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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the Fiscal Year Ended September 30, 2003

For the transition period from                      to                      .

Commission File No. 000-23783

MICROMUSE INC.

(Exact name of registrant as specified in its charter)

139 Townsend Street

San Francisco, California 94107

(415) 538-9090

(Address of Principal Executive Office, including ZIP code and telephone number)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.01 par value

(Title of class)

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  ¨    No  x

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2):  Yes  x    No  ¨

The aggregate market value of the Registrant’s common stock held by non-affiliates of the Registrant on March 31, 2004, based upon the closing price of a share of the Registrant’s common stock as reported by the Nasdaq National Market on that date, was approximately $607.0 million. As of May 3, 2004, there were 78,270,124 shares of the Registrant’s common stock, $.01 par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:  None

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MICROMUSE INC.

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PART I

This document contains forward-looking statements that involve risks and uncertainties. The Company’s actual results may differ materially from the results discussed in such forward-looking statements. Factors that might cause such differences include, but are not limited to, fluctuations in customer demand, risks associated with competition and risks identified in the Company’s Securities and Exchange Commission filings, including, but not limited to, those discussed elsewhere in this Form 10-K under the heading “Risk Factors” located at the end of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this Form 10-K.

Item 1.    Business

Micromuse develops, markets and supports a family of scalable, highly configurable, rapidly deployable software solutions that enable service and business assurance—the effective monitoring of the status of multiple devices and elements underlying an Information Technology (IT) service delivery infrastructure, to help provide the continuous availability of IT-based services and businesses. The Micromuse Netcool^® product suite collects, normalizes and consolidates high volumes of event information from heterogeneous network management environments into an active database that de-duplicates and correlates the resulting data in real-time. It then rapidly distributes graphical views of the information to operators and administrators responsible for monitoring service levels. Netcool’s unique architecture allows for the rapid, programmerless association of devices and specific attributes of those devices to the business services they impact. This readily enables network operations teams to create and modify their service views during systems operations to monitor particular business services, rapidly identify which users are affected by which network faults, pinpoint sources of network problems, automate operator responses, facilitate problem resolution and report on the results.

We market and distribute to customers through our own sales force, OEMs, value-added resellers and systems integrators. For example, we currently have distribution agreements with Cisco Systems, IBM Global Services, Ericsson, Nortel, Alcatel, and Sun Microsystems. As of September 30, 2003, we had licensed our software to nearly 1,600 customers operating in and serving a variety of industries. Micromuse customers include Cable & Wireless, Charles Schwab, Citigroup, Deutsche Telekom, Digex, Earthlink, Electronic Data Systems, GE Appliances, ITC^DeltaCom, J.P. Morgan Chase, T-Mobile, and Verizon.

Micromuse operates as a single operating segment, and further geographic and segment information is included in Note 8 “Geographic and Segment Information” of the Notes to Consolidated Financial Statements included in this Form 10-K. For a discussion of customers accounting for 10% or more of our consolidated revenue and credit concentration, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Revenues,” and Note 1 “Concentration of Credit Risk” of the Notes to Consolidated Financial Statements included in this Form 10-K.

Micromuse was founded in 1989 in London, England, and in 1997 reorganized as a Delaware corporation and re-located its headquarters to San Francisco, California.

Information Available on the Micromuse Website

The Micromuse website is www.micromuse.com.

Micromuse makes the following filings available on its website as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports filed or furnished under applicable provisions of the Securities Exchange Act of 1934 and SEC rules. You may access these filings on our website at http://www.micromuse.com/ by clicking on “Our Company,” then “Investor Relations,” and then “SEC filings.” Within the “SEC filings” section, we provide a link to view our SEC filings referred to above, and a separate link to view the “Section 16 Filings” that our directors and officers (and, if applicable, more than 10% stockholders) make to report initial beneficial ownership and changes in beneficial ownership of our common stock.

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Micromuse also makes available, in a corporate governance section on our website, the charters of the Audit Committee, Nominating and Corporate Governance Committee, and Compensation Committee of the Micromuse Board of Directors, and the Micromuse Code of Business Conduct. You may access these documents on our website by clicking on “Our Company,” then “Investor Relations,” and finally “Corporate Governance.”

The Micromuse Code of Business Conduct is applicable to Micromuse directors, officers and employees, and meets the definition of a code of ethics set forth in SEC Regulation S-K Item 406. The code also includes a section entitled “Financial Code of Ethics for Employees with Financial Reporting Obligations” applicable to our Chief Executive Officer, Chief Financial Officer and other members of our finance department that contains specific ethical and related standards applicable to those with responsibilities for financial reporting and disclosure to investors. As permitted by SEC rules, in lieu of filing this code as an exhibit to this Form 10-K, we have made the code available on our website as described above.

Under revised Nasdaq listing standards, Micromuse may grant waivers of the Code of Business Conduct for directors and officers only if approved by the board of directors, and must make any such waivers along with the reasons for the waivers publicly available by filing a Form 8-K within 5 business days. Under SEC rules, Micromuse is required to file a Form 8-K to disclose any amendment of the code (other than non-substantive amendments) or any explicit or implicit waiver of the code (i.e., any material departure from the code) granted to the chief executive officer, chief financial or accounting officer, controller or persons performing similar functions, if the waiver relates to matters contained in the SEC’s definition of a code of ethics. As permitted by SEC rules, Micromuse intends to satisfy the requirement under SEC rules to disclose amendments and waivers of the code by posting this information on the Micromuse website under the corporate governance link indicated above. To the extent the Nasdaq rules do not permit this alternate means of disclosure allowed by SEC rules, Micromuse will file a Form 8-K to report waivers, if any.

All of the filings and governance documents available under the Investor Relations link on our website are free of charge.

Restatement of Financial Statements

The Company has restated its consolidated financial statements for the fiscal years ended September 30, 2001 and 2002 and for the quarters ended December 31, 2000 through June 30, 2003. We have also adjusted the consolidated financial statement information for the quarter and fiscal year ended September 30, 2003 announced on October 29, 2003 and the preliminary financial information for the quarter ended December 31, 2003 announced on February 10, 2004. All applicable financial information contained in this Annual Report on Form 10-K gives effect to these restatements. Accordingly, the financial statements for those fiscal periods described above that have been included in the Company’s previous filings with the Securities and Exchange Commission or included in previous announcements should not be relied upon.

For information concerning the background of the restatements and the specific adjustments made on an annual and quarterly basis, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Restatement of Financial Statements”, and Notes 2 and 11 of the Notes to Consolidated Financial Statements included in Item 8. Remedial measures that were recommended or identified in the course of the restatement process are summarized in Item 9A, “Controls and Procedures.”

Business Developments

Changes in Executive Officers

On January 12, 2004, the Company announced the appointment of Arun Oberoi as Executive Vice President, Global Sales and Technical Services. See Item 10 of this Form 10-K for a description of Mr. Oberoi’s business background.

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Effective September 30, 2003, Michael S. Donohue resigned his executive officer status as Senior Vice President, Sales and Business Operations.

On July 29, 2003, the Company announced the appointment of Lloyd A. Carney as Chairman and Chief Executive Officer. See Item 10 of this Form 10-K for a description of Mr. Carney’s business background.

Effective December 31, 2002, Gregory Q. Brown resigned as Chairman and Chief Executive Officer, to assume a position as an officer of another company. As a result of his resignation, and until the appointment of Mr. Carney, Director David C. Schwab served as Chairman, and Michael L. Luetkemeyer, served as interim Chief Executive Officer while retaining his responsibilities as Chief Financial Officer.

