<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
--------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number
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ISS GROUP, INC.
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(Exact name of registrant as specified in its charter)
DELAWARE 58-2362189
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(State or jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6600 PEACHTREE-DUNWOODY ROAD, 300 EMBASSY ROW, SUITE 500, ATLANTA, GEORGIA 30328
- --------------------------------------------------------------------------------
(Address of principal executive offices)
Registrant's telephone number, including area code (678) 443-6000
--------------
NOT APPLICABLE
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(Former name, former address and former fiscal year, if changed since
last report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Number of Shares Outstanding
Title of each class as of August 10, 1998
------------------------------------ ---------------------------------
Common Stock, $0.001 par value 16,876,438
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<PAGE> 2
<TABLE>
<CAPTION>
PAGE
PART I. FINANCIAL INFORMATION NUMBER
------
<S> <C> <C>
Item 1 Consolidated Financial Statements:
Consolidated Statements of Operations for the Three Months
and Six Months ended June 30, 1998 and June 30, 1997................................3
Consolidated Balance Sheets at June 30, 1998 and
December 31, 1997...................................................................4
Consolidated Statements of Cash Flows for the Six
Months ended June 30, 1998 and 1997.................................................5
Notes to Consolidated Financial Statements..........................................6
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations......................................10
PART II. OTHER INFORMATION
Item 2 Changes in Securities and Use of Proceeds..........................................14
Item 6 Exhibits and Reports on Form 10-Q..................................................14
</TABLE>
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<PAGE> 3
ISS GROUP, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
--------------------- --------------------
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Revenues:
Licenses $ 5,559 $ 2,150 $ 10,434 4,022
Support services 1,772 521 2,970 874
-------- -------- -------- ------
7,331 2,671 13,404 4,896
Costs and expenses:
Cost of revenues 892 137 1,405 224
Research and development 1,832 569 3,468 1,062
Sales and marketing 5,431 2,342 10,079 4,096
General and administrative 1,100 301 2,081 621
-------- -------- -------- ------
9,255 3,349 17,033 6,003
-------- -------- -------- ------
Operating loss (1,924) (678) (3,629) (1,107)
Interest income, net 841 68 907 103
-------- -------- -------- ------
Net loss $ (1,083) $ (610) $ (2,722) (1,004)
======== ======== ======== =======
Basic and diluted net loss per share of Common Stock $ (0.06) $ (0.08) $ (0.21) (0.13)
======== ======== ======== =======
Weighted average number of shares used in calculating
basic and diluted net loss per share of Common Stock 16,865 7,902 12,803 7,902
======== ======== ======== =======
Unaudited pro forma net loss per share of Common Stock $ (0.04) $ (0.18) (0.08)
======== ======== =======
Unaudited weighted average number of shares used in
calculating pro forma net loss per share of Common
Stock 13,639 15,417 13,117
======== ======== =======
</TABLE>
See notes to consolidated financial statements.
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<PAGE> 4
ISS GROUP, INC. and SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
June 30, 1998 December 31, 1997
-------------- -----------------
(Unaudited) (Audited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 59,935 $ 3,929
Accounts receivable, less allowance for doubtful
accounts of $257,000 and $255,000, respectively 7,318 4,038
Other current assets 677 281
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Total current assets 67,930 8,248
Property and equipment:
Computer equipment 2,952 1,688
Office furniture and equipment 614 268
Leasehold improvements 175 15
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3,741 1,971
less accumulated depreciation 860 402
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2,881 1,569
Other assets 156 49
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Total assets $ 70,967 $ 9,866
============= =============
Current liabilities:
Accounts payable $ 1,122 $ 2,002
Accrued expenses 2,175 1,798
Deferred revenues 4,338 2,106
Current portion of long term debt - 70
------------- -------------
Total current liabilities 7,635 5,976
Non current liabilities 141 -
Long term debt - 70
Redeemable, Convertible Preferred Stock (5,737,000
shares authorized):
Series A; $.001 par value; none issued or outstanding and
3,650,000 issued and outstanding; (liquidation preference
$1 per share) - 3,621
Series B; $.001 par value; none issued or outstanding and
2,087,000 issued and outstanding (liquidation preference
$2.53 per share) - 5,257
Stockholders' equity (deficit):
Common stock, $.001 par value, 50,000,000 shares
authorized, 16,862,000 and 7,921,000 issued and
outstanding, respectively 17 8
Additional paid-in capital 72,103 695
Deferred compensation (1,022) (571)
Cumulative adjustment for currency revaluation 5 -
Accumulated deficit (7,912) (5,190)
------------- -------------
Total stockholders' equity (deficit) 63,191 (5,058)
Total liabilities and stockholders' equity: $ 70,967 $ 9,866
============== ==============
</TABLE>
See notes to consolidated financial statements.
