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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, 2002                                           
|     |  |                                                                                         
|     |  | 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
incorporation or organization) |  | (I.R.S. Employer
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.

|                               |  |                                               
|------------------------------ |  | ----------------------------------------------
|Title of each class            |  | Number of Shares Outstanding
as of May 3, 2002
|                               |  |                                               
|Common Stock, $0.001 par value |  | 48,322,265                                    





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TABLE OF CONTENTS



|                           |                                                                                       |                                            |  |  |  |  |  | 
|-------------------------- | ------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|                           |                                                                                       | CONSOLIDATED BALANCE SHEETS               
|                           |                                                                                       | CONSOLIDATED STATEMENTS OF OPERATIONS     
|                           |                                                                                       | CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                           |                                                                                       | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                           | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                           | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                   
|PART II. OTHER INFORMATION
|                           | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                             
|SIGNATURES                



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##### Table of Contents



|                           |  |                                                                                                    |  |       
|-------------------------- |  | -------------------------------------------------------------------------------------------------- |  | ------
|                           |  |                                                                                                    |  | PAGE  
|PART I.                    |  | FINANCIAL INFORMATION                                                                              |  | NUMBER
|                           |  |                                                                                                    |  |       
|Item 1                     |  | Consolidated Financial Statements:                                                                 |  |       
|                           |  |                                                                                                    |  |       
|                           |  | Consolidated Balance Sheets at March 31, 2002 and
December 31, 2001                                |  | 3     
|                           |  |                                                                                                    |  |       
|                           |  | Consolidated Statements of Operations for the three months
ended March 31, 2002 and March 31, 2001 |  | 4     
|                           |  |                                                                                                    |  |       
|                           |  | Consolidated Statements of Cash Flows for the three
months ended March 31, 2002 and March 31, 2001 |  | 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 6                     |  | Exhibits and Reports on Form 8-K                                                                   |  | 21    





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INTERNET SECURITY SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except per share amounts)

|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |              |         |  |  | 
|----------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ------- | ------- | ----------- | ------- | ------------ | ------- |  |  | 
|                                                                                    |                                                                                                                              |                                            |         |         |         | March 31,   |         | December 31,
|                                                                                    |                                                                                                                              |                                            |         |         |         | 2002        |         | 2001        
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    |                                                                                                                              |                                            |         |         |         | (UNAUDITED) |         |              |         | 
|ASSETS                                                                             
|Current assets:                                                                     |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    | Cash and cash equivalents                                                                                                    |                                            | $       | 129,360 |         |             | $       | 108,038      |        
|                                                                                    | Marketable securities                                                                                                        |                                            |         | 39,113  |         |             |         | 55,129       |        
|                                                                                    | Accounts receivable, less allowance for doubtful accounts
of $2,626 and $2,563, respectively                                 |                                            |         | 52,374  |         |             |         | 50,259       |        
|                                                                                    | Inventory                                                                                                                    |                                            |         | 1,703   |         |             |         | 1,768        |        
|                                                                                    | Prepaid expenses and other current assets                                                                                    |                                            |         | 7,555   |         |             |         | 6,018        |        
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    |                                                                                                                              | Total current assets                       |         |         | 230,105 |             |         |              | 221,212 | 
|Property and equipment:                                                             |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    | Computer equipment                                                                                                           |                                            |         | 31,869  |         |             |         | 31,043       |        
|                                                                                    | Office furniture and equipment                                                                                               |                                            |         | 21,729  |         |             |         | 20,872       |        
|                                                                                    | Leasehold improvements                                                                                                       |                                            |         | 21,051  |         |             |         | 17,835       |        
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    |                                                                                                                              |                                            | 74,649  |         |         |             | 69,750  |             
|                                                                                    | Less accumulated depreciation                                                                                                |                                            |         | 28,467  |         |             |         | 25,254       |        
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    |                                                                                                                              |                                            | 46,182  |         |         |             | 44,496  |             
|Restricted marketable securities                                                    |                                                                                                                              |                                            | 12,500  |         |         |             | 12,500  |             
|Goodwill, less accumulated amortization of $27,381                                  |                                                                                                                              |                                            | 196,884 |         |         |             | 197,060 |             
|Other intangibles, less accumulated amortization of
$5,772 and $4,644, respectively |                                                                                                                              |                                            | 17,642  |         |         |             | 19,722  |             
|Other assets                                                                        |                                                                                                                              |                                            | 7,185   |         |         |             | 5,994   |             
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    |                                                                                                                              | Total assets                               |         | $       | 510,498 |             |         | $            | 500,984 | 
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             
|LIABILITIES AND STOCKHOLDERS EQUITY                                               
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             
|Current liabilities:                                                                |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    | Accounts payable                                                                                                             |                                            | $       | 2,234   |         |             | $       | 3,553        |        
|                                                                                    | Accrued expenses                                                                                                             |                                            |         | 21,013  |         |             |         | 20,440       |        
|                                                                                    | Deferred revenues                                                                                                            |                                            |         | 50,025  |         |             |         | 48,139       |        
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    |                                                                                                                              | Total current liabilities                  |         |         | 73,272  |             |         |              | 72,132  | 
|Other non-current liabilities                                                       |                                                                                                                              |                                            | 1,829   |         |         |             | 1,917   |             
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             
|Stockholders equity:                                                               |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    | Preferred stock; $.001 par value; 20,000,000 share authorized, none issued or outstanding                                    |                                            |         |        |         |             |         |             |        
|                                                                                    | Common stock, $.001 par value, 120,000,000 shares authorized,
48,312,000 and 47,871,000 issued and outstanding, respectively |                                            |         | 48      |         |             |         | 48           |        
|                                                                                    | Additional paid-in capital                                                                                                   |                                            |         | 435,624 |         |             |         | 430,449      |        
|                                                                                    | Deferred compensation                                                                                                        |                                            |         | (1,382  | )       |             |         | (1,985       | )      
|                                                                                    | Accumulated other comprehensive loss                                                                                         |                                            |         | (2,997  | )       |             |         | (2,312       | )      
|                                                                                    | Retained earnings                                                                                                            |                                            |         | 4,104   |         |             |         | 735          |        
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             
|                                                                                    |                                                                                                                              | Total stockholders equity                 |         |         | 435,397 |             |         |              | 426,935 | 
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |              |        
|                                                                                    |                                                                                                                              | Total liabilities and stockholders equity |         | $       | 510,498 |             |         | $            | 500,984 | 
|                                                                                    |                                                                                                                              |                                            |         |         |         |             |         |             

