<PAGE>   1

                                  UNITED STATES
                       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, 2001
                                        --------------------------------------

                                       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
                                          --------------------

                         INTERNET SECURITY SYSTEMS, INC.
        -----------------------------------------------------------------
             (Exact name of registrant as specified in its charter)

           DELAWARE                                       58-2362189
    ------------------------------                   -------------------
    (State or jurisdiction of                        (I.R.S. Employer
    incorporation or organization)                   Identification No.)


                   6303 BARFIELD ROAD, ATLANTA, GEORGIA 30328
                   ------------------------------------------
                    (Address of principal executive offices)


        Registrant's telephone number, including area code (404) 236-2600
                                                            -------------


                                 NOT APPLICABLE
     ---------------------------------------------------------------------
     (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 7, 2001
-------------------------------                 ----------------------------
Common Stock, $0.001 par value                          43,128,060

<PAGE>   2


<TABLE>
<CAPTION>
                                                                          PAGE
PART I.           FINANCIAL INFORMATION                                   NUMBER
                                                                          ------

<S>      <C>                                                              <C>
Item 1   Consolidated Financial Statements:

         Consolidated Balance Sheets at March 31, 2001 and
         December 31, 2000.....................................................3

         Consolidated Statements of Operations for the three months
         ended March 31, 2001 and March 31, 2000...............................4

         Consolidated Statements of Cash Flows for the three
         months ended March 31, 2001 and March 31, 2000........................5

         Notes to Consolidated Financial Statements............................6

Item 2   Management's Discussion and Analysis of
         Financial Condition and Results of Operations........................ 9

Item 3   Quantitative and Qualitative Disclosures about Market Risk...........20

PART II. OTHER INFORMATION

Item 5   Other Information....................................................21

Item 6   Exhibits and Reports on Form 8-K.....................................21
</TABLE>


                                      -2-
<PAGE>   3


                         INTERNET SECURITY SYSTEMS, INC.
                           CONSOLIDATED BALANCE SHEETS
                  (AMOUNTS IN THOUSANDS, EXCEPT SHARE AMOUNTS)


<TABLE>
<CAPTION>
                                                                                    MARCH 31,          DECEMBER 31,
                                                                                      2001                 2000
                                                                                  --------------------------------
                                                                                  (UNAUDITED)           (AUDITED)
<S>                                                                               <C>                  <C>
                                           ASSETS

Current assets:
       Cash and cash equivalents                                                   $  88,071           $  66,210
       Marketable securities                                                          60,756              65,938
       Accounts receivable, less allowance for doubtful accounts
          of $1,522 and $1,188, respectively                                          55,633              56,358
       Inventory                                                                       1,102               2,275
       Prepaid expenses and other current assets                                       8,905               5,717
                                                                                   ------------------------------
                Total current assets                                                 214,467             196,498

Property and equipment:
       Computer equipment                                                             23,803              20,199
       Office furniture and equipment                                                 13,196               9,958
       Leasehold improvements                                                          8,813               6,609
                                                                                   ------------------------------
                                                                                      45,812              36,766
       Less accumulated depreciation                                                  16,222              13,673
                                                                                   ------------------------------
                                                                                      29,590              23,093

Restricted marketable securities                                                      12,500              12,500
Goodwill, less accumulated amortization of $1,073
       and $875, respectively                                                          2,969               3,167
Other intangibles, less accumulated amortization of
       $1,668 and $1,500, respectively                                                 3,177               3,346
Other assets                                                                           2,334               1,636
                                                                                   ------------------------------
                Total assets                                                       $ 265,037           $ 240,240
                                                                                   ==============================


                            LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
       Accounts payable                                                            $   8,336           $   4,200
       Accrued expenses                                                               15,520              15,490
       Deferred revenues                                                              33,555              31,675
                                                                                   ------------------------------
                Total current liabilities                                             57,411              51,365

Other non-current liabilities                                                            412                 486

Stockholders' equity:
       Common stock, $.001 par value, 120,000,000 shares authorized,
          42,932,000 and 42,415,000 issued and outstanding, respectively                  43                  42
       Additional paid-in capital                                                    186,196             172,985
       Deferred compensation                                                             (65)                (86)
       Accumulated other comprehensive income (loss)                                  (1,694)               (745)
       Retained earnings                                                              22,734              16,193
                                                                                   ------------------------------
                Total stockholders' equity                                           207,214             188,389

                                                                                   ------------------------------
                Total liabilities and stockholders' equity                         $ 265,037           $ 240,240
                                                                                   ==============================
</TABLE>


                                      -3-
<PAGE>   4


                INTERNET SECURITY SYSTEMS, INC.
             CONSOLIDATED STATEMENTS OF OPERATIONS
       (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                          (UNAUDITED)