Fiscal 2003 Employee Reduction

On October 29, 2002, the Company announced plans to reduce headcount by approximately 18% during the first quarter of fiscal 2003, from a base of 660 employees as of September 30, 2002. As of September 30, 2003, we had 573 employees, including those who joined the Company from two acquisitions described below that were completed in fiscal 2003.

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 intends 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 agreed to pay up to $2.7 million in cash and assume $0.9 million in outstanding debt. Approximately $1.0 million of the cash purchase price was paid at closing, a further $1.2 million was paid as of September 30, 2003 in connection with certain earnouts in relation to revenue, development and employee retention goals. The remaining earnouts of $0.3 million and $0.2 million were paid in the quarters ended December 31, 2003 and March 31, 2004, respectively. The transaction was accounted for under the purchase method of accounting with Lumos’ results of operations included from the acquisition date.

On August 20, 2003, the Company announced it had completed the acquisition of NETWORK HARMONi (NHI) for approximately $23.0 million in cash. NHI’s HARMONi suite of intelligent agents provides the core data collection technology within Netcool^®/System Service Monitors^™ (Netcool/SSMs) and Netcool^®/Application Service Monitors^™ (Netcool/ASMs), which gather realtime information about distributed systems, servers, and applications across the IT infrastructure. In addition to the extensive library of intelligent HARMONi agents, Micromuse acquired NHI’s OpCenter product, a lightweight, centralized IT management and problem resolution system that is ideally tailored for mid-sized enterprise IT infrastructures. Micromuse also assumed several pending patent applications that had previously been filed by NHI.

Products and Technology

Micromuse provides a suite of software products that enable business and service assurance for enterprises and service providers. Our Netcool solutions include the flagship Netcool/OMNIbus^™ product family, which collects, consolidates, de-duplicates and correlates information from more than 1,000 network management platforms and devices and presents realtime user-configurable views of faults, network, service and business status. This product family allows network operations personnel to react to problems in their network infrastructure before they cause outages in service availability and/or to identify outages and their probable causes. These capabilities enable network managers to improve the reliability and functionality of their networks, thereby enhancing operating efficiencies, productivity and profitability of network operators and users. The components of the Netcool/OMNIbus Product Family are described in the section entitled “Netcool/OMNIbus Product Family.”

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Micromuse also provides several other product families that work in conjunction with Netcool/OMNIbus and provide enhanced business and service assurance capabilities. These include the Netcool/Service Monitors^™ product family, the Netcool/Precision^™ product family, the Netcool/Impact^™ product family and the Netcool/Dashboards^™ product family.

In addition, the Netcool suite includes packaged software “solutions” comprised of product family components and targeted to specific customer environments. These solutions include:

Brief descriptions of the Netcool product families are provided below:

Netcool/OMNIbus Product Family

Micromuse’s flagship Netcool/OMNIbus product family provides realtime business and service assurance. As the cornerstone of the Netcool suite, it collects and consolidates events and alarms from more than 1,000 IT environments in realtime—and presents this information to IT executives and operations personnel in an intuitive, graphical console. Netcool/OMNIbus provides realtime monitoring, management, and event de-duplication and helps organizations proactively manage their IT infrastructures to ensure continuous uptime of business services and applications. Environments supported by Netcool/OMNIbus include business applications, Windows and UNIX systems, data switches, voice switches, IP routers, frameworks and others.

The Netcool ObjectServer^™, the core component of Netcool/OMNIbus, is a high-speed database that collects event information from throughout the infrastructure. Netcool Probes & Monitors^™ collect event messages from throughout the IT infrastructure and forward them to the Netcool ObjectServer for consolidation, filtering, de-duplication, suppression, and analysis.

The Netcool suite also provides Executive Dashboards that allow you to customize realtime views of operations and business services, based on geography, department, or supporting IT resources. Point-and-click interfaces allow you to address and prioritize the resolution of IT problems based upon their business or customer impact. Designed to meet the needs of both IT executives and operations personnel, the Netcool dashboards provide a ‘birds-eye’ view of services as well as detailed analysis of specific IT resources.

Netcool Probes & Monitors collect and consolidate data from over 1,000 environments off-the-shelf. Netcool manages events at the device and system level while also testing service and application availability from the service user’s perspective.

Netcool Gateways^™ interface to third-party databases and applications that need to share event data interactively with the Netcool/OMNIbus realtime event database engine. Examples of gateway-supported environments include Oracle, Sybase, SQL Server, Informix, Remedy, Clarify (Amdocs), Vantive (PeopleSoft), Siebel, and Metasolv.

Using generic probes, proprietary probes, standards-based probes (such as SNMP trapd and TL1), gateways, and monitors, Netcool/OMNIbus can collect data from virtually any networked environment.

Netcool/Monitors Product Family

Supporting a variety of IP, Internet and wireless-based services and applications, Netcool/Monitors use ‘synthetic transactions’ to monitor availability and performance over fixed line and wireless infrastructures.

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Netcool/Application Service Monitors^™ (ASMs) provide detailed application and database monitoring for Oracle, Microsoft SQL, Microsoft Exchange, Apache and MS IIS. Netcool/ASMs monitor a variety of metrics from these applications and offer suggested resolution procedures aimed at repairing problems.

Netcool/System Service Monitors^™ (SSMs) accurately measure the availability and performance of host systems and applications running on them. Its distributed systems management includes CPU utilization, memory utilization, and disk space and can track blocks, inodes, total and free files in each file system. Netcool/SSMs can also manage running processes and execute restarts when they go down.

Netcool/Data Center Monitors^™ (DCMs) consolidate realtime management from IBM mainframe and midrange systems—the IBM S/390 (IBM zSeries) and IBM AS/400 (IBM iSeries). Netcool/DCMs allow you to monitor events across mainframe alerts such as VTAM sessions and MVS subsystems as well as midrange-computing systems. Netcool/DCMs identify problems before applications and services are affected.

Netcool/Internet Service Monitors^™ (ISMs) for managing HTTP and HTTPS web pages and financial transactions help determine the cause of problems affecting eCommerce transactions. Netcool/ISMs measure the availability and performance of Web-based applications and offer Web-based historical reports that can be measured against service agreements. Netcool/ISMs that provide support for SMTP, POP3, and IMAP protocols ensure the availability and response time of email services. Netcool/ISMs also manage the underlying infrastructure protocols, such as DHCP, DNS, FTP, ICMP, NNTP, NTP, TCP Port, and Radius. Netcool/ISMs help ensure the availability of Internet, voice and wireless infrastructures.

The Netcool/Usage Service Monitors^™ (USMs) provide usage-metering and show the status of network usage in realtime or over a period of time. These usage monitors measure how many people are using a device and/or service. They also allow you to view the usage for a given department or business unit such as the quantity of hits, or bandwidth usage.

The Netcool/Wireless Service Monitors^™ (WSMs) for managing end-to-end availability and performance of WAP and SMS-based services act like a wireless service user to simulate transactions. These Netcool/Service Monitors can test page availability and content accuracy by connecting to defined WAP pages via WAP Gateways.

Netcool/Precision Product Family

The Netcool/Precision product family is built on a flexible architecture designed specifically for modern networks. Utilizing its accurate topology and network connectivity information, Netcool/Precision monitors the network to locate and isolate network problems as they develop and reports these problems to network staff. This enables administrators to resolve problems fast, before they escalate into more serious outages that impact the availability and performance of critical business services.