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INTERNET SECURITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share amounts)
(Unaudited)

|                                                                   |                                                                |                                         |        |                    |        |      |        |        |        | 
|------------------------------------------------------------------ | -------------------------------------------------------------- | --------------------------------------- | ------ | ------------------ | ------ | ---- | ------ | ------ | ------ | 
|                                                                   |                                                                |                                         |        | Three months ended
|                                                                   |                                                                |                                         |        | March 31,         
|                                                                   |                                                                |                                         |        |                   
|                                                                   |                                                                |                                         |        | 2002               |        | 2001
|                                                                   |                                                                |                                         |        |                    |        |     
|Revenues:                                                          |                                                                |                                         |        |                    |        |      |        |       
|                                                                   | Product licenses and sales                                     |                                         | $      | 30,213             |        |      | $      | 36,176 |       
|                                                                   | Subscriptions                                                  |                                         |        | 20,322             |        |      |        | 15,136 |       
|                                                                   | Professional services                                          |                                         |        | 7,842              |        |      |        | 9,843  |       
|                                                                   |                                                                |                                         |        |                    |        |      |        |       
|                                                                   |                                                                |                                         | 58,377 |                    |        |      | 61,155 |       
|Costs and expenses:                                                |                                                                |                                         |        |                    |        |      |        |       
|                                                                   | Cost of revenues:                                              |                                         |        |                    |        |      |        |        |       
|                                                                   |                                                                | Product licenses and sales              |        |                    | 2,327  |      |        |        | 6,544  | 
|                                                                   |                                                                | Subscriptions and professional services |        |                    | 12,509 |      |        |        | 11,838 | 
|                                                                   |                                                                |                                         |        |                    |        |      |        |       
|                                                                   | Total cost of revenues                                         |                                         |        | 14,836             |        |      |        | 18,382 |       
|                                                                   | Research and development                                       |                                         |        | 8,607              |        |      |        | 8,315  |       
|                                                                   | Sales and marketing                                            |                                         |        | 22,687             |        |      |        | 21,634 |       
|                                                                   | General and administrative                                     |                                         |        | 5,444              |        |      |        | 4,511  |       
|                                                                   | Write-off of lease obligation                                  |                                         |        |                   |        |      |        | 1,072  |       
|                                                                   | Amortization of other intangibles and
stock-based compensation |                                         |        | 1,496              |        |      |        | 168    |       
|                                                                   | Amortization of goodwill                                       |                                         |        |                   |        |      |        | 198    |       
|                                                                   |                                                                |                                         |        |                    |        |      |        |       
|                                                                   |                                                                |                                         | 53,070 |                    |        |      | 54,280 |       
|                                                                   |                                                                |                                         |        |                    |        |      |        |       
|Operating income                                                   |                                                                |                                         | 5,307  |                    |        |      | 6,875  |       
|Interest income, net                                               |                                                                |                                         | 730    |                    |        |      | 1,958  |       
|Minority interest                                                  |                                                                |                                         | (139   | )                  |        |      |       |        |       
|Other income (expense), including gain on
sale of subsidiary stock |                                                                |                                         | (37    | )                  |        |      | 1,638  |       
|Foreign currency exchange gain (loss)                              |                                                                |                                         | 23     |                    |        |      | (251   | )     
|                                                                   |                                                                |                                         |        |                    |        |      |        |       
|Income before income taxes                                         |                                                                |                                         | 5,884  |                    |        |      | 10,220 |       
|Provision for income taxes                                         |                                                                |                                         | 2,515  |                    |        |      | 3,679  |       
|                                                                   |                                                                |                                         |        |                    |        |      |        |       
|Net income                                                         |                                                                | $                                       | 3,369  |                    |        | $    | 6,541  |       
|                                                                   |                                                                |                                         |        |                    |        |      |        |       
|Basic net income per share of Common Stock                         |                                                                | $                                       | 0.07   |                    |        | $    | 0.15   |       
|                                                                   |                                                                |                                         |        |                    |        |      |        |       
|Diluted net income per share of Common Stock                       |                                                                | $                                       | 0.07   |                    |        | $    | 0.15   |       
|                                                                   |                                                                |                                         |        |                    |        |      |        |       
|Weighted average shares:                                           |                                                                |                                         |        |                    |        |      |        |       
|                                                                   | Basic                                                          |                                         |        | 48,037             |        |      |        | 42,683 |       
|                                                                   |                                                                |                                         |        |                    |        |      |        |       
|                                                                   | Diluted                                                        |                                         |        | 49,148             |        |      |        | 44,556 |       
|                                                                   |                                                                |                                         |        |                    |        |      |        |       

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INTERNET SECURITY SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)