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<PAGE> 5
ISS GROUP, INC. and SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
For the Six Months ended
June 30,
-----------------------
1998 1997
<S> <C> <C>
OPERATING ACTIVITIES
Net loss $ (2,722) $(1,004)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation 458 100
Deferred compensation expense 360 -
Deferred rent 141 -
Changes in assets and liabilities:
Accounts receivable (3,280) (1,314)
Prepaid expenses and other assets (503) (159)
Accounts payable and accrued expenses (501) 855
Deferred revenues 2,232 1,072
------------------------
Net cash used in operating activities (3,815) (450)
INVESTING ACTIVITIES
Purchases of property and equipment (1,770) (498)
-----------------------
Net cash used in investing activities (1,770) (498)
FINANCING ACTIVITIES
Payments on long term debt (140) (35)
Net proceeds from Redeemable, Convertible
Preferred Stock issuance - 5,253
Proceeds from exercise of stock options 179 -
Net proceeds from initial public offering 61,547 -
-----------------------
Net cash provided by financing activities 61,586 5,218
Foreign currency impact on cash 5 -
-----------------------
Net increase in cash and cash equivalents 56,006 4,270
Cash and cash equivalents at beginning of period 3,929 2,007
-----------------------
Cash and cash equivalents at end of period $ 59,935 $ 6,277
=======================
SUPPLEMENTAL CASH FLOW DISCLOSURE
Interest paid $ 8 $ 5
=======================
</TABLE>
See notes to consolidated financial statements.
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<PAGE> 6
ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Significant Accounting Policies
The accompanying consolidated financial statements of ISS Group, Inc.
("ISS" or "Company") should be read in conjunction with the Company's
consolidated financial statements for the year ended December 31, 1997.
Significant accounting policies disclosed therein have not changed.
The accompanying consolidated financial statements are unaudited; however,
in the opinion of management, they include all normal recurring
adjustments necessary for a fair presentation of the consolidated
financial position of the Company at June 30, 1998 and the consolidated
results of its operations and cash flows for the six months ended June 30,
1998 and 1997. Results of operations reported for interim periods are not
necessarily indicative of results for the entire year.
The consolidated balance sheet at December 31, 1997 has been derived from
the audited financial statements at that date but does not include all the
footnotes required by generally accepted accounting principles for
complete financial statements.
The Company's business is focused on maintaining the latest security
threat and vulnerability checks within existing products and creating new
products and services that are consistent with the Company's goal of
providing an adaptive security management approach to network security.
This approach entails continuous security risk monitoring and response to
develop an active and informed network security policy.
2. Initial Public Offering
On March 23, 1998, ISS completed an initial public offering of its Common
Stock ("the IPO"). The Company's shares are traded on the National Market
of the Nasdaq Stock Market under the ticker symbol "ISSX". A total of
3,450,000 shares were sold in the IPO, including 3,070,000 newly issued
shares by the Company and 380,000 outstanding shares sold by existing
stockholders. The Company did not receive any of the proceeds from the
sale of stock by the selling stockholders. The shares were sold to the
underwriting group in the IPO at a price of $22.00 per share which, after
underwriters' discount of $4,728,000 and offering expenses of $1,265,000,
resulted in net proceeds to ISS of $61,547,000. The proceeds of the IPO
have been used for general corporate purposes and at June 30, 1998 are
invested in short term interest-bearing investments.