Netcool/Precision for IP Networks^™ (Netcool/PrecisionIP) automatically discovers IP networks, gathering topology data to deliver a complete picture of devices and layer 2 and layer 3 connectivity, including MPLS, ATM and Frame networks. It monitors all discovered elements for status and continually updates its database with new device information as the network changes. When network problems occur, Netcool/PrecisionIP analyzes events and identifies the root cause of the problem—significantly reducing the time it takes to isolate network faults. Fully integrated with the Netcool suite, Netcool/ PrecisionIP delivers a complete picture of network connectivity, and quickly isolates the source of network downtime.

Netcool/Precision for Transmission Networks^™ (Netcool/PrecisionTN) automatically discovers transmission layer (Layer 1) networks, deepening the visibility provided by Netcool/Precision IP at network layers 2 and 3. Netcool/Precision TN collects and sends alarm, inventory, facility, and connection information to Netcool/OMNIbus from any TL1- or SNMP-managed NEs so that you can drill down to the very shelf, card, and

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port involved in the alarm—and all in realtime. This information can be used to visualize the problems with Netcool/Precision TN’s rich web-based GUI or with common reporting tools. And the information is stored in a MySQL or an Oracle database, providing additional opportunities to generate reports and analyze network data.

Like an “engineer in a box,” Netcool/Visionary^™ analyzes information from industry-standard SNMP devices and applications and provides real-time, device-centric diagnoses. Its patent-pending MicroCorrelation^™ technology analyzes the SNMP Management Information Base information to pinpoint the underlying cause of hundreds of unique problems that pertain to specific devices. Whenever a device such as a server, switch or router shows a deviation from normal behavior, Netcool/Visionary provides an explanation for the condition—showing details on why problems occur and the recommended solution. Netcool/Visionary sends this data to Netcool/OMNIbus.

Netcool/Impact Product Family

Tightly integrated with Netcool/OMNIbus, Netcool/Impact shows the realtime business impact analysis of specific faults within the infrastructure. It allows you to see how Netcool-collected events will impact IT-based business processes, services, and business-critical applications.

Netcool/ Impact retrieves business process, customer and service information from a variety of databases and files. When events occur, Netcool/Impact automatically enriches Netcool/OMNIbus events by linking the right information with each event. This “enriched” event gives you the knowledge needed to define resolution policies and instruct Netcool/Impact to take automatic corrective action on faults. In addition it can escalate events to email, pagers and other systems—ensuring fast and efficient notification. Netcool/Impact’s analysis of events helps you prioritize work and focus on business-critical events.

Netcool/SLA Manager^™ delivers realtime service modeling and reporting, allowing you to monitor the impact of IT performance on services and SLAs. From the top down, you can drill into services and view the collection of network and Web devices and server farms supporting them. Its graphical views can be customized to provide a complete picture of business process, IT workflow and faults—calculating how services are performing relative to SLAs historically and in realtime.

Netcool/SLA Manager (Netcool/SLAM) incorporates data across IT components that make up a service, including network devices such as routers and switches, wireless and broadband components, systems and applications. This information is correlated to measure service availability, performance and usage as well as the overall customer experience. By assimilating this information into a broader service model, Netcool/SLAM can show both IT and business executives an ‘at-a-glance’ view of service and application health as well as impending problems.

Netcool/Dashboards Product Family

Netcool/Desktop^™ is the proprietary client interface into Netcool/OMNIbus, providing dynamic, intuitive, realtime views of the IT infrastructure. You can toggle easily among list-based, map-based, logical, topological, and graphical views of device-level and service-affecting events. Tools, notifications, and other applications can be launched from within the Netcool Desktop, enabling true, realtime, centralized IT management.

Netcool/Webtop^™ is a richly-featured, web-based version of Netcool/Desktop, enabling Netcool views to be configured and accessed across a secure Web interface. In addition to providing “anytime, anywhere” access over any Web-connected PC, Netcool/Webtop can be ported to any other type of web-enabled device, including PDAs and wireless devices. Netcool/Webtop can be configured easily into a wide range of operational and executive views for all types of users.

Netcool/Reporter^™ receives event data from the Netcool/OMNIbus^™ application and translates it into meaningful reports. By analyzing and presenting data generated over time, Netcool/Reporter provides long-term,

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retrospective information about the behavior of devices, systems and services. Its drill-down features and access to journals, details, and event histories allows managers to troubleshoot specific problems quickly and effectively. Netcool/Reporter offers an intelligent window into event trends, revealing “hot spots” so you can intervene before larger problems occur. Its easy, intuitive reports enable you to understand the behavior of your infrastructure over time. Designed to help you more effectively manage service and application availability over time, Netcool/Reporter also offers device availability reports, personnel response-time measures, and other statistics to help you report against committed service-level agreements.

Sales and Marketing

We market our software and services primarily through our direct sales organization with United States offices in Chicago, Dallas, New York, San Francisco, and McLean, Virginia; and international offices in Australia, Austria, Brazil, China, France, Germany, Italy, Japan, Mexico, the Netherlands, Poland, Singapore, Spain, and the United Kingdom, among other locations. Additionally, we have a growing channel consisting of OEMs, value-added resellers (VARs) and systems integrators.

Typically, the sales process will include an initial sales presentation, a product demonstration, at times a proof of concept evaluation, a closing meeting and a purchase process. The sales process typically takes six to nine months, although we have experienced shorter, longer and less predictable cycles. Companies often start with a moderate deployment of certain Netcool software components, and upon its demonstrated effectiveness subsequently make additional and larger purchases. A majority of our sales are from repeat customers who renew maintenance agreements and often purchase additional software as their networks expand, or as additional sites within the customer account learn of the services provided by, and the benefits of, the Netcool software.

We have a number of marketing programs designed to inform potential customers about the capabilities and benefits of our products. Our marketing efforts include investing in our technical leadership, participation in industry trade shows, technical conferences and technology seminars, preparation of competitive analyses, analyzing returns on investment in our software, sales training, publication of technical and educational articles in industry journals, advertising and sponsorships.

If we are to achieve significant revenue growth in the future, we must successfully train and retain our existing sales force and recruit additional premier sales personnel, if needed, and increase their productivity. Competition for such individuals is intense, and there can be no assurance that we will be able to either retain and adequately train our current sales force or attract qualified sales personnel in the future. If we are unable to retain, train or hire such people and make them productive on a timely basis, our business, operating results or financial condition would be adversely affected. See “Risk Factors—We depend on our key personnel, and the loss of any of our key personnel could harm our business.”

To achieve significant growth in revenues in the future we must continue to expand and improve the performance of our network of distribution partners. Our network of distribution partners currently includes OEMs, VARs, and systems integrators, such as Cisco Systems, IBM Global Services, Ericsson, Nortel, Alcatel and Sun Microsystems. These partners license our products at a discount to list price for re-licensing and may provide training, support and technical and customer services to the end users of our products. At times, members of our technical services organization will assist a channel partner with training and technical support. We offer a comprehensive channel-partnering program consisting of training, certification, technical support, priority communications regarding upcoming activities and products, and joint sales and marketing activities. There can be no assurance that we will be able to continue to attract and retain OEMs, VARs, and systems integrators or that such organizations will be able to market and sell our products effectively. In addition, there can be no assurance that our existing or future channel partners will continue to represent our products. See “Risk Factors—We need to continue to expand our distribution channels and retain our existing third-party distributors.”

