PILOT NETWORK SERVICES INC, 424B4, 1998-08-11

PILOT NETWORK SERVICES INC
424B4, 1998-08-11
MISCELLANEOUS BUSINESS SERVICES

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<PAGE>

Filed Pursuant to Rule 424(b)(4)
Registration No. 333-57453

3,250,000 Shares

[LOGO OF PILOT NETWORK SERVICES, INC.]

Common Stock
($0.001 par value)

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

Of the 3,250,000 shares of Common Stock ("Common Stock") offered hereby (the
"Offering"), 3,110,000 shares are being sold by Pilot Network Services, Inc.
("Pilot" or the "Company") and 140,000 shares are being sold by the Selling
Stockholders named herein under "Selling Stockholders" (the "Selling
Stockholders"). The Company will not receive any of the proceeds of shares
sold by the Selling Stockholders. Prior to the Offering, there has been no
public market for the Common Stock. For information relating to the
factors to be considered in determining the initial public offering price
to the public, see "Underwriting." The Common Stock has been approved
for quotation on The Nasdaq Stock Market's National Market under the
symbol "PILT."

FOR A DISCUSSION OF MATERIAL FACTORS THAT SHOULD BE CONSIDERED IN CONNECTION
WITH AN INVESTMENT IN THE COMMON STOCK, SEE "RISK FACTORS" ON PAGE 5
HEREIN.

THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
UNDERWRITING PROCEEDS TO
PRICE TO DISCOUNTS AND PROCEEDS TO SELLING
PUBLIC COMMISSIONS COMPANY(1) STOCKHOLDERS
-------- ------------- ----------- ------------
<S> <C> <C> <C> <C>
Per Share.................... $14.00 $0.98 $13.02 $13.02
Total(2)..................... $45,500,000 $3,185,000 $40,492,200 $1,822,800
</TABLE>

(1) Before deduction of expenses payable by the Company estimated at
$1,000,000.
(2) The Company has granted the Underwriters an option, exercisable for 30
days from the date of this Prospectus, to purchase a maximum of 487,500
additional shares of Common Stock to cover over-allotments of shares. If
the option is exercised in full, the total Price to Public will be
$52,325,000, Underwriting Discounts and Commissions will be $3,662,750,
Proceeds to Company will be $46,839,450 and Proceeds to Selling
Stockholders will be $1,822,800.

The shares of Common Stock are offered by the several Underwriters when, as
and if issued by the Company, delivered to and accepted by the Underwriters
and subject to their right to reject orders in whole or in part. It is
expected that the shares of Common Stock will be ready for delivery on or
about August 14, 1998, against payment in immediately available funds.

CREDIT SUISSE FIRST BOSTON
BANCAMERICA ROBERTSON STEPHENS
HAMBRECHT & QUIST

Prospectus dated August 10, 1998
<PAGE>

[OUTSIDE FRONT COVER, INSIDE GATE FOLD]

PILOT'S SECURE INFRASTRUCTURE FOR ELECTRONIC COMMERCE

[Chart shows Pilot Dynamic Security Infrastructure, that allows Pilot to
provide Secure Access and Gateways, Secure Hosting and Electronic Commerce and
Secure Extranet and Virtual Private Networking services with continuous change
and action, that connects customer networks to the Internet.]

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

SECURE ACCESS AND SECURE HOSTING AND SECURE EXTRANET AND
GATEWAY SERVICES: ELECTRONIC COMMERCE VIRTUAL PRIVATE
SERVICES: NETWORKING SERVICES

Secure Internet Services
Authentication Services Secure Hosting Services Secure Road Warrior
Secure Telecommuting Secure Commerce Web Corporate Partner
Services Secure Flex Web Privacy
Auxiliary Services

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE SECURITIES OFFERED
HEREBY, INCLUDING OVER-ALLOTMENT, STABILIZING TRANSACTIONS, SYNDICATE SHORT
COVERING TRANSACTIONS AND PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES,
SEE "UNDERWRITING."

2
<PAGE>

[INSIDE FRONT COVER, INSIDE GATE FOLD]

PILOT ENABLES SECURE ELECTRONIC COMMERCE OVER THE INTERNET

[Chart shows terminals connected to the Internet through Pilot's Network
Security Centers and terminals not connected through the Network Security
Centers that are subject to computer attacks.]

[The following text will be on the left of the illustration:]

Pilot offers services designed to combine the highest level of commercially
available security with high bandwidth connectivity to enable secure
electronic commerce over the Internet. The foundation of Pilot's solution is
its Dynamic Security Infrastructure, consisting of a multi-layered defensive
architecture and security operations 24 hours a day, 7 days a week, delivered
through geographically dispersed Network Security Centers. This infrastructure
allows Pilot to continuously manage and monitor Internet traffic to and from
customer networks in order to respond in real-time to security threats.

The Pilot solution aggregates the experience gained from protecting each
customer against attacks and leverages such experience for the collective
benefit of all customers. The Dynamic Security Infrastructure offers benefits
over other security approaches by eliminating single points of failure,
enhancing attack detection, delivering real-time defenses, and adapting
continuously to external conditions.

Pilot provides a broad range of security services for a fixed monthly fee on
an annual subscription basis, including secure access and gateway services,
secure hosting and electronic commerce services, and secure extranet and
virtual private networking services. The Company offers a scalable solution
that enables customers to quickly deploy and expand electronic commerce
capabilities by subscribing to Pilot's secure Internet services. As a result,
companies avoid costs associated with implementing an in-house solution,
including set-up costs for security and systems design, hardware, software,
ISP services and labor, and ongoing costs for telecommunications, staffing,
maintenance and upgrades. Pilot's services enable customers to concentrate on
their core business because the secure infrastructure for electronic commerce
is provided by Pilot.
<PAGE>

PROSPECTUS SUMMARY

The following summary should be read in conjunction with, and is qualified in
its entirety by, the more detailed information and Financial Statements and
Notes thereto appearing elsewhere in this Prospectus. Except as otherwise noted
herein, information in this Prospectus assumes (i) no exercise of the
Underwriters' over-allotment option, (ii) the automatic conversion of all
outstanding shares of Preferred Stock of the Company into shares of Common
Stock of the Company upon the closing of this Offering, (iii) a two-for-one
stock split of the Company's shares of Common Stock effected on August 4, 1998
and (iv) the exercise of warrants to purchase shares of Series F Preferred
Stock, which are convertible into an aggregate of 600,000 shares of Common
Stock.

THE COMPANY

Pilot Network Services, Inc. ("Pilot" or the "Company") provides
comprehensive security services that incorporate high-bandwidth connectivity
and enable secure electronic commerce over the Internet. The Company provides a
broad range of security services for a fixed monthly fee on an annual
subscription basis. The Company's services include secure access and gateway
services that enable secure connectivity between a corporate network and the
Internet, secure hosting of customer Internet servers at Company locations and
electronic commerce services, and secure extranet and virtual private
networking services that enable remote users or networks to securely
communicate over the Internet with a local network. The Company offers a
scalable solution that allows customers to quickly deploy and expand electronic
commerce capabilities by subscribing to Pilot's secure Internet services.

The Internet's promise of more cost-efficient and higher quality
communications has made it an increasingly attractive platform for complex
business applications such as marketing and sales, contract negotiations and
customer support. According to International Data Corporation, use of the
Internet for electronic commerce is expected to grow substantially from $12
billion in 1997 to $425 billion in 2002. Despite the advantages of conducting
business on the Internet, lack of Internet security is a significant inhibitor
to the adoption and growth of electronic commerce. Although losses due to
computer crime and security breaches are difficult to estimate, independent
industry sources estimate such losses to be between $3 billion and $5 billion
in 1997. Traditional approaches to Internet security, such as firewall
products, that control the flow of data between an internal network and the
Internet, do not effectively meet the needs of businesses conducting electronic
commerce. Such products typically provide only a static, single point of
defense, are often difficult to configure adequately and maintain and can be
expensive to properly monitor and manage. For example, in a 1995 study
conducted by the FBI and the Computer Security Institute, 30 percent of all
reported successful break-ins involving the Internet took place despite the
presence of a firewall.

Pilot's subscription-based secure Internet services allow customers to avoid
the risks associated with traditional approaches to Internet security.
Customers can avoid extensive costs associated with implementing an in-house
solution, including set-up costs for security and systems design, hardware,
software, Internet access services provided by Internet Service Providers
("ISPs"), and labor, and ongoing costs for telecommunications, staffing,
maintenance and upgrades. The foundation of Pilot's solution is its Dynamic
Security Infrastructure, an Internet security approach developed by Pilot to
continuously manage and monitor Internet traffic to and from customer networks
in order to respond in real-time to security threats. The Dynamic Security
Infrastructure consists of a multi-layered defensive architecture and around-
the-clock security operations delivered through geographically dispersed Pilot
customer centers called Network Security Centers that are connected to customer
networks via dedicated, high-speed data lines. The Pilot solution aggregates
the experience gained from protecting each customer against attacks and
leverages such experience for the collective benefit of all customers. The
Dynamic Security Infrastructure offers benefits over other security approaches
by eliminating single points of failure, enhancing attack detection, delivering
real-time defenses and adapting continuously to external conditions. Customers
can concentrate on their core business because the secure infrastructure for
electronic commerce is provided by Pilot.