|                                                                                  |                                    |                                                                |                                                     |   |                    |        |         |   |        |        |  
|--------------------------------------------------------------------------------- | ---------------------------------- | -------------------------------------------------------------- | --------------------------------------------------- | - | ------------------ | ------ | ------- | - | ------ | ------ | -
|                                                                                  |                                    |                                                                |                                                     |   | Three months ended
|                                                                                  |                                    |                                                                |                                                     |   | March 31,         
|                                                                                  |                                    |                                                                |                                                     |   |                   
|                                                                                  |                                    |                                                                |                                                     |   | 2002               |        | 2001   
|                                                                                  |                                    |                                                                |                                                     |   |                    |        |        
|OPERATING ACTIVITIES                                                              |                                    |                                                                |                                                     |   |                    |        |         |  
|Net income                                                                        |                                    | $                                                              | 3,369                                               |   |                    | $      | 6,541   |  
|Adjustments to reconcile net income to net cash
provided by operating activities: |                                    |                                                                |                                                     |   |                    |        |         |  
|                                                                                  |                                    | Depreciation                                                   |                                                     |   | 3,213              |        |         |   | 2,549  |       
|                                                                                  |                                    | Amortization of goodwill                                       |                                                     |   |                   |        |         |   | 198    |       
|                                                                                  |                                    | Amortization of other intangibles and stock-based compensation |                                                     |   | 1,496              |        |         |   | 168    |       
|                                                                                  |                                    | Accretion of discount on marketable securities                 |                                                     |   | 469                |        |         |   | 269    |       
|                                                                                  |                                    | Minority interest                                              |                                                     |   | 139                |        |         |   |       |       
|                                                                                  |                                    | Other non-cash items                                           |                                                     |   |                   |        |         |   | 23     |       
|                                                                                  |                                    | Income tax benefit from exercise of stock options              |                                                     |   | 1,843              |        |         |   | 2,830  |       
|                                                                                  |                                    | Gain on sale of subsidiary stock                               |                                                     |   |                   |        |         |   | (1,638 | )     
|                                                                                  | Changes in assets and liabilities: |                                                                |                                                     |   |                    |        |         |   |       
|                                                                                  |                                    | Accounts receivable                                            |                                                     |   | (2,115             | )      |         |   | 725    |       
|                                                                                  |                                    | Inventory                                                      |                                                     |   | 65                 |        |         |   | 1,173  |       
|                                                                                  |                                    | Prepaid expenses and other assets                              |                                                     |   | (2,728             | )      |         |   | (3,886 | )     
|                                                                                  |                                    | Accounts payable and accrued expenses                          |                                                     |   | (973               | )      |         |   | 3,964  |       
|                                                                                  |                                    | Deferred revenues                                              |                                                     |   | 3,013              |        |         |   | 1,880  |       
|                                                                                  |                                    |                                                                |                                                     |   |                    |        |         |  
|                                                                                  |                                    |                                                                | NET CASH PROVIDED BY OPERATING ACTIVITIES           |   |                    | 7,791  |         |   |        | 14,796 |  
|                                                                                  |                                    |                                                                |                                                     |   |                    |        |         |  
|INVESTING ACTIVITIES                                                              |                                    |                                                                |                                                     |   |                    |        |         |  
|Net proceeds from maturity of marketable securities                               |                                    |                                                                | 33,284                                              |   |                    |        | 46,375  |  
|Purchases of marketable securities                                                |                                    |                                                                | (17,737                                             | ) |                    |        | (41,462 | )
|Purchases of property and equipment                                               |                                    |                                                                | (4,899                                              | ) |                    |        | (9,047  | )
|Net proceeds from sale of subsidiary stock                                        |                                    |                                                                |                                                    |   |                    |        | 1,766   |  
|                                                                                  |                                    |                                                                |                                                     |   |                    |        |         |  
|                                                                                  |                                    |                                                                | NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES |   |                    | 10,648 |         |   |        | (2,368 | )
|FINANCING ACTIVITIES                                                              |                                    |                                                                |                                                     |   |                    |        |         |  
|Proceeds from exercise of stock options                                           |                                    |                                                                | 2,426                                               |   |                    |        | 9,154   |  
|Proceeds from issuance of common stock                                            |                                    |                                                                | 1,142                                               |   |                    |        | 1,228   |  
|                                                                                  |                                    |                                                                |                                                     |   |                    |        |         |  
|                                                                                  |                                    |                                                                | NET CASH PROVIDED BY FINANCING ACTIVITIES           |   |                    | 3,568  |         |   |        | 10,382 |  
|Foreign currency impact on cash                                                   |                                    |                                                                | (685                                                | ) |                    |        | (949    | )
|                                                                                  |                                    |                                                                |                                                     |   |                    |        |         |  
|Net increase in cash and cash equivalents                                         |                                    |                                                                | 21,322                                              |   |                    |        | 21,861  |  
|Cash and cash equivalents at beginning of period                                  |                                    |                                                                | 108,038                                             |   |                    |        | 66,210  |  
|                                                                                  |                                    |                                                                |                                                     |   |                    |        |         |  
|Cash and cash equivalents at end of period                                        |                                    | $                                                              | 129,360                                             |   |                    | $      | 88,071  |  
|                                                                                  |                                    |                                                                |                                                     |   |                    |        |         |  
|                                                                                  |                                    |                                                                |                                                     |   |                    |        |         |  
|SUPPLEMENTAL CASH FLOW DISCLOSURE                                                 |                                    |                                                                |                                                     |   |                    |        |         |  
|Interest paid                                                                     |                                    | $                                                              |                                                    |   |                    | $      | 3       |  
|                                                                                  |                                    |                                                                |                                                     |   |                    |        |         |  
|Income taxes paid                                                                 |                                    | $                                                              | 2,332                                               |   |                    | $      |        |  
|                                                                                  |                                    |                                                                |                                                     |   |                    |        |         |  

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INTERNET SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of presentation and 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, 2001. 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, 2002 and the consolidated results of its operations and cash flows for the
three months ended March 31, 2002 and 2001. Results of operations reported for
interim periods are not necessarily indicative of results for the entire year.

The consolidated financial statements include the accounts of Internet
Security Systems, Inc. and its majority-owned subsidiaries. All significant
intercompany and investment accounts and transactions have been eliminated in
consolidation. The consolidated balance sheet at December 31, 2001 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.

The preparation of financial statements and related disclosures in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates.

Certain reclassifications have been made to conform to the current period
presentation.

2. Other income and expense

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. As part of the planning for an IPO in Japan of a minority interest
in our Asia-Pacific subsidiary that was completed in September 2001, 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.

3. Income taxes

The Company recorded tax provisions of $2.5 million and $3.7 million for the
quarters ended March 31, 2002 and 2001, 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,
2002, ISS had a net operating loss carryforward of approximately $85 million.
The tax benefit of this carryforward will be recorded as additional
paid-in-capital as realized. There are also approximately $2.6 million of
research and development tax credit carryforwards which expire between 2011 and
2021 and foreign tax credit carryforwards of $1.2 million that expire in 2006.