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In part, because we first sold our software in the United Kingdom and were previously domiciled in London, sales of our software to end-users located outside of the United States (i.e., “international sales”) have historically comprised a significant portion of our total revenue. International sales accounted for 39%, 49% and 39% of total revenues in fiscal 2003, 2002 and 2001, respectively. A majority of these international sales were made to customers in the United Kingdom and Continental Europe. While we believe there are significant opportunities in Europe, we expect international revenues from Europe as a percentage of total revenues to decline in future periods as we more fully exploit opportunities in the United States and in the Pacific Rim. See “Risk Factors—Our business is subject to risks from global operations and we are exposed to fluctuations in currency exchange rates.”

Technical Services

Our technical services organization provides customers with a broad range of support services including pre-sales demonstrations, evaluations, implementations, consulting services, training and ongoing technical support. In addition, the technical services organization serves a variety of internal functions, including drafting support and training documentation, product management, product testing and research and development related to specific customer industries.

Our expansion of the customer base of Netcool has increased the demands on our technical services organization. Competition for qualified technical personnel is intense. There can be no assurance that the current resources in our technical services organization will be sufficient to manage any future growth in our business. The failure to align our technical services organization at least commensurate with the expansion in the installed base of Netcool products would have a material adverse effect on our business, operating results and financial condition. See “Risk Factors—We depend on our key personnel, and the loss of any of our key personnel could harm our business.”

Customer Support

The customer support organization is responsible for providing ongoing technical support for our customers after implementation of the product and for training the next generation of our software engineers and technical services personnel. Based on feedback by customers, we believe that the quality and responsiveness of our customer support organization provides us with a significant competitive advantage. See “Risk Factors—We depend on our key personnel, and the loss of any of our key personnel could harm our business.”

For an annual maintenance fee, a customer will receive toll-free telephone and email support, as well as certain new releases of our products. We offer two support packages to our customers: 8 hours a day, 5 days a week support or 24 hours a day, 7 days a week support. While support personnel generally answer the technical support calls and resolve most problems over the phone, we will deploy one of our technical support personnel in the event that an on-site visit is necessary. As our installed base of Netcool customers has grown, revenue from maintenance fees has grown. Due to more recent general economic and specific customer factors, some customers have chosen to reduce or forego their maintenance coverage. We are implementing initiatives to counter these trends but there can be no assurance that maintenance revenue will continue at its current level or will continue its historic growth. The failure to grow maintenance revenue would have a material adverse impact on our business results and financial condition.

Research and Development

We believe that our future success depends in large part on our ability to continue to enhance existing products and develop new products that maintain technological and operational competitiveness and leadership and deliver a rapid ROI to our customers. We have historically developed and expect to continue to develop our products in conjunction with our existing and potential customers. Extensive product development input is obtained through customers, through our monitoring of end-user needs and changes in the marketplace and through partnerships with leading research institutes.

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Our research and development organization spans the United States, United Kingdom and Australia and includes team members who have joined Micromuse through our acquisitions of Calvin Alexander Networking (“CAN”), NetOps, RiverSoft plc, Lumos Technologies Inc. and NHI. Research and development teams are organized around specific products and product families. These teams work closely with customers, product managers, technical service engineers, and salespeople to ensure that product specifications and enhancements are aligned to market requirements.

We have made and intend to continue to make substantial investments in research and development. Our total expenses for research and development for fiscal 2003, 2002 and 2001 were $29.4 million, $32.4 million and $33.4 million, respectively. To date, our development efforts have not resulted in any capitalized software development costs.

The market for our products is characterized by rapidly changing technologies, evolving industry standards, changing regulatory environments, frequent new product introductions and rapid changes in customer requirements. The introduction or announcement of products by the Company or our competitors embodying new technologies and the emergence of new industry standards and practices can render existing products obsolete and unmarketable. As a result, the life cycles of our products are difficult to estimate. Our future success will depend on our ability to enhance our existing products and to develop and introduce, on a timely and cost-effective basis, new products and product features that keep pace with technological developments and emerging industry standards and that address the increasingly sophisticated needs of our customers. There can be no assurance that we will be successful in developing and marketing new products or product features that respond to technological change or evolving industry standards, that we will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these new products and features, or that our new products or product features will adequately meet the requirements of the marketplace and achieve market acceptance. 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. If we are unable, for technological or other reasons, to develop and introduce enhancements of existing products or new products in a timely manner, our business, operating results and financial condition will be materially adversely affected. See “Risk Factors—Rapid technological change, including evolving industry standards and regulations and new product introductions by our competitors, could render our products obsolete” and “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.” In addition, software products as complex as ours may contain defects or failures when introduced or when new versions or enhancements are released. See “Risk Factors—If we ship products that contain defects, the market acceptance or our products and our reputation will be harmed, and our customers could seek to recover their damages from us.”

Competition

As noted above, our products are designed for use in the evolving business and service assurance and enterprise network management markets. Competition in these markets is intense and is characterized by rapidly changing technologies, new and evolving industry standards, frequent new product introductions and rapid changes in customer requirements. Our current and prospective competitors offer a variety of solutions to address the infrastructure management, service-level management, and security management markets. Competitors generally fall within the following four categories: (i) customer’s internal design and development organizations that produce “homegrown” Service Level Management (SLM) and network management applications for their particular needs; (ii) vendors who provide enterprise network and systems management frameworks including Computer Associates International, Inc. and BMC Software, Inc; (iii) vendors who provide service provider network and systems management frameworks including Hewlett Packard and Team Telecom, Inc.; and (iv) vendors who provide niche management applications. In the future, as we enter new markets, we expect that such markets may have additional, market-specific competitors. In addition, because there are relatively low barriers to entry in the software market, we have become aware of new and potential entrants in portions of our market space and we expect additional competition from these and other established and emerging companies. Increased

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competition may result in price reductions, reduced gross margins and/or loss of market share, any of which could materially adversely affect our business, operating results or financial condition.

Some 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. 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.

Many of our current and potential competitors have longer operating histories and have significantly greater financial, technical, sales, marketing and other resources, as well as greater name recognition and a larger customer base, than 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 management functionality offered by our products with their current applications. Moreover, our current and potential competitors may increase their share of the service and business assurance market through strategic alliances and/or the acquisition of competing companies. In addition, network operating system vendors could introduce new or upgrade and extend existing operating systems or environments that include management functionality offered by our products, which could render our products obsolete and unmarketable. There can be no assurance that we will be able to compete successfully against current or future competitors or that competitive pressures faced by us will not materially adversely affect our business, operating results or financial condition. See “Risk Factors—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.”

Intellectual Property and Other Proprietary Rights

Our success and ability to compete is significantly dependent upon our proprietary software technology. We rely on a combination of trade secret, copyright, patent and trademark laws, nondisclosure and other contractual agreements and technical measures to protect our proprietary rights. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. There can be no assurance that the steps taken by us to protect our proprietary technology will prevent misappropriation of such technology, and such protections may not preclude competitors from developing products with functionality or features similar to our products. In addition, effective patent, copyright and trade secret protection may be unavailable or limited in certain foreign countries. While we believe that our products and trademarks do not infringe upon the proprietary rights of third parties, there can be no assurance that we will not receive future communications or claims from third parties asserting that our products infringe, or may infringe, the proprietary rights of third parties. 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. 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. In the event of a successful claim of product infringement against us and our failure or inability to develop non-infringing technology or license the infringed or similar technology, our business, operating results or financial condition could be materially adversely affected. See Part I, Item 3 “Legal Proceedings” for a description of pending litigation relating to claims of infringement against us.

We rely on certain 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. There can be no assurance that these third-party software licenses will continue to be available to us on commercially reasonable terms or at all.

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Although we believe 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 our product shipments until equivalent software could be developed internally or identified, licensed and integrated, which would have a material adverse effect on our business, operating results and financial condition. See “Risk Factors—Our efforts to protect our intellectual property may not be adequate, or a third-party could claim that we are infringing its proprietary rights” and “We rely on software that we have licensed from third-party developers to perform key functions in our products.”