The Company's customers span a diverse range of industries. Well-known,
representative customers include 20th Century Fox, Altera Corp., American Bar
Association, American Medical Association, American Stock Exchange, Inc.,
American Stores, E-Stamp, Inc., First Data Corporation, The Good Guys, Inc.,
Kaiser Aluminum and Chemical Corporation, Lucent Technologies, PeopleSoft,
Inc., Playboy Enterprises, Inc., PR Newswire, Wilson Sporting Goods and Ziff-
Davis Comdex & Forums. See "Business--Customers" for a list of additional
customers.

The Company was incorporated in California on August 6, 1992 and was
reincorporated in Delaware on August 4, 1998. Unless the context otherwise
requires, the term "Company" or "Pilot" refers to Pilot Network Services, Inc.,
a Delaware corporation, and its California predecessor. The Company has federal
trademark applications pending for the Pilot logo, Pilot and Corporate Partner
Privacy, and Dynamic Security Infrastructure, Secure Commerce Web, Secure Flex
Web and Secure Road Warrior are trademarks of the Company. All other brand
names or trademarks appearing in this Prospectus are the property of their
respective holders.

The Company's executive offices are located at 1080 Marina Village Parkway,
Alameda, California 94501. Its telephone number at that location is (510) 433-
7800 and its Web site address is www.pilot.net. Information contained on the
Company's Web site is not part of this Prospectus.

3
<PAGE>

THE OFFERING

<TABLE>
<C> <S>
Common Stock offered............................ 3,250,000 shares (including
3,110,000 shares by the
Company and 140,000 shares by
the Selling Stockholders)
Common Stock to be outstanding after the
Offering(1).................................... 13,745,686 shares
Use of proceeds................................. General corporate purposes,
including working capital,
capital expenditures and
repayment of certain
indebtedness. See "Use of
Proceeds."
Nasdaq National Market symbol................... PILT
</TABLE>

SUMMARY FINANCIAL DATA
(In thousands)
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED MARCH 31, ENDED JUNE 30,
------------------------- ----------------
1996 1997 1998 1997 1998
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Service revenues................. $ 2,525 $ 6,300 $11,317 $ 2,461 $ 3,720
Cost of service revenues......... 1,424 4,181 9,825 1,745 4,023
Gross margin..................... 1,101 2,119 1,492 716 (303)
Total operating expenses......... 2,720 4,448 6,656 1,351 3,121
Net loss......................... (1,750) (2,652) (5,635) (718) (3,632)
Accretion on redeemable
convertible preferred stock..... (263) (478) (1,069) (132) (337)
Net loss attributable to common
stockholders.................... (2,013) (3,130) (6,704) (850) (3,969)
</TABLE>

<TABLE>
<CAPTION>
JUNE 30, 1998
---------------------------
PRO FORMA
ACTUAL AS ADJUSTED(1)(2)
-------- -----------------
BALANCE SHEET DATA:
<S> <C> <C>
Cash and cash
equivalents............ $ 6,176 $49,268
Total current assets.... 8,830 51,922
Current liabilities..... 15,760 15,760
Capital lease
obligations, net of
current portion........ 4,429 4,429
Total stockholders'
equity (deficit)....... (14,746) 40,826
</TABLE>
- --------
(1) Based on the number of shares outstanding as of June 30, 1998. Pro forma as
adjusted amounts include the number of shares to be issued upon the
exercise of warrants outstanding as of June 30, 1998 to purchase Series F
Preferred Stock (the "Series F Warrants"), which are convertible into an
aggregate of 600,000 shares of Common Stock, and exclude (i) 1,756,940
shares issuable upon exercise of options outstanding as of June 30, 1998
with a weighted average exercise price of $1.99 per share, (ii) shares
issuable upon exercise of outstanding warrants as of June 30, 1998 to
purchase Series B Preferred Stock and Series D Preferred Stock, which are
convertible into an aggregate of 142,910 shares of Common Stock with a
weighted average exercise price of $1.31 per share, (iii) shares issuable
upon exercise of outstanding warrants as of June 30, 1998 to purchase an
aggregate of 150,000 shares of Common Stock at an exercise price of $11.20
per share, (iv) shares issuable upon exercise of options to purchase 20,000
shares of Common Stock at an exercise price of $13.00 per share, and (v)
1,380,000 shares available for issuance under the Company's 1998 stock
plans. See "Management--Stock Plans" and Note 5 of Notes to Consolidated
Financial Statements.
(2) Adjusted to reflect the sale of 3,110,000 shares of Common Stock offered by
the Company at the initial public offering price of $14.00 per share and
after deducting the estimated underwriting discount and offering expenses,
and the receipt and application of the net proceeds therefrom, and the
receipt of $3.6 million from the exercise of the Series F Warrants. See
"Use of Proceeds" and "Capitalization."

4
<PAGE>

RISK FACTORS

An investment in the shares of Common Stock offered hereby involves a high
degree of risk. The following factors, in addition to the other information in
this Prospectus, should be considered in evaluating the Company and its
business before purchasing the Common Stock offered hereby. This Prospectus
contains forward-looking statements that involve risks and uncertainties. The
Company's actual results may differ significantly from the results discussed
in the forward-looking statements. Factors that might cause such differences
include those discussed below and in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business," as well as
those discussed elsewhere in this Prospectus.

LIMITED OPERATING HISTORY; HISTORY OF LOSSES

The Company began operations in 1993, and has experienced operating losses
and negative cash flows from operations in each quarterly and annual period.
As of June 30, 1998, the Company had an accumulated deficit of approximately
$16.7 million. The revenue and income potential of the Company's business and
market is unproven, and the Company's limited operating history makes an
evaluation of the Company and its prospects difficult. The Company has
recently made and expects to continue making significant investments in new
and existing Network Security Centers, sales and marketing activities, and the
development of new services. As a result, the Company experienced a decline in
gross margin and an increase in net loss in fiscal 1997 and expects to
continue experiencing significant net losses on a quarterly and annual basis
for the foreseeable future, including a decline in its gross margin at least
through fiscal 1999. The Company and its prospects must be considered in light
of the risks, expenses and difficulties encountered by companies in the new
and rapidly evolving market for Internet system and network management
solutions. To address these risks, among other things, the Company must market
its brand name effectively, provide scaleable, reliable and cost-effective
services, continue to grow its infrastructure to accommodate new Network
Security Centers and increased bandwidth use of its network, expand its
channels of distribution, retain and motivate qualified personnel and continue
to respond to competitive developments. Failure of the Company's services to
achieve market acceptance would have a material adverse effect on the
Company's business, results of operations and financial condition. Although
the Company has experienced significant growth in revenues in recent periods,
the Company does not believe that this growth rate necessarily is indicative
of future operating results, and there can be no assurance that the Company
will ever achieve profitability on a quarterly or an annual basis or will
sustain profitability if achieved. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations."

POTENTIAL FLUCTUATIONS IN RESULTS OF OPERATIONS

The Company derives revenue from its customers primarily through initial set
up fees and ongoing monthly service charges. For each new customer, the
Company must incur costs in anticipation of the customer's decision to use the
Company's services and in advance of the receipt of sufficient revenues to
repay these costs and provide a return on the Company's investment. As a
result, a relatively large portion of the Company's expenditures are fixed in
the short-term, and the Company's success is substantially dependent on the
continuous growth in its customer base and the retention of its customers for
sufficient periods to provide returns on the Company's investment. The
Company's customers generally enter into one year contracts with the Company,
with renewal periods, and there can be no assurance that the Company's
customers will maintain or renew their commitments to use the Company's
services. The Company typically experiences a lengthy sales cycle for its
services, particularly given the importance to customers of adequately
securing Internet connectivity for electronic commerce and the need to educate
them regarding the requirements for effective network security. Changes in the
rate of growth in the Company's customer base, customer renewal rates and the
sales cycle for the Company's services, have caused, or are expected in the
future to cause, significant fluctuations in the Company's results of
operations on a quarterly and an annual basis.

5
<PAGE>

introductions of services or enhancements by the Company and its competitors;
the length of sales cycles; customer retention; the timing and success of
marketing efforts and service introductions by the Company; the timely
expansion of existing Network Security Centers and completion of new Network
Security Centers; the timing and magnitude of capital expenditures, including
construction costs relating to the expansion of operations; capacity
utilization of its Network Security Centers; the introduction by third parties
of new security, Internet and networking technologies; increased competition
in the Company's markets; changes in the pricing policies of the Company and
its competitors; reliable security, continuity of service and network
availability; the ability to increase bandwidth as necessary; fluctuations in
bandwidth used by customers and fluctuations in the cost of such bandwidth;
the retention of key personnel; economic conditions specific to the Internet
and Internet security industries; and other general economic factors. In
addition, although the Company has not encountered significant difficulties in
collecting upon accounts receivable in the past, there can be no assurance
that the Company will be able to collect receivables on a timely basis.

For these and other reasons, in some future quarters, the Company's results
of operations may fall below the expectations of securities analysts or
investors, which could have a material adverse effect on the market price of
the Company's Common Stock. See "--Risks of Business Expansion and Management
of Growth" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations."

