<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 March 31, 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.
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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
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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.
Number of Shares Outstanding
Title of each class as of May 5, 1999
-------------------------------- ----------------------------
Common Stock, $0.001 par value 18,921,312
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PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
PAGE
NUMBER
------
<S> <C> <C>
Item 1 Consolidated Financial Statements:
Consolidated Statements of Operations for the Three Months
ended March 31, 1999 and March 31, 1998.............................................3
Consolidated Balance Sheets at March 31, 1999 and
December 31, 1998...................................................................4
Consolidated Statements of Cash Flows for the Three
Months ended March 31, 1999 and March 31, 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 2 Changes in Securities and Use of Proceeds..........................................14
Item 6 Exhibits and Reports on Form 10-Q..................................................14
</TABLE>
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ISS GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended
March 31,
--------------------------
1999 1998
--------------------------
<S> <C> <C>
Revenues:
Perpetual licenses $ 10,950 $ 4,875
Subscriptions 3,487 1,169
Professional services 1,549 29
--------------------------
15,986 6,073
Costs and expenses:
Costs of revenues 2,186 513
Research and development 3,822 1,636
Sales and marketing 7,825 4,648
General and administrative 1,409 981
Amortization 251 --
--------------------------
15,493 7,778
Operating income (loss) 493 (1,705)
Interest income, net 882 66
--------------------------
Income (loss) before income taxes 1,375 (1,639)
Provision for income taxes 75 0
--------------------------
Net income (loss) $ 1,300 $ (1,639)
==========================
Basic net income (loss) per share of Common Stock $ 0.07 $ (0.19)
======== ========
Diluted net income (loss) per share of Common Stock $ 0.07 $ (0.19)
======== ========
Weighted average number of shares:
Basic 17,776 8,741
======== ========
Diluted 19,436 8,741
======== ========
Unaudited pro forma net income (loss) per share of
Common Stock $ (0.12)
========
Unaudited weighted average number of shares used in
calculating unaudited pro forma net loss per share of
Common Stock 13,968
========
</TABLE>
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ISS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
MARCH 31, 1999 DECEMBER 31, 1998
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(UNAUDITED) (AUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 133,976 $ 52,632
Accounts receivable, less allowance for doubtful accounts
of $347 and $287, respectively 13,982 12,586
Prepaid expenses and other current assets 854 743
--------- ---------
Total current assets 148,812 65,961
Property and equipment:
Computer equipment 4,935 4,370
Office furniture and equipment 1,670 1,027
Leasehold improvements 289 275
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6,894 5,672
Less accumulated depreciation 2,146 1,655
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4,748 4,017
Goodwill, less accumulated amortization of $159
and $77, respectively 3,012 3,094
Other intangibles, less accumulated amortization of $322
and $154, respectively 4,523 4,692
Other assets 244 257
--------- ---------
Total assets $ 161,339 $ 78,021
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,315 $ 692
Accrued expenses 4,046 4,202
Deferred revenues 9,371 6,678
-----------------------------
Total current liabilities 14,732 11,572
Non-current liabilities 130 134
Stockholders' equity:
Common stock, $.001 par value, 50,000,000 shares authorized,
18,891,000 and 17,292,000 issued and outstanding,
respectively 19 17
Additional paid-in captial 154,938 76,110
Deferred compensation (569) (662)
Cumulative adjustment for currency revaluation 81 142
Accumulated deficit (7,992) (9,292)
-----------------------------
Total stockholders' equity 146,477 66,315
-----------------------------
Total liabilities and stockholders' equity $ 161,339 $ 78,021
=============================
</TABLE>
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ISS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
1999 1998
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<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ 1,300 $ (1,639)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation 491 171
Amortization of goodwill and intangibles 251 --
Amortization of deferred compensation expense 93 65
Other non-cash expense (9) 17
Changes in operating assets and liabilities:
Accounts receivable (1,396) (1,375)
Prepaid expenses and other assets (98) (472)
Accounts payable and accrued expenses 473 437
Deferred revenues 2,693 1,870
-----------------------------
Net cash provided by (used in) operating activities 3,798 (926)
INVESTING ACTIVITIES
Purchases of property and equipment (1,222) (498)
-----------------------------
Net cash used in investing activities (1,222) (498)
FINANCING ACTIVITIES
Payments on long term debt -- (23)
Proceeds from exercise of stock options 1,433 162
Net proceeds from Common Stock offerings 77,397 61,547
-----------------------------
Net cash provided by financing activities 78,830 61,686
Foreign currency impact on cash (62) (7)
-----------------------------
Net increase in cash and cash equivalents 81,344 60,255
Cash and cash equivalents at beginning of period 52,632 3,929
-----------------------------
Cash and cash equivalents at end of period $ 133,976 $ 64,184
=============================
SUPPLEMENTAL CASH FLOW DISCLOSURE
Interest paid $ -- $ 4
=============================
</TABLE>
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ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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 March 31, 1999 and the consolidated results of its
operations and cash flows for the three months ended March 31, 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 March 31, 1999 aggregated
$1,362,000. The effect of foreign exchange gains and losses arising from
translations of asset and liabilities of the Company's foreign operations
into U.S. dollars are included as a component of comprehensive income. Such
amounts were $62,000 in the period ended March 31, 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 shares that were newly issued by the Company and
1,200,000 previously outstanding shares that were sold by existing
stockholders. The Company did not receive any of the proceeds from the
stock sold 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 March 31, 1999.
