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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, 1999
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
Commission File Number ________________
ISS GROUP, INC.
(Exact name of registrant as specified in its charter)
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<S> <C>
DELAWARE 58-2362189
(State or jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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6600 PEACHTREE-DUNWOODY ROAD, 300 EMBASSY ROW, SUITE 500, ATLANTA, GEORGIA 30328
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(Address of principal executive offices)
Registrant's telephone number, including area code (678) 443-6000
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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.
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<CAPTION>
Number of Shares Outstanding
Title of each class as of August 12, 1999
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<S> <C>
Common Stock, $0.001 par value 37,985,638
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PAGE
PART I. FINANCIAL INFORMATION NUMBER
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Item 1 Consolidated Financial Statements:
Consolidated Statements of Operations for the Three Months
and Six Months ended June 30, 1999 and June 30, 1998.............................. 3
Consolidated Balance Sheets at June 30, 1999 and
December 31, 1998................................................................. 4
Consolidated Statements of Cash Flows for the Six
Months ended June 30, 1999 and June 30, 1998...................................... 5
Notes to Consolidated Financial Statements........................................ 6
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations..................................... 8
PART II. OTHER INFORMATION
Item 1 Legal Proceedings................................................................. 14
Item 2 Changes in Securities and Use of Proceeds......................................... 14
Item 4 Submission of Matters to a Vote of Security Holders............................... 14
Item 6 Exhibits and Reports on Form 10-Q................................................. 15
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ISS GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
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<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- ---------------------
1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Revenues:
Perpetual licenses $ 11,336 $ 5,559 $22,286 $ 10,434
Subscriptions 3,904 1,487 7,391 2,656
Professional services 1,709 285 3,258 314
-------- -------- ------- --------
16,949 7,331 32,935 13,404
Costs and expenses:
Costs of revenues 2,369 892 4,555 1,405
Research and development 4,469 1,832 8,291 3,468
Sales and marketing 8,253 5,431 16,079 10,079
General and administrative 1,372 1,100 2,781 2,081
Amortization 248 -- 498 --
-------- -------- ------- --------
16,711 9,255 32,204 17,033
Operating income (loss) 238 (1,924) 731 (3,629)
Interest income, net 1,537 841 2,419 907
Income (loss) before income taxes 1,775 (1,083) 3,150 (2,722)
Provision for income taxes (125) -- (200) --
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Net income (loss) $ 1,650 $ (1,083) $ 2,950 $ (2,722)
======== ======== ======= ========
Basic net income (loss) per share of Common Stock $ 0.04 $ (0.03) $ 0.08 $ (0.11)
======== ======== ======= ========
Diluted net income (loss) per share of Common Stock $ 0.04 $ (0.03) $ 0.07 $ (0.11)
======== ======== ======= ========
Weighted average number of shares:
Basic 37,862 33,730 36,707 25,606
======== ======== ======= ========
Diluted 40,906 33,730 39,889 25,606
======== ======== ======= ========
Unaudited pro forma net income (loss) per share of
Common Stock $ (0.09)
========
Unaudited weighted average number of shares used in
calculating unaudited pro forma net loss per
share of Common Stock 30,834
========
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ISS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
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<CAPTION>
JUNE 30, 1999 DECEMBER 31, 1998
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(UNAUDITED) (AUDITED)
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ASSETS
Current assets:
Cash and cash equivalents $ 133,608 $ 52,632
Accounts receivable, less allowance for doubtful accounts
of $407 and $287, respectively 14,959 12,586
Prepaid expenses and other current assets 1,547 743
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Total current assets 150,114 65,961
Property and equipment:
Computer equipment 6,030 4,370
Office furniture and equipment 1,923 1,027
Leasehold improvements 519 275
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8,472 5,672
Less accumulated depreciation 3,035 1,655
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5,437 4,017
Goodwill, less accumulated amortization of $239
and $77, respectively 2,933 3,094
Other intangibles, less accumulated amortization of $490
and $154, respectively 4,355 4,692
Other assets 525 257
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Total assets $ 163,364 $ 78,021
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,349 $ 692
Accrued expenses 3,149 4,202
Deferred revenues 10,296 6,678
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Total current liabilities 14,794 11,572
Non-current liabilities 110 134
Stockholders' equity:
Common stock, $.001 par value, 120,000,000 shares authorized,
37,954,000 and 34,584,000 issued and outstanding,
respectively 38 35
Additional paid-in captial 155,278 76,092
Deferred compensation (475) (662)
Cumulative adjustment for currency revaluation (39) 142
Accumulated deficit (6,342) (9,292)
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Total stockholders' equity 148,460 66,315
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Total liabilities and stockholders' equity $ 163,364 $ 78,021
========= ========
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ISS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
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SIX MONTHS ENDED JUNE 30,
-------------------------
1999 1998
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OPERATING ACTIVITIES
Net income (loss) 2,950 $ (2,722)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation 1,380 458
Amortization 498 --
Deferred compensation expense 187 360
Deferred rent (24) 141
Changes in assets and liabilities:
Accounts receivable (2,373) (3,280)
Prepaid expenses and other assets (1,072) (503)
Accounts payable and accrued expenses (396) (501)
Deferred revenues 3,618 2,232
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Net cash provided by (used in) operating activities 4,768 (3,815)
INVESTING ACTIVITIES
Purchases of property and equipment (2,800) (1,770)
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Net cash used in investing activities (2,800) (1,770)
FINANCING ACTIVITIES
Payments on long term debt -- (140)
Proceeds from exercise of stock options 1,792 179
Net proceeds from secondary offering 77,397 61,547
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Net cash provided by financing activities 79,189 61,586
Foreign currency impact on cash (181) 5
--------- --------
Net increase in cash and cash equivalents 80,976 56,006
Cash and cash equivalents at beginning of period 52,632 3,929
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Cash and cash equivalents at end of period $ 133,608 $ 59,935
========= ========
SUPPLEMENTAL CASH FLOW DISCLOSURE
Interest paid -- $ 8
========= ========
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ISS GROUP, INC
NOTES TO CONSOLIDTED 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, 1998.