RISKS ASSOCIATED WITH SECURITY BREACHES

The Company's success is substantially dependent on the continued confidence
of its current and future customers that the Company provides superior network
security protection. Despite the Company's focus on Internet security, there
can be no assurance that the Company will be able to stop unauthorized
attempts, whether made unintentionally or by computer "attackers," to gain
access to or disrupt the network operations of the Company's customers. The
Company's Network Security Centers are designed to prevent unauthorized access
to customers' networks from the Internet. Any failure by the Company to stop
unauthorized access from the Internet or disruptions to related Internet
operations of its customers could materially adversely affect such customers
and the Company. Although the Company generally limits warranties and
liabilities relating to security in its customer contracts, the Company's
customers may seek to hold the Company responsible for any losses suffered by
the customer as a result of unauthorized access to customers' network systems
from the Internet. This could result in liability to the Company, which could
have a material adverse effect upon its business, operating results and
financial condition. Moreover, computer attackers from the Internet could
infiltrate the Company's network and seek to sabotage its network or services
by creating bugs or viruses or through other means. In addition, any adverse
publicity resulting from any such unauthorized access could deter future
customers from using the Company's services and could cause current customers
to cease using the Company's services, which could have a material adverse
effect upon the Company's business, operating results and financial condition.

RISKS ASSOCIATED WITH THE EMERGING MARKET FOR OUTSOURCED NETWORK SECURITY
SERVICES

The market for Internet security monitoring, detection and defense services
in general is new and rapidly evolving. Growth of this market will depend, in
large part, upon the public recognition of the potential threat posed by
computer attackers and other unauthorized users, the increased use of the
Internet and corporate intranets for electronic commerce and business
communications, the ability of network infrastructures to support an
increasing number of users and services, and the continued development of new
and improved services for implementation across the Internet and between the
Internet and corporate intranets. If the necessary network infrastructure or
complementary products and services are not developed in a timely manner and,
consequently, the market for network security solutions fails to grow or grows
more slowly than the Company currently anticipates, the Company's business,
operating results and financial condition would be materially and adversely
affected. Moreover, to date, most businesses have purchased and managed their
own network security solutions and have not sought to outsource network
security to a third party service provider. As a result, customer acceptance
of outsourcing network security services is extremely limited. The Company has
spent, and intends to continue to spend, considerable resources educating
potential customers about the value of outsourcing services provided by

6
<PAGE>

the Company. To date, the Company has experienced lengthy sales cycles for its
services. There can be no assurance that such expenditures will increase
market acceptance of the Company's services, or that such sales cycles will
shorten. If the market for such services fails to grow or grows more slowly
than the Company currently anticipates, the Company's business, operating
results and financial condition would be materially and adversely affected.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations," "Business--Industry Background," "--Sales, Marketing and
Customer Support" and "--Competition."

RISKS OF BUSINESS EXPANSION AND MANAGEMENT OF GROWTH

The Company intends to expand domestically and internationally by adding
Network Security Centers in new locations and expanding Network Security
Centers in existing locations. The Company is in the process of commencing
operations of four new Network Security Centers in the Boston, Minneapolis,
Washington, D.C. and London metropolitan areas and relocating Network Security
Centers in the Los Angeles and Chicago metropolitan areas to new facilities in
such areas. The Company intends to establish additional Network Security
Centers in the United States, Europe and Asia, although the Company has not
identified specific locations for expansion. In addition, there can be no
assurance with respect to the timing or extent of such expansion or that the
Company will be successful in expanding its operations. This expansion will
depend, among other things, on the Company's ability to hire qualified
personnel, install facilities and establish local peering interconnections
with Internet Service Providers (ISPs), all in a timely manner, at reasonable
costs and on terms and conditions acceptable to the Company. The Company's
ability to manage this expansion effectively will require it to continue to
implement and improve its operational and financial systems and to expand,
train and manage its employee base. The Company's inability to manage
effectively its expansion, including any disruption of service to current
customers, would have a material adverse effect upon the Company's business,
results of operations and financial condition. See "--Dependence on
Scalability of Company's Network."

In addition, the Company will be required to expend substantial resources
for leases and improvements of facilities, significant improvements of such
facilities, purchases of equipment, implementation of multiple
telecommunications connections and hiring of network, administrative, customer
support, and sales and marketing personnel. Furthermore, any problems
encountered in connection with the expansion of existing Network Security
Centers may cause the interruption of service to current customers.

In addition, from June 30, 1997 to June 30, 1998, the number of Company
employees increased from 55 to 116. Furthermore, more than half of the
Company's sales personnel have joined the Company since January 1998. This
growth has placed and may continue to place a significant strain on the
Company's financial, management, operational and other resources. The rapid
growth of the Company's sales team, in particular, may limit the effectiveness
of the Company's sales efforts in the immediate future. In addition, the
Company may be required to manage multiple relationships with third party
partners and vendors as it seeks to complement its service offerings. There
can be no assurance that the Company's financial, management, operational and
other systems, procedures and controls will be adequate to support the
Company's existing and future operations. The Company's ability to manage its
growth effectively will require it to continue to expand its operating and
financial procedures and controls, to replace or upgrade its financial,
management and operational systems and to attract, train, motivate, manage and
retain key employees. The Company has recently hired many key employees and
officers, including its Senior Vice President, Sales and Marketing, its Vice
President of Operations and Business Development, and its Chief Financial
Officer. As a result, the Company's entire management team has worked together
for only a brief time, which may limit their ability to operate effectively
together. The Company also has plans to hire a Vice President of Operations,
to allow the Company's current Vice President of Operations and Business
Development to focus solely on business development. If the Company's
executives are unable to manage growth effectively, the Company's business,
results of operations and financial condition would be materially adversely
affected. See "--Dependence on Key Personnel" and "Management."

COMPETITION

7
<PAGE>

existing competitors and new market entrants in the future. The Company
believes that this market is characterized by a limited period of time during
which participants must grow rapidly and achieve a significant presence in the
market in order to compete effectively. The principal competitive factors in
this market include Internet system and security engineering expertise,
customer service, network and security capabilities, reliability, quality and
scalability of service, broad geographic presence, brand name, technical
expertise and functionality, the variety of services offered, the ability to
maintain and expand distribution channels, customer support, price, the timing
of introductions of new services, financial resources and conformity with
industry standards. There can be no assurance that the Company will have the
resources or expertise to compete successfully in the future.

The Company competes with a broad range of products and services. The
Company's competitors include companies providing security, electronic
commerce, and secure Internet networking products that are offered as stand-
alone point solutions. Companies offering stand-alone products include
providers of firewall software, such as Check Point Software Technologies and
AXENT Technologies (formerly Raptor Systems), security monitoring software,
such as ISS Group, and electronic commerce products. The security and
electronic commerce products provided by these companies are typically
implemented and managed by internal MIS departments of enterprises. In
addition, internal corporate MIS departments increasingly rely on third party
consultants or system integrators to manage the integration and implementation
of multiple stand-alone products from different vendors.

The Company also competes with third party service providers that offer
Internet hosting and access services, including (i) providers of server
hosting services, such as Exodus Communications and PSI Net; (ii) national and
regional ISPs such as Concentric Network Corp., UUNET Technologies ("UUNET"),
certain subsidiaries of GTE Corporation and Global Center, which was recently
acquired by Frontier Corporation; and (iii) global, regional and local
telecommunications companies such as MCI Communications Corporation ("MCI"),
Sprint Corporation ("Sprint"), WorldCom, and regional bell operating
companies. The Company also competes with information technology service firms
providing either outsourcing or systems integration services such as
International Business Machines Corporation and Electronic Data Systems.
Although these third party service providers often add security features to
their service offerings, either through internal development efforts or
through the incorporation of products purchased from vendors of stand-alone
point solutions, the Company believes that generally these competitors do not
offer the same level of security in their services as the Company. However,
the Company expects competition to intensify as third party service providers
incorporate a broader range of security, electronic commerce and secure
Internet networking services and products into their service offerings.
Furthermore, the Company may face competition from its vendors and other
partners. The Company's agreements with its vendors and other partners
generally do not limit or restrict those parties from selling similar products
and services directly to the Company's customers or its competitors, thereby
enabling such parties to compete against the Company. There can be no
assurance that such vendors or other partners will not compete with the
Company in the future.

Many of the Company's competitors have substantially greater financial,
technical and marketing resources, larger customer bases, longer operating
histories, greater name recognition and more established relationships in the
industry than the Company. As a result, certain of these competitors may be
able to develop and expand their network infrastructures and service offerings
more quickly, adapt to new or emerging technologies and changes in customer
requirements more quickly, take advantage of acquisition and other
opportunities more readily, devote greater resources to the marketing and sale
of their products and adopt more aggressive pricing policies than the Company.
In addition, these competitors have entered, and will likely continue to
enter, into joint ventures or consortiums to provide additional services
competitive with those provided by the Company. Certain of the Company's
competitors may be able to provide customers with additional benefits in
connection with their Internet system and network management solutions,
including reduced communications costs, which could reduce the overall costs
of their services relative to the Company's. There can be no assurance that
the Company will be able to offset the effects of any resulting price
reductions. In addition, the Company believes that the businesses in which the
Company competes are likely to encounter consolidation in the near future,

8
<PAGE>

which could result in increased price and other competition that could have a
material adverse effect on the Company's business, results of operations and
financial condition.

