
additional qualified technical personnel to perform the required functions is
intense and such personnel may not be available. If our technical services and
customer support resources are insufficient to support our growth our business
will be harmed.

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

We need to continue to develop relationships with leading network equipment and
telecommunications providers and to expand our third-party channels of
distribution through OEMs, resellers and systems integrators. We are currently
investing, and plan to continue to invest, significant resources to develop
these relationships and channels of distribution, which could reduce our ability
to generate profits.


                                       16
<PAGE>

                                 MICROMUSE INC.

Third-party distributors accounted for approximately 34% of our total revenues
in fiscal 2000. Our business will be harmed if we are not able to attract
additional distributors that market our products effectively. Further, many of
our agreements with third-party distributors are nonexclusive, and many of the
companies with which we have agreements also have similar agreements with our
competitors or potential competitors. Our third-party distributors have
significantly greater sales and marketing resources than we do, and their sales
and marketing efforts may conflict with our direct sales efforts. In addition,
although sales through third-party distributors result in reduced sales and
marketing expense with respect to such sales, we sell our products to
third-party distributors at reduced prices, resulting in lower gross margins on
such third-party sales. We believe that our success in penetrating markets for
our fault and service level management applications depends substantially on our
ability to maintain our current distribution relationships, in particular, those
with Cisco Systems, Ericsson, Unisphere (Siemens) and others. Our business will
be harmed if network equipment and telecommunications providers and distributors
discontinue their relationships with us, compete directly with us or form
additional competing arrangements with our competitors.

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

The market for our products is in an early stage of development and is very
dynamic. Although the rapid expansion and increasing complexity of computer
networks in recent years and the resulting emergence of service level agreements
has increased the demand for fault and service level management software
products, the awareness of and the need for such products is a recent
development. Because the market for these products is only beginning to develop,
it is difficult to assess the size of this market, the appropriate features and
prices for products to address this market, the optimal distribution strategy
and the competitive environment that will develop.

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

Telecommunications carriers, including Internet service providers, that deliver
advanced communications services to their customers have accounted for
approximately 75% of our total revenues in fiscal 2000. In addition, these
providers are the central focus of our sales strategy. If these customers cease
to deploy advanced communications services for any reason, the market for our
products will be harmed. Also, delays in the introduction of advanced services,
such as network management outsourcing, or the failure of such services to gain
widespread market acceptance or the decision of telecommunications carriers and
other service providers not to use our products in the deployment of these
services would harm our business.

Consolidations in, or a slowdown in the growth of, 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 recent trends indicate that this growth and capital spending by
that industry have slowed, and may be affected by a general decline in national
economic growth. Our business is highly dependent on the growth of the
telecommunications industry and on continued capital spending by our customers
in that industry. In the event of a significant slowdown in the growth or
capital spending of the telecommunications industry, our business could 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


                                       17
<PAGE>

                                 MICROMUSE INC.

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.

Our business depends on the continued growth 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. Rapid growth in the use of and interest in the Internet and
online services is a recent phenomenon. Our business could be harmed if this
rapid growth does not continue or if the rate of technological innovation,
deployment or use of the Internet slows or declines.

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.

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:

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


                                       18
<PAGE>

                                 MICROMUSE INC.

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

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

o     providers of specific market applications; and

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

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

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

If we ship products that contain defects, the market acceptance 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. Despite our extensive product testing, we have in the past released
versions of Netcool/OMNIbus with defects and have discovered software errors in
certain of our products after their introduction. For example, version 3.0 of
Netcool/OMNIbus, released in 1996, had a number of material defects. Version 1.0
of Netcool/Reporter, released in 1998, had features and performance
characteristics that limited market acceptance. A significant portion of our
technical personnel resources were required to address these defects. Because of
these 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.


                                       19
<PAGE>

                                 MICROMUSE INC.

The sales cycle for our software products can be as long as nine months, and our
delay or failure to complete one or more large license transactions in a quarter
could harm our operating results. Our software is generally used for
division-wide or enterprise-wide, business-critical purposes and involves
significant capital commitments by customers. Potential customers generally
commit significant resources to an evaluation of available enterprise software
and requires 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 and continue
to experience difficulty in recruiting qualified personnel. Because we face
intense competition in our recruiting activities, we may be unable to attract
and/or retain qualified personnel.

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

We have acquired other businesses and we may make additional acquisitions in the
future, which will complicate our management tasks and could result in
substantial expenditures. For example, on December 28, 1999 we completed the
acquisition of Calvin Alexander Networking, Inc., a developer of network
auto-discovery software. On July 18, 2000, the Company completed the acquisition
of NetOps Corporation, a developer of network diagnostic software. Because of
these acquisitions, we will need to integrate distinct products, customers and
corporate cultures into our own. These past and potential future acquisitions
create numerous risks for us, including:

o     failure to successfully assimilate acquired operations and products;

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

o     loss of key employees of acquired companies;

o     substantial transaction costs;

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

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


                                       20
<PAGE>

                                 MICROMUSE INC.