Employees

As of September 30, 2003, we had 573 employees. None of our employees are represented by a collective bargaining agreement, nor have we experienced work stoppages.

We believe that our future success will depend in large part on our ability to align our employee skills and population with market requirements, including our ability to retain and even attract highly skilled managerial, sales, technical services, customer support and product development personnel. We have at times experienced and continue to experience difficulty in retaining and recruiting qualified personnel. Competition for qualified personnel in the software industry is intense, and there can be no assurance that we will be successful in retaining such personnel. Failure to do so could materially adversely affect our business, operating results or financial condition. See “Risk Factors—Failure to manage our growth may adversely affect our business; Our restructuring of operations may not achieve the results we intend and may harm our business; and We depend on our key personnel, and the loss of any of our key personnel could harm our business.”

Item 2.    Properties

Our headquarters are located in approximately 21,935 square feet of office space in San Francisco, under a lease that expires in January 2008. Our principal product development operations as well as our European headquarters are located in approximately 30,077 square feet of office space in London pursuant to a lease that expires in April 2009. We also maintain offices in Chicago, Dallas, McLean, New York, Santa Monica, Beijing, Dusseldorf, Frankfurt, Hong Kong, Madrid, Mexico, Milan, Boston, Paris, Perth, Russia, Sao Paulo, Shanghai, Singapore, Sydney, Taipei, Tokyo, Utrecht, Vienna and Warsaw. We believe that our current facilities are adequate for our needs through the next twelve months, and that, should it be needed, suitable additional space will be available to accommodate expansion of our operations on commercially reasonable terms, although there can be no assurance in this regard.

Item 3.    Legal Proceedings

On December 9, 2002, Aprisma Management Technologies, Inc. (“Aprisma”) filed a complaint against the Company in the U.S. District Court for the District of New Hampshire. The complaint alleges that the Company’s network and systems management products, including our Netcool products, infringe six patents held by Aprisma. The complaint seeks injunctive relief as well as unspecified compensatory and enhanced damages, attorneys’ fees, interest, costs and expenses. The complaint was served on the Company’s counsel on February 20, 2003. The Company filed its answer to the complaint on April 11, 2003, in which the Company alleged affirmative defenses of patent invalidity and non-infringement of the patents by the Company’s products, as well as other equitable defenses. The Company has also asserted counterclaims against Aprisma regarding patent invalidity, non-infringement and patent unenforceability, including without limitation on the grounds that Aprisma failed to disclose material prior art to the Patent Office. The parties are now completing discovery (the exchange of documents and the taking of depositions) and preparing for the court’s hearing on the legal scope of the patents’ claims. Based upon current knowledge, the Company maintains that it has not infringed and does not infringe the patents in suit, and it will continue to vigorously defend its position and pursue the counterclaims against Aprisma.

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On November 10, 2003, Agilent Technologies, Inc. (“Agilent”) filed a complaint against the Company in the United States District Court for the Eastern District of Virginia. The complaint alleges that the Company infringes two patents, one of which is held by Agilent and the other of which is jointly owned by Agilent and Hewlett-Packard Company (“HP”). The complaint seeks injunctive relief, as well as unspecified compensatory and enhanced damages, attorneys’ fees, interest, costs and expenses. In response, the Company moved to: (i) dismiss the case or require Agilent to file a more definite statement of its claims; (ii) join HP as a necessary party; and (iii) transfer the case to the Southern District of New York, or in the alternative, to the Northern District of California. In a ruling dated April 15, 2004, the court granted Micromuse’s motion to transfer and ordered that the lawsuit be moved to the United States District Court for the Southern District of New York, where the remaining motions described in (i) and (ii) above are expected to be decided. Based upon current knowledge, the Company maintains that it has not infringed and does not infringe the patents in suit, and the Company intends to vigorously defend against the action.

Between January 12, 2004 and March 5, 2004, seven securities class action complaints were filed in the United States District Court for the Northern District of California against the Company and certain of its current and former officers and directors. The complaints were filed as purported class actions by individuals who allege that they purchased the Company’s common stock during a purported class period and seek an unspecified amount of damages. The complaints assert causes of action for alleged violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, arising out of the Company’s decision to restate its previously issued financial statements for the fiscal years ended September 30, 2001 and 2002 and for the quarters ended December 31, 2000 through June 30, 2003 and the Company’s decision to adjust its preliminary consolidated financial statement information for the quarter and fiscal year ended September 30, 2003, as initially announced on October 29, 2003. Plaintiffs have moved to consolidate those actions and name the law firm of Berman, DeValerio, Please, Tabacco, Burt & Pucillo as Lead Plaintiffs’ Counsel. The Court has yet to rule on that motion. Lead Plaintiffs will file a consolidated amended complaint after the Company files its restated financial statements. The Company will respond to that consolidated amended complaint after it is filed. The Company intends to vigorously defend these lawsuits.

Between February 2, 2004 and March 16, 2004, the Company was also named as a nominal defendant along with certain of its current and former officers and directors in three derivative actions, purportedly brought by shareholders on the Company’s behalf, filed in the Superior Court of California, County of San Francisco. On April 21, those actions were consolidated and the law firm of Robbins, Umeda & Fink was named as Lead Plaintiffs’ Counsel in those actions. On March 3, 2004, the Company was also named as a nominal defendant along with certain of its current and former officers and directors in another derivative action, purportedly brought by shareholders on the Company’s behalf, filed in the District Court for the Northern District of California. The derivative complaints allege that, as a result of the events underlying the restatement, certain of the Company’s current and former officers and directors breached their fiduciary duties to the Company, and that certain current and former officers and directors engaged in insider trading in violation of California law. The plaintiffs seek unspecified damages on the Company’s behalf from the defendants. The Company has not yet responded to the complaints.

On January 15, 2004, the Securities & Exchange Commission notified the Company that it had initiated an informal inquiry regarding the Company. This inquiry is ongoing and the Company is cooperating fully. It is our understanding that it is customary for the SEC to undertake an informal inquiry of many announced accounting restatements. The detailed information contained in this Form 10-K relating to the restatement of financial statements has not been reviewed previously by the SEC.

The Company is also subject to other pending or threatened litigation from time to time in addition to the matters specifically listed above, including other cases now pending. The Company has recorded certain liabilities it does not believe to be material related to some of the pending litigation (other than the patent and securities litigation specifically listed above) based on claims for which management believes a loss is probable and for which management can reasonably estimate the amount and range of loss.

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The litigation matters specifically listed above and other pending or future litigation are inherently unpredictable, could be costly and divert our management’s attention away from our business, and could have a material adverse effect on our business, financial results or condition, or cash flow. See also Risk Factors in Part II, Item 7, “Our efforts to protect our intellectual property may not be adequate, and third-parties have in the recent past claimed and may claim in the future that we are infringing their proprietary rights” and “We restated our annual and quarterly financial statements for 2001, 2002, and the first three quarters of 2003, we did not file our Annual Report on Form 10-K for fiscal year 2003 on a timely basis, and we did not file our Quarterly Report on Form 10-Q for the first quarter of 2004 on a timely basis. Litigation and regulatory proceedings regarding the restatement of our Consolidated Financial Statements could seriously harm our business.”

Due to the inherent unpredictability of litigation, the Company cannot predict the outcome of these or other pending matters with any certainty. Because of the uncertainties related to both the amount and range of losses in the event of an unfavorable outcome in the lawsuits listed above or in certain other pending proceedings for which loss estimates have not been recorded, management of the Company is unable to make a reasonable estimate of the losses that could result from these matters.