RISK OF SYSTEM FAILURE

The Company's success depends on the uninterrupted operation of its network
infrastructure. To maintain this uninterrupted operation, the Company must
protect its network infrastructure against damage and disruption from human
error, fire, earthquakes, floods, power loss, telecommunications failures,
sabotage, intentional acts of vandalism and similar events. Despite existing
and planned precautions by the Company, the occurrence of a natural disaster
or other unanticipated problems at one or more of the Company's Network
Security Centers could result in interruptions in the services provided by the
Company. In addition, the failure of any of the Company's telecommunications
providers to provide the data communications capacity required by the Company,
for any reason, could result in interruptions in the Company's services. Any
damage to or failure of the Company's systems or those of its service
providers could result in reductions in, or terminations of, services supplied
to the Company's customers. Such reductions or terminations in service could
materially and adversely impact the Company's customers, which could have a
material adverse effect on the Company's business, results of operations and
financial condition. In addition, the Company's reputation could be materially
adversely affected. Although the Company generally contractually limits its
liability for incidental, punitive, indirect and consequential damages and
personal injury resulting from disruption of service, there can be no
assurance that the Company would not be found liable for any such damages and
personal injury, or that the amount of any such liability would not exceed the
Company's liability insurance, if any. See "Business--Customers" and "--Pilot
Dynamic Security Infrastructure."

FUTURE CAPITAL NEEDS

The Company expects to incur significant expenditures as part of its planned
expansion, including expenditures for new and expanded Network Security
Centers, increases in sales and marketing activities and the development of
new services. The Company believes that the net proceeds from this offering,
together with existing cash balances, and up to $3 million available under
existing lines of credit, should be sufficient to meet its capital
requirements for at least the next twelve months. However, there can be no
assurance that the Company will be successful in generating anticipated levels
of cash from operations or borrowings. If the Company is not successful, it
may be required to sell assets, scale down its operations and expansion plans,
seek to refinance all or a portion of its existing indebtedness or seek to
obtain other financing earlier than planned, any of which could have a
material adverse effect on the Company's business, results of operations and
financial condition. There can be no assurance that any such refinancing would
be available on commercially reasonable terms, or at all, or that any other
financing could be obtained or would not result in significant dilution to the
Company's stockholders. See "Use of Proceeds," "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources" and Notes 3 and 6 of Notes to Financial Statements.

RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS

A key component of the Company's long-term strategy is to expand into
international markets. If revenue generated by any international Network
Security Center is not adequate to offset the expense of establishing and
maintaining any such international operation, the Company's business, results
of operations and financial condition could be materially adversely affected.
In addition, the Company faces certain risks inherent in conducting business
internationally, such as unexpected changes in regulatory requirements, export
restrictions, tariffs and other trade barriers, challenges in staffing and
managing foreign operations, differing technology standards, employment laws
and practices in foreign countries, longer payment cycles, problems in
collecting accounts receivable, political instability, fluctuations in
currency exchange rates, imposition of currency exchange controls, seasonal
reductions in business activity and potentially adverse tax consequences, any
of which could adversely affect the Company's international operations.
Furthermore, certain foreign governments, such as Germany, have enforced laws
and regulations related to content distributed over the Internet that are

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<PAGE>

more strict than those currently in place in the United States. There can be
no assurance that one or more of these factors will not have a material
adverse effect on the Company's current or future international operations
and, consequently, on the Company's business, results of operations and
financial condition. In addition, there can be no assurance that the Company
will be able to compete effectively in international markets. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

DEPENDENCE UPON SCALABILITY OF THE COMPANY'S NETWORK

The Company must continue to expand and adapt its network infrastructure as
the number of users and the amount of information they wish to transmit
increases, and as customer requirements change. The expansion and adaptation
of the Company's telecommunications infrastructure will require substantial
financial, operational and management resources. If the Company is required to
expand its network significantly and rapidly due to increased usage,
additional stress will be placed upon the Company's existing network
infrastructure. Due to the limited deployment of the Company's services to
date, the ability of the Company's network to connect and manage a
substantially larger number of customers at high transmission speeds is as yet
unknown, and the Company faces risks related to the network's ability to
operate with higher customer levels while maintaining superior performance. As
customers' usage of bandwidth increases, the Company will need to make
additional investments in its infrastructure to maintain adequate data
transmission speeds, the availability of which may be limited or the cost of
which may be significant. As a result, there can be no assurance that the
Company's network will be able to achieve or maintain a sufficiently high
capacity of data transmission, especially if customer usage increases. The
Company's failure to achieve or maintain high capacity data transmission could
significantly reduce customer demand for its services and have a material
adverse effect on its business, results of operations and financial condition.
In addition, as the Company upgrades its telecommunications infrastructure to
increase bandwidth available to its customers, it is likely to encounter a
certain level of equipment or software incompatibility which may cause delays
in implementation. There can be no assurance that the Company will be able to
expand or adapt its telecommunications infrastructure to meet additional
demand or its customers' changing requirements. See "Business--Pilot Dynamic
Security Infrastructure."

DEPENDENCE UPON THIRD PARTY NETWORK INFRASTRUCTURE PROVIDERS

The Company's success will depend upon third party network infrastructure
providers. In particular, the Company is dependent on telecommunications
network suppliers such as MCI, Sprint and WorldCom for its backbone capacity.
In addition, the Company relies on a number of public and private peering
interconnections (i.e., arrangements among access providers to carry traffic
of each other) to deliver its services. If the carriers that operate the
Internet exchange points ("IXPs") were to discontinue their support of the
peering points and no alternative providers were to emerge, or such
alternative providers were to increase the cost of utilizing the IXPs, the
transmission of network traffic by the Company would be significantly
constrained. Furthermore, as traffic through the IXPs increases, if
commensurate increases in bandwidth are not added, the Company's ability to
distribute content rapidly and reliably through these networks will be
adversely affected. Many of the operators of the private peering
interconnections are competitors of the Company. If these organizations were
to refuse to continue to peer directly with the Company, the Company might be
required to purchase Internet transit access services from these
organizations. In those cases where the Company currently purchases Internet
transit access from other organizations, if these organizations were to
increase the pricing associated with their Internet transit access, the
Company might be required to identify alternative methods through which it can
transmit its customers' traffic. If the Company were unable to access on a
cost-effective basis alternative networks to distribute its customers' content
or pass through any additional costs of utilizing these networks to its
customers, the Company's business, results of operations and financial
condition could be materially adversely affected. See "Business--Pilot Dynamic
Security Infrastructure."

The recent growth in the use of the Internet has caused frequent periods of
performance degradation, requiring the upgrade of routers and switches,
telecommunications links and other components forming the infrastructure of
the Internet by ISPs and other organizations with links to the Internet. Any
perceived degradation in the performance of the Internet as a whole could
undermine the benefits of the Company's

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<PAGE>

services. Potentially increased performance provided by the services of the
Company and others is ultimately limited by and reliant upon the speed and
reliability of the networks operated by third parties. Consequently, the
emergence and growth of the market for the Company's services is dependent on
improvements being made to the entire Internet infrastructure to alleviate
overloading and congestion.

DEPENDENCE ON OTHER THIRD-PARTY RELATIONSHIPS

The Company is dependent on other companies to supply certain key components
of its telecommunications infrastructure and system and network management
solutions that, in the quantities and quality demanded by the Company, are
available only from sole or limited sources. The Company uses routers and
switches supplied primarily by Cisco Systems, hardware servers supplied
primarily by Sun Microsystems and virtual private networking software and
hardware supplied by VPNet Technologies. The Company purchases these
components pursuant to purchase orders placed from time to time, does not
carry significant inventories of these components and has no guaranteed supply
arrangements with these vendors. In addition, the Company includes within its
services certain security software products that are available only from
certain vendors. Any failure to obtain required components or software on a
timely basis and at an acceptable cost would have a material adverse effect on
the Company's business, results of operations and financial condition. The
loss of any such components or software could require the Company to obtain
substitute components or software of lower quality or performance standards or
at greater cost, which could materially adversely affect the Company's
business, results of operations and financial condition. In addition, any
failure of the Company's sole or limited source suppliers to provide
components or software that comply with evolving Internet and
telecommunications standards or that interoperate with other components or
software used by the Company in its communications infrastructure could have a
material adverse effect on the Company's business, results of operations and
financial condition.

The Company also intends to develop alternative distribution and lead
generation channel partners for the Company's services, such as systems
integration firms and bandwidth providers. Any failure by the Company to
develop these channel partners could materially and adversely impact the
ability of the Company to generate increased revenues, which could have a
material adverse effect on the Company's business, results of operations and
financial condition. See "Business--Sales, Marketing and Customer Support" and
"--Strategic Relationships."