Under the conversion feature of the Company's previously outstanding
Redeemable, Convertible Preferred Stock, all of the outstanding shares of
preferred stock were automatically converted into an aggregate of
5,737,000 shares of Common Stock upon the closing of the IPO.
Additionally, the Company's repurchase rights with respect to 4,586,000
shares that were originally issued to the Company's founder in 1994 in
exchange for the assignment of technology previously developed and
distributed by the founder as shareware expired as a result of the IPO.
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<PAGE> 7
ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
3. Stock Option Plans
During the fourth quarter of 1997 and the first quarter of 1998, the
Company recorded deferred compensation related to stock option grants that
were made in December 1997 and in January and February 1998. The amount
was determined by comparing the exercise price of the stock options to the
fair value of the Common Stock on the respective dates of grant. The fair
value for December grants was established based on the estimated price
range for the IPO as set forth in the initial filing of the Company's
Registration Statement on Form S-1 that was filed with the Securities and
Exchange Commission (the "Commission") on January 20, 1998. The fair value
for January and February 1998 grants was determined to be $20 based on the
final estimated price range contained in the Company's March 1998
pre-effective amendment to its Registration Statement for the IPO.
Deferred compensation of $811,000 in the first quarter of 1998 and
$571,000 in the fourth quarter of 1997 has been reflected as a reduction
of stockholders' equity in the accompanying consolidated balance sheets.
The amounts are being charged to operations proportionately over the four
year vesting period of the related stock options. The statements of
operations for the three months and six months ended June 30, 1998
included $295,000 and $360,000, respectively, of compensation expense
related to such amortization.
4. Loss per share
Basic and diluted historical net loss per share was computed by dividing
net loss plus accretion of the Series A and Series B Redeemable,
Convertible Preferred Stock by the weighted average number of shares of
Common Stock outstanding. Common Stock equivalents were antidilutive and
therefore were not included in the computation of weighted average shares
used in computing diluted loss per share.
Pro forma loss per share was computed by dividing net loss by the weighted
average number of shares of Common Stock outstanding plus the conversion
of the Redeemable, Convertible Preferred Stock into 5,737,000 shares of
Common Stock as of the later of (i) the beginning of each period reported
or (ii) the date of issuance of such preferred stock, instead of the date
when such shares of preferred stock automatically converted into Common
Stock (which occurred on March 27, 1998).
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<PAGE> 8
ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following tables set forth the computation of basic, diluted and
unaudited pro forma net loss per share for the three months and six months
ended June 30:
<TABLE>
<CAPTION>
Three months ended June 30
-------------------------------
1998 1997
------------ --------------
<S> <C> <C>
Numerator:
Net loss $ (1,083,000) $ (610,000)
Accretion of Series A and Series B Redeemable,
Convertible Preferred Stock - (3,000)
------------ --------------
$ (1,083,000) $ (613,000)
Denominator:
Denominator for basic and diluted net loss per
share - weighted average shares 16,865,000 7,902,000
Redeemable, Convertible Preferred Stock - 5,737,000
------------ --------------
Weighted average shares for pro forma net loss per
share 16,865,000 13,639,000
Basic net loss per share $ (0.06) $ (0.08)
Diluted net loss per share $ (0.06) $ (0.08)
Pro forma net loss per share $ (0.06) $ (0.04)
</TABLE>
<TABLE>
<CAPTION>
Six months ended June 30
-------------------------------
1998 1997
------------ --------------
<S> <C> <C>
Numerator:
Net loss $ (2,722,000) $ (1,004,000)
Accretion of Series A and Series B Redeemable
Convertible Preferred Stock - (3,000)
------------ --------------
$ (2,722,000) $ (1,007,000)
Denominator:
Denominator for basic and diluted net loss per
share - weighted average shares 12,803,000 7,902,000
Redeemable, Convertible Preferred Stock 2,614,000 5,215,000
------------ --------------
Weighted average shares for pro forma net loss per
share 15,417,000 13,117,000
Basic net loss per share $ (0.21) $ (0.13)
Diluted net loss per share $ (0.21) $ (0.13)
Pro forma net loss per share $ (0.18) $ (0.08)
</TABLE>
Options aggregating 1,175,000 and 2,493,000 at June 30, 1998 and June 30,
1997, respectively are not included in the above calculations as they are
anti-dilutive.