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, 1999 and the
consolidated results of its operations and cash flows for the six
months ended June 30, 1999 and 1998. Results of operations reported for
interim periods are not necessarily indicative of results for the
entire year.
The consolidated balance sheet at December 31, 1998 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. Comprehensive Income
Comprehensive income for the quarter ended June 30, 1999 aggregated
$1,831,000. The effects of foreign exchange gains and losses arising
from translations of assets and liabilities of our foreign operations
into U.S. dollars at June 30, 1999 are included as a component of
comprehensive income. Such amounts were $181,000 in the period ended
June 30, 1999.
3. Secondary Stock Offering
On March 2, 1999, ISS completed a public offering of its Common Stock
("the Offering"). A total of 2,588,800 shares were sold in the Offering
including 1,388,800 newly issued shares by the Company and 1,200,000
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
Offering at a price of $59.00 per share which, after underwriters'
discount and offering expenses, resulted in net proceeds to ISS of
$77,397,000. The proceeds of the Offering are invested in short-term
interest-bearing investments at June 30, 1999.
4. Income (loss) per share
On April 1, 1999, the Company's Board of Directors declared a
two-for-one stock split effected in the form of a stock dividend paid
on May 19, 1999 to stockholders of record on May 5, 1999. Accordingly,
all share and income (loss) per share amounts have been retroactively
restated for this 100% stock dividend.
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ISS GROUP, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. Income (loss) per share (continued)
Basic historical net income (loss) per share was computed by dividing
net income (loss) by the weighted average number of shares of Common
Stock outstanding. Diluted historical net income (loss) per share was
computed by dividing net income (loss) by the weighted average shares
outstanding, including Common Stock equivalents if dilutive. For the
quarter and six months ended June 30, 1998, options aggregating
4,688,000 were antidilutive and therefore were not included in the
computation. For the quarter and six months ended June 30, 1999
weighted average shares included 3,045,000 and 3,189,000 shares,
respectively, to reflect the dilutive impact of stock options.
Pro forma loss per share for the quarter ended June 30, 1998 was
computed by dividing the 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 January 1, 1998 instead of March 27, 1998 when such shares
of preferred stock automatically converted into Common Stock.
5. Commitments & Contingencies
On July 13, 1999 ISS and Network Associates, Inc. announced that the
patent infringement suit filed in July 1998 by Network Associates, Inc.
against Internet Security Systems, Inc. (a wholly-owned subsidiary of
ISS) was resolved to the parties' mutual satisfaction. The resolution
of this previously pending litigation had no material adverse effect on
the business, operating results, or financial condition of ISS.
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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,
the matters discussed in this Quarterly Report on Form 10-Q may be considered
"forward-looking" statements. Such statements include declarations regarding our
intent, belief or current expectations. Such forward-looking statements are not
guarantees of future performance and involve a number of risks and
uncertainties. Actual results may 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
Annual Report on Form 10-K for the year ended December 31, 1998 as filed with
the Securities and Exchange Commission and available at their Web site at
www.sec.gov.
OVERVIEW
We are a leading source for e-business risk management solutions. Our Adaptive
Security Management approach to Internet and network security protects
distributed computing environments, such as internal corporate networks,
inter-company networks and electronic commerce environments, from attacks,
misuse and security policy violations. Our SAFEsuite(R) family of products is a
critical element of an active Internet and networking security program within
today's world of global connectivity, enabling organizations to proactively
monitor, detect and respond to risks to enterprise information. Our business is
focused on maintaining the latest security threat and vulnerability checks
within our existing products, creating new products and providing technical and
professional services that are consistent with our goal of providing enterprise
solutions to address network security.