DEPENDENCE ON THE INTERNET AS A MEANS OF CONDUCTING BUSINESS

The increased use of the Internet for retrieving, sharing and transferring
information among businesses, consumers, suppliers and partners has only
recently begun to develop, and the Company's success will depend in large part
on continued growth in the use of the Internet. Critical issues concerning the
commercial use of the Internet, including security, reliability, cost, ease of
access, quality of service and necessary increases in bandwidth availability,
remain unresolved and are likely to affect the development of the market for
the Company's services. The adoption of the Internet for information retrieval
and exchange, commerce and communications, particularly by those enterprises
that have historically relied upon alternative means of commerce and
communications, generally will require the acceptance of a new medium of
conducting business and exchanging information. Demand and market acceptance
of the Internet are subject to a high level of uncertainty and are dependent
on a number of factors, including the growth in consumer access to and
acceptance of new interactive technologies, the development of technologies
that facilitate interactive communication between organizations and targeted
audiences and increases in user bandwidth. If the Internet as a commercial or
business medium fails to develop or develops more slowly than expected, the
Company's business, results of operations and financial condition could be
materially adversely affected. See "Business--Industry Background" and "--
Pilot Dynamic Security Infrastructure."

RAPID TECHNOLOGICAL CHANGE; EVOLVING INDUSTRY STANDARDS

The Company's future success will depend, in part, on its ability to offer
services that incorporate leading technology, address the increasingly
sophisticated and varied needs of its current and prospective customers and

11
<PAGE>

respond to technological advances and emerging industry standards and
practices on a timely and cost-effective basis. The market for the Company's
services is characterized by rapidly changing and unproven technology,
evolving industry standards, changes in customer needs, emerging competition
and frequent new service introductions. There can be no assurance that future
advances in technology will be beneficial to, or compatible with, the
Company's business or that the Company will be able to incorporate such
advances on a cost-effective and timely basis into its business. Moreover,
certain operating platforms, such as Windows NT, may be less compatible with
security technologies than other platforms, such as UNIX-based systems, and
may be more susceptible to security breaches. To the extent the Company's
current and prospective customers adopt Windows NT, the Company may not be
able to provide the same levels of security as it provides to customers
employing UNIX-based systems. As a result, if a breach of security were to
occur involving a customer in a Windows NT environment, the general perception
of the Company in the market as a provider of secure bandwidth and electronic
commerce services may be adversely effected, which would have a material
adverse effect on the Company's business, results of operations and financial
condition. In addition, technological advances may have the effect of
encouraging certain of the Company's current or future customers to rely on
in-house personnel and equipment to furnish the services currently provided by
the Company. In addition, keeping pace with technological advances in the
Company's industry may require substantial expenditures and lead time.

The Company believes that its ability to compete successfully is also
dependent upon the continued compatibility and interoperability of its
services with products, services and architectures offered by various vendors
as part of the Company's services. There can be no assurance that such
products will be compatible with the Company's infrastructure or that such
products will adequately address changing customer needs. Although the Company
currently intends to support emerging standards, there can be no assurance
that industry standards will be established or that, if they become
established, the Company will be able to conform to these new standards in a
timely fashion and maintain a competitive position in the market. The failure
of the Company to conform to the prevailing standard, or the failure of a
common standard to emerge, could have a material adverse effect on the
Company's business, results of operations and financial condition. In
addition, there can be no assurance that products, services or technologies
developed by others will not render the Company's services uncompetitive or
obsolete. See "Business--Services" and "--Pilot Dynamic Security
Infrastructure."

DEPENDENCE ON KEY PERSONNEL

The Company's success depends in significant part upon the continued
services of its key technical, sales and senior management personnel,
including the Company's President and Chief Executive Officer, Marketta
Silvera, and the Company's Vice President, Engineering and Development, Thomas
Wadlow. None of the Company's officers is a party to an employment agreement
with the Company. Any officer or employee of the Company can terminate his or
her relationship with the Company at any time. The Company's future success
will also depend on its ability to attract, train, retain and motivate highly
qualified technical, marketing, sales and management personnel. In the past,
the Company has experienced high rates of employee turnover, which in certain
periods has limited the Company's ability to effectively manage its growth.
Competition for such personnel is intense, and there can be no assurance that
the Company will be able to attract and retain sufficient numbers of qualified
personnel to handle its planned expansion, particularly because the Company
maintains stringent hiring standards and conducts a thorough background check
for each prospective employee. The loss of the services of one or more of the
Company's key employees or the Company's failure to attract additional
qualified personnel could have a material adverse effect on the Company's
business, results of operations and financial condition. See "Business--
Employees" and "Management."

GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES

There is currently only a small body of laws and regulations directly
applicable to access to or commerce on the Internet, other than regulations
applicable to businesses generally and regulations applicable to certain
encryption technologies incorporated into products provided by certain of the
Company's vendors. However, because the Internet has recently emerged, there
is significant uncertainty as to the application of existing laws and
regulations with respect to the Internet, covering issues such as user
privacy, freedom of expression, pricing,

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<PAGE>

characteristics and quality of products and services, taxation, advertising,
intellectual property rights, information security and the convergence of
traditional telecommunications services with Internet communications.
Moreover, a number of laws and regulations have been proposed and are
currently being considered by federal, state and foreign legislatures with
respect to such issues. The nature of any new laws and regulations and the
manner in which existing and new laws and regulations may be interpreted and
enforced cannot be fully determined. Therefore, such laws and regulations
could decrease the growth of the Internet, decrease demand for the Company's
services, restrict the Company's activities, impose taxes or other costly
technical requirements, subject the Company and/or its customers to potential
liability or otherwise adversely affect the Company or its customers, each of
which could have a material adverse effect on the Company's business, results
of operations and financial condition. For example, because the Company's
services are available over the Internet in multiple states and foreign
countries, and as the Company facilitates sales by its customers to end users
located in such states and foreign countries, such jurisdictions may claim
that the Company is required to qualify to do business as a foreign
corporation in each such state or foreign country, which could have a material
adverse effect on the Company's business, results of operations and financial
condition.

A number of governments have imposed controls, export license requirements
and restrictions on the export of encryption technologies provided by certain
of the Company's vendors. To the extent the Company or its vendors are
required to export products incorporating certain encryption technology
developed in the United States in support of services provided to the
Company's customers located outside of the United States, the Company and its
vendors will need to comply with United States export controls. In particular,
all cryptographic products require either qualification under appropriate
licensing exemptions or export licenses from either the U.S. State Department,
acting under the authority of the International Traffic in Arms Regulation, or
the U.S. Commerce Department, acting under the authority of the Export
Administration Regulations. Furthermore, if the Company is unable to comply
with such export controls, it may not be able to obtain on commercially
reasonable terms encryption technologies developed outside the United States
for its international services that provide for encryption as strong as those
developed in the United States. There can be no assurance that U.S. export
restrictions will be changed to allow stronger encryption for international
delivery, that the Company or its vendors will be able to comply with such
restrictions, or that such factors will not have a material adverse effect on
the Company's business, operating results and financial condition.

RISKS ASSOCIATED WITH INFORMATION DISSEMINATED THROUGH THE COMPANY'S NETWORK

The law relating to the liability of online services companies and Internet
access providers for information carried on or disseminated through their
networks is currently unsettled. It is possible that claims could be made
against online services companies and Internet access providers under both
United States and foreign law for defamation, negligence, copyright or
trademark infringement, or other theories based on the nature and content of
the materials disseminated through their networks. Several private lawsuits
seeking to impose such liability upon online services companies and Internet
access providers are currently pending. In addition, legislation has been
proposed that imposes liability for or prohibits the transmission over the
Internet of certain types of information. The imposition upon the Company and
other Internet network providers of potential liability for information
carried on or disseminated through their systems could require the Company to
implement measures to reduce its exposure to such liability, which may require
the expenditure of substantial resources, or to discontinue certain service or
product offerings. The increased attention focused upon liability issues as a
result of these lawsuits and legislative proposals could adversely impact the
growth of Internet use. While the Company carries general liability and errors
and omissions insurance, it may not be adequate to compensate or may not cover
the Company in the event the Company becomes liable for information carried on
or disseminated through its networks. Any costs not covered by insurance
incurred as a result of such liability or asserted liability could have a
material adverse effect on the Company's business, results of operations and
financial condition. Certain businesses, organizations and individuals send
unsolicited commercial e-mails to massive numbers of people, typically to
advertise products or services. This practice, known as "spamming," can lead
to complaints against service providers that enable such activities,
particularly where recipients view the materials received as offensive. The
Company is not aware of instances in which spamming has occurred from servers
hosted at its

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<PAGE>

facilities. However, certain ISPs and other online services companies could
deny network access to the Company if undesired content or spamming were to be
transmitted from servers hosted at its facilities. Although the Company's
customer-use policy prohibits its customers from spamming, there can be no
assurance that its customers will not engage in this practice, which could
have a material adverse effect on the Company's business, results of
operations and financial condition.

PROTECTION AND ENFORCEMENT OF INTELLECTUAL PROPERTY RIGHTS

The Company relies on a combination of copyright, trademark, service mark
and trade secret laws and contractual restrictions to establish and protect
certain proprietary rights in technology underlying its services. The Company
has recently applied for three separate patents in the U.S. and intends to
continue to seek patents on its inventions when appropriate, although the
Company currently has no patented technology that would preclude or inhibit
competitors from entering the Company's market. There can be no assurance that
patents will issue from currently pending or any future applications, or that
any patents that may be issued will be sufficient in scope or strength to
provide meaningful protection or any commercial advantage to the Company. The
Company has three separate trademark applications pending in the United States
and counterparts in certain foreign jurisdictions for distinct marks,
including its distinctive Pilot logo; however, there can be no assurance that
such trademarks will be granted. The laws of certain foreign countries may not
protect the Company's products, services or intellectual property rights to
the same extent as do the laws of the United States.