<TABLE>
<CAPTION>
                                                                 THREE MONTHS ENDED
                                                                      MARCH 31,
                                                           ----------------------------
                                                             2001                2000
                                                           ----------------------------
<S>                                                        <C>                <C>
Revenues:
   Product licenses and sales                              $ 36,176           $ 24,778
   Subscriptions                                             15,136              8,089
   Professional services                                      9,843              6,424
                                                           ----------------------------
                                                             61,155             39,291

Costs and expenses:
   Cost of revenues:
        Product licenses and sales                            6,544              5,255
        Subscriptions and professional services              11,838              6,733
                                                           ----------------------------
   Total cost of revenues                                    18,382             11,988
   Research and development                                   8,315              6,802
   Sales and marketing                                       21,634             14,284
   General and administrative                                 4,511              2,884
   Write-off of lease obligation                              1,072                  -
   Amortization                                                 366                248
                                                           ----------------------------
                                                             54,280             36,206

Operating income                                              6,875              3,085
Interest income, net                                          1,958              1,868
Other income                                                  1,638                  -
Foreign currency exchange loss                                 (251)              (126)
                                                           ----------------------------
Income before income taxes                                   10,220              4,827
Provision for income taxes                                    3,679              1,757
                                                           ----------------------------
Net income                                                 $  6,541           $  3,070
                                                           ============================

Basic net income per share of Common Stock                 $   0.15           $   0.07
                                                           ============================
Diluted net income per share of Common Stock               $   0.15           $   0.07
                                                           ============================

Weighted average shares:
   Basic                                                     42,683             41,398
                                                           ============================
   Diluted                                                   44,556             44,843
                                                           ============================
</TABLE>


                                      -4-
<PAGE>   5

                  INTERNET SECURITY SYSTEMS, INC.
               CONSOLIDATED STATEMENTS OF CASH FLOWS
                      (AMOUNTS IN THOUSANDS)
                            (UNAUDITED)


<TABLE>
<CAPTION>
                                                                        THREE MONTHS ENDED
                                                                             MARCH 31,
                                                                   ---------------------------
                                                                      2001              2000
                                                                   ---------------------------
<S>                                                                <C>                <C>
OPERATING ACTIVITIES
Net income                                                            6,541             3,070
Adjustments to reconcile net income to net cash
     provided by operating activities:
         Depreciation                                                 2,549             1,272
         Amortization of goodwill and intangibles                       366               248
         Accretion of discount on marketable securities                 269              (250)
         Other non-cash items                                            23                46
         Income tax benefit from exercise of stock options            2,830             1,166
     Changes in assets and liabilities:
         Accounts receivable                                            725            (4,229)
         Inventory                                                    1,173              (234)
         Prepaid expenses and other assets                           (3,886)             (754)
         Accounts payable and accrued expenses                        4,092               (86)
         Deferred revenues                                            1,880             2,506
                                                                   ---------------------------
            NET CASH PROVIDED BY OPERATING ACTIVITIES                16,562             2,755

INVESTING ACTIVITIES
Net proceeds from maturity of marketable securities                  46,375            45,926
Purchases of marketable securities                                  (41,462)          (33,417)
Purchases of property and equipment                                  (9,047)           (3,082)
                                                                   ---------------------------
            NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES      (4,134)            9,427

FINANCING ACTIVITIES
Payments on long-term debt and capital leases                             -              (411)
Proceeds from exercise of stock options                               9,154             1,982
Proceeds from issuance of common stock                                1,228               655
                                                                   ---------------------------
            NET CASH PROVIDED BY FINANCING ACTIVITIES                10,382             2,226

Foreign currency impact on cash                                        (949)              (35)
                                                                   ---------------------------
Net increase in cash and cash equivalents                            21,861            14,373
Cash and cash equivalents at beginning of period                     66,210            70,090
                                                                   ---------------------------
Cash and cash equivalents at end of period                           88,071            84,463
                                                                   ===========================

SUPPLEMENTAL CASH FLOW DISCLOSURE
Interest paid                                                             3                33
                                                                   ===========================
</TABLE>


                                      -5-
<PAGE>   6

                         INTERNET SECURITY SYSTEMS, INC
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.       Significant Accounting Policies

The accompanying consolidated financial statements of Internet Security Systems,
Inc. ("ISS" or the "Company") should be read in conjunction with our
consolidated financial statements for the year ended December 31, 2000.

ISS is focused on maintaining the latest security threat and vulnerability
checks within existing products and creating new products and services that are
consistent with our goal of providing security management solutions. This
approach entails continuous security risk monitoring and response to develop an
active and informed network security policy.

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 ISS
at March 31, 2001 and the consolidated results of its operations and cash flows
for the three months ended March 31, 2001 and 2000. Results of operations
reported for interim periods are not necessarily indicative of results for the
entire year.