We generate the substantial portion of our revenues from our SAFEsuite family of
products in the form of perpetual licenses and subscriptions. We recognize
perpetual license revenues upon delivery of software or, if the customer has
evaluation software, delivery of the software key and issuance of the related
license, assuming that no significant vendor obligations or customer acceptance
rights exist. Where payment terms are extended over periods greater than 12
months, revenue is recognized as such amounts are billable. Annual renewable
maintenance is a separate component of each perpetual license agreement with
revenue recognized ratably over the maintenance term. Subscription revenues
include maintenance and term licenses including managed service arrangements.
Term licenses allow customers to use our product and receive maintenance
coverage for a specified period, generally 12 months. We recognize revenues from
each subscription agreement ratably over the subscription term. Professional
services, which are typically billed on a time-and-materials basis, assist in
the successful deployment of our products within customer networks, the
development of customers' security policies and the assessment of security
policy decisions. We recognize professional services as such services are
rendered.
We believe that each of our current products and products in development,
together with maintenance and professional services, will represent important
sources of revenue in the future. While we expect the expansion of these product
offerings to originate primarily from internal development, our strategy
includes acquiring products and technologies that fit within our product
strategy and that potentially accelerate the timing of the commercial
introduction of such products and technologies as integrated components of our
enterprise network security solutions.
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ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Our business has grown rapidly since 1995. Prior to the quarter ended March 31,
1999, we experienced net losses that had resulted, in large part, from
significant costs incurred in the development and sales of our products and
professional services. We expect to continue to expand our domestic and
international sales and marketing operations, increase our investment in product
development and our proprietary threat and vulnerability database, seek
acquisition candidates that will enhance our products and market share, and
improve our internal operating and financial infrastructure in support of our
strategic goals and objectives. All of these initiatives will increase operating
expenses. As a result, while we narrowed our operating losses over the course of
1998 and achieved profitability in the first and second quarters of 1999, we
cannot be certain that we can sustain such profitability.
Due to our fast growth in an emerging market, period-to-period comparisons of
our operating results are not meaningful. Although we continue to experience
significant revenue growth, we cannot assure our stockholders that such growth
can be sustained and, therefore, investors should not rely on our past growth as
a predictor of future performance. Rather, our prospects must be considered in
light of the risks and difficulties frequently encountered by companies in new
and rapidly evolving markets. There can be no assurance that we will be
successful in addressing such risks and difficulties. See the risk factors
included as Exhibit 99 to the Quarterly Report on Form 10-Q.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated historical operating
information, as a percentage of total revenues, for the three months and six
months ended June 30, 1999 and 1998:
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Three months ended Six months ended
June 30 June 30
1999 1998 1999 1998
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<S> <C> <C> <C> <C>
Licenses 66.9% 75.8% 67.7% 77.9%
Subscriptions 23.0% 20.3% 22.4% 19.8%
Professional services 10.1% 3.9% 9.9% 2.3%
----- ----- ----- -----
Total revenues 100.0% 100.0% 100.0% 100.0%
----- ----- ----- -----
Costs of revenues 14.0% 12.1% 13.8% 10.5%
Research and development 26.3% 25.0% 25.2% 25.9%
Sales and marketing 48.7% 74.1% 48.8% 75.2%
General and administrative 8.1% 15.0% 8.5% 15.5%
Amortization 1.5% -- 1.5% --
----- ----- ----- -----
Total costs and expenses 98.6% 126.2% 97.8% 127.1%
----- ----- ----- -----
Operating income (loss) 1.4% (26.2)% 2.2% (27.1)%
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ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
REVENUES
Our total revenues increased 131% to $16,949,000 for the three months ended June
30, 1999 and 146% to $32,935,000 on a year-to-date basis compared with the same
periods in the prior year. Perpetual license revenues continued to be the
primary source of revenue generation, but decreased as a percentage of total
revenues from approximately 76% and 78% of total revenues in the three months
and six months ended June 30, 1998, respectively, to 67% and 68% of total
revenues in the three months and six months ended June 30, 1999, respectively.
Both subscription revenues and professional service revenues increased compared
to the comparable periods in the prior year in both absolute dollars and as a
percentage of total revenues. Subscription revenues, consisting of maintenance
and term licenses of product usage, accounted for 23% and 22% of our total
revenues in the three-month and six-month periods ended June 30, 1999,
respectively, a 3% increase in percentage of total revenues over the comparable
periods in the prior year. Professional services represented 10% of total
revenues in both the three month and six month periods ended June 30, 1999 as we
continued our initiative begun in 1998 to build our service capabilities to
address the demand from our customers for implementation, training and
consulting services.