4. Income (loss) per share
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 ended March
31, 1998 options aggregating approximately 2,371,000 were antidilutive and
therefore they were not included in the computation. For the quarter ended
March 31, 1999, weighted average shares included 1,660,000 shares to
reflect the dilutive impact of stock options.
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ISS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Pro forma loss per share for the quarter ended March 31, 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.
4. Subsequent Event
On April 1, 1999 the Company's Board of Directors declared a two-for-one
stock split to be effected in the form of a stock dividend of one share for
each share outstanding on May 5, 1999 payable on May 19, 1999. Share
amounts in these financial statements do not reflect this stock split.
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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 the leading provider of network security monitoring, detection and
response software that protects the security and integrity of enterprise
information systems according to market share reports by Aberdeen Group, Gartner
Group and the Yankee Group. Our SAFEsuite family of products protects
distributed computing environments, such as internal corporate networks,
inter-company networks and the Internet from attacks, misuse and security policy
violations. 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
licenses, 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. Term licenses allow customers to use the
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.
Our business has grown rapidly since 1995. Prior to the quarter ended March 31,
1999, we experienced net losses resulting from significant costs incurred in the
development and sales of
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ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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 quarter 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 recently have experienced
significant revenue growth, we cannot assume that we can sustain such growth
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 ended March
31, 1999 and 1998.
<TABLE>
<CAPTION>
Three months ended
March 31
1999 1998
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<S> <C> <C>
Revenues:
Perpetual licenses 68.5% 80.3%
Subscriptions 21.8% 19.2%
Professional services 9.7% 0.5%
---------------------
Total revenues 100.0% 100.0%
Costs and Expenses:
Costs of revenues 13.7% 8.5%
Research and development 23.9% 26.9%
Sales and marketing 48.9% 76.5%
General and administrative 8.8% 16.2%
Amortization 1.6% --
---------------------
Total costs and expenses 96.9% 128.1
---------------------
---------------------
Operating income (loss) 3.1% (28.1)%
---------------------
</TABLE>
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ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Revenues
Our total revenues of $15,986,000 for the three months ended March 31, 1999
represented an increase of 163% as compared to the same period 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
80% of revenues during the three months ended March 31, 1998, to 69% for the
three months ended March 31, 1999. Perpetual license revenues from our intrusion
detection products for the three months ended March 31, 1999 included revenues
of approximately $4.5 million recognized under a contract with a large
telecommunications entity. This enterprise contract included licenses for our
scanner, intrusion detection and SAFEsuite Decisions products. Additionally,
there are maintenance and professional service components to the contract.
Subscriptions revenues, consisting of maintenance and annual licenses of product
usage, accounted for 22% and 19% of our total revenues in the three months ended
March 31, 1999 and March 31, 1998, respectively. Professional services comprise
the smallest category of revenue, but have grown from less than 1% of our total
revenues in the three months ended March 31, 1998 to 10% of our total revenues
in the three months ended March 31, 1999. This was due primarily to our
initiative to build our capabilities to address the demand from our customers
for implementation, training and consulting services.
The Company's suite of product offerings continues to provide increased product
diversification. Our intrusion detection product, Real Secure, grew from 20% of
new license revenues in the three months ended March 31, 1998 to 53% in the
three months ended March 31, 1999. Our scanner family of products, providing
vulnerability assessment, represented over 40% of our license revenues, down
significantly from the three months ended March 31, 1998 when it represented
almost 80% of license revenues. SAFEsuite Decisions, our enterprise security
management application released in the fourth quarter of 1998, represented
approximately 5% of our perpetual license revenues for the three months ended
March 31, 1999.