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<PAGE> 9
ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
5. Commitments & Contingencies
In the first quarter of 1998, ISS entered into a noncancellable operating
lease for new headquarters and research and development facilities in
Atlanta, Georgia The lease expires in June 2002 and provides for minimum
annual lease payments of approximately $842,000.
On July 7, 1998, Network Associates, a competitor of the Company, filed a
patent infringement suit against ISS for the Federal District Court in the
Northern District of California. This suit alleges that ISS' product,
RealSecure, violates certain patent claims issued for Network Associates'
intrusion detection technology. ISS believes the lawsuit is without merit,
and intends to defend against it vigorously. However there can be no
assurance that the Network Associates lawsuit will not have or result in a
material adverse effect on the Company's business, operating results or
financial condition. See also Exhibit 99 to this Quarterly Report on
Form 10-Q.
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<PAGE> 10
ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and related Notes thereto included elsewhere in this
Quarterly Report on Form 10-Q. Except for the historical financial information
contained herein, the matters discussed in this Quarterly Report on Form 10-Q
may be considered "forward-looking" statements within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Such statements include declarations regarding
the intent, belief or current expectations of the Company and its management.
Prospective investors are cautioned that any such forward-looking statements are
not guarantees of future performance and involve a number of risks and
uncertainties. Actual results could differ materially from those indicated by
such forward-looking statements. Among the important factors that could cause
actual results to differ materially from those indicated by such forward-looking
statements are the risk factors included under Exhibit 99 at the end of this
Quarterly Report on Form 10-Q, as well as the risk factors identified in the
Company's Registration Statement on Form S-1 as filed with the Commission and
available at the Commission's Web site at www.sec.gov.
OVERVIEW
Internet Security Systems is the leading provider of network security
monitoring, detection and response software that protects the security and
integrity of enterprise information systems, according to various market share
reports, including the July 1998 report of The Yankee Group. The Company's
products rely on an innovative Adaptive Security Management ("ASM") approach to
network security which entails continuous security risk monitoring and responses
to develop an active and informed network security policy.
The Company continues to generate a substantial portion of its revenues from the
license and related maintenance of its SAFEsuite products. The Company has also
derived a smaller portion of its revenues from responses to customer requests
for training and implementation services, typically billed on a time and
materials basis, to assist in the successful deployment of its products within
customer networks, development of customers' security policies and assessment of
security policy decisions. The Company believes that each of its current
products and products in development, together with professional services, will
represent important revenue sources in the future.
The market for the Company's products has recently emerged and studies indicate
that substantial growth may occur in this market. The ability of the Company to
sustain a leading position in its market is critical to its long-term success.
The Company's prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in the early stage of
development, particularly companies in new and rapidly evolving markets. There
can be no assurance that the Company will be successful in addressing such risks
or difficulties or that ISS will achieve profitability in the future. See the
risk factors included as Exhibit 99 to this Quarterly Report on Form 10-Q.
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<PAGE> 11
ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
RESULTS OF OPERATIONS
The following table sets forth certain consolidated historical operating
information for the Company, as a percentage of total revenues, for the periods
ended June 30.