The consolidated balance sheet at December 31, 2000 has been derived from the
audited financial statements at that date but does not include all the footnotes
required by accounting principles generally accepted in the United States for
complete financial statements.

Revenue Recognition

ISS recognizes its perpetual license revenue upon (i) delivery of software or,
if the customer has evaluation software, delivery of the software key, and (ii)
issuance of the related license, assuming no significant vendor obligations or
customer acceptance rights exist. For perpetual license agreements, when payment
terms extend over periods greater than twelve months, revenue is recognized as
such amounts are billable. Product sales consist of (i) appliances sold in
conjunction with ISS licensed software and (ii) software developed by third
party-partners, combined in some instances with associated hardware appliances
and partner maintenance services. These sales are recognized upon shipment to
the customer.

Subscriptions revenues include maintenance, term licenses and security
monitoring services. Annual renewable maintenance is a separate component of
perpetual license agreements for which the revenue is recognized ratably over
the maintenance contract term. Term licenses allow customer use of the product
and maintenance for a specified period, generally twelve months, for which
revenues are also recognized ratably over the contract term. Security monitoring
services of information assets and systems are a part of managed services and
are recognized as such services are provided. Professional services revenues,
including consulting and training, are recognized as such services are
performed.

Cost of Revenues

Costs of revenues include the costs of products and services. Cost of products
represents the cost of product sales, which are incurred upon recognition of the
associated product revenues. Cost of services includes the cost of our technical
support group who provide assistance to customers with maintenance agreements,
the operations center costs of providing managed services and the costs related
to our professional services and training.


                                      -6-
<PAGE>   7

                         INTERNET SECURITY SYSTEMS, INC
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)


2.       Subsequent Event

On April 30, 2001, ISS entered into an Agreement and Plan of Merger (the "Merger
Agreement") to acquire Network ICE Corporation, a privately held corporation in
San Mateo, California ("Network ICE"). Network ICE is a leading developer of
desktop intrusion protection technology and highly scalable security management
system. Under the terms of the Merger Agreement, provided the merger is
consummated,, ISS will issue approximately 4.3 million common shares for all of
the outstanding shares of Network ICE. Additionally, approximately 300,000
shares of ISS common stock will be reserved for future issuance upon exercise of
all of the options to purchase Network ICE common shares that will be assumed by
ISS in the merger. The transaction has been approved by the board of directors
of each company and voting agreements in favor of the transaction have been
obtained from sellers representing more than 70% of the outstanding capital
stock of Network ICE. The transaction is subject to certain regulatory approvals
and customary closing conditions, including approval of the merger by Network
ICE shareholders. ISS currently anticipates that the transaction will close in
June 2001.

Based on unaudited results for the most recent quarter, Network ICE has an
annualized revenue run rate of approximately $14 million. The merger will be
accounted for as a purchase and, accordingly, the operating results of Network
ICE Corporation will be included in the consolidated financial statements of ISS
from the date of closing of the transaction.

3.       Nonrecurring income and expense items

Included in pretax income in the quarter ended March 31, 2001, is a
non-recurring other income item of $1.6 million generated from the sale of
approximately 2% of the outstanding shares of our Asia-Pacific subsidiary in
March 2001. The Company is presently planning for an IPO in Japan of a minority
interest in our Asia-Pacific subsidiary later in 2001. This will provide more
visibility of this operation in its marketplace as well as generate funds for
the expansion of the business in this market. As part of the planning, options
were granted in the subsidiary as a means of key employee retention and
approximately 2% of the outstanding shares were sold to employees and key
partners. The price was established based on a valuation of the company by an
independent appraisal firm. The gain represents the difference between proceeds
received and the underlying basis in the stock.

In the quarter ended March 31, 2001, the Company recorded a $1.1 million
write-off of the remaining lease obligation on our previous Atlanta office
space. This non-recurring expense originated in the quarter as available
subleased space in the area grew substantially as the result of layoffs,
closures and consolidations, diminishing the prospects of subleasing our old
space.

4.       Income taxes

The Company recorded tax provisions of $3.7 million and $1.8 million for the
quarters ended March 31, 2001 and 2000, respectively. While income tax expense
was recorded on domestic income, domestic taxes payable was reduced by
deductions related to the employee exercise of stock options. The tax benefit of
these deductions was recorded as additional paid-in-capital. As of March 31,
2001, ISS had a net operating loss carryforward of approximately $89 million.
The tax benefit of this carryforward will be recorded as additional
paid-in-


                                      -7-
<PAGE>   8

                         INTERNET SECURITY SYSTEMS, INC
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



capital as realized. There are also approximately $2.6 million of research and
development tax credit carryforwards that expire between 2011 and 2021.