Our suite of product offerings continues to provide increased product
diversification, although there can be fluctuations on a quarterly basis. In the
second quarter of 1999, licenses of our vulnerability assessment products were
strong, representing 59% of our license revenues. Our intrusion detection
product, RealSecure, represented 39% of license revenues for the second quarter
and SAFEsuite Decisions, our enterprise security management application released
in the fourth quarter of 1998, represented 2% of our license revenues. For the
six months ended June 30, 1999 vulnerability assessment products comprised 51%
of license revenues and intrusion detection represented 46%, with SAFEsuite
Decisions comprising 3%. This compares to the first half of 1998 where
vulnerability assessment products represented 72% of license revenues and
intrusion detection products represented 28% of license revenues.
Geographically, we derived the majority of our revenues from sales to customers
within North America; however, international operations continued to be a
significant contributor to revenues, as revenues from customers outside of North
America represented 26% of revenues in the first half of 1999, compared to 21%
of total revenues for the comparable period in 1998.
COSTS AND EXPENSES
Costs of revenues include packaging and distribution costs for our software
licenses. Since we use the Internet to provide product updates and keys
necessary to activate a customer's software, this is a minor cost. Costs of
revenues also include costs associated with the technical support group that
provides assistance to maintenance customers. Finally, the category includes the
costs we incur to provide professional services to customers. As a result of the
growth in our professional services capabilities which began in 1998, our gross
margin, represented by total revenues less costs of revenues expressed as a
percentage of total revenues, decreased from 89% in the quarter ended June 30,
1998 and 88% in the first half of 1998 to 86% in the comparable periods of 1999.
Research and development expenses consist of salary and related costs of
research and development personnel, including costs for employee benefits, and
depreciation on computer
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ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
equipment. These costs include those associated with maintaining and expanding
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.
Research and development expenses increased from $1,832,000, or 25% of total
revenues, in the quarter ended June 30, 1998 to $4,469,000, or 26% of total
revenues, in the comparable quarter in 1999. On a year-to-date basis, research
and development expenses increased 139% to $8,291,000 in 1999 from $3,468,000 in
1998. We continue to increase these expenditures as we perceive primary research
and product development as essential ingredients for retaining our leadership
position in the market. These increases were due primarily to increases in
personnel focused on our best-of-breed products, enterprise applications and
research for future product offerings. Additionally, we continued our
development efforts in connection with certain OEM arrangements. Under these
arrangements entered into during the second half of 1998, we began to earn
royalties, which are expected to increase to higher levels in future periods.
Sales and marketing expenses consist primarily of salaries, travel expenses,
commissions, advertising, maintenance of the ISS Website, trade show expenses,
costs of recruiting sales and marketing personnel and costs of marketing
materials. In the quarter ended June 30, 1999, sales and marketing expenses were
$8,254,000, or 49% of total revenues, compared with $5,431,000, or 74% of total
revenues, in the quarter ended June 30, 1998. Year-to-date figures exhibit
similar trends. The absolute increases have occurred principally from our larger
workforce, which has increased each quarter since 1997 both domestically and
internationally. The decrease in sales and marketing expenses as a percentage of
total revenues continues a trend that occurred during 1998 as a higher
percentage of the ISS enterprise sales force is achieving greater levels of
productivity due to more experience in selling our products and a broader
enterprise offering of enterprise products.
General and administrative expenses in the quarter ended June 30, 1999 increased
to $1,372,000, or 8% of our total revenues from $1,100,000, or 15% of our total
revenues in the comparable quarter in 1998. Year-to-date amounts reflect similar
dollar and percentage trends. General and administrative expenses consist of
personnel-related costs for executive, administrative, finance and human
resources, information systems and other support services and legal, accounting
and other professional service fees. The increase in these expenses in absolute
dollars is attributable to our effort, through additional employees and systems,
to enhance our management's ability to obtain and analyze information about our
domestic and international operations, as well as the expansion of our
facilities.
We recorded $498,000 of amortization expense in the six months ended June 30,
1999 related to goodwill and intangible assets resulting from the October 1998
acquisitions of March Information Systems, Inc., a United Kingdom-based
developer of Windows NT and Unix-based security assessment technologies, and the
technology assets of DbSecure, Inc., a developer of database security risk
assessment software.
INCOME TAXES
We recorded a provision for income taxes of $125,000 and $200,000 for the
quarter and six-month periods ended June 30, 1999, respectively, related to our
European operations. No provision for federal, state or foreign income taxes has
been recorded for the United States and
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ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Asia/Pacific operations due to the existence of net operating loss
carryforwards. We have not recognized any benefit from the future use of loss
carryforwards for these periods or any other periods since our inception because
management's evaluation of all the available evidence related to the
realizability of the tax benefits of such loss carryforwards indicates that the
underlying assumptions of continued profitable operations in the future contain
risks that do not provide sufficient assurance to recognize such benefits
currently.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operations in the first six months of 1999 was $4,768,000
and included net income of $2,950,000 and $2,041,000 of non-cash expense
charges. Additionally, billings and collections generated additional cash as the
increase in net accounts receivable in the first half of 1999 of $2,373,000
associated with our growth was more than offset by the $3,618,000 increase in
deferred revenues. The increase in deferred revenues was due to growth in both
annual maintenance contracts and term licenses.