4. Comprehensive income

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

|                                                                                               |  |                    |       |      |  |   |       |  
|---------------------------------------------------------------------------------------------- |  | ------------------ | ----- | ---- |  | - | ----- | -
|                                                                                               |  | Three months ended
|                                                                                               |  | March 31,         
|                                                                                               |  |                   
|                                                                                               |  | 2002               |       | 2001
|                                                                                               |  |                    |       |     
|Net income                                                                                     |  | $                  | 3,369 |      |  | $ | 6,541 |  
|Change in cumulative translation adjustment, net
of tax benefit of $247 and $342, respectively |  |                    | (438  | )    |  |   | (607  | )
|                                                                                               |  |                    |       |      |  |   |       |  
|Comprehensive income                                                                           |  | $                  | 2,931 |      |  | $ | 5,934 |  
|                                                                                               |  |                    |       |      |  |   |       |  

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INTERNET SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5. Income per share

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

|                              |                                                                        |   |                    |        |      |   |      |        | 
|----------------------------- | ---------------------------------------------------------------------- | - | ------------------ | ------ | ---- | - | ---- | ------ | 
|                              |                                                                        |   | Three months ended
|                              |                                                                        |   | March 31,         
|                              |                                                                        |   |                   
|                              |                                                                        |   | 2002               |        | 2001
|                              |                                                                        |   |                    |        |     
|Basic net income per share:   |                                                                        |   |                    |        |      |   |      |       
|                              | Net income                                                             |   | $                  | 3,369  |      |   | $    | 6,541  | 
|                              | Weighted average number of common shares
outstanding during the period |   |                    | 48,037 |      |   |      | 42,683 | 
|                              |                                                                        |   |                    |        |      |   |      |       
|Basic net income per share    |                                                                        | $ | 0.07               |        |      | $ | 0.15 |       
|                              |                                                                        |   |                    |        |      |   |      |       
|Diluted net income per share: |                                                                        |   |                    |        |      |   |      |       
|                              | Net income                                                             |   | $                  | 3,369  |      |   | $    | 6,541  | 
|                              | Weighted average number of common shares
outstanding during the period |   |                    | 48,037 |      |   |      | 42,683 | 
|                              | Dilutive stock options                                                 |   |                    | 1,111  |      |   |      | 1,873  | 
|                              |                                                                        |   |                    |        |      |   |      |       
|                              | Total shares for purpose of calculating
diluted net income per share   |   |                    | 49,148 |      |   |      | 44,556 | 
|                              |                                                                        |   |                    |        |      |   |      |       
|Diluted net income per share  |                                                                        | $ | 0.07               |        |      | $ | 0.15 |       
|                              |                                                                        |   |                    |        |      |   |      |       

6. Segment and geographic information

ISS conducts business in one operating segment, providing information
security management solutions. The Company does, however, prepare information
for internal use on a geographic basis. This information consists of the
operating results of each geographic segment. The segment operating costs
reported internally generally consist of direct sales expenses, an executive
team and infrastructure to support its employee and customer and partner base,
and supporting billing and financial systems. Unallocated corporate expenses
include research and development, general and administrative costs that support
the global organization and amortization of intangibles, stock based
compensation and goodwill.

The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. There are no intersegment
sales. Our chief executive officer and chief financial officer evaluate
performance based on operating profit or loss from operations by segment.
Assets and liabilities are not discretely allocated or reviewed by segment.

The following table presents ISSs revenues, operating expenses and
operating income by reportable operating segment (amounts in
thousands).

|                                  |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |        |        | 
|--------------------------------- | --------------------------------------- | ---------------------- | ------ | --------------------------------- | ------ | ---- | ----- | -------- | ----- | ----------- | ----- | ----- | ----- | - | ------- | - | - | - | ------ | ------ | ------ | 
|                                  |                                         |                        |        | Three months
ended March 31, 2002
|                                  |                                         |                        |        |                                  
|                                  |                                         |                        |        | Americas                          |        | EMEA |       | Asia/Pac |       | Unallocated |       | Total
|                                  |                                         |                        |        |                                   |        |      |       |          |       |             |       |      
|Revenues from external customers: |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |       
|                                  | Product licenses and sales              |                        | $      | 20,850                            |        |      | $     | 4,330    |       |             | $     | 5,033 |       |   | $       |  |   |   | $      | 30,213 |       
|                                  | Subscriptions                           |                        |        | 15,782                            |        |      |       | 2,587    |       |             |       | 1,953 |       |   |         |  |   |   |        | 20,322 |       
|                                  | Professional services                   |                        |        | 5,110                             |        |      |       | 1,337    |       |             |       | 1,395 |       |   |         |  |   |   |        | 7,842  |       
|                                  |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |       
|                                  |                                         | Total revenue          |        |                                   | 41,742 |      |       |          | 8,254 |             |       |       | 8,381 |   |         |   |  |   |        |        | 58,377 | 
|Cost of revenues:                 |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |       
|                                  | Product licenses and sales              |                        |        | 2,285                             |        |      |       |         |       |             |       | 42    |       |   |         |  |   |   |        | 2,327  |       
|                                  | Subscriptions and professional services |                        |        | 8,562                             |        |      |       | 2,176    |       |             |       | 1,771 |       |   |         |  |   |   |        | 12,509 |       
|                                  |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |       
|                                  |                                         | Total cost of revenues |        |                                   | 10,847 |      |       |          | 2,176 |             |       |       | 1,813 |   |         |   |  |   |        |        | 14,836 | 
|Operating expenses                |                                         |                        | 16,425 |                                   |        |      | 4,428 |          |       |             | 1,834 |       |       |   | 15,547  |   |   |   | 38,234 |       
|                                  |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |       
|Total expenses                    |                                         |                        | 27,272 |                                   |        |      | 6,604 |          |       |             | 3,647 |       |       |   | 15,547  |   |   |   | 53,070 |       
|Segment operating income          |                                         | $                      | 14,470 |                                   |        | $    | 1,650 |          |       | $           | 4,734 |       |       | $ | (15,547 | ) |   | $ | 5,307  |       