5.       Comprehensive income

The components of comprehensive income, net of tax, are as follows (in
thousands):


<TABLE>
<CAPTION>
                                                                          Three months ended
                                                                               March 31,
                                                                         --------------------
                                                                            2001       2000
                                                                         --------------------
                  <S>                                                    <C>         <C>
                  Net income                                              $ 6,541     $ 3,070
                  Change in cumulative translation adjustment, net
                  of tax benefit of $342 and $13, respectively               (607)        (22)
                                                                         --------------------
                  Comprehensive income                                    $ 5,934     $ 3,048
</TABLE>

6.       Income per share

The computation of net income per share is as follows (amounts in thousands,
except per share amounts):

<TABLE>
<CAPTION>
                                                                       Three months ended
                                                                            March 31,
                                                                       -------------------
                                                                        2001         2000
                                                                       -------------------
                      <S>                                              <C>         <C>
                       Basic net income per share:
                          Net income                                   $ 6,541     $ 3,070
                          Weighted average number of common shares
                          outstanding during the period                 42,683      41,398
                                                                       -------------------
                       Basic net income per share                      $  0.15     $  0.07

                       Diluted net income per share:
                          Net income                                   $ 6,541     $ 3,070
                          Weighted average number of common shares
                          outstanding during the period                 42,683      41,398
                          Dilutive stock options                         1,873       3,445
                                                                       -------------------
                          Total shares for purpose of calculating
                          diluted net income per share                  44,556      44,843
                                                                       -------------------
                       Diluted net income per share                    $  0.15     $  0.07
</TABLE>


                                      -8-
<PAGE>   9


                         INTERNET SECURITY SYSTEMS, 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 in 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, 2000 as filed with the Securities and Exchange Commission and
available at their Web site at www.sec.gov.

OVERVIEW

We are a leading global provider of security management solutions for protecting
digital business assets. Our continuous lifecycle approach to information
security protects distributed computing environments, such as internal corporate
networks, inter-company networks and electronic commerce environments, from
attacks, misuse and security policy violations, while ensuring the
confidentiality, privacy, integrity and availability of proprietary information.
We deliver an end-to-end security management solution through our SAFEsuite
security management platform coupled with around-the-clock remote security
monitoring through our managed services offerings. Our SAFEsuite 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
managed services offerings currently provide remote management of the industry's
best-of-breed security technology including firewalls, VPNs, anti-virus and URL
filtering software, security assessment and intrusion detection systems. We
focus on serving as the trusted security provider to our customers by
maintaining within our existing products the latest counter-measures to security
risks, creating new innovative products based on our customers' needs and
providing professional and managed services.

We generate a majority of our revenues from our SAFEsuite family of products in
the form of perpetual licenses and subscriptions, and sales of best-of-breed
technology products developed by our partners. We recognize perpetual license
revenues from ISS developed products 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. Product
sales consist of (i) appliances sold in conjunction with ISS licensed software
and (ii) software developed by third party-partners, combined in some instances
with associated hardware appliances and partner maintenance services. These
sales are recognized upon shipment to the customer.

Annual renewable maintenance is a separate component of each perpetual license
agreement for ISS products with revenue recognized ratably over the maintenance
term. Subscription revenues include maintenance, term licenses, and managed
service arrangements. Term licenses allow customers to use our products and
receive maintenance coverage for a specified period, generally 12 months. We
recognize revenues from these term agreements ratably over the subscription
term. Security monitoring services of information assets and systems are part of
managed services and are recognized as such services are provided. Professional
services revenues include consulting services


                                      -9-
<PAGE>   10

                         INTERNET SECURITY SYSTEMS, INC.
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                       RESULTS OF OPERATIONS (CONTINUED)


and training. Consulting services, 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 such professional services revenues as
the related services are rendered.

We believe that our total solutions approach will grow all of our revenue
categories. This includes our products and managed services offerings, as well
as maintenance and professional services and training. While we expect the
expansion of these product and service offerings to originate primarily from
internal development, our strategy includes acquiring products, technologies and
service capabilities that fit within our strategy and that potentially
accelerate the timing of the commercial introduction of such products and
technologies.

Our business has been growing rapidly. 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. We expect to continue to expand our domestic
and international sales and marketing operations, increase our investment in
product development including our proprietary threat and vulnerability database
and managed services capabilities, 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. Thus, our prospects must be
considered in light of the risks and difficulties frequently encountered by
companies in new and rapidly evolving markets. As a result, while we have
achieved profitability, we cannot be certain that we can sustain such
profitability. See "Risk Factors".