The Company has entered into confidentiality and invention assignment
agreements with its employees and contractors, and nondisclosure agreements
with its suppliers, distributors and appropriate customers in order to limit
access to and disclosure of its proprietary information. There can be no
assurance that these contractual arrangements or other steps taken by the
Company to protect its intellectual property will prove sufficient to prevent
infringement of or misappropriation of the Company's technology or to deter
independent third-party development of similar technologies. Any such
infringement or misappropriation, should it occur, could have a material
adverse effect on the Company's business, results of operation and financial
condition. Furthermore, litigation may be necessary to enforce the Company's
intellectual property rights, to protect the Company's trade secrets, to
determine the validity and scope of the proprietary rights of others, or to
defend against claims of infringement or invalidity. Such litigation could
result in substantial costs and diversion of resources and could have a
material adverse effect on the Company's business, results of operations and
financial condition.

To date, the Company has not been notified that the Company's products
infringe the proprietary rights of third parties, but there can be no
assurance that third parties will not claim infringement or indemnification by
the Company with respect to current or future products. The Company expects
that participants in its markets will be increasingly subject to infringement
claims as the number of products and competitors in the Company's industry
segment grows. Any such claim, whether meritorious or not, could be time-
consuming, result in costly litigation, cause product installation delays,
prevent the Company from using important technologies or methods, subject the
Company to substantial damages, or require the Company to enter into royalty
or licensing agreements. Such royalty or licensing agreements might not be
available on terms acceptable to the Company or at all. As a result, any such
claim could have a material adverse effect upon the Company's business,
results of operations and financial condition.

YEAR 2000 RISKS

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<PAGE>

their Internet operations on commercially available operating systems, which
may be impacted by Year 2000 complications. In addition, the Company relies on
third party vendors for certain equipment and software included within the
Company's services which may not be Year 2000 compliant. The Company is in the
early stages of conducting an audit of its third-party suppliers as to the
Year 2000 compliance of their systems. To date, the Company has not incurred
significant incremental costs in order to comply with Year 2000 requirements
and does not believe it will incur significant incremental costs in the
foreseeable future. However, failure of the Company's internal computer
systems or of such third-party equipment or software, or of systems maintained
by the Company's suppliers, to operate properly with regard to the Year 2000
and thereafter could require the Company to incur significant unanticipated
expenses to remedy any problems and could have a material adverse effect on
the Company's customers, which could have a material adverse effect on the
Company's business, financial condition and results of operations. The
Company, however, is not aware of any significant suppliers that anticipate
Year 2000 problems.

POSSIBLE VOLATILITY OF STOCK PRICE

The market price of the shares of Common Stock is likely to be highly
volatile and could be subject to wide fluctuations in response to factors such
as actual or anticipated variations in the Company's results of operations,
announcements of technological innovations or new Network Security Centers,
new products or services introduced by the Company or its competitors, changes
in financial estimates by securities analysts, conditions and trends in the
Internet, general market conditions and other factors. Further, the stock
markets, and in particular the Nasdaq National Market, have experienced
extreme price and volume fluctuations that have particularly affected the
market prices of equity securities of many technology companies and that often
have been unrelated or disproportionate to the operating performance of such
companies. The trading prices of many technology companies' stocks are at or
near historical highs and reflect price to earnings ratios substantially above
historical levels. There can be no assurance that these trading prices and
price to earnings ratios will be sustained. These broad market factors may
adversely affect the market price of the Common Stock. These market
fluctuations, as well as general economic, political and market conditions
such as recessions, interest rates or international currency fluctuations, may
adversely affect the market price of the Common Stock. In the past, following
periods of volatility in the market price of a company's securities,
securities class action litigation has often been instituted against such
companies. Such litigation, if instituted, could result in substantial costs
and a diversion of management's attention and resources, which would have a
material adverse effect on the Company's business, results of operations and
financial condition.

CONTROL BY PRINCIPAL STOCKHOLDERS, EXECUTIVE OFFICERS AND DIRECTORS

Upon completion of this Offering, the Company's executive officers,
directors and existing 5% and greater stockholders (and their affiliates)
will, in the aggregate, beneficially own approximately 68.4% of the Company's
outstanding Common Stock (66.1% if the Underwriters' over-allotment option is
exercised in full). As a result, such persons, acting together, will have the
ability to control all matters submitted to stockholders of the Company for
approval (including the election and removal of directors and any merger,
consolidation or sale of all or substantially all of the Company's assets) and
to control the management and affairs of the Company. Accordingly, such
concentration of ownership may have the effect of delaying, deferring or
preventing a change in control of the Company, impede a merger, consolidation,
takeover or other business combination involving the Company or discourage a
potential acquirer from making a tender offer or otherwise attempting to
obtain control of the Company, which in turn could have an adverse effect on
the market price of the Common Stock. See "Management" and "Principal and
Selling Stockholders."

SHARES ELIGIBLE FOR FUTURE SALE

Sales of substantial amounts of Common Stock (including shares issued upon
the exercise of outstanding options and warrants) in the public market after
this offering could adversely affect the market price of the Common Stock.
Such sales also might make it more difficult for the Company to sell equity or
equity-related securities in the future at a time and price that the Company
deems appropriate. In addition to the 3,250,000

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<PAGE>

shares of Common Stock offered hereby (assuming no exercise of the
Underwriters' over-allotment option), as of the date of this Prospectus, there
will be 10,495,686 shares of Common Stock outstanding (including 600,000
shares to be issued upon exercise of the Series F Warrants prior to the
closing of the Offering), all of which are restricted shares ("Restricted
Shares") under the Securities Act of 1933, as amended (the "Securities Act").
As of such date, no Restricted Shares will be eligible for sale in the public
market. Following the expiration of 180-day lock-up agreements (the "Lock-up
Period") with the representatives of the Underwriters or the Company, (i)
2,507,246 of the Restricted Shares will be eligible for immediate sale without
restriction under Rules 144(k) or 701 under the Securities Act, (ii) 7,188,440
of the Restricted Shares will be eligible for sale subject to compliance with
the volume and other restrictions of Rule 144, and (ii) 800,000 of the
Restricted Shares (including 600,000 shares to be issued upon exercise of the
Series F Warrants prior to the closing of the Offering) will become eligible
for sale at various times after the Lock-up Period upon expiration of
applicable holding periods under Rule 144, subject in some cases to the volume
and other restrictions of Rule 144. In addition, as of June 30, 1998, there
were outstanding 1,756,940 options and 292,910 warrants to purchase shares of
the Company (excluding 600,000 shares which are to be issued upon exercise of
the Series F Warrants prior to the closing of the Offering) and all of such
options and warrants will be subject to 180-day lock-up agreements. Following
the expiration of the Lock-up Period, all of the warrants will be exercisable
and 369,518 of such options will be exercisable. Credit Suisse First Boston
Corporation may, in its sole discretion and at any time without notice,
release all or any portion of the securities subject to lock-up agreements. In
addition, the holders of approximately 8,839,918 Restricted Shares and
warrants to purchase 892,910 shares of Common Stock of the Company are
entitled to certain rights with respect to registration of such shares for
sale in the public market. If such holders sell in the public market, such
sales could have a material adverse effect on the market price of the
Company's Common Stock.

Immediately after this Offering, the Company intends to register
approximately 2,956,940 shares of Common Stock subject to outstanding options
and reserved for issuance under its stock option and purchase plans. See
"Shares Eligible for Future Sale."

BROAD MANAGEMENT DISCRETION IN ALLOCATION OF PROCEEDS; USE OF PROCEEDS

The net proceeds to the Company from the sale of the shares of Common Stock
being offered by the Company hereby at the initial public offering price of
$14.00 per share are estimated to be approximately $39.5 million
(approximately $45.8 million if the Underwriters' over-allotment option is
exercised in full), after deducting the estimated underwriting discount and
estimated offering expenses. The principal purposes of this Offering are to
obtain additional capital, create a public market for the Common Stock,
facilitate future access by the Company to public equity markets and to
provide increased visibility and credibility in a marketplace where many of
the Company's current and potential competitors are or will be publicly held
companies. The Company expects to use such proceeds for general corporate
purposes, including funding of approximately $1.5 million in capital
expenditures for geographic expansion for the fiscal year ended March 31,
1999, the repayment after December 31, 1998 (unless sooner demanded by the
lenders as described below) of approximately $6.0 million of debt that bears
interest at the rate of 13.5% per annum and has a maturity date of June 1999,
and the repayment of approximately $1.5 million of debt that bears interest at
the rate of 11% per annum and has a maturity date of May 1999. The lenders
have the right to require the Company to repay the full amount of the $6.0
million of debt immediately after the closing of this Offering. The Company
expects to use approximately $30.5 million of such proceeds for working
capital and other general corporate purposes, including the funding of
operating losses which the Company expects to be significant on a quarterly
and annual basis for the foreseeable future. The Company's management will
retain broad discretion in the allocation of a substantial portion of the net
proceeds. The failure of management to apply such funds effectively could have
a material adverse effect on the Company's business, results of operations and
financial condition. See "Use of Proceeds."