Investment in equipment totaled $2,800,000 in the first half of 1999 as we
continued to provide existing and new personnel with the necessary hardware and
software tools to perform their job functions.
Cash provided by financing activities of $79,189,000 was primarily the result of
our secondary stock offering that was consummated in March 1999. The net
proceeds resulting from the stock offering were $77,397,000.
As of June 30, 1999, we had $133,608,000 of cash and cash equivalents,
consisting primarily of United States government agency securities, money market
accounts and short-term, commercial paper carrying the highest investment grade
rating. We believe that such cash and cash equivalents will be sufficient to
meet our working capital needs and capital expenditures for the foreseeable
future. We expect to evaluate possible acquisition and investment opportunities
in businesses, products or technologies that are complementary to ours. Although
we have not identified any specific businesses, products or technologies that we
intend to acquire or invest in, and there any not any current agreements with
respect to any such transactions, from time to time we expect to evaluate such
opportunities. In the event we determine to pursue such opportunities, we may
use our available cash and cash equivalents. Pending such uses, we will continue
to invest available cash in short-term, investment grade, interest-bearing
investments.
YEAR 2000
We have reviewed our products and believe that they are designed to properly
function through and beyond the year 2000. Furthermore, we only support the
current and the most recent prior version of our products. While we have
conducted tests of our software and have informed our customers that our
products are Year 2000 compliant, we cannot guarantee that our products,
particularly when they incorporate third-party software, will contain all date
code changes necessary to ensure Year 2000 compliance.
In addition, we use several internal management and other information systems in
the operation of our business. Since we have experienced most of our growth in
systems and personnel since
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ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
January 1, 1997, purchases and upgrades of systems have occurred principally
since 1997. Internal systems for financial, human resources and sales reporting,
as well as telephone, voice mail and other office support systems, have all been
purchased since 1998 and are reflected in either the balance sheet as property
and equipment or expensed under our standard policy. We used our best efforts to
ensure that these new systems are Year 2000 compliance.
We have either tested or contacted providers of various tools used in our
product development process and the providers of desktop systems (primarily
Microsoft) to determine that these recognized systems, such as Windows NT and
Windows 95/98, will be Year 2000 compliant with appropriate fixes. We do not
depend on any suppliers or manufacturers whose failure to be Year 2000 compliant
would have any significant impact on our financial condition or results of
operations. We have completed much of our Year 2000 project for these remaining
items and expect to be completed by September 30, 1999. We do not expect to
expend any significant funds to correct Year 2000 issues. Any minor expenses
will be funded through cash provided by operations.
Based on available information, we do not believe any material exposure to
significant business interruptions exists as a result of Year 2000 compliance
issues, or that the cost of remedial actions will have a material adverse effect
on our business, financial condition or results of operations. Accordingly, we
have not adopted any formal contingency plan in the event we do not achieve Year
2000 compliance.
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OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On July 13, 1999, ISS and Network Associates, Inc. announced that the
patent infringement suit filed by Network Associates, Inc. in July 1998
against Internet Security Systems, Inc. (a wholly-owned subsidiary of
ISS) was resolved to the parties' mutual satisfaction. The resolution
of this previously pending litigation had no material adverse effect on
the business, operating results, or financial condition of ISS.
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 this offering were
$61,547,200. During the three months ended June 30, 1999, the
Company used none of the proceeds from the offering for
general or other corporate purposes. The remaining $52,585,400
of the proceeds remain in temporary investments consisting of
money market accounts available on a daily basis, U.S.
Government agency investments and short-term, commercial
paper.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of ISS Group, Inc. was held
on Tuesday, May 25, 1999.
The first matter submitted to a vote of the stockholders at
this meeting was the election of two directors to serve a
three-year term ending in the year 2002. Richard S. Bodman and
Kevin J. O'Connor were elected at the Annual Meeting by the
holders of Common Stock by the following votes: (a) Mr.
Bodman: 15,332,049 votes for and 21,630 votes withheld, and
(b) Mr. O'Connor: 14,030,713 votes for and 1,322,966 votes
withheld. There were no broker non-votes for purposes of any
such votes.
The second matter submitted to a vote and approved by the
shareholders was the approval of a series of amendments to the
Restated 1995 Stock Incentive Plan. The vote was as follows:
(a) Voting for: 11,708,334 shares, (b) Voting Against:
3,629,578 shares, and (c) Abstentions: 15,767 shares.