                                      -10-
<PAGE>   11


                         INTERNET SECURITY SYSTEMS, INC.
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                       RESULTS OF OPERATIONS (CONTINUED)


RESULTS OF OPERATIONS

The following table sets forth certain consolidated historical operating
information, as a percentage of total revenues, for the period indicated:

<TABLE>
<CAPTION>
                                                        Three months ended
                                                            March 31,
                                                     ----------------------
                                                       2001           2000
                                                     ----------------------
                  <S>                                <C>            <C>
                  Product and license sales             59%            63%
                  Subscriptions                         25%            21%
                  Professional services                 16%            16%
                                                     ----------------------
                     Total revenues                    100%           100%
                                                     ----------------------

                  Cost of product revenues              11%            14%
                  Cost of subscription and
                    professional service revenues       19%            17%
                  Research and development              14%            17%
                  Sales and marketing                   35%            36%
                  General and administrative             7%             7%
                  Write-off of lease obligation          2%             -
                  Amortization                           1%             1%
                                                     ----------------------
                     Total costs and expenses           89%            92%
                                                     ----------------------

                  Operating income                      11%             8%
                                                     ======================
</TABLE>

REVENUES

Our total revenues increased 56% to $61.2 million for the three months ended
March 31, 2001 as compared with the same period in the prior year. Product and
license sales, including perpetual licenses and sales of partner software and
hardware appliances, continued to be the primary source of revenue generation at
59% of total revenues for the three month period ended March 31, 2001 and 63%
for the corresponding period in 2000. Product sales are generated both through a
direct sales force and through channel partners. When our partners generate
sales, revenues are recognized when the end user sale has occurred, which is
identified through electronic delivery of a software key that is necessary to
operate the product.


We continue to add functionality to our SAFEsuite product family, including our
vulnerability assessment and intrusion detection products providing both network
and host based solutions and our security management applications. In addition,
in the second half of 2000 we introduced Nokia RealSecure, an integrated
offering of ISS intrusion detection software on a Nokia hardware appliance.
These improvements and new offerings provide our customers with more powerful
and easier-to-use solutions for security management across the enterprise. In
addition to sales of our proprietary software, product licenses and sales
include the sales of partner products as a part of our total solution approach
whereby we source such products to provide a single solution for our customers.


                                      -11-

<PAGE>   12

                         INTERNET SECURITY SYSTEMS, INC.
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                       RESULTS OF OPERATIONS (CONTINUED)


Subscription revenues grew 87% from $8.1 million in the three months ended March
31, 2000 to $15.1 million in the three months ended March 31, 2001, increasing
from 21% of total revenues in the first quarter of 2000 to 25% of total revenues
in the first quarter of 2001. Subscription revenues consist of maintenance, term
licenses of product usage and security-monitoring fees for managed services
offerings. While all components of subscription revenues grew, the highest
growth component was experienced in monitoring fees that comprised 6% of total
revenues in the first quarter of 2001. Growing this element of the business has
been and remains a focus of ISS.

Professional services revenue increased 53% from $6.4 million for the three
months ended March 31, 2000 to $9.8 million for the three months ended March 31,
2001 representing 16% of total revenues in both periods. We continue to build
our service capabilities to address the demand from our customers for security
consulting and implementation services and for expanded training offerings.

Geographically, we derived our revenues as a percentage of total revenues as
follows:

<TABLE>
         <S>                                               <C>
         Americas.................................         73%
         Europe...................................         15%
         Asia/Pacific Rim.........................         12%
</TABLE>


COSTS AND EXPENSES

Cost of revenues

Cost of revenues consists of several components. Substantially all of the cost
of product licenses and sales represents payments to partners for their products
that we integrate with our products or directly provision to our customers in
providing a single solution source. Costs associated with licensing our products
are minor. Costs of product revenues as a percentage of total revenues decreased
from 14% for the three months ended March 31, 2000 to 11% for the comparable
period in 2001 as sales of partner software and hardware appliances represented
a lower percentage of total revenues. There was a conscious effort during the
first half of 2000 to eliminate sales of partner products where such sales were
not accompanied by the ISS solution methodology that includes professional
services or monitoring services.

Cost of subscription and services includes the cost of our technical support
personnel who provide assistance to customers under maintenance agreements, the
operations center costs of providing managed security monitoring services and
the costs related to consulting and training. These costs represented 17% of
total revenues for the three-month period ended March 31, 2000 and increased to
19% for the comparable period in 2001. The percentage increase is a direct
result of our significant commitment to our managed security offerings in terms
of automated systems, number of managed security operations centers and
personnel resources. We also committed resources to continue to build
professional services capabilities and more automated technical support
programs.


Research and development


                                      -12-
<PAGE>   13

                         INTERNET SECURITY SYSTEMS, 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," our internal team 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. We continue to increase these expenditures, as we
perceive primary research and product development and managed service offerings
as essential ingredients for retaining our leadership position in the market. We
also increased the number of our development personnel focused on our
best-of-breed products, enterprise applications, managed services offerings and
research for future product offerings. Accordingly, research and development
expenses increased in absolute dollars from $6.8 million in the three months
ended March 31, 2000 to $8.3 million in the three months ended March 31, 2001.
These costs decreased as a percentage of total revenues from 17% in the quarter
ended March 31, 2000 to 14% in the quarter ended March 31, 2001. We will
continue to seek leverage in the research and development area while continuing
to invest in the enhancement of current technologies and the development of new
technologies.