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

There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year ended September 30, 2003.

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PART II

Item 5.    Market for the Registrant’s Common Equity and Related Stockholder Matters

Price Range of Common Stock

Our common stock is traded publicly on the Nasdaq National Market. Our trading symbol changed to “MUSEE” on January 2, 2004, as a result of the delayed filing of this Form 10-K. We anticipate that the trading symbol will change back to “MUSE” after we have filed this Form 10-K and Forms 10-Q for the first two quarters of fiscal 2004. The following table sets forth for the quarterly periods indicated the high and low closing prices of the common stock for the last two fiscal years:

On May 3, 2004, the closing price of the common stock on the Nasdaq National Market was $6.27 per share. As of May 3, 2004, there were approximately 127 holders of record of the common stock.

Dividend Policy

We did not declare or pay any cash dividends on our capital stock during fiscal 2003, 2002 or 2001 and do not expect to do so in the foreseeable future. We anticipate that all future earnings, if any, generated from operations will be retained by us to develop and expand our business. Any future determination with respect to the payment of dividends will be at the discretion of the Board of Directors and will depend upon, among other things, our operating results, financial condition and capital requirements, the terms of then-existing indebtedness, general business conditions and such other factors as the Board of Directors deems relevant.

Private Issuance of Securities

On July 28, 2003, the Company issued a warrant to an executive search firm entitling it to purchase 50,000 shares of the Company’s common stock as more fully described under Item 12 of this Form 10-K under the sub-heading “Warrants” and incorporated here by this reference. The warrant was not registered under the Securities Act of 1933, as amended, pursuant to an exemption under, among other things, Section 4(2) promulgated thereunder.

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Item 6.    Selected Financial Data

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements, the notes to the consolidated financial statements, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” which are included elsewhere in this report for the years ended September 30, 2003, 2002 and 2001.

Consolidated Statements of Operations Data:

Consolidated Balance Sheet Data:

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Quarterly Financial Data:

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations —Restatement of Financial Statements” and Note 2 and Note 11 of Notes to Consolidated Financial Statements for more detailed information regarding the restatement of our consolidated financial statements for the fiscal years ended September 30, 2002 and 2001 and restated unaudited quarterly data for fiscal quarters during the years ended September 30, 2003, 2002, and 2001 respectively.

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with “Selected Financial Data” and our Consolidated Financial Statements and Notes thereto included elsewhere in this Form 10-K. This document contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from the results discussed in such forward-looking statements. Factors that might cause such differences include, but are not limited to, fluctuations in customer demand, risks associated with competition and risks identified in our most recent Securities and Exchange Commission filings, including, but not limited to, those discussed in this Form 10-K under the heading “Risk Factors.” Except as otherwise noted, the discussion of financial results gives effect to the accounting adjustments described in “Restatement of Financial Statements” below.

The Company has restated its consolidated financial statements for the fiscal years ended September 30, 2001 and 2002 and for the quarters ended December 31, 2000 through June 30, 2003. We have also adjusted the consolidated financial statement information for the quarter and fiscal year ended September 30, 2003 announced on October 29, 2003 and the preliminary financial information for the quarter ended December 31, 2003 announced on February 10, 2004. All applicable financial information contained in this Annual Report on Form 10-K gives effect to these restatements. Accordingly, the financial statements for those fiscal periods described above that have been included in the Company’s previous filings with the Securities and Exchange Commission or included in previous announcements should not be relied upon.

In September 2003, the Audit Committee of our Board of Directors, with assistance from independent legal counsel and subsequently, independent forensic accountants, undertook an internal investigation regarding questions raised internally, primarily concerning the accounting for accrued expenses, expense recognition and certain journal entries. The Audit Committee initially determined on December 28, 2003, that it was likely the

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Company would have to restate its financial statements for the periods described above based upon the status of the investigation at that date. On December 29, 2003, the Company informed Nasdaq and the SEC that the Company would not timely file its Form 10-K for fiscal year 2003. On December 30, 2003, we filed a Notification of Late Filing on Form 12b-25 with the SEC disclosing that this Form 10-K would be delayed pending completion of that internal investigation and issued a press release stating the same. The December 30, 2003 press release also announced that the Company expected that this inquiry would lead to a restatement of historical financial statements including adjustments to previously filed and published financial results, resulting in a positive impact to earnings in certain periods and a negative impact in others. Also on December 30, 2003, Lloyd Carney and Michael Luetkemeyer hosted a conference call to inform the public of the accounting inquiry and explain the delay in filing the Company’s Form 10-K. The Company furnished a copy of the transcript of that call as an exhibit to a Form 8-K filed on December 31, 2003.

On January 29, 2004, the Audit Committee met with its independent legal counsel at which time the investigation’s findings and conclusions were presented. The Audit Committee approved those findings and conclusions that certain accruals for certain expenses were overstated in certain periods, and understated in other periods and that adjustments were required in certain other areas more fully described below. The Audit Committee has discussed with the Company’s independent accountants, KPMG LLP, the Committee’s findings and conclusions and the adjustments described below.

The Company has adopted and implemented a number of remedial measures that were recommended or identified in the course of the investigation. These measures are summarized in Item 9A, “Controls and Procedures” in this Form 10-K.

Restatement of Financial Statements

The net effect of all of the restatement adjustments is to decrease the Company’s net loss by $2.3 million in fiscal year 2003, to decrease the Company’s net loss by $964 thousand in fiscal year 2002, and to increase the Company’s net income by $438 thousand in fiscal year 2001. The Company’s consolidated statements of cash flows have been restated to reflect the reclassification of changes in assets and liabilities during the period as discussed above.

Restated consolidated financial statements reflect the following adjustments during the past three fiscal years:

Note that numbers in parentheses represent an increase in expense and/or a decrease in income. Numbers with no parentheses represent a decrease in expense and/or an increase in income.

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Effects on Net Income—Increase (Decrease)

Effects on Net Loss—(Increase) Decrease

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Revenues

The Company identified certain revenue related adjustments for which the amount of the net revenue and the timing of the revenue recorded originally required adjustment. These adjustments caused the pre-tax loss to decrease by $722 thousand in fiscal year 2003 and to decrease by $253 thousand in fiscal year 2002, and the pre-tax income to increase by $69 thousand in fiscal year 2001.

Expenses

Total expense adjustments decreased the pre-tax loss by $1.7 million and $644 thousand in fiscal 2003 and 2002, respectively, and increased the pre-tax income by $484 thousand in fiscal 2001.

The Company allocates costs incurred by the Technical Services Department between Cost of Revenues, Sales and Marketing, and Research and Development. A review of the allocation rates led to certain adjustments in these rates to more accurately reflect the time spent by certain employees in various departments. These adjustments had no effect on net income or loss for the fiscal years presented. See Item 8, Note 1 “Use of Estimates” in the accompanying Consolidated Financial Statements for additional discussion on these allocations.

The allowance for doubtful accounts was adjusted to reflect a change to correct the original accounting for a transaction with a customer that declared bankruptcy and adjustments to reflect the application of a consistent global policy in this area.

In addition to the allocation rate and allowance impacts to expenses noted above, fiscal 2003, 2002 and 2001 was impacted by adjustments in accrued expenses. The Company identified several accrued expense items for which it concluded that the amount of the liability, the timing of the liability recognition, or the timing of the release of the liability could not be substantiated or was in error and should be adjusted.