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 expense. It is possible that our
efforts to consummate or integrate acquisitions will not be successful, which
would harm our business.

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

All of our revenues have been derived from licenses for our Netcool family of
products and related maintenance, training and consulting services. We currently
expect that Netcool/OMNIbus-related revenues will continue to account for a
substantial percentage of our revenues beyond fiscal 2000 and for the
foreseeable future thereafter. Although we have Netcool/OMNIbus for Voice
Networks, Netcool/Precision, Netcool/Visionary and other products, our future
operating results, particularly in the near term, are significantly dependent
upon the continued market acceptance of Netcool/OMNIbus, improvements to
Netcool/OMNIbus and new and enhanced Netcool/OMNIbus applications. Our business
will be harmed if Netcool/OMNIbus does not continue to achieve market acceptance
or if we fail to develop and market improvements to Netcool/OMNIbus or new or
enhanced products. The life cycles of Netcool/OMNIbus, including the
Netcool/OMNIbus applications, are difficult to estimate due in large part to the
recent emergence of many of our markets, the effect of future product
enhancements and competition. A decline in the demand for Netcool/OMNIbus as a
result of competition, technological change or other factors would harm our
business.

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

We derive a significant portion of our revenues in any particular period from a
limited number of customers. Although no customer accounted for more than 10% of
revenues in fiscal 2000, 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 international sales and operations expose us to currency fluctuation risks
and other inherent risks.

We license our products in foreign countries. In addition, we maintain a
significant portion of our operations, including the bulk of our software
development operations, in the United Kingdom. Fluctuations in the value of
these currencies relative to the United States dollar have adversely impacted
our results in the past and may do so in the future. These fluctuations can
cause our prices to not be competitive or raise our expenses and reduce our
profitability. See 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


                                       21
<PAGE>

                                 MICROMUSE INC.

portion of our total revenues in the future. We pay the expenses of our
international operations in local currencies and do not currently engage in
hedging transactions with respect to such obligations.

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

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

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

o     an even lengthier sales cycle than with domestic customers;

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

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

o     changes in regulatory requirements, including a slowdown in the rate of
      privatization of telecommunications service providers, reduced protection
      for intellectual property rights in some countries and tariffs and other
      trade barriers;

o     changes in payroll, stock option, employee stock purchase and business
      related taxation;

o     political or economic instability;

o     lack of acceptance of non-localized products;

o     legal and cultural differences in the conduct of business; and

o     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 by expanding our direct sales
force and pursuing additional strategic relationships. Such expansion will
require significant management attention and expenditure of significant
financial resources and could adversely affect our ability to generate profits.
If we are 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 (for example TMN architecture) would force us to
adapt our products to such standard, which we may be unable to do on a timely
basis or at all. In addition, to the extent that any product upgrade or
enhancement requires extensive installation and configuration, current customers
may postpone or forgo the purchase of new versions of


                                       22
<PAGE>

                                 MICROMUSE INC.

our products. Further, the introduction or announcement of new product offerings
by us or one or more of our competitors may cause our customers to defer
licensing of our existing products.

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

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

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

We cannot guarantee that the steps we have taken to protect our proprietary
rights will be adequate to deter misappropriation of our intellectual property.
In addition, we may not be able to detect unauthorized use or our intellectual
property and take appropriate steps to enforce our rights. If third parties
infringe or misappropriate our trade secrets, copyrights, trademarks or other
proprietary information or intellectual property, our business could be harmed.
In addition, protection of intellectual property in many foreign countries is
weaker and less reliable than in the United States, so as our international
operations expand, the risk that we will fail to adequately protect our
intellectual property increases. Further, while we believe that our products and
trademarks do not infringe upon the proprietary rights of third parties, other
parties may assert that our products infringe, or may infringe, their
proprietary rights. Any such claims, with or without merit could be
time-consuming, result in costly litigation and diversion of technical and
management personnel, cause product shipment delays or require us to develop
non-infringing technology or enter into royalty or licensing agreements. Such
royalty or licensing agreements, if required, may not be available on terms
acceptable to us or at all. We expect that software product developers will be
increasingly subject to infringement claims as the number of products and
competitors in our industry segment grows and the functionality of products in
different industry segments overlaps.

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

We rely on software that we license from third parties, including software that
is integrated with internally developed software and used in our products to
perform key functions. We could lose the right to use this software or it could
be made available to us only on commercially unreasonable terms. Although we
believe that alternative software is available from other third-party suppliers,
the loss of or inability to maintain any of these software licenses or the
inability of the third parties to enhance in a timely and cost-effective manner
their products in response to changing customer needs, industry standards or
technological developments could result in delays or reductions in product
shipments by us until equivalent software could be developed internally or
identified, licensed and integrated, which would harm our business.


                                       23
<PAGE>

                                 MICROMUSE INC.

Our stock price is volatile.

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

o     actual or anticipated fluctuations in our operating results;

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

o     developments with respect to copyrights or proprietary rights;

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

o     general market conditions and other factors.