Sales and marketing

Sales and marketing expenses consist primarily of salaries, travel expenses,
commissions, advertising, maintenance of our Website, trade show expenses, costs
of recruiting sales and marketing personnel and costs of marketing materials. In
the quarter ended March 31, 2001, sales and marketing expenses were $21.6
million or 35% of total revenues, compared to $14.3 million or 37% of total
revenues in the quarter ended March 31, 2000. Sales and marketing expenses
increased in total dollars during this period primarily from our larger
workforce, which has increased each quarter since March 2000, both domestically
and internationally. The slight decrease in sales and marketing expenses as a
percentage of total revenues is due to greater levels of productivity achieved
by our sales force. We believe that sales force productivity continued to
benefit from more experienced sales personnel as well as the heightened interest
of the marketplace in our product and services offerings. We expect to continue
to create leverage in our sales and marketing efforts through better market
segmentation, by focusing our direct sales force, and by expanding the channel
as a source of our product sales.

General and administrative

General and administrative expenses in the quarter ended March 31, 2001
increased $1.6 million from the quarter ended March 31, 2000 to $4.5 million,
but remained constant at 7% of our total revenues. General and administrative
expenses consist of personnel-related costs for executive, administrative,
finance and human resources, information systems and other support services
costs and legal, accounting and other professional service fees. The increase in
these expenses in absolute dollars is attributable to our efforts, 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. Since March 2000, we have relocated most of
our Atlanta personnel into our new corporate headquarters, incurring expenses
associated with the move.

In the quarter ended March 31, 2001, we recorded a $1.1 million write-off of the
remaining lease obligation on our previous Atlanta headquarters office space.
This non-recurring expense


                                      -13-
<PAGE>   14


                         INTERNET SECURITY SYSTEMS, INC.
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                       RESULTS OF OPERATIONS (CONTINUED)


originated in the quarter as available subleased space in the area grew
substantially in the quarter as the result of layoffs, closures and
consolidations, dimming the prospects of subleasing our old space.

Included in pretax income in the quarter ended March 31, 2001, is a
non-recurring other income item of $1.6 million generated from the sale of
approximately 2% of the outstanding shares of our Asia-Pacific subsidiary in
March 2001. The Company is presently planning for an IPO in Japan of a minority
interest in our Asia-Pacific subsidiary later in 2001. This will provide more
visibility of this operation in its marketplace as well as generate funds for
the expansion of the business in this market. As part of the planning, options
were granted in the subsidiary as a means of key employee retention and
approximately 2% of the outstanding shares were sold to employees and key
partners. The price was established based on a valuation of the company by an
independent appraisal firm. The gain represents the difference between proceeds
received and the underlying basis in the stock.

We recorded $366,000 of amortization expense in the three months ended March 31,
2001 related to goodwill and intangible assets resulting from acquisitions.

Interest income and foreign currency exchange loss

Net interest income increased from $1,868,000 in the quarter ended March 31,
2000 to $1,958,000 in the comparable quarter of 2001, primarily due to increased
amounts of cash invested in interest-bearing securities. The exchange loss of
$251,000 in the three months ended March 31, 2001 is a result of fluctuations in
currency exchange rates between the U.S. dollar and other currencies, primarily
the Japanese Yen and the Euro.

Income taxes

Income tax expense was approximately 36% of pre-tax net income for the quarters
ended March 31, 2000 and 2001.

LIQUIDITY AND CAPITAL RESOURCES

Net cash provided by operations in the first three months of 2001 was $16.6
million and included net income of $6.5 million, non-cash depreciation and
amortization expense charges of $2.9 million, income tax benefit from employee
exercises of stock options of $2.8 million, growth in deferred revenue of $1.9
million; and changes in working capital.

Investing activities in the first three months of 2001 include the purchase of
$41.5 million of marketable securities, primarily commercial paper, offset by
net proceeds from the maturity of marketable securities of $46.4 million. These
assets have quality characteristics similar to cash equivalents except their
maturities are longer than three months. We also invested in equipment totaling
$9.0 million as we provided existing and new personnel with the computer
hardware and software environment necessary to perform their job functions and
incurred leasehold improvement costs for our new headquarters.


                                      -14-
<PAGE>   15
                         INTERNET SECURITY SYSTEMS, INC.
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                       RESULTS OF OPERATIONS (CONTINUED)



Our financing activities provided $10.4 million of cash in the quarter ended
March 31, 2001, which consisted primarily of proceeds from the exercise of stock
options by our employees and from the issuance of common stock through our
Employee Stock Purchase Plan.