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 21% of revenues in the first three months of 1999, compared
to 19% 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. Cost of
revenues also includes 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. During the three
months ended March 31, 1998, costs of revenues included the development of a
professional services management team who then developed a billable consulting
staff over the balance of the year. As a result of the growth in our
professional services, our gross margin, which is represented by total revenues
less costs of revenues expressed as a percentage of total revenues, decreased in
the quarter-to-quarter period from 92% for the three months ended March 31, 1998
to 86% for the three months ended March 31, 1999.
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ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
Research and development expenses consist of salary and related costs of
research and development personnel, including costs for employee benefits, and
depreciation on computer 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 in absolute dollars from $1,636,000,
or 27% of total revenues, in the quarter ended March 31, 1998 to $3,822,000, or
24% of total revenues, in the comparable quarter in 1999. 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 began development efforts in connection with
certain OEM arrangements. Under these arrangements, which were entered into
during the second half of 1998, our products are to be incorporated into the
OEM's products for which we are to receive a royalty. No significant revenues
have yet been generated from these arrangements.
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 March 31, 1999, sales and marketing expenses
were $7,825,000, or 49% of total revenues, compared with $4,648,000, or 77% of
total revenues, in the quarter ended March 31, 1998. 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 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 and a broader
enterprise offering of products.
General and administrative expenses in the quarter ended March 31, 1999
increased to $1,409,000, or 9% of our total revenues from $981,000, or 16% of
our total revenues in the comparable quarter in 1998. 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 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 expansion of our
facilities.
We recorded $251,000 of amortization expense in the three months ended March 31,
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
For the quarter ended March 31, 1999, we recorded a provision for income taxes
of $75,000 related to our European operations. No provision for federal, state
or foreign income taxes has been recorded for the United States and Asia/Pacific
operations due to the existence of net
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ISS GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (CONTINUED)
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.
CAPITAL RESOURCES AND LIQUIDITY
Net cash provided by operations in the first three months of 1999 of $3,798,000
included net income of $1,300,000 in the period plus $826,000 of non-cash
expense charges. Additionally, $1,297,000 of net cash from operations associated
with billings and collections resulted from an increase in accounts receivable
of $1,396,000 associated with our growth which was offset by an increase of
$2,693,000 in our deferred revenue account balance. The increase in deferred
revenue was due primarily to growth in annual maintenance contracts and term
licenses.
Investment in equipment totaled $1,222,000 in the first three months 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 $78,830,000 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 March 31, 1999, we had $133,976,000 of cash and cash equivalents,
consisting primarily of Unites 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 or
negotiations 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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<PAGE> 13
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 are in the process of contacting 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 expect to complete our Year 2000 project for these remaining
items by the middle of 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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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 March 31, 1999 the
Company used approximately $708,800 of the proceeds from the
Offering toward general corporate purposes, including working
capital. 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 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 Statements for Forward-Looking Statements
(b) Reports on Form 8-K.
ISS filed no reports on Form 8-K during this reporting period
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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: May 13, 1999 By /s/ Richard Macchia
---------------------- --------------------------------------------
Chief Financial Officer
(Principal Financial and Accounting Officer)
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<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 THREE
MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 133,976
<SECURITIES> 0
<RECEIVABLES> 14,329
<ALLOWANCES> 347
<INVENTORY> 0
<CURRENT-ASSETS> 148,812
<PP&E> 6,894
<DEPRECIATION> 2,146
<TOTAL-ASSETS> 161,339
<CURRENT-LIABILITIES> 14,732
<BONDS> 0
0
0
<COMMON> 19
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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 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 this
quarter. 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:
- the growth of private Internet-based networks (often referred
to as intranets);
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- 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.
WE FACE RAPID TECHNOLOGICAL CHANGE IN OUR INDUSTRY AND FREQUENT INTRODUCTIONS OF
NEW PRODUCTS
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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;
- export license requirements and restrictions on the export of
certain technology, especially encryption technology;
- trade restrictions;
- changes in tariff and freight rates; and
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- 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 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.
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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 Stated 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 violates a patent claim for intrusion detection technology held by
Network Associates. We believe that the lawsuit is without merit and are
vigorously defending against Network Associates' claims. However, should Network
Associates prevail in the suit, it could materially and adversely affect our
business.
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.
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
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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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