The Company believes that the net proceeds from this offering, together with
existing cash balances and up to $3 million available under existing lines of
credit, should be sufficient to meet its capital requirements for at least the
next 12 months. However, there can be no assurance that the Company will be
successful in generating

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<PAGE>

anticipated levels of cash from operations or borrowings. If the Company is
unable to generate sufficient cash flow from operations or additional
borrowings, it may be required to sell assets, scale down its operations and
expansion plans, refinance all or a portion of its existing indebtedness or
obtain other sources of financing earlier than planned, any of which could
have a material adverse effect on the Company's business, results of
operations and financial condition. There can be no assurance that any such
refinancing would be available on commercially reasonable terms, or at all, or
that any other financing could be obtained.

ANTI-TAKEOVER EFFECTS OF DELAWARE LAW

Upon completion of this offering, the Company's Board of Directors will have
the authority to issue up to 2,000,000 shares of Preferred Stock and to
determine the price, rights, preferences, privileges and restrictions,
including voting rights, of those shares without any further vote or action by
the stockholders. The rights of the holders of Common Stock will be subject
to, and may be adversely affected by, the rights of the holders of any
Preferred Stock that may be issued in the future. The issuance of Preferred
Stock, while providing flexibility in connection with possible acquisitions
and other corporate purposes, could have the effect of making it more
difficult for a third party to acquire a majority of the outstanding voting
stock of the Company. The Company has no current plans to issue shares of
Preferred Stock. The Company is also subject to certain provisions of Delaware
law which could have the effect of delaying, deterring or preventing a change
in control of the Company, including Section 203 of the Delaware General
Corporation Law, which prohibits a Delaware corporation from engaging in any
business combination with any interested stockholder for a period of three
years from the date the person became an interested stockholder unless certain
conditions are met. In addition, the Company's certificate of incorporation
and bylaws contain certain provisions that, together with the ownership
position of the Company's executive officers and directors and their
affiliates, could discourage potential takeover attempts and make more
difficult attempts by stockholders to change management which could adversely
affect the market price of the Company's Common Stock. See "--Control by
Principal Stockholders, Executive Officers and Directors" and "Description of
Capital Stock."

NO PRIOR MARKET FOR COMMON STOCK

Prior to this Offering, there has been no public market for the Common
Stock, and there can be no assurance that an active public market will develop
or be sustained after this Offering or that investors will be able to sell the
Common Stock should they desire to do so. The initial public offering price
will be determined by negotiations between the Company and the representatives
of the Underwriters and may bear no relationship to the price at which the
Common Stock will trade upon completion of this offering. See "Underwriting"
for a discussion of the factors to be considered in determining the initial
public offering price.

IMMEDIATE AND SUBSTANTIAL DILUTION

Purchasers of the Common Stock in this Offering will suffer immediate and
substantial dilution of $11.03 per share in the net tangible book value of the
Common Stock from the initial public offering price. To the extent that
outstanding options or warrants to purchase the Company's Common Stock are
exercised, there may be further dilution. See "Dilution."

17
<PAGE>

USE OF PROCEEDS

The principal purposes of this Offering are to obtain additional capital,
repay certain existing and expected indebtedness, create a public market for
the Common Stock, facilitate future access by the Company to public equity
markets and to provide increased visibility and credibility in a marketplace
where many of the Company's current and potential competitors are or will be
publicly held companies. The Company expects to use such proceeds for general
corporate purposes, including funding of approximately $1.5 million in capital
expenditures for geographic expansion for the fiscal year ended March 31,
1999, the repayment after December 31, 1998 (unless sooner demanded by the
lenders as described below) of approximately $6.0 million of debt that bears
interest at the rate of 13.5% per annum and has a maturity date of June 1999,
and the repayment of approximately $1.5 million of debt that bears interest at
the rate of 11% per annum and has a maturity date of May 1999. The lenders
have the right to require the Company to repay the full amount of the $6.0
million of debt immediately after the closing of this Offering. The Company
expects to use approximately $30.5 million of such proceeds for working
capital and other general corporate purposes, including the funding of
operating losses which the Company expects to be significant on a quarterly
and annual basis for the foreseeable future. The Company's management will
retain broad discretion in the allocation of a substantial portion of the net
proceeds. Pending use of the net proceeds for the above purposes, the Company
intends to invest such funds in short-term, interest bearing, investment grade
securities. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources" and "Risk
Factors--Broad Management Discretion in Allocation of Proceeds."

DIVIDEND POLICY

The Company has never declared or paid any cash dividends on its capital
stock. The Company currently intends to retain all available funds and any
future earnings of its business for use in the operation of its business and
does not anticipate paying any cash or other dividends in the foreseeable
future. In addition, the terms of the Company's current credit facility
prohibit the paying of dividends without the lender's consent.

18
<PAGE>

CAPITALIZATION

The following table sets forth as of June 30, 1998: (i) the actual
capitalization of the Company; (ii) the pro forma capitalization of the
Company giving effect to the conversion of the outstanding Preferred Stock
into Common Stock and the filing of a Restated Certificate of Incorporation
prior to the closing of this Offering; and (iii) the pro forma capitalization
of the Company as adjusted to reflect the receipt of the estimated net
proceeds from the sale of the 3,110,000 shares of Common Stock offered by the
Company hereby at the initial public offering price of $14.00 per share, after
deducting the estimated underwriting discount and offering expenses payable by
the Company, and the exercise of Warrants to purchase 600,000 shares of Series
F Preferred Stock at $6.00 per share. This table contains unaudited numbers
and should be read in conjunction with "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and the Financial Statements
and Notes thereto included elsewhere in this Prospectus.

<TABLE>
<CAPTION>
JUNE 30, 1998
-------------------------------
PRO PRO FORMA
ACTUAL FORMA AS ADJUSTED
-------- -------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Long-term obligations, net of current
maturities................................... $ 4,429 $ 4,429 $ 4,429
Redeemable convertible preferred stock; $0.001
par value, 7,432,810 shares authorized
actual; 6,363,030 shares issued and
outstanding, actual; no shares authorized,
issued or outstanding pro forma and pro forma
as adjusted.................................. 12,480 -- --
Stockholders' equity:
Convertible Series A preferred stock, $0.001
par value; 1,400,000 shares authorized,
issued and outstanding, actual; no shares
authorized, issued or outstanding pro forma
and pro forma as adjusted.................... 1 -- --
Preferred Stock, $0.001 par value, no shares
authorized, issued or outstanding actual;
2,000,000 shares authorized pro forma and pro
forma as adjusted; no shares issued or
outstanding pro forma and pro forma as
adjusted..................................... -- -- --
Common Stock, $0.001 par value, 40,000,000
shares authorized actual, pro forma and pro
forma as adjusted; 2,272,656 shares issued
and outstanding actual; 10,035,686 shares
issued and outstanding pro forma; 13,745,686
shares issued and outstanding pro forma as
adjusted(1).................................. 2 11 14
Additional Paid in Capital.................... 4,687 17,159 60,248
Deferred Compensation related to grant of
common stock options, net of amortization.... (2,772) (2,772) (2,772)
Accumulated deficit........................... (16,664) (16,664) (16,664)
-------- -------- --------
Total stockholders' equity (deficit).......... (14,746) (2,266) 40,826
-------- -------- --------
Total capitalization.......................... $ 2,163 $ 2,163 $ 45,255
======== ======== ========
</TABLE>
- --------
(1) Based on the number of shares outstanding as of June 30, 1998. The pro
forma as adjusted amounts include the number of shares to be issued upon
the exercise of warrants outstanding as of June 30, 1998 to purchase
Series F Preferred Stock, which are convertible into an aggregate of
600,000 shares of Common Stock, and exclude (i) 1,756,940 shares issuable
upon exercise of options outstanding as of June 30, 1998 with a weighted
average exercise price of $1.99 per share, (ii) shares issuable upon
exercise of outstanding warrants as of June 30, 1998 to purchase Series B
Preferred Stock and Series D Preferred Stock, which are convertible into
an aggregate of 142,910 shares of Common Stock with a weighted average
exercise price of $1.31 per share, (iii) shares issuable upon exercise of
outstanding warrants as of June 30, 1998 to purchase an aggregate of
150,000 shares of Common Stock at an exercise price of $11.20 per share,
(iv) shares issuable upon exercise of options to purchase 20,000 shares of
Common Stock at an exercise price of $13.00 per share, and (v) 1,380,000
shares available for issuance under the Company's 1998 stock plans. See
"Management--Stock Plans" and Note 5 of Notes to Consolidated Financial
Statements.

19
<PAGE>

DILUTION

The pro forma net tangible book deficit of the Company was approximately
$2,266,000, or $0.23 per share of Common Stock, as of June 30, 1998. Pro forma
net tangible book value (deficit) per share represents the amount of total
tangible assets less total liabilities, divided by the total pro forma number
of shares of Common Stock outstanding, after giving effect to the automatic
conversion of all outstanding shares of Preferred Stock. After giving effect
to the sale of the 3,110,000 shares of Common Stock offered by the Company
hereby at the initial public offering price of $14.00 per share, after
deducting the estimated underwriting discount and offering expenses payable by
the Company and the exercise of 600,000 Warrants to purchase Series F
Preferred Stock at $6.00 per share, the pro forma net tangible book value of
the Company, as adjusted, at June 30, 1998, would have been approximately
$40,826,000 or $2.97 per share of Common Stock. This amount represents an
immediate increase in such net tangible book value of $3.20 per share to
existing stockholders and an immediate dilution of $11.03 per share to new
investors. The following table illustrates this per share dilution:

<TABLE>
<S> <C> <C>
Initial public offering price per share........................ $14.00
Pro forma net tangible book deficit at June 30, 1998......... $(0.23)
Increase attributable to new investors....................... 3.20
------
Adjusted pro forma net tangible book value after this
Offering...................................................... 2.97
------
Dilution per share to new investors............................ $11.03
======
</TABLE>

The following table summarizes, on a pro forma as adjusted basis as of June
30, 1998, the differences between the existing stockholders and new investors
with respect to the number of shares of Common Stock purchased from the
Company, the total consideration paid to the Company, and the average price
per share paid.