As of March 31, 2001, we had $148.8 million of cash and cash equivalents and
marketable securities, consisting primarily of money market accounts and
commercial paper carrying the highest investment grade rating. We believe that
such cash and cash equivalents and marketable securities will be sufficient to
meet our working capital needs and capital expenditures for the foreseeable
future. From time to time we evaluate possible acquisition and investment
opportunities in businesses, products or technologies that are complimentary to
ours. 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 our available cash in investment grade, interest-bearing investments.

Additionally, we have restricted marketable securities of $12.5 million securing
a $10 million letter of credit issued in connection with our commitment to a
long-term lease of our Atlanta corporate operations.

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 contained in this Quarterly Report on Form 10-Q for any reason, even
if new information becomes available or other events occur in the future.

  We Have Only Recently Achieved Profitability

         We began operations in 1994 and achieved profitability in 1999. 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.

         We cannot be certain that we will successfully address these risks. As
a result, we cannot assure our investors that we will be able to continue to
operate profitably in the future.


                                      -15-
<PAGE>   16

                         INTERNET SECURITY SYSTEMS, INC.
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                       RESULTS OF OPERATIONS (CONTINUED)


  Our Future Operating Results Will Likely 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 in the acceptance of, and activity on, the Internet
                  and the World Wide Web, particularly by corporate,
                  institutional and government users;

         -        the extent to which the public perceives that unauthorized
                  access to and use of online information are threats to network
                  security;

         -        the volume and timing of orders, including seasonal trends in
                  customer purchasing;

         -        our ability to develop new and enhanced product and managed
                  service offerings and expand our professional services
                  capabilities;

         -        our ability to provide scalable managed services offerings
                  through our partners in a cost effective manner;

         -        foreign currency exchange rates that affect our international
                  operations;

         -        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, and managed security services, rather than on the sale of component
products. As a result, each sale may require additional time and effort from our
sales and support 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 and services companies,
many of our customers typically complete transactions in the last month of a
quarter.

         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.

         Our ability to provide timely guidance and meet the expectations of
investors, industry analysts and brokerage firms with respect to our operating
and financial results is impacted by the tendency of a majority of our sales to
be completed in the last month of a quarter. We may not be


                                      -16-
<PAGE>   17

                         INTERNET SECURITY SYSTEMS, INC.
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                       RESULTS OF OPERATIONS (CONTINUED)


able to determine whether we will experience material deviations from guidance
or expectations until the end of a quarter.

  We Must Attract and Retain Personnel While Competition for Personnel in Our
  Industry is Intense

         Competition in recruiting personnel in the software, network consulting
and managed services industries is intense. We believe our future success will
depend in part on our ability to recruit and retain highly skilled engineering,
technical, consulting, marketing, sales and management personnel. To accomplish
this, we believe we must provide competitive compensation, including stock
options that may require additional stockholder approval for increased
availability. Without sufficient available stock options, our ability to attract
and retain personnel may be impaired.

  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. Our chief competitors generally
fall within one of five categories:

         -        internal information technology departments of our customers
                  and the consulting firms that assist them in formulating
                  security systems;

         -        relatively smaller software companies offering relatively
                  limited applications for network and Internet security;

         -        large companies, including Symantec Corp., Cisco Systems,
                  Inc., Network Associates, Inc. and Bindview Development Corp.,
                  that sell competitive products and offerings, as well as other
                  large software companies that have the technical capability
                  and resources to develop competitive products;

         -        software or hardware companies like Cisco Systems, Inc. that
                  could integrate features that are similar to our products into
                  their own products; and

         -        small and large companies with competitive offerings to
                  components of our managed services offerings.

         Mergers or consolidations among these competitors, or acquisitions of
small competitors by larger companies, would make such combined entities more
formidable competitors to us. Large companies may have advantages over us
because of their longer operating histories, greater name recognition, larger
customer bases or greater financial, technical and marketing resources. As a
result, they may be able to adapt more quickly to new or emerging technologies
and changes in customer requirements. They can also devote greater resources to
the promotion and sale of their products than we can. In addition, these
companies have reduced and could continue to reduce, the price of their security
monitoring, detection and response products and managed security services, which
increases pricing pressures within our market.


                                      -17-
<PAGE>   18

                         INTERNET SECURITY SYSTEMS, INC.
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                       RESULTS OF OPERATIONS (CONTINUED)


         Several companies currently sell software products (such as encryption,
firewall, operating system security and virus detection software) that our
customers and potential customers have broadly adopted. Some of these companies
sell products that perform the same functions as some of our products. In
addition, the vendors of operating system software or networking hardware may
enhance their products to include the same kinds of functions that our products
currently provide. The widespread inclusion of comparable features to our
software in operating system software or networking hardware could render our
products obsolete, particularly if such features are of a high quality. Even if
security functions integrated into operating system software or networking
hardware are more limited than those of our software, a significant number of
customers may accept more limited functionality to avoid purchasing additional
software.