|                                  |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |        |        | 
|--------------------------------- | --------------------------------------- | ---------------------- | ------ | --------------------------------- | ------ | ---- | ----- | -------- | ----- | ----------- | ----- | ----- | ----- | - | ------- | - | - | - | ------ | ------ | ------ | 
|                                  |                                         |                        |        | Three months
ended March 31, 2001
|                                  |                                         |                        |        |                                  
|                                  |                                         |                        |        | Americas                          |        | EMEA |       | Asia/Pac |       | Unallocated |       | Total
|                                  |                                         |                        |        |                                   |        |      |       |          |       |             |       |      
|Revenues from external customers: |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |       
|                                  | Product licenses and sales              |                        | $      | 26,434                            |        |      | $     | 4,340    |       |             | $     | 5,402 |       |   | $       |  |   |   | $      | 36,176 |       
|                                  | Subscriptions                           |                        |        | 11,357                            |        |      |       | 2,701    |       |             |       | 1,079 |       |   |         |  |   |   |        | 15,137 |       
|                                  | Professional services                   |                        |        | 6,913                             |        |      |       | 1,872    |       |             |       | 1,057 |       |   |         |  |   |   |        | 9,842  |       
|                                  |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |       
|                                  |                                         | Total revenue          |        |                                   | 44,704 |      |       |          | 8,913 |             |       |       | 7,538 |   |         |   |  |   |        |        | 61,155 | 
|Cost of revenues:                 |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |       
|                                  | Product licenses and sales              |                        |        | 6,450                             |        |      |       | 84       |       |             |       | 10    |       |   |         |  |   |   |        | 6,544  |       
|                                  | Subscriptions and professional services |                        |        | 9,052                             |        |      |       | 1,615    |       |             |       | 1,171 |       |   |         |  |   |   |        | 11,838 |       
|                                  |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |       
|                                  |                                         | Total cost of revenues |        |                                   | 15,502 |      |       |          | 1,699 |             |       |       | 1,181 |   |         |   |  |   |        |        | 18,382 | 
|Operating expenses                |                                         |                        | 13,447 |                                   |        |      | 4,660 |          |       |             | 2,329 |       |       |   | 15,462  |   |   |   | 35,898 |       
|                                  |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |       
|Total expenses                    |                                         |                        | 28,949 |                                   |        |      | 6,359 |          |       |             | 3,510 |       |       |   | 15,462  |   |   |   | 54,280 |       
|                                  |                                         |                        |        |                                   |        |      |       |          |       |             |       |       |       |   |         |   |   |   |        |       
|Segment operating income          |                                         | $                      | 15,755 |                                   |        | $    | 2,554 |          |       | $           | 4,028 |       |       | $ | (15,462 | ) |   | $ | 6,875  |       

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INTERNET SECURITY SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7. Recent pronouncements

In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 142, (SFAS 142), Accounting for Goodwill
and Other Intangibles. Under SFAS 142, goodwill and indefinite lived
intangible assets are no longer amortized, but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. Separable intangible
assets that are not deemed to have an indefinite life will continue to be
amortized over their useful lives. Companies were required to immediately adopt
the amortization provisions of SFAS 142 as it relates to goodwill and
intangible assets acquired after June 30, 2001. With respect to goodwill and
intangible assets acquired prior to July 1, 2001, companies were required to
adopt SFAS 142 in their fiscal year beginning after December 15, 2001. The
Company adopted SFAS 142 effective January 1, 2002. Substantially all of the
Companys goodwill balance of $196.9 million as of March 31, 2002, was recorded
in June of 2001, in conjunction with the acquisition of Network ICE. The
impact of the adoption as it relates to goodwill, which exists currently, is to
eliminate amortization of goodwill expense beginning with the year ending
December 31, 2002. In 2001, amortization of goodwill totaled $26.5 million.

8. Contingencies

Beginning on September 28, 2001, the Company and certain of its officers
and directors were named as defendants in several lawsuits alleging violations
of the federal securities laws, including Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934, as amended, and Rule 10b-5 thereunder. As of
March 27, 2002, six such actions have been filed in the United States District
Court for the Northern District of Georgia. The complaints, which are
substantially similar in nature, purport to be brought on behalf of a class of
investors who purchased the Companys stock during the period from April 5,
2001 through August 14, 2001 (the Class Period). The complaints generally
allege that the Company and the individual defendants violated the anti-fraud
provisions of the federal securities laws and caused the Companys stock to
trade at artificially high prices by making misrepresentations relating to the
Companys financial condition and prospects during the Class Period. The
complaints seek damages in an unspecified amount. The Company anticipates that
all six of these actions, along with any other similar actions, which may
hereafter be filed, will be consolidated into a single case. No answer or other
responsive papers are yet due from the defendants. The Company believes that it
has meritorious defenses and intends to defend the actions vigorously.

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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, 2001 as filed with the Securities and
Exchange Commission and available at their Web site at www.sec.gov.

OVERVIEW

We are a global leader in information protection solutions dedicated to
protecting online assets. Our proactive line of defense protects networks,
servers and desktops against an ever-changing spectrum of threats, with a
comprehensive line of products and services designed specifically for the
particular needs of enterprise, smaller enterprise, consumer and service
provider markets. These threat protection solutions go beyond basic access
control to deliver multiple layers of defense that detect, prevent and respond
to threats prior to those threats causing damage to our customers business
operations.

We provide a wide range of proactive protection that spans networks,
servers and individual desktops, built around the need for comprehensive,
cost-effective detection, prevention and response arising from attacks, misuse
and security policy violations, all while ensuring the confidentiality,
privacy, integrity and availability of proprietary information.

Our 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 line of products is designed specifically for the
particular needs of enterprise, smaller enterprise, consumer and service
provider markets.

Our managed services offerings currently provide remote management of the
industrys best-of-breed security technology including security assessment and
intrusion detection systems, firewalls, VPNs, anti-virus and URL filtering
software. 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 have experienced significant annual revenue growth year-after-year.
Except for our quarter ended June 30, 2001 decrease from the previous quarter
ended March 31, 2001, we have had consistent quarterly increases over the last
five years in measuring sequential quarterly revenues. The third and fourth
quarters ended September 30, 2001 and December 31, 2001, and the first quarter
ended March 31, 2002, showed sequential quarterly revenue growth over the
previous quarter. Many factors effect financial performance, and past
performance is no assurance of similar future performance. We expect, in the
long-term, 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 and alliances with partners and
alliances with partners with products, technologies or services capabilities
complimentary to our solutions; and improve our internal operating and
financial infrastructure in support of our strategic goals and objectives. At
the same time, we will adjust our organization size in light of current
economic conditions and maintain emphasis on controlling discretionary spending
and capital expenditures. While we believe in the long-term success of our
business solutions, our prospects must be considered in light of the recent
experience, risks and difficulties that are frequently encountered by companies
in new and rapidly evolving markets. See Risk Factors.