The third matter submitted to a vote and approved by the
stockholders was the approval of the 1999 Employee Stock
Purchase Plan. The vote was as follows: (a) Voting for:
15,197,616 shares, (b) Voting Against: 136,971 shares, and (c)
Abstentions: 19,092 shares.
The fourth matter submitted to a vote and approved by the
stockholders was the approval of an amendment to the Company's
Certificate of Incorporation, which increased the number of
authorized shares of Common Stock of the Company from
50,000,000 to 120,000,000. The vote was as follows: (a) Voting
for:
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<PAGE> 15
OTHER INFORMATION
14,092,697 shares, (b) Voting Against: 1,250,079 shares, and
(c) Abstentions: 10,903 shares.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
27 Financial Data Schedule (for SEC use only)
99 Private Securities Litigation Reform Act of 1995 Safe Harbor
Compliance Statements for Forward-Looking Statements
(b) Reports on Form 8-K.
ISS filed no reports on Form 8-K during this reporting period
- 15 -
<PAGE> 16
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 13, 1999 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
CONSOLIDATED FINANCIAL STATEMENTS OF ISS GROUP, INC. AS OF AND FOR THE SIX
MONTHS ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<EXCHANGE-RATE> 1
<CASH> 133,608
<SECURITIES> 0
<RECEIVABLES> 15,366
<ALLOWANCES> 407
<INVENTORY> 0
<CURRENT-ASSETS> 150,114
<PP&E> 8,472
<DEPRECIATION> 3,035
<TOTAL-ASSETS> 163,364
<CURRENT-LIABILITIES> 14,794
<BONDS> 0
0
0
<COMMON> 38
<OTHER-SE> 148,422
<TOTAL-LIABILITY-AND-EQUITY> 163,364
<SALES> 0
<TOTAL-REVENUES> 32,935
<CGS> 0
<TOTAL-COSTS> 32,204
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 3,150
<INCOME-TAX> 200
<INCOME-CONTINUING> 2,950
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,950
<EPS-BASIC> 0.08
<EPS-DILUTED> 0.07
</TABLE>
<PAGE> 1
Private Securities Litigation Reform Act of 1995 EXHIBIT 99
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 1, 1999.
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.
RISK FACTORS
Forward-looking statements are inherently uncertain as they are based on various
expectations and assumptions concerning future events and are subject to known
and unknown risks and uncertainties. Our forward-looking statements should be
considered in light of the following important risk factors. Variations from our
stated intentions or failure to achieve objectives could cause actual results to
differ from those projected in our forward-looking statements. We undertake no
obligation to update publicly any forward-looking statements for any reason,
even if new information becomes available or other events occur in the future.
WE ARE A YOUNG COMPANY THAT HAS NEVER BEEN PROFITABLE
We were incorporated in April 1994 and have only achieved profitability over the
past two-quarter periods ended June 30, 1999. We cannot be certain that we can
sustain such profitability in any future period. You should be aware that we
have only a limited operating history upon which to evaluate our business and
prospects. We operate in a new and rapidly evolving market and must, among other
things:
- respond to competitive developments;
- continue to upgrade and expand our product and services
offerings; and
- continue to attract, retain and motivate our employees.
OUR FUTURE OPERATING RESULTS WILL FLUCTUATE SIGNIFICANTLY
As a result of our limited operating history, we cannot predict our future
revenues and operating results. However, we do expect our future revenues and
operating results to fluctuate due to a combination of factors, including:
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<PAGE> 2
- the growth of private Internet-based networks (often referred
to as intranets);
- the extent to which the public perceives that unauthorized
access to and use of online information is a threat to network
security;
- the volume and timing of orders, including seasonal trends in
customer purchasing;
- our ability to develop new and enhanced products and expand
our professional services;
- the growth in the acceptance of, and activity on, the Internet
and the World Wide Web, particularly by corporate,
institutional and government users;
- customer budgets which may limit their ability to purchase our
products;
- foreign currency exchange rates that affect our international
operations;
- the mix of distribution channels through which we sell our
products;
- product and price competition in our markets; and
- general economic conditions, both domestically and in our
foreign markets.
We increasingly focus our efforts on sales of enterprise-wide security
solutions, which consist of our entire product suite and related professional
services, rather than on the sale of component products. As a result, we expect
that each sale may require additional time and effort from our sales staff. In
addition, the revenues associated with particular sales vary significantly
depending on the number of products licensed by a customer, the number of
devices used by the customer and the customer's relative need for our
professional services. Large individual sales, or even small delays in customer
orders, can cause significant variation in our license revenues and results of
operations for a particular period. The timing of large orders is usually
difficult to predict and, like many software companies, our customers typically
license most of our products in the last month of a quarter.