         For the above reasons, we may not be able to compete successfully
against our current and future competitors. Increased competition may result in
price reductions, reduced gross margins and loss of market share.

  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 and services
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


                                      -18-
<PAGE>   19

                         INTERNET SECURITY SYSTEMS, INC.
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                       RESULTS OF OPERATIONS (CONTINUED)


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 our presence 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; and

         -        export license requirements and restrictions on the export of
                  certain technology, especially encryption technology and trade
                  restrictions.

         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.

  Our Networks, Products and Services May be Targeted by Hackers

         Like other companies, our websites, networks, information systems,
products and services may be targets for sabotage, disruption or
misappropriation by hackers. As a leading network security solutions company, we
are a high profile target. Although we believe we have sufficient controls in
place to prevent disruption and misappropriation, and to respond to situations,
we expect these efforts by hackers to continue. If these efforts are successful,
our operations, reputation and sales could be adversely affected.

  We Must Successfully Integrate Acquisitions

         As part of our growth strategy, we have and may continue to acquire or
make investments in companies with products, technologies or professional
services capabilities complementary to our solutions. When engaging in
acquisitions, we could encounter difficulties in assimilating new personnel and
operations into our company. These difficulties may 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 cannot be certain that we will successfully
overcome these risks with respect to any of our recent or future acquisitions or
that we


                                      -19-
<PAGE>   20

                         INTERNET SECURITY SYSTEMS, INC.
         MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                       RESULTS OF OPERATIONS (CONTINUED)


will not encounter other problems in connection with our recent or any future
acquisitions. In addition, any future acquisitions may require us to incur debt
or issue equity securities. The issuance of equity securities could dilute the
investment of our existing stockholders.

  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 have obtained one United States patent and have nine patent
applications under review. 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.

         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.


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Sensitivity

         The primary objective of our investment activities is to preserve
principal while at the same time maximizing the income we receive from our
investments without significantly increasing risk. Some of the securities that
we have invested in may be subject to market risk. This means that a change in
prevailing interest rates may cause the principal amount of the investment to
fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing rate and the prevailing interest rate later
rises, the principal amount of our investment will probably decline. To minimize
this risk, we maintain our portfolio of cash equivalents and marketable
securities in a variety of relatively short-term investments, including
commercial paper and overnight repurchase agreements. As of March 31, 2001,
$38,314,000 of our securities had maturities beyond 90 days.


                                      -20-
<PAGE>   21


                                OTHER INFORMATION


ITEM 5.  OTHER INFORMATION

On April 30, 2001, ISS entered into an Agreement and Plan of Merger (the "Merger
Agreement") to acquire Network ICE Corporation, a privately held corporation in
San Mateo, California ("Network ICE"). Network ICE is a leading developer of
desktop intrusion protection technology and highly scalable security management
system. Under the terms of the Merger Agreement, provided the merger is
consummated,, ISS will issue approximately 4.3 million common shares for all of
the outstanding shares of Network ICE. Additionally, approximately 300,000
shares of ISS common stock will be reserved for future issuance upon exercise of
all of the options to purchase Network ICE common shares that will be assumed by
ISS in the merger. The transaction has been approved by the board of directors
of each company and voting agreements in favor of the transaction have been
obtained from sellers representing more than 70% of the outstanding capital
stock of Network ICE. The transaction is subject to certain regulatory approvals
and customary closing conditions, including approval of the merger by Network
ICE shareholders. ISS currently anticipates that the transaction will close in
June 2001.

Based on unaudited results for the most recent quarter, Network ICE has an
annualized revenue run rate of approximately $14 million. The merger will be
accounted for as a purchase and, accordingly, the operating results of Network
ICE Corporation will be included in the consolidated financial statements of ISS
from the date of closing of the transaction.


ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)      Exhibits.

         2.1      Agreement and Plan of Merger by and among Internet Security
         Systems, Inc., ISS Acquisition Corp. II, Network ICE Corporation and
         certain selling shareholders of Network ICE Corporation dated as of
         April 30, 2001.

(b)      Reports on Form 8-K.

         ISS filed no reports on Form 8-K during this reporting period.


                                      -21-
<PAGE>   22



                         INTERNET SECURITY SYSTEMS, 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.

                                         INTERNET SECURITY SYSTEMS, INC.
                                         -------------------------------
                                                   (Registrant)



Date:    May 11, 2001           By   /s/ Richard Macchia
     ------------------              ------------------------------------------
                                     Chief Financial Officer
                                     Vice President and Chief Financial Officer

                                By   /s/ Maureen Richards
                                     ------------------------------------------
                                     Corporate Controller


                                      -22-