Critical accounting policies

The consolidated financial statements were prepared in conformity with
accounting principles generally accepted in the United States. As such,
management is required to make certain estimates, judgments and assumptions
they believe are reasonable based upon the information available. These
estimates and assumptions affect the reported amounts of assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the periods presented. The significant accounting policies
which management believes are the most critical to aid in fully understanding
and evaluating our reported financial results include the following:

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INTERNET SECURITY SYSTEMS, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Revenue recognition

Revenue is recognized under Statement of Position (SOP) 97-2 as modified
by SOP 98-9, when the following criteria have been met:



| |  |  | persuasive evidence of an arrangement exists;        
| | - |  | -----------------------------------------------------
|
| |  |  | delivery has occurred or services have been rendered;
|
| |  |  | price is fixed and determinable; and                 
|
| |  |  | collection is probable.                              

We recognize perpetual license revenues from ISS developed products 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 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.

License sales of enterprise and small enterprise products are generated
both through a direct sales force and through resellers. License sales of small
office/home office and consumer products are made through a distributor to
retail establishments and are sold directly to customers via the Internet.
License revenue for sales made through resellers and distributors are
recognized only when the product is delivered to the end user.

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 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.

Multiple element arrangements can include any combination of hardware,
software or services. When some elements are delivered prior to others in an
arrangement, revenue is deferred until the delivery of the last element unless
there is all of the following:



| |  |  | vendor specific objective evidence (VSOE) of fair value of the
undelivered elements;     
| | - |  | -----------------------------------------------------------------------------------------
|
| |  |  | the functionality of the delivered elements is not dependent on the
undelivered elements;
|
| |  |  | delivery of the delivered elements represents the culmination of the
earnings process    

Our historical rate of return for our software products is negligible. We
offer demonstration software available via download from our website that
allows potential customers to see the functionality of the products on their
own networks. We did not have any transactions in the first quarter of 2002 or
2001 involving reciprocal arrangements where goods or services were purchased
from an organization at the same time that we licensed software or provided
services to that organization.

Allowance for doubtful accounts

Our sales are global, including companies located in the United States,
Europe, Latin America and the Asia/Pacific regions. We perform periodic credit
evaluations of our customers financial condition and do not require
collateral. Credit risk with respect to trade accounts receivable are limited
due to the large number of entities that comprise the Companys customer base.
We provide for estimated credit losses as such losses become probable and such
losses have been within managements expectations. While credit losses have
historically been within managements expectations and the provisions
established, we cannot guarantee that we will continue to experience the same
credit loss rates we have in the past. If the financial condition of our
customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required.

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INTERNET SECURITY SYSTEMS, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Impairment of goodwill

We have significant intangible assets related to goodwill. We periodically
evaluate acquired businesses for potential impairment. Our judgments regarding
the existence of impairment indicators are based on legal factors, market
conditions and operational performance of our acquired businesses. Future
events could cause us to conclude that impairment indicators exist and that
goodwill associated with our acquired business is impaired. Any resulting
impairment could have a material adverse impact on our financial statements and
results of operations.

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INTERNET SECURITY SYSTEMS, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Results of operations

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

|                                                               |                          |  |                    |     |      |  |    |     |  
|-------------------------------------------------------------- | ------------------------ |  | ------------------ | --- | ---- |  | -- | --- | -
|                                                               |                          |  | Three months ended
|                                                               |                          |  | March 31,         
|                                                               |                          |  |                   
|                                                               |                          |  | 2002               |     | 2001
|                                                               |                          |  |                    |     |     
|Product and license sales                                      |                          |  | 52                 | %   |      |  | 59 | %  
|Subscriptions                                                  |                          |  | 35                 | %   |      |  | 25 | %  
|Professional services                                          |                          |  | 13                 | %   |      |  | 16 | %  
|                                                               |                          |  |                    |     |      |  |    |    
|                                                               | Total revenues           |  |                    | 100 | %    |  |    | 100 | %
|                                                               |                          |  |                    |     |      |  |    |    
|Cost of product revenues                                       |                          |  | 4                  | %   |      |  | 11 | %  
|Cost of subscription and
professional service revenues         |                          |  | 21                 | %   |      |  | 19 | %  
|Research and development                                       |                          |  | 15                 | %   |      |  | 14 | %  
|Sales and marketing                                            |                          |  | 39                 | %   |      |  | 35 | %  
|General and administrative                                     |                          |  | 9                  | %   |      |  | 7  | %  
|Write-off of lease obligation                                  |                          |  |                   |     |      |  | 2  | %  
|Amortization of goodwill                                       |                          |  |                   |     |      |  | 1  | %  
|Amortization of other intangibles and
stock-based compensation |                          |  | 3                  | %   |      |  |   |    
|                                                               |                          |  |                    |     |      |  |    |    
|                                                               | Total costs and expenses |  |                    | 91  | %    |  |    | 89  | %
|                                                               |                          |  |                    |     |      |  |    |    
|Operating income                                               |                          |  | 9                  | %   |      |  | 11 | %  
|                                                               |                          |  |                    |     |      |  |    |    

Revenues

Product licenses and sales

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 52% of total revenues for the three month period ended
March 31, 2002 and 59% for the corresponding period in 2001. The decrease in
product licenses and sales as a percentage of total revenues is due to the
decrease in the sales of third-party products.

We made several changes starting in 2000 and continuing into 2001 that
impacted the level of sales of third-party products. Primarily, this movement
away from direct sales of third-party products was a conscious effort to
simplify our business by focusing on our own ISS solutions. The business of
selling third-party products arose from our Netrex acquisition in 1999.
Although we have de-emphasized sales of third party products, we continue it as
part of our managed security services offerings. Additionally, in 2001 we
modified our agreement with Nokia, a maker of appliances that work in
conjunction with ISS RealSecure software and certain Checkpoint software. We
previously purchased and resold these Nokia appliances with ISS RealSecure
software, but now the sale of the Nokia appliances occurs primarily through
Nokia resellers, with the sale of ISS RealSecure software directly by us or
through our resellers to our customers. This change lowered our sales because
the Nokia appliances component of sales is now occurring through Nokia
resellers.

License sales of enterprise and small enterprise products are generated
both through a direct sales force and through resellers. When our resellers
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.

License sales of small office/home office and consumer products are made
through distributors to retail establishments and are sold directly to
customers via the Internet. License revenue for sales made through our
distributors is recognized only when the product is sold to the end user.