The Company further identified an expense adjustment from the elimination of accrued tax liabilities in fiscal year 2001 that should have been released in an earlier period as an increase to additional paid-in capital rather than a credit to General and Administrative expenses.

The Company identified that it had not been accounting for its lease expense on a straight-line basis in accordance with SFAS No. 13, Accounting for Leases. As a result, the Company adjusted its lease expense and the related deferred lease liability.

In addition, a reclassification was made in fiscal year 2003 between cost of revenue and research and development to appropriately classify certain earnout payments related to the Lumos acquisition. This reclassification had no impact on net income or loss.

Interest and Other Income

The Company identified certain cumulative translation adjustment accounts that required adjustment to properly reflect foreign subsidiary account balances and appropriate foreign currency translation rates. In addition to these adjustments, which resulted in a reclassification between accumulated comprehensive income and accumulated deficit, certain other adjustments caused the pre-tax loss to increase by $73 thousand in fiscal year 2003, the pre-tax loss to decrease by $55 thousand in fiscal year 2002 and the pre-tax income to decrease by $227 thousand in fiscal year 2001.

Provision for Income Taxes

The above adjustments resulted in changes to the Company’s provision for income taxes. The tax effect of each individual adjustment depends on the period and the taxing jurisdiction in which the adjustment occurred, as well as the Company’s preexisting tax position and the effect of any other adjustments. The combined effect of the above adjustments resulted in an increase to the net loss of $24 thousand in fiscal year 2003, a decrease to the net loss of $12 thousand in fiscal year 2002, and an increase to net income of $112 thousand in fiscal year 2001.

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Fiscal Year 2001 Opening Balances

Fiscal year 2001 opening retained earnings was restated to reflect certain adjustments primarily related to accruals as described above in the amount of $1.1 million.

Overview

Micromuse Inc. develops, markets and supports a family of scalable, highly configurable, rapidly deployable software solutions that enable 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. The Company was founded in 1989 and subsequently developed our Netcool/OMNIbus software, which we began shipping in January 1995. The Company continues to develop and enhance our Netcool family of products with more than 50 new products, product enhancements and integrations occurring during the fiscal year ended September 30, 2003. All of our revenues continue to be derived from licenses for our Netcool family of products and related maintenance, training and consulting services. We currently expect that Netcool-related revenues will continue to account for all or substantially all of our revenues for the foreseeable future. As a result, our future operating results are dependent upon continued market acceptance of our Netcool products and enhancements thereto.

As of September 30, 2003, we had licensed our Netcool products to nearly 1,600 customers worldwide in comparison to nearly 1,400 customers in 2002. This increase substantially reflects the growth in customers in the enterprise sector, which generated 40% of total revenue in the fiscal year ended September 30, 2003, compared with 26% in the fiscal year ended September 30, 2002. We license our software through our direct sales force, OEMs and value-added resellers. Revenues from OEMs and resellers combined accounted for approximately 48%, 48% and 42% of our total license revenues for fiscal 2003, 2002 and 2001, respectively. Our ability to achieve significant additional revenue growth in the future will depend substantially on our success in recruiting and training sufficient sales and technical services personnel, maintaining our current distribution relationships and establishing additional relationships with OEMs, resellers and systems integrators.

The decrease in revenue in fiscal 2003 and 2002, respectively, was primarily attributable to the economic slowdown that limited the overall capital spending of existing and potential customers especially in the telecommunications market. However, fiscal 2003 quarterly revenue and the first two quarters of fiscal year 2004 revenue has increased across each quarter, compared to the fourth quarter of fiscal year 2002. This increase was primarily attributable to the decreasing impact of the economic slowdown and a reduced reliance on the telecommunications sector. Our ability to achieve significant additional revenue growth and increased profitability in the future will depend substantially on our success in establishing an appropriate strategy to meet ongoing general economic and individual market conditions, increased diversification across market sectors, and increased market penetration in emerging growth markets such as Central and Eastern Europe and the Asia Pacific region.

Operating expenses in fiscal 2003 and 2002 decreased primarily due to reductions in headcount. However, in the first two quarters of fiscal 2004, the Company incurred an unanticipated increase in General and Administrative Expenses. This increase consisted initially of professional fees associated with the retention of independent legal counsel and forensic accountants separate from our independent auditors to assist the investigation undertaken by the Audit Committee of the Company’s Board of Directors in connection with the restatement of financial statements described above under “Restatement of Financial Statements” in this section and in Note 2 of the Notes to Consolidated Financial Statements included in Item 8. This increase also includes unanticipated professional fees to our independent auditors in connection with the delayed completion of the audit of our financial statements included in this Form 10-K, and the fees payable to an accounting firm (separate from the forensic accountants and independent auditors) that we retained to assist with the day-to-day responsibilities of the restatement process in January 2004 and preparation of this Form 10-K and Forms 10-Q for the first two fiscal quarters of fiscal 2004. The Company estimates that accounting and legal fees associated

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with this investigation and related matters, including additional costs incident to the completion of the audit of the financial statements included in this Form 10-K, will be in the range of approximately $4.0 to $5.0 million. These costs do not affect fiscal 2003 results and were not anticipated at the time the Company announced its fiscal 2003 results and related guidance for the first quarter of fiscal 2004.

We also expect expenses for professional fees to increase during fiscal 2004 and perhaps beyond, as compared to prior periods, due to pending litigation. We currently estimate that professional service fees associated with pending litigation will be in the range of $4.0 to $5.0 million during fiscal 2004. Actual fees incurred may be higher or lower depending on many factors beyond our control. See Part I, Item 3—“Legal Proceedings” for additional information on current legal proceedings.

As a result of our multinational operations and sales, our operating results are subject to significant fluctuations based upon changes in the exchange rates of certain currencies, particularly the British pound, in relation to the U.S. dollar. For example, while our United States headquarters is located in San Francisco, California, our principal product development operations are located in London, England. As a result, a substantial portion of our costs and expenses are denominated in currencies other than the U.S. dollar. For the fiscal years ended September 30, 2003, 2002 and 2001, license, maintenance and service revenues from customers located outside of the United States accounted for 39%, 49% and 39% of our total revenues, respectively. See Note 8 “Geographic and Segment Information” of Notes to Consolidated Financial Statements. Although we will continue to monitor our exposure to currency fluctuations, there can be no assurance that exchange rate fluctuations will not have a material adverse effect on our business and operating results.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these 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 ongoing basis, we evaluate our estimates, including, but not limited to, revenue recognition, bad debts, intangible assets, 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 the consolidated financial statements:

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 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 hourly rates that we charge for these services when sold independently from a software license. 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 ratably over the period that these elements are delivered.

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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:

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.

Allowance for Doubtful Accounts.    We regularly review the adequacy of our allowance for doubtful accounts after considering the size 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 a specific allowance is appropriate based on its risk category. In addition, we maintain a general reserve for all invoices by applying a percentage to each 30-day age 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 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. Deterioration in the economy could result in more customers being placed in the specific reserve category, thereby increasing our reserve estimate and negatively impacting operating results.

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Impairment Assessments.    We review the carrying amount of goodwill for impairment on an annual basis in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets. In addition 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, a 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. If indicators suggest the carrying value of our long-lived assets may not be recoverable we then estimate the fair value of these long-lived assets based on the sum of the expected discounted future cash flows expected to result from the use of the assets and their eventual disposition under the requirements of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

Allowance for Returns.    For customers having a right of return, the Company estimates future returns based on historical experience and other assumptions, to determine if an allowance is appropriate. To date, the Company has experienced an immaterial level of returns, and as a result, the Company’s allowance for returns has been insignificant. If historical data used to calculate the allowance for returns does not reflect actual future returns, additional provisions for returns may be needed and future results of operations could be materially affected. However, historically the reserve has proven to be adequate.