Our future operating expenses are expected to increase in future periods as we
intend to:
- expand our domestic and international sales and marketing
operations;
- increase our investments in product development and our
proprietary threat and vulnerability database;
- expand our professional services capabilities;
- seek acquisition candidates that will enhance our products and
market share; and
- improve our internal operating and financial systems.
We cannot predict our operating expenses based on our past results. Instead, we
establish our spending levels based in large part on our expected future
revenues. As a result, if our actual revenues in any future period fall below
our expectations, our operating results likely will be adversely affected
because very few of our expenses vary with our revenues. Because of the factors
listed above, we believe that our quarterly and annual revenues, expenses and
operating results likely will vary significantly in the future.
WE FACE INTENSE COMPETITION IN OUR MARKET
The market for network security monitoring, detection and response solutions is
intensely competitive, and we expect competition to increase in the future. We
cannot guarantee that we will compete successfully against our current or
potential competitors, especially those with significantly greater financial
resources or brand name recognition.
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<PAGE> 3
WE FACE RAPID TECHNOLOGICAL CHANGE IN OUR INDUSTRY AND FREQUENT INTRODUCTIONS OF
NEW PRODUCTS
Rapid changes in technology pose significant risks to us. We do not control nor
can we influence the forces behind these changes, which include:
- the extent to which businesses and others seek to establish
more secure networks;
- the extent to which hackers and others seek to compromise
secure systems;
- evolving computer hardware and software standards;
- changing customer requirements; and
- frequent introductions of new products and product
enhancements.
To remain successful, we must continue to change, adapt and improve our products
in response to these and other changes in technology. Our future success hinges
on our ability to both continue to enhance our current line of products and
professional services and to introduce new products that address and respond to
innovations in computer hacking, computer technology and customer requirements.
We cannot be sure that we will successfully develop and market new products that
do this. Any failure by us to timely develop and introduce new products, to
enhance our current products or to expand our professional services capabilities
in response to these changes could adversely affect our business, operating
results and financial condition.
Our products involve very complex technology, and as a consequence, major new
products and product enhancements require a long time to develop and test before
going to market. Because this amount of time is difficult to estimate, we have
had to delay the scheduled introduction of new and enhanced products in the past
and may have to delay the introduction of new products and product enhancements
in the future.
The techniques computer hackers use to gain unauthorized access to or to
sabotage networks and intranets are constantly evolving and increasingly
sophisticated. Furthermore, because new hacking techniques are usually not
recognized until used against one or more targets, we are unable to anticipate
most new hacking techniques. To the extent that new hacking techniques harm our
customers' computer systems or businesses, affected customers may believe that
our products are ineffective, which may cause them or prospective customers to
reduce or avoid purchases of our products.
RISKS ASSOCIATED WITH OUR GLOBAL OPERATIONS
The expansion of our international operations includes the maintenance of sales
offices in dispersed locations throughout the world, including throughout Europe
and the Asia/Pacific and Latin America regions. Our international presence and
expansion exposes us to risks not present in our U.S. operations, such as:
- the difficulty in managing an organization spread over various
countries located across the world;
- unexpected changes in regulatory requirements in countries
where we do business;
- excess taxation due to overlapping tax structures;
- fluctuations in foreign currency exchange rates, which may be
aggravated in European markets by the recent introduction of
the Euro currency;
- 19 -
<PAGE> 4
- export license requirements and restrictions on the export of
certain technology, especially encryption technology;
- trade restrictions;
- changes in tariff and freight rates; and
- depressed regional and economic conditions, such as those
currently affecting many regions in Asian markets.
Despite these risks, we believe that we must continue to expand our operations
in international markets to support our growth. To this end, we intend to
establish additional foreign sales operations, expand our existing offices, hire
additional personnel, expand our international sales channels and customize our
products for local markets. If we fail to execute this strategy, our
international sales growth will be limited.
To date, we have primarily denominated our revenues from international
operations in United States dollars; however, we will increasingly denominate
sales in local foreign currencies in the future. An increase in the value of the
United States dollar relative to foreign currencies would make our products more
expensive and, therefore, potentially less competitive in foreign markets. In
addition, even if we successfully expand our international operations, we may
not be able to maintain or increase international market demand for our
products.
WE INCREASINGLY RELY ON INDIRECT DISTRIBUTION CHANNELS
Although our direct sales have accounted for a majority of our revenues in this
quarter, we expect to continue to license a significant percentage of our
products to end users through indirect distribution channels in the future. Our
indirect distribution channel partners include:
- original equipment manufacturers that bundle our products with
products that they sell to their customers;
- managed service providers, such as telecommunications
companies and Internet service providers, that host networking
and Internet operations for business customers; and
- consultants and systems integrators that incorporate our
products into customized solutions that they have implemented
for their customers.