In addition, the stock market has from time to time experienced significant
price and volume fluctuations that have particularly affected the market price
for the common stock of technology companies. These types of broad market
fluctuations may adversely affect the market price of our common stock. In the
past, following periods of volatility in the market price of a company's
securities, securities class action litigation has often been initiated against
such company. Such litigation could result in substantial costs and a diversion
of our management's attention and resources that could harm our business.

General economic and market conditions may impair our business.

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

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

As of December 31, 2000, we had approximately 71.1 million shares of common
stock outstanding, excluding approximately 13.7 million shares subject to
options outstanding as of such date under our stock option plans that are
exercisable at prices ranging from approximately $0.01 to $104.31 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 the 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.


                                       24
<PAGE>

                                 MICROMUSE INC.

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

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

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

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

Year 2000 issues could impair our business.

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

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

Euro conversion may adversely affect our business.

On January 1, 1999, various European countries established fixed conversion
rates between their existing currencies and a new single currency known as the
Euro to be introduced through a transition period ending in 2002. Issues we are
reviewing as a result of the Euro include updating information technology
systems, assessing currency risk, reviewing licensing agreements and contracts
for currency issues, and processing tax and accounting records. Although we do
not currently expect the Euro to have a material adverse effect on our financial
conditions or results of operations, we cannot assure that issues relating to
the Euro will not harm our business.

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 December 31, 2000, no hedging
contracts were outstanding.


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                                 MICROMUSE INC.

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

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

Fixed Income Investments

Our exposure to market risks for changes in interest rates relate primarily to
investments in debt securities issued by U.S. government agencies and corporate
debt securities. We place our investments with high credit quality issuers and,
by policy, 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 highly liquid
investments with less than three months to maturity at purchase are considered
to be cash equivalents; investments with maturities of three months or less are
considered cash equivalents; investments with maturities between three and
twelve months are considered to be short-term investments; investments with
maturities in excess of twelve months are considered to be long-term
investments. The weighted average pre-tax interest rate on the investment
portfolio is approximately 5.9%. We do not expect any material loss with respect
to our investment portfolio.


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<PAGE>

                                 MICROMUSE INC.

Part II - OTHER INFORMATION

Item 1. Legal Proceedings.

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

Item 2. Changes in Securities and Use of Proceeds.

The Board of Directors approved a two-for-one split of its common stock for each
share of record held at close of business on December 5, 2000. Our transfer
agent has distributed the shares resulting from the split in December 2000.
Following approval at a special meeting of stockholders held on December 5,
2000, the Company amended its Restated Certificate of Incorporation to (i)
increase the number of authorized shares of Common Stock from 60,000,000 to
200,000,000 shares, and (ii) delete a previous requirement that at least 75% of
the voting power of outstanding capital stock approve action to amend, alter or
repeal most provisions of the Restated Certificate of Incorporation, and
substitute a provision to the effect that future amendments of the Restated
Certificate may be made in the manner prescribed by the Delaware General
Corporation Law.

Item 3. Defaults upon Senior Securities.

Not applicable.

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

A Special Meeting of Stockholders of the Registrant was held on December 5,
2000. At the Meeting, the following matters were submitted to a vote of
stockholders and were approved, with the votes cast on each matter indicated:

Two Amendments to the Company's Restated Certificate of Incorporation were
approved as follows: An increase in the authorized number of shares of Common
Stock from 60,000,000 to 200,000,000 shares was approved with 28,837,321 shares
voting for, 809,741 voting against, 9,322 shares abstaining and no broker non
votes; and an amendment to Article X to allow future amendments to be made in
the manner prescribed by the General Corporation Law of the State of Delaware,
instead of the supermajority (75%) approval of the stockholders of the
Corporation was approved with 26,430,741 shares voting for, 122,211 shares
voting against and 17,973 shares abstaining and 3,085,459 broker non votes.

Item 5. Other Information.

Not applicable.


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<PAGE>

                                 MICROMUSE INC.

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

      (a) Exhibits

Exhibit
Number        Description
-------       ------------------------------------------------------------------

3.1           Restated and Amended Certificate of Amendment dated December 5,
              2000, of Restated and Amended Certificate of Incorporation of
              Micromuse Inc.

      (b) Reports on Form 8-K

      During the 1st quarter ending December 31, 2000, the Company filed (i) on
      October 2, 2000, a Form 8-K/A including financial statements relating to
      the Company's acquisition of NetOps Corporation, amending a Form 8-K
      (initially reporting that transaction) filed on August 2, 2000, (ii) on
      October 4, 2000, a Form 8-K/A amending information in the foregoing Form
      8-K/A, and (iii) on December 20, 2000, a Form 8-K reporting the results of
      a special meeting of stockholders on December 5, 2000, approving
      amendments to the Company's Restated Certificate of Incorporation and
      press release announcing the record and distribution dates of a 2-for-1
      stock split in December 2000.


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<PAGE>

                                 MICROMUSE INC.

                                    SIGNATURE

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

                                        MICROMUSE INC.
                                        (Registrant)


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

                                        Stephen A. Allott

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


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