<TABLE>
<CAPTION>
Three months ended June 30 Six months ended June 30
1998 1997 1998 1997
------ ------ ------ ------
<S> <C> <C> <C> <C>
Licenses 75.8% 80.5% 77.8% 82.1%
Support services 24.2% 19.5% 22.2% 17.9%
--------------------------------------------------
Total revenues 100.0% 100.0% 100.0% 100.0%
--------------------------------------------------
Costs of revenues 12.1% 5.1% 10.5% 4.6%
Research and development 25.0% 21.3% 25.9% 21.7%
Sales and marketing 74.1% 87.7% 75.2% 83.6%
General and administrative 15.0% 11.3% 15.5% 12.7%
--------------------------------------------------
Total costs and expenses 126.2% 125.4% 127.1% 122.6%
--------------------------------------------------
Operating loss (26.2)% (25.4)% (27.1)% (22.6)%
Interest income, net 11.4% 2.6% 6.8% 2.1%
--------------------------------------------------
Net loss (14.8)% (22.8)% (20.3)% (20.5)%
===================================================
</TABLE>
REVENUES
The Company's revenues increased 175% to $7,331,000 in the three months ended
June 30, 1998 and 174% to $13,404,000 on a year-to date basis compared with the
same periods in the prior year. During these periods, perpetual license revenues
were the primary source of revenue generation, but continue to decrease as a
percentage of total revenues, from over 80% of revenues in the quarter and six
months ended June 30, 1997 to 76% of revenues in the second quarter of 1998 and
78% of revenues on a year-to-date basis in 1998. The Company's suite of product
offerings continues to provide increased product diversification, especially due
to the market acceptance of RealSecure, the Company's network-based intrusion
detection product offering. While Internet Scanner continued to grow and
accounted for the majority of license revenues, it decreased from 87% of new
license revenues in the three months ended June 30, 1997 to 61% of revenues in
the quarter ended June 30, 1998.
Support services, consisting of maintenance, annual licenses of products on a
usage basis and professional services, accounted for the remaining 24% and 22%
of total revenues in the three month and six month periods ended June 30, 1998,
respectively. Maintenance is the majority component of this category, but all
three components increased as a percentage of revenues from 1997 to 1998.
Geographically, the majority of the Company's revenues were from sales to
customers within North America; however, the Company's international operations
continued to be a significant
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<PAGE> 12
ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
contributor as revenues from customers outside of North America represented 21%
of revenues in the first half of 1998, the same percentage it represented for
the year ended December 31, 1997.
COSTS AND EXPENSES
Costs of revenues include packaging and distribution costs for the Company's
software products which, since the Company uses the Internet to provide product
updates and keys necessary to activate a customer's software, is a minor cost.
The category also includes the costs related to the Company's professional
services offerings, which were provided by a dedicated employee group. During
1998, expenses included the recruitment and compensation of a professional
services management team and a larger billable consulting staff. As a result,
professional services revenues grew to 4% of total revenues in the quarter ended
June 30, 1998 and gross margin, represented by total revenues less costs of
revenues, decreased to 88% of total revenues.
Research and development expenses consist of salary and related costs of
research and development personnel, including costs for employee benefits,
depreciation on computer equipment and support services used in product and
technology development. This includes the "X-Force", a team composed of security
experts dedicated to understanding, documenting and coding new vulnerability
checks, real-time threats and attack signatures and developing solutions to
address global security issues. ISS continued to increase these expenditures as
it perceives primary research and product development as essential ingredients
for retaining its leadership position in its market. Accordingly, research and
development expenses increased from $569,000, or 21% of revenues, in the quarter
ended June 30, 1997 to $ 1,832,000, or 25% of revenues, in the comparable 1998
quarter. On a year-to-date basis, research and development expenses increased
227% to $3,468,000 in 1998 from $1,062,000 in 1997. These increases were
principally due to the impact of additional personnel hires in Atlanta and the
establishment of a development team in Mountain View, California during the
first quarter of 1998.