We continue to add functionality to our product family, providing network,
server and desktop-based solutions, as well as to our security management
applications. In the second quarter of 2001, the acquisition of Network ICE
added desktop intrusion detection and highly scalable security management
systems to the family. We have incorporated some of this technology into the
ISS product sets and enhanced Network ICE offerings during the second half of
2001 and the first quarter of 2002, with more expected over 2002. We
completed a full
launch of RealSecure SiteProtector 1.0 and Security Fusion Module 1.0 during
the first quarter of 2002 after shipping the software to selected customers
under a controlled release in the fourth quarter of 2001. These offerings are
our first version of our

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INTERNET SECURITY SYSTEMS, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

new security management platform and automated security intelligence
module. We unveiled the next generation in network protection with RealSecure
Network Sensor 7.0 and RealSecure Guard, an advanced, in line intrusion
detection system. During the quarter, we shipped our wireless security
assessment solution, delivering Wireless Scanner version 1.0. These
improvements as well as planned new offerings are intended to provide our
customers with more powerful and easier-to-use solutions for security
management across the enterprise.

Subscriptions

Subscriptions revenue represented 35% of total revenues in the three
months ended March 31, 2002 increasing from 25% of total revenues in the three
months ended March 31, 2001. Subscription revenues consist of maintenance, term
licenses of product usage and security-monitoring fees for managed services
offerings. The increase in subscriptions revenue as a percentage of total
revenues was due to maintenance, the largest component, which grew from 15% of
total revenues in the three months ended March 31, 2001 to 25% in 2002. This
growth is due to a high level of maintenance contract renewals and the
continuing increase of our software client base that generate maintenance
revenues. Security-monitoring fees did not increase significantly in 2002 from
2001 because we have decreased non-core services such as security combined with
internet service provider services and eliminated contracts where the partner
contracted for capacity, but did not achieve the underlying end-user contracts.
We believe that we now have a higher component of business that we perceive as
providing long-term value-add services to our customers.

Professional services

Professional services revenue represented 13% of total revenues in the
three months ended March 31, 2002 decreasing from 16% in the corresponding
period of 2001. During 2002, professional services as a percentage of total
revenues decreased as a result of reduced customer spending as entities
curtailed costs beginning in the second half of 2001. Further contributing to
this decline was a narrowing of our consulting offerings to focus on services
that directly contribute to our protection platform strategy. We also decreased
the number of training classes related to third-party products and increased
our emphasis on courses related to ISS solutions.

Geographic regions

Geographically, we derived the majority of our revenues from sales to
customers within the Americas region; however, international operations
continued to be a significant contributor to revenues and a growing percentage
of the business. Revenues by region represented the following percentages of
total revenues for the periods indicated:

|                 |  |                    |    |      |  |  |    |  
|---------------- |  | ------------------ | -- | ---- |  |  | -- | -
|                 |  | Three months ended
|                 |  | March 31,         
|                 |  |                   
|                 |  | 2002               |    | 2001
|                 |  |                    |    |     
|Americas         |  |                    | 72 | %    |  |  | 73 | %
|EMEA             |  |                    | 14 | %    |  |  | 15 | %
|Asia/Pacific Rim |  |                    | 14 | %    |  |  | 12 | %

Revenues in Asia/Pacific Rim increased from 12% of total revenues in the
three months ended March 31, 2001 to 14% in the corresponding period of 2002
due to continued strong growth in this region, fueled at least in part by the
visibility gained from its IPO in September 2001. The Americas revenue, as a
percent of total revenue, decreased slightly due to the reduction in sales of
third party products.

Costs and Expenses

Cost of product licenses and sales

Cost of revenues consists of several components. Costs associated with
licensing our software products are minor. 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 of product revenues as a percentage
of total revenues decreased from 11% for the three months ended March 31, 2001
to 4% for the comparable period in 2002 as sales of partner software and
hardware appliances represented a lower percentage of total revenues. This
decrease was the result of a reduction in sales of third party products
consistent with our movement away from the direct sales of third-party
products, except where related to ISS managed services.

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INTERNET SECURITY SYSTEMS, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Cost of subscriptions and services

Cost of subscription and services includes the cost of our technical
support personnel who provide assistance to customers under maintenance
agreements, the security operations center (SOC) costs of providing managed
security monitoring services and the costs related to consulting and training.
These costs as a percentage of total revenues were 21% and 19% in the three
months ended March 31, 2002 and 2001, respectively. The percentage increase is
a result of our continued commitment to subscription and services revenues. We
continue to expand our managed security offering capabilities in terms of
automated systems, number of managed security operations centers and personnel
resources. We made an increased investment in automated systems and personnel
resources for our Asia/Pacific SOC, which began operating in the third quarter
of 2001, and in our United States SOC to handle anticipated growth.

Research and development

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.

We increased these expenditures, as we believe primary research and
product development and managed service offerings are essential ingredients for
retaining our leadership position in the market. Accordingly, research and
development expenses increased in absolute dollars from $8.3 million in the
three months ended March 31, 2001 to $8.7 million in the three months ended
March 31, 2002. These costs represented 14% of total revenues in 2001, and 15%
in 2002, respectively. We continue to integrate the Network ICE technologies
into our technologies. We will continue to seek more 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 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. Sales and marketing expenses were $22.7 million in the three months
ended March 31, 2002 and $21.6 million in the corresponding period of 2001.
Sales and marketing expenses increased as a percentage of total revenues from
35% in 2001 to 39% in 2002, primarily due to several factors. In the three
months ended March 31, 2002 we launched our aggressive television and print
advertising campaign designed to demonstrate the multitude of threats that can
compromise the security of a companies networks, servers or desktops. This
campaign is aimed at increasing awareness of the Internet Security Systems
brand, especially at the mainstream medium and small business market. In
addition, continued difficult economic conditions resulted in increased sales
and marketing efforts in order to achieve our targets. While it is our
expectation to gain leverage in our sales and marketing costs in the future,
this will be largely dependent on economic and competitive conditions in future
periods.

General and administrative

General and administrative expenses of $5.4 million in the first quarter
of 2002 and $4.5 million in the first quarter of 2001 represented approximately
9% of total revenues in 2002 and 8% in 2001. 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 is attributable to our continued efforts, through additional
employees and systems, to enhance our managements ability to obtain and
analyze information about our domestic and international operations, and to
support a larger employee base, as well as the expansion of our facilities. We
continue to expand our general and administrative support staff in the EMEA and
Asia/Pacific regions as we focus on growth in those areas.

Write-off of lease obligation

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 originated in the first quarter of 2001 as
available subleased space in the area grew substantially in that quarter as the
result of layoffs, closures and consolidations, dimming the prospects of
subleasing our old space.