<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------ ------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing Stockholders(1)
(2)..................... 10,635,686 77.4% $11,087,921 20.3% $ 1.04
New Investors............ 3,110,000 22.6 43,540,000 79.7 14.00
---------- ----- ----------- -----
Total(1)............... 13,745,686 100.0% $54,627,921 100.0%
========== ===== =========== =====
</TABLE>
- --------
(1) Based on the number of shares outstanding as of June 30, 1998. Pro forma
as adjusted amounts include the number of shares to be issued upon the
exercise of warrants outstanding as of June 30, 1998 to purchase Series F
Preferred Stock, which are convertible into an aggregate of 600,000 shares
of Common Stock, and exclude (i) 1,756,940 shares issuable upon exercise
of options outstanding, as of June 30, 1998 with a weighted average
exercise price of $1.99 per share, (ii) shares issuable upon exercise of
outstanding warrants as of June 30, 1998 to purchase Series B Preferred
Stock and Series D Preferred Stock, which are convertible into an
aggregate of 142,910 shares of Common Stock with a weighted average
exercise price of $1.31 per share, (iii) shares issuable upon exercise of
outstanding warrants as of June 30, 1998 to purchase an aggregate of
150,000 shares of Common Stock at an exercise price of $11.20 per share,
(iv) shares issuable upon exercise of options to purchase 20,000 shares of
Common Stock at an exercise price of $13.00 per share, and (v) 1,380,000
shares available for issuance under the Company's 1998 stock plans. See
"Management--Stock Plans" and Note 5 of Notes to Consolidated Financial
Statements.
(2) Sales by the Selling Stockholders will reduce the number of shares of
Common Stock held by existing stockholders to 10,495,686 or 76.4% of the
total number of shares (or 73.7% if the Underwriters' over-allotment
option is exercised in full) and will increase the number of shares of
Common Stock held by new investors to 3,250,000 or 23.6% (or 26.3% if the
Underwriters' over-allotment option is exercised in full). See "Principal
and Selling Stockholders."

20
<PAGE>

SELECTED FINANCIAL DATA

The selected financial data set forth below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operation," the Financial Statements and the Notes thereto and the other
information contained in this Prospectus. The selected statements of
operations data for the years ended March 31, 1996, 1997 and 1998 and the
selected balance sheet data as of March 31, 1997 and 1998, are derived from,
and are qualified by reference to, the audited financial statements of the
Company appearing elsewhere in this Prospectus. The selected statements of
operations data for the year ended March 31, 1995, and the selected balance
sheet data as of March 31, 1995 and 1996, are derived from audited financial
statements of the Company not included herein. The selected statement of
operations data for the year ended March 31, 1994 and for the three months
ended June 30, 1997 and 1998, and the selected balance sheet data as of March
31, 1994 and June 30, 1998, are derived from unaudited financial statements of
the Company not included in this Prospectus which have been prepared by the
Company on a basis consistent with the audited financial statements appearing
elsewhere in the Prospectus. The historical results are not necessarily
indicative of future results.

<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED MARCH 31, ENDED JUNE 30,
------------------------------------------------- ---------------
1994 1995 1996 1997 1998 1997 1998
------ --------- --------- --------- --------- ------ -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Service revenues........ $ 151 $ 800 $ 2,525 $ 6,300 $ 11,317 $2,461 $ 3,720
Cost of service
revenues............... 83 322 1,424 4,181 9,825 1,745 4,023
------ -------- --------- --------- --------- ------ -------
Gross margin............ 68 478 1,101 2,119 1,492 716 (303)
Operating expenses:
Sales and marketing... 127 579 1,792 3,109 4,306 868 2,134
Engineering and
development.......... 78 93 162 275 799 142 299
General and
administrative....... 110 253 766 1,064 1,551 341 688
------ -------- --------- --------- --------- ------ -------
Total operating
expenses........... 315 925 2,720 4,448 6,656 1,351 3,121
------ -------- --------- --------- --------- ------ -------
Operating loss.......... (247) (447) (1,619) (2,329) (5,164) (635) (3,424)
Interest expense, net... (1) (1) (131) (323) (471) (83) (208)
------ -------- --------- --------- --------- ------ -------
Net loss................ $ (248) $ (448) $ (1,750) $ (2,652) $ (5,635) $ (718) $(3,632)
Accretion on redeemable
convertible preferred
stock.................. (12) (80) (263) (478) (1,069) (132) (337)
------ -------- --------- --------- --------- ------ -------
Net loss attributable to
common stockholders.... $ (260) $ (528) $ (2,013) $ (3,130) $ (6,704) $ (850) $(3,969)
====== ======== ========= ========= ========= ====== =======
Basic and diluted net
loss per share(1)...... $(1.39) $ (0.39) $ (1.07) $ (1.58) $ (3.31) $(0.42) $ (1.81)
====== ======== ========= ========= ========= ====== =======
Shares used in computing
basic and diluted net
loss per share(1)...... 187 1,350 1,889 1,982 2,025 2,005 2,198
====== ======== ========= ========= ========= ====== =======
Pro forma basic and
diluted net loss per
share(1)............... $ (0.60) $ (0.36)
========= =======
Shares used in computing
pro forma basic and
diluted net loss per
share(1)............... 9,355 9,961
========= =======
</TABLE>

<TABLE>
<CAPTION>
MARCH 31,
----------------------------------------- JUNE 30,
1994 1995 1996 1997 1998 1998
----- ------ ------- ------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash
equivalents............. $ 339 $1,149 $ 420 $ 3,081 $ 1,447 $ 6,176
Total current assets..... 378 1,329 1,056 3,927 2,786 8,830
Total current
liabilities............. 90 333 1,695 3,291 5,749 15,760
Capital lease
obligations, net of
current portion......... 43 205 908 1,946 3,444 4,429
Total stockholders'
deficit................. (271) (766) (2,762) (5,882) (12,414) (14,746)
</TABLE>
- --------
(1) See Notes 1 and 5 of Notes to Financial Statements for an explanation of
the determination of the number of shares used in computing per share
amounts.

21
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the
"Selected Financial Data" and the Company's Financial Statements and Notes
thereto included elsewhere in this Prospectus. This Prospectus contains
forward-looking statements that involve risks and uncertainties. The Company's
actual results may differ materially from the results discussed in such
forward-looking statements. Factors that might cause such a difference
include, but are not limited to, those discussed below and in "Risk Factors"
and "Business," as well as those discussed elsewhere in this Prospectus.

OVERVIEW

Pilot provides comprehensive security services that incorporate high
bandwidth connectivity and enable secure electronic commerce over the
Internet. Pilot's services include secure access and gateway services, secure
hosting and electronic commerce services, and secure extranet and virtual
private networking services. The Company delivers its services from
geographically dispersed Network Security Centers that are connected through
its secure high performance Internet backbone.

The Company was incorporated in August 1992 and commenced operations in
1993. The Company opened its first Network Security Center in the San
Francisco metropolitan area in 1993, followed by three additional centers in
the Los Angeles, New York and Chicago metropolitan areas in 1995. The Company
is commencing operations at Network Security Centers in the Boston,
Minneapolis, Washington, D.C. and London metropolitan areas during 1998.

Customers subscribe to the Company's services for an initial setup fee plus
a fixed monthly fee. The Company's contracts with its customers are generally
based on a one-year term with renewal periods. The minimum first-year
commitment is $62,000 consisting of an installation fee of $6,000 per month
for the first two months of service and a recurring fee of $5,000 per month
for ten months. Service fees vary according to the services selected by the
customer. In fiscal 1998, the average new customer commitment for the first
year of service was $81,000. Installation fees are typically recognized as
revenue over the installation period, which is generally 60 days. The ongoing
monthly fees are billed one month in advance for the following month and
recognized as revenue when earned in the following month.

The Company has recently expanded and expects to continue to expand its
capacity significantly, sales and marketing activities and the development of
new services by making significant investments in new and existing Network
Security Centers. This subjects the Company to relatively large increments of
fixed expenses in advance of potential future revenues. As a result, the
Company has incurred and expects to incur substantially higher costs of
revenues during these periods. The Company has and anticipates that it will
continue to add customers over time to utilize this planned capacity
expansion. However, because its services are offered on a subscription basis
rather than for an up front fee, revenues from any additional customers
increase gradually. As a result, although the planned capacity expansion may
potentially increase the Company's revenue and profitability over the long
term, the Company experienced a decline in gross margin and an increase in net
loss in fiscal 1997 