Sales and marketing expenses consist primarily of salaries, travel expenses,
commissions, advertising, maintenance of the ISS Web site, trade show expenses,
personnel recruiting costs and costs of marketing materials. Sales and marketing
expenses continue to increase in absolute dollars, but have begun to show
indications of leverage as a higher percentage of the ISS enterprise sales force
has achieved the necessary time with ISS to reach greater levels of
productivity. In the quarter ended June 30, sales and marketing expenses were
$5,431,000, or 74% of revenues, in 1998 compared with $2,342,000, or 88% of
revenues, in 1997. Year-to-date figures exhibit similar trends. These increases
have occurred principally as a result of higher personnel head counts, which
have increased each quarter from early 1997 (both domestically and
internationally, including both the Europe and Asia/Pacific regions).
General and administrative expenses in the quarter ended June 30, 1998 increased
to $1,100,000 from $301,000 in the comparable 1997 period. For the six month
periods, these expenses totaled $2,081,000 in 1998 and $621,000 in 1997. Such
expenses included salaries and other personnel-related costs for the Company's
executive, administrative, finance and human resources personnel, support
services and professional services fees. In the first half of 1998, the Company
successfully implemented upgrades to its internal financial reporting systems
and expects to continue these efforts to enhance management's ability to obtain
and analyze information about its domestic and international operations. In
addition, ISS incurred approximately $250,000 of expense in 1998 ($100,000 in
the second quarter) in connection with the Company's relocation of its
headquarters and research and development facilities to a new Atlanta location.
Also, in 1998 the Company incurred approximately $360,000 of amortization
($295,000 in the second quarter)
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<PAGE> 13
ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
of deferred compensation related to the valuation of stock options to employees
and directors granted around the time of the Company's IPO, the majority of
which has been recorded in the general and administrative expense category.
No provision for federal, state or foreign income taxes has been recorded
because the Company had a net loss for the 1997 and 1998 periods. The Company
has not recognized any benefit from the future use of loss carryforwards for
these period or other periods since inception because management's evaluation of
all the available evidence in assessing the realizability of the tax benefits of
such loss carryforwards indicates that the underlying assumptions of future
profitable operations contain risks that do not provide sufficient assurance to
recognize such benefits currently.
CAPITAL RESOURCES AND LIQUIDITY
Net cash used in operations for the first six months of 1998 of $3,815,000
resulted from the net loss of $2,722,000 in the period plus an increase in
working capital. There was a growth in accounts receivable of $3,280,000 in 1998
commensurate with the growth of the Company's revenues, which was partially
offset by an increase of $2,232,000 in the deferred revenue liability account
balance. The increase in deferred revenue was due to growth in annual
maintenance contracts, the upfront billing of multi-year maintenance
arrangements with certain customers and growth in term licenses.
Investment in equipment totaled $1,770,000 in the first half of 1998 as ISS
provided existing and new personnel with the necessary hardware and software
tools to perform their job. This included a new telephone switch and engineering
lab equipment installed at the time of the relocation of the Company to its new
headquarters facilities.
Cash provided by financing activities of $61,586,000 was primarily the result of
the initial public offering of the Company's Common Stock that was consummated
in March 1998. Additionally, upon consummation of the initial public offering,
all shares of the Company's Convertible, Redeemable Preferred Stock
automatically converted into shares of Common Stock, removing the Company's
obligations with respect to such preferred stock redemption requirements in the
future.
As of June 30, 1998, the Company had $59,935,000 of cash and cash equivalents,
which consisted primarily of money market accounts and short-term, commercial
paper carrying the highest investment grade rating. The Company believes that
these investments will be sufficient to fund its anticipated operating losses
and to meet its working capital needs and capital expenditures for the
foreseeable future. Although the Company has not identified any specific
businesses, products or technologies that it may acquire, nor are there any
current agreements or negotiations with respect to any such transactions, the
Company from time to time evaluates such opportunities. In the event ISS
determines to pursue such opportunities, it may use its available cash and cash
equivalents. Pending such uses, cash will continue to be invested in short-term,
investment grade, interest-bearing investments.
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<PAGE> 14
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(d) Use of Proceeds.