Our future performance will also depend, in part, on our ability to both retain
the channel partner relationships we have built and attract new channel partners
to market and support our products effectively, especially in new markets. We
cannot assure you that revenue from channel partners that accounted for
significant revenues in past periods will continue or, if continued, will reach
or exceed past performance levels. In addition, we often depend upon our channel
partners to install and support our products for end users. If our channel
partners fail to provide adequate installation and support, end users of our
products could cease using, or improperly implement and operate, our products.
Such a failure could substantially increase our customer support costs and
adversely affect our business.
POTENTIAL FUTURE ACQUISITIONS OR INVESTMENTS
As part of our growth strategy, we have acquired, and may continue to acquire or
make investments in, companies with products, technologies or professional
services capabilities complementary to our solutions. In acquiring companies in
the future, we could encounter difficulties in assimilating their personnel and
operations into our company. These difficulties
- 20 -
<PAGE> 5
could disrupt our ongoing business, distract our management and employees,
increase our expenses and adversely affect our results of operations. These
difficulties could also include accounting requirements, such as amortization of
goodwill or in-process research and development expense.
WE DEPEND ON OUR KEY PERSONNEL
Our future success also depends on our continuing ability to attract and retain
highly qualified engineers, managers and sales and professional services
personnel. The competition for employees at all levels of the software industry,
especially those with experience in the relatively new discipline of security
software, is increasingly intense.
WE DEPEND ON OUR INTELLECTUAL PROPERTY RIGHTS AND USE LICENSED TECHNOLOGY
We rely primarily on copyright and trademark laws, trade secrets,
confidentiality procedures and contractual provisions to protect our proprietary
rights. We also believe that the technological and creative skills of our
personnel, new product developments, frequent product enhancements, our name
recognition, our professional services capabilities and delivery of reliable
product maintenance are essential to establishing and maintaining our technology
leadership position. We cannot assure you that our competitors will not
independently develop technologies that are similar to ours.
We seek to protect our software, documentation and other written materials under
the trade secret and copyright laws, which afford only limited protection. We
have also submitted two United States patent applications. Patents may not issue
from these applications or, if issued, may not provide any meaningful
competitive advantages to us.
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. Policing unauthorized use of our products is difficult.
While we cannot determine the extent to which piracy of our software products
occurs, we expect software piracy to be a persistent problem. In addition, the
laws of some foreign countries do not protect our proprietary rights to as great
an extent as do the laws of the United States and many foreign countries do not
enforce these laws as diligently as U.S. government agencies and private
parties.
We are not aware that any of our products infringes the proprietary rights of
others, but it is conceivable that our current or future products may infringe
the proprietary rights of others. In fact, in July 1998 Network Associates, one
of our competitors, filed a lawsuit against us alleging that our Real Secure
product violated a patent claim for intrusion detection technology held by
Network Associates. The parties resolved this lawsuit in July 1999 without any
material affect on our business, operating results or financial condition.
We expect the number of intellectual property infringement lawsuits against
software companies to increase. Any such claims, with or without merit, could be
time consuming, result in costly litigation, cause product shipment delays or
require us to enter into royalty or licensing agreements.
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<PAGE> 6
WE LACK CERTAIN TRADEMARK PROTECTION
We currently cannot obtain trademark protection on the name "Internet Security
Systems" due to its general use in a variety of security-related applications.
While we have in the past taken and will continue to take action against any use
of that name in a manner that may create confusion for our products in our
current or future markets, we may not be successful in these efforts.
WE FACE POTENTIAL PRODUCT LIABILITY EXPOSURE AND PRODUCT DEFECTS
Many organizations use our products for critical functions of monitoring and
enhancing network security. As a result, we risk product liability and related
claims for our products if they do not adequately perform this function. In our
licensing agreements, we typically seek to limit our liability for special,
consequential or incidental damages, but these provisions may not in all cases
be enforceable under applicable laws. In addition, we currently have $2.0
million of product liability insurance coverage that, subject to customary
exclusions, covers claims resulting from failure of our products or services to
perform their intended function or to serve their intended purpose. A product
liability claim, to the extent not covered by our insurance, could materially
and adversely affect our business, operating results and financial condition.
Complex software products such as ours may contain undetected "bugs" that,
despite our testing, are discovered only after installation and use by our
customers. The occurrence of these bugs could result in adverse publicity, loss
of or delay in market acceptance or claims by customers against us, any of which
could have a material adverse effect upon our business, operating results and
financial condition. Customers who deploy or use our products improperly or
incompletely may experience temporary disruptions to their computer networking
systems, which could damage our relationship with them and our reputation. Our
current products may not be error-free and it is extremely doubtful that our
future products will be error-free. Furthermore, computers are manufactured in a
variety of different configurations with different operating systems (such as
Windows, Unix, Macintosh and OS/2) and embedded software. As a result, it is
very difficult to comprehensively test our software products for programming or
compatibility errors. Errors in the performance of our products, whether due to
our design or their compatibility with products of other companies, could hinder
the acceptance of our products.
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