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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended December 31, 2003

For the transition period from              to             .

Commission file number 000-23783

MICROMUSE INC.

(Exact name of registrant as specified in its charter)

139 TOWNSEND STREET

SAN FRANCISCO, CALIFORNIA 94107

(415) 538-9090

(Address, including ZIP code, and telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   ¨    No   x

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

78,270,124 shares of Common Stock, $0.01 par value, were outstanding as of May 3, 2004

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MICROMUSE INC.

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MICROMUSE INC.

EXPLANATORY NOTE

This Form 10-Q includes restated financial information for certain periods indicated below in this report that ended prior to our fiscal quarter that began on October 1, 2003. We filed a Form 12b-25 with the SEC on February 13, 2004, to report that our filing of this Form 10-Q would be delayed due to our then pending 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. 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 in 2003 or earlier or included in previous announcements in 2003 or earlier should not be relied upon.

The Company’s Form 10-K for the fiscal year ended September 30, 2003, filed with the SEC on May 17, 2004, contains restated information for all of the above periods to which the restatement applies and other information relating to the restatement, in the Form 10-K Item 6 “Selected Financial Data,” Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Restatement of Financial Statements,” Notes 2 and 11 of the Notes to Consolidated Financial Statements included in Item 8, and Item 9A, “Controls and Procedures.”

Certain information concerning the restatement relating to the periods included in this report is contained in Part I to this Form 10-Q in Note 2 below to the Condensed Consolidated Financial Statements (Unaudited), Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 4, “Controls and Procedures.” This information should be read in conjunction with relevant information in the Company’s most recent Form 10-K referred to above.

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MICROMUSE INC.

PART I - FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

(Unaudited)

See accompanying notes to the condensed consolidated financial statements

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MICROMUSE INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

See accompanying notes to the condensed consolidated financial statements

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MICROMUSE INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

See accompanying notes to the condensed consolidated financial statements

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MICROMUSE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

The condensed consolidated financial statements are the unaudited historical financial statements of Micromuse Inc. and subsidiaries (the “Company”) and reflect all adjustments (consisting only of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of interim period results. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K as filed with the Securities and Exchange Commission on May 17, 2004. The September 30, 2003 condensed consolidated balance sheet included herein was derived from audited financial statements, but does not include all disclosures, including notes, required by generally accepted accounting principles.

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

Reclassifications

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

Use of Estimates

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

On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, allocation of technical services department costs among expense categories, provision for doubtful accounts and sales returns, fair value of investments, fair value of acquired intangible assets and goodwill, useful lives of intangible assets and property and equipment, income taxes, restructuring costs, and contingencies and litigation, among others. We base our estimates on historical experience and on various other assumptions that are believed 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 could differ significantly from the estimates made by management with respect to these items and other items that require management’s estimates.

The costs of our technical services department are allocated between cost of revenue, sales and marketing expenses, and research and development expenses based upon an estimate of the time spent by the technical services’ employees in various departments and the areas benefited by that time. Total costs of the technical services department were $6.2 million and $6.1 million for the quarters ended December 31, 2003 and 2002, respectively. The allocation rates applied to these department costs were 20% to cost of revenue, 76% to sales and marketing, and 4% to research and development in the quarter ended December 31, 2003 and 23% to cost of revenue, 71% to sales and marketing, and 6% to research and development in the quarter ended December 31, 2002. The allocation estimate is subject to change and, if changed, will impact the allocation of expenses in the statement of operations but will not impact net income or loss.

Cash Equivalents

The Company considers all highly liquid instruments with an original maturity of three months or less to be cash equivalents.

Earnings Per Share

Basic per share amounts are calculated using the weighted-average number of common shares outstanding during the period. Diluted per share amounts are calculated using the weighted-average number of common shares outstanding during the period and, when dilutive, the weighted-average number of potential common shares from the exercise of outstanding options and warrants to purchase common stock using the treasury stock method. Excluded from the computation of diluted earnings per share for the quarter ended December 31, 2003, were options to acquire 9.0 million shares of common stock because of the application of the treasury stock method to calculate fully diluted shares outstanding. Excluded from the computation of diluted loss per share for the quarter ended December 31, 2002, were options to acquire 15.2 million shares of common stock and a warrant to acquire 54,321 shares of common stock at $5.42 per share because their effect would be anti-dilutive. A reconciliation of the numerators and denominators used in the basic and diluted net income (loss) per share amounts follows (in thousands):

Concentration of Revenues

One third-party distributor customer accounted for approximately 17% and 20% of revenues for the quarters ended December 31 2003 and 2002, respectively. No one end-user customer accounted for 10% of revenues for the quarter ended December 31, 2003. One end user customer accounted for 17% of revenues for the quarter ended December 31, 2002.

Accounts Receivable

Accounts receivable includes an allowance for doubtful accounts of $1.3 million and $1.2 million as of December 31, 2003 and September 30, 2003, respectively.

Accumulated Other Comprehensive Loss

The only component of accumulated other comprehensive loss is net foreign currency translation adjustments. Other comprehensive loss, net of tax, for the quarters ended December 31, 2003 and 2002 was $0.1 million and $0.5 million respectively.

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