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INTERNET SECURITY SYSTEMS, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Amortization

We incurred amortization expense of $1.5 million and $366,000 in the three
months ended March 31, 2002 and 2001, respectively. In 2002 amortization
relates to intangible assets and stock-based compensation, resulting from
acquisitions accounted for under the purchase method. Beginning January 1,
2002, goodwill is no longer to be amortized, but will be subject to periodic
tests for impairment.

Interest income

Net interest income decreased from $1.96 million in the quarter ended
March 31, 2001 to $730,000 in the comparable quarter of 2002, primarily due to
lower market rates of interest on interest bearing cash equivalents and
marketable securities. The market rate of interest paid on investment quality
commercial paper and similar investments dropped from approximately 5.8% during
the first quarter of 2001 to approximately 2% in the first quarter of 2002. As
a result, interest income decreased despite an increase in cash and cash
equivalents and interest bearing marketable securities.

Minority interest

Minority interest totaled $139,000 in the three months ended March 31,
2002. Minority interest represents the portion of earnings that would be
distributed to shares not held by us if the Asia/Pacific Rim subsidiary
declared a dividend equal to its earnings. In March 2001 we sold approximately
2% of the outstanding shares of our Asia/Pacific Rim subsidiary to employees
and key partners. In September 2001, our Asia/Pacific Rim subsidiary sold newly
issued shares equal to approximately 10% of its previously outstanding shares
in its initial public offering on the Japan over-the counter market. Minority
interest expense for the three months ended March 31, 2001 was not material.

Other income

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. As part of the planning for an IPO in Japan of a minority interest
in our Asia-Pacific subsidiary that was completed in September 2001, 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.

Foreign currency exchange gain (loss)

The exchange gain of $23,000 in the three months ended March 31, 2002 and
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 and changes in value
of assets and liabilities that are denominated in foreign currencies.

Provision for income taxes

The effective tax rate was 43% and 36% for the quarters ended March 31,
2002 and 2001, respectively. The change in effective rate resulted from
expenses related to the June 2001 acquisition of Network ICE that are not
deductible for income tax purposes.

Liquidity and Capital Resources

Net cash provided by operations in the first three months of 2002 was $7.8
million and included net income of $3.4 million, non-cash depreciation and
amortization expense charges of $4.7 million, income tax benefit from employee
exercises of stock options of $1.8 million, growth in deferred revenues of $3.0
million; and changes in working capital of $(5.8) million.

Investing activities in the first three months of 2002 include the
purchase of $17.7 million of marketable securities, primarily commercial paper,
offset by net proceeds from the maturity of marketable securities of $33.3
million. These assets have quality characteristics similar to cash equivalents,
except their maturities when we acquire them are longer than three months. We
also invested in equipment totaling $4.9 million as we provided existing and
new personnel with improved computer hardware and incurred leasehold
improvement costs related primarily to new offices in Japan.

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INTERNET SECURITY SYSTEMS, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Our financing activities provided $3.6 million of cash in the quarter
ended March 31, 2002, which consisted 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, 2002, we had $168.5 million of cash and cash equivalents
and marketable securities, consisting primarily of money market accounts and
investment grade commercial paper. An additional $12.5 million of commercial
paper investments are pledged as collateral for stand-by letters of credit
related to the operating leases of our facilities and are shown on the balance
sheet as restricted cash. 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. Furthermore, we are not aware
of any trends, events or uncertainties that are reasonable likely to results in
any significant changes to our liquidity. 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.

We do not have any off-balance sheet financing arrangements or any
relationships with structured finance or special purpose entities. Other
than our non-cancelable operating leases for office space, we do not have any
contractual obligations that would impact our liquidity. Our payment for
operating leases is secured by three stand-by letters of credit totaling
approximately $10,600,000. The stand-by letters of credit are annually
renewable over the duration of the applicable leases. We do not anticipate
utilizing these stand-by letters of credit to provide any liquidity needs.

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 Operate in a Rapidly Evolving Market

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.

Our Future Operating Results Will Likely Fluctuate Significantly

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;                     

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INTERNET SECURITY SYSTEMS, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS



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

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.,
Enterasys Networks, 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.

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INTERNET SECURITY SYSTEMS, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

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 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 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 extents 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 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.

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INTERNET SECURITY SYSTEMS, INC.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

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;                                            
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | compliance with, and unexpected changes in, a wide range of complex
regulatory requirements in countries where we do business;                
|
| |  |  | increased financial accounting and reporting burdens and complexities
and potentially adverse tax consequences;                               
|
| |  |  | excess taxation due to overlapping tax structures;                                                                                            
|
| |  |  | fluctuations in foreign currency exchange rates resulting in losses
or gains from transactions and expenses denominated in foreign
currencies;
|
| |  |  | reduced protection for intellectual property rights in some
countries; 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 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 fifteen
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.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Item 7a. 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 market value 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. Our marketable
securities at March 31, 2002 mature as follows: $22.4 million within 3 months,
$3.9 million in three to six months and $12.8 million in
more than six months.

Risk Associated with Foreign Exchange Rates

ISS is subject to foreign exchange risk as a result of exposures to
changes in currency exchange rates. Our foreign operations are, for the most
part, naturally hedged against exchange rate fluctuations since both revenues
and expenses of each foreign affiliate are denominated in the same currency. As
a result, an unfavorable change in the exchange rate for any particular foreign
subsidiary would result in lower revenues and expenses with regards to
operating results, and lower assets and liabilities with regards to the balance
sheet. Therefore, we do not engage in formal hedging activities, but we do
periodically review the potential impact of this risk to ensure that the risk
of significant potential losses remains minimal.

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PART II. OTHER INFORMATION




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

|    |  |                                                               
|--- |  | --------------------------------------------------------------
|(a) |  | Exhibits.                                                     
|    |  |                                                               
|(b) |  | Reports on Form 8-K.                                          
|    |  |                                                               
|    |  | ISS filed no reports on Form 8-K during this reporting period.

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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 14, 2002 |  | By |  | /s/ Richard MacchiaChief Financial Officer
Vice President and Chief Financial Officer
|                  
|                   |  |    |  |                                                                                      
|                  
|                   |  | By |  | /s/ Maureen RichardsCorporate Controller                                             

22