Restructuring-related Assessments.    Our critical accounting policy and judgment as it relates to restructuring-related assessments in accordance with Emerging Issues Task Force (EITF) No. 94-3 Liability Recognition for Certain Employee Benefits and Other Costs to Exit an Activity (including certain costs incurred in a restructuring) and SFAS No. 146 Accounting for Costs Associated with Exit or Disposal Activities includes our estimate of the loss related to 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. This lease loss 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). In the quarter ended September 30, 2002, the fiscal 2002 restructuring plan resulted in the elimination of excess facilities. In the quarter ended June 30, 2003, as a result of a potential tenant terminating negotiations with us, an additional restructuring charge of $1.7 million was incurred on property leases relating to the fiscal 2002 restructuring plan. 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 $3.1 million, relating to severance and employment related charges.

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.

Legal contingencies.    The Company is subject to various claims and legal actions arising in the ordinary course of business. We have accrued for estimated losses in the accompanying consolidated financial statements for those matters where we believe that the likelihood that a loss has occurred is probable and the amount of loss is reasonably estimable. Although we currently believe that we have adequately accrued for estimable and probable losses regarding the outcome of outstanding legal proceedings, claims and litigation involving us and

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that such outcome will not have a material adverse effect on our business, results of operations or financial condition, litigation is inherently uncertain, and there can be no assurance that existing or future litigation will not have a material adverse effect on our business, results of operations or financial condition or that the current amount of accrued losses is sufficient for any actual losses that may be incurred.

Accrued Commission Policy.    The Company accounts for commission accruals and related expenses to reflect a liability in the period the obligation arose for the actual amounts to be paid, with the related expense being recorded in the period in which the related revenue was recognized. The Company calculates the total commission liability for all valid purchase orders or approved written contracts received in the period and adjusts the accrued liability for purchase orders or approved written contracts not recognized as revenue in the period because they did not meet one or more of the revenue recognition requirements of SOP 97-2.

Non-GAAP Financial Results

We prepare and release quarterly unaudited financial statements prepared in accordance with generally accepted accounting principles (“GAAP”). We also disclose and discuss certain non-GAAP financial information in the related earnings release and investor conference call. This non-GAAP financial information excludes certain non-cash and special charges, consisting primarily of the amortization and impairment of goodwill and other intangible assets, write-off of in-process research and development, restructuring costs, costs of the internal inquiry and restatement, certain stock-based compensation, executive recruiting costs, and related income tax effects. We believe the disclosure of the non-GAAP financial information helps investors more meaningfully evaluate the results of our ongoing operations. 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 Operations

The following discussion and analysis gives effect to the restatement described above in “Restatement of Financial Statements” and in “Note 2—Restatement of Financial Statements” in the accompanying Notes to Consolidated Financial Statements. For this reason, the data set forth in this section may not be comparable to discussions and data in our previously-filed annual and quarterly reports.

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

Revenues

Total revenues were $126.2 million, $139.4 million and $212.6 million in fiscal 2003, 2002 and 2001, respectively. License revenues were $67.2, $78.8 million and $148.4 million in fiscal 2003, 2002 and 2001, respectively. The decrease in license revenue in fiscal 2003 and 2002 was primarily attributable to the economic slowdown that limited the overall capital spending of existing and potential customers especially in the telecommunications market. Fiscal 2003 quarterly total revenue was $33.7 million, $32.9 million, $32.1 million and $27.4 million for the 4^th quarter, 3^rd quarter, 2^nd quarter and 1^st quarter, respectively. This quarterly revenue growth across fiscal 2003 was primarily attributable to the decreasing impact of the economic slowdown and the

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related growth in our customer base to nearly 1,600 customers from 1,400 in fiscal 2002. This growth in our customer base also reflects our reduced reliance on sales to the telecommunication sector with 40% of total sales generated from other sectors in fiscal 2003 compared to 26% in fiscal 2002.

Our revenue adjustments described in “Restatement of Financial Statements” caused total revenue to increase by $722 thousand in fiscal year 2003, and by $253 thousand in fiscal year 2002, and to increase by $69 thousand in fiscal year 2001.

Maintenance and service revenues were $59.0 million, $60.6 million and $64.2 million in fiscal 2003, 2002 and 2001, respectively. The decrease in maintenance and service revenue in fiscal 2003 and fiscal 2002 was primarily a result of lower services revenue. Service revenues decreased by $2.4 million and $9.3 million across fiscal 2003 and fiscal 2002, respectively, primarily as a result of our resellers providing increased consulting services directly to the end users of our software. The percentage of our total revenues attributable to licensing our software was 53%, 57% and 70% in fiscal 2003, 2002 and 2001, respectively. Maintenance and services revenues accounted for 47%, 43% and 30% in fiscal 2003, 2002 and 2001, respectively.

Revenues from U.S. operations were 61%, 51% and 61% of total revenues in fiscal 2003, 2002 and 2001, respectively. International revenues include all revenues other than those from the United States and are based on location of the customer. See Note 8 of the Notes to Consolidated Financial Statements.

To date, our revenues have resulted primarily from sales to the telecommunications industry, including internet service providers (ISPs). License revenues from telecommunications industry customers and ISPs combined accounted for 60%, 74% and 81% of our total revenues in fiscal 2003, 2002 and 2001, respectively. Also, one third-party distributor, Cisco Systems, Inc, accounted for approximately 24%, 16% and 15% of revenues in fiscal 2003, 2002 and 2001, respectively. No one end user accounted for more than 10% of total revenue for fiscal 2003, 2002 and 2001.

Cost of Revenues

Cost of license revenues consists primarily of technology license fees paid to third-party software vendors and the costs of software media, packaging and production. Cost of license revenues as a percentage of license revenues were 6.7%, 8.3% and 5.4% in fiscal 2003, 2002 and 2001, respectively. The decrease in fiscal 2003 over the year 2002 was primarily due to the re-negotiation of an expired time based royalty contract. The increase in fiscal 2002 over 2001 was mainly as a result of the Company entering into a fixed fee time based royalty contract for fiscal 2002, in which the royalty cost as a percentage of license revenue increased as license revenue declined.

Cost of maintenance and service revenues consists primarily of personnel-related costs incurred in providing maintenance, consulting and training to customers. Cost of maintenance and service revenues decreased as a percentage of maintenance and service revenues to 17.9% in fiscal 2003 from 23.8% in fiscal 2002 and 36.9% in fiscal 2001. The improvements in fiscal 2003 over fiscal 2002 and in fiscal 2002 over fiscal 2001 were principally due to a proportionally greater percentage of higher-margin maintenance revenues as compared to services revenue.

Cost of the amortization of developed technology relates to the amortization of developed technology acquired in the acquisitions of CAN, NetOps Corporation, RiverSoft plc, Lumos Technologies Inc. and NHI over two to six years. The increase in each of the fiscal years is due to additional acquisitions in the preceding fiscal year.

Our cost of revenue adjustments described in “Restatement of Financial Statements” caused cost of revenues to decrease by $3.1 million in fiscal year 2003, decrease by $2.9 million in fiscal year 2002, and decrease by $1.6 million in fiscal year 2001. These adjustments included certain reallocations within the statement of operations of $1.8 million, $3.9 million, and $758 thousand in fiscal year 2003, 2002, and 2001, respectively, which had no impact on net income or loss.

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Operating Expenses

Sales and Marketing Expenses