(1) On March 23, 1998 the Company's Registration Statement on Form
S-1, SEC Registration No. 333-44529 (the "IPO Registration
Statement"), was declared effective by oral order of the SEC.
Net proceeds to the Company from the Offering were
$61,547,200. During the three months ended June 30, 1998, the
Company used $1,612,000 of the proceeds from the Offering
toward general corporate purposes, including working capital.
The remaining $59,935,000 of proceeds remains in temporary
investments consisting of money market accounts available on a
daily basis and short-term commercial paper.
ITEM 6. EXHIBITS AND REPORTS ON FORM 10-Q
(a) Exhibits
27 Financial Data Schedule (for SEC use only)
99 Private Securities Litigation Reform Act of 1995
Safe Harbor Compliance Statement for Forward-Looking
Statements
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<PAGE> 15
ISS GROUP, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ISS GROUP, INC.
---------------
(Registrant)
Date: August 14, 1998 By /s/ Richard Macchia
--------------------- --------------------------------------------
Chief Financial Officer
(Principal Financial and Accounting Officer)
-16-
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS OF ISS GROUP, INC. AS OF AND FOR
THE SIX MONTHS ENDED JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
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<PERIOD-START> JAN-01-1998
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<PAGE> 1
EXHIBIT 99
Private Securities Litigation Reform Act of 1995
Safe Harbor Compliance Statement for Forward-Looking Statements
In passing the Private Securities Litigation Reform Act of 1995 (the "Reform
Act"), Congress encouraged public companies to make "forward-looking statements"
by creating a safe-harbor to protect companies from securities law liability in
connection with forward-looking statements. ISS Group, Inc. ("ISS") intends to
qualify both its written and oral forward-looking statements for protection
under the Reform Act.
In addition to the other information in this Quarterly Report on Form 10-Q,
stockholders should carefully consider the following factors in evaluating the
Company and its business, as well as the Risk Factors set forth in the Company's
Registration Statement on Form S-1 as filed with the Securities and Exchange
Commission on March 23, 1998.
To qualify oral forward-looking statements for protection under the Reform Act,
a readily available written document must identify important factors that could
cause actual results to differ materially from those in the forward-looking
statements. ISS provides the following information in connection with its
continuing effort to qualify forward-looking statements for the safe harbor
protection of the Reform Act.
SIGNIFICANT POTENTIAL FLUCTUATIONS IN FUTURE OPERATING RESULTS
The Company's future revenues and operating results are uncertain and
are expected to fluctuate from quarter to quarter and from year to year due to a
combination of factors, including the level of demand for the Company's
products, the volume and timing of orders, product and price competition, the
Company's ability to expand its domestic and international sales and marketing
organizations, the Company's ability to develop new and enhanced products, the
Company's ability to attract and retain key technical, sales and managerial
personnel, the mix of distribution channels through which the Company's products
are sold, the growth in the acceptance of, and activity on, the Internet and
World Wide Web ("Web"), particularly by corporate, institutional and government
users, the growth of private Internet protocol ("IP") networks (or "intranets"),
the extent to which unauthorized access and use of online information is
perceived as a threat to network security, customer budgets, the assertion of
infringement claims with respect to the Company's intellectual property,
seasonal trends in customer purchasing, foreign currency exchange rates, general
economic factors and risks concerning the rapid change in technology. As the
Company increasingly focuses on sales of the Company's product suite rather than
individual products, the Company expects that the sales cycle associated with
the purchase of the Company's products will lengthen. In addition, the amount of
revenues associated with particular licenses can vary significantly based upon
the number of products that are licensed and the number of devices involved in
the installation. The Company has experienced, and may continue to experience
from time to time, large individual license sales which can cause significant
variations in quarterly license revenues. Moreover, small delays in customer
orders can cause significant variability in the Company's license revenues and
results of operations for any particular period. As a result, the timing of
significant orders is unpredictable and, like many software companies, the
Company typically realizes a significant portion of its software license
revenues in the last month of a quarter. The Company establishes its expenditure
levels for product development, sales and marketing and other operating expenses
based, in large part, on its expected future revenues. As a result, if revenues
fall below expectations, operating results and net income are likely to be
adversely and disproportionately affected because only a small portion of the
Company's expenses vary with its revenues.
-17-
<PAGE> 2
EXHIBIT 99
LIMITED OPERATING HISTORY
The Company has only a limited operating history upon which an
evaluation of the Company and its prospects can be based and is subject to all
of the risks inherent in the establishment of a new business enterprise. The
Company has never achieved profitability, nor does the Company expect to achieve
profitability in the foreseeable future.
COMPETITION
The market for security monitoring, detection and response products and
services is intensely competitive and the Company expects competition to
increase further in the future. There can be no assurance that the Company can
maintain its competitive position against current and potential competitors,
especially those with significantly greater financial, marketing, service,
support, technical and other competitive resources.
RAPID TECHNOLOGICAL CHANGE AND NEW PRODUCTS
The market for the Company's products is characterized by rapid
technological advances, including by those seeking to establish more secure
systems and those seeking to compromise such systems, evolving industry
standards in computer hardware and software technology, changes in customer
requirements and frequent new product introductions and enhancements. As a
result, the Company must continually change and improve its products in response
to changes in operating systems, application and networking software, computer
and communications hardware, programming tools and computer language technology.
INTELLECTUAL PROPERTY RIGHTS; USE OF LICENSED TECHNOLOGY
The Company relies primarily on a combination of copyright and
trademark laws, trade secrets, confidentiality procedures and contractual
provisions to protect its proprietary rights. The Company believes that factors
such as the technological and creative skills of its personnel, new product
developments, frequent product enhancements, name recognition and reliable
product maintenance are essential to establishing and maintaining a technology
leadership position.
Although the Company is not aware that any of its products infringes
the proprietary rights of third parties, there can be no assurance that third
parties will not claim infringement by the Company with respect to current or
future products and, in fact, a competitor has recently filed a complaint
alleging infringement of its patents by the Company's intrusion detection
technology. The Company is vigorously defending this suit, and although the
Company believes that the claims asserted are without merit, there can be no
assurance that the Company will prevail in this suit or, if the Company does not
prevail, that no material adverse affect to the Company's results of operations
will result. The Company expects that software product developers will
increasingly be subject to infringement claims as the number of products and
competitors in the Company's industry segment grows and the functionality of
products in different industry segments overlaps. Any such claims, with or
without merit, could be time consuming distract management attention, result in
costly litigation, cause product shipment delays or require the Company to enter
into royalty or licensing agreements. Such royalty or licensing agreements, if
required, may not be available on terms acceptable to the Company or at all,
which could have a material adverse effect upon the Company's business,
operating results and financial condition.
RISKS ASSOCIATED WITH THE EMERGING MARKET FOR SECURITY PRODUCTS
The market for the Company's products is rapidly evolving. There can be
no assurance that Internet protocols will continue to be used to facilitate
communications or that the market for security monitoring, detection and
response systems in general will continue to expand. If the market for products
to monitor Internet and intrant security fails to grow or grows more slowly
than the Company currently anticipates, the Company's business, operating
results and financial condition would be materially and adversely affected.
OTHER RISK FACTORS
In addition to the above-referenced items, the Company's business,
financial condition and results of operations may be affected by (i) risks
associated with its international operations, (ii) the Company's reliance on
indirect distribution channels, (iii) current product concentration, (iv) the
Company's dependence on key personnel, (v) management of growth, (vi) the
Company's inability to provide complete protection with respect to its
proprietary intellectual property, (vii) potential product liability or product
defects, (viii) the risk of targeted attacks against the Company and (ix)
government regulation of the Company's products. For a more complete description
of these risks, stockholders and others are encouraged to review the section
captioned "Risk Factors" in the Company's Registration Statement on Form S-1 as
filed with the Securities and Exchange Commission on March 23, 1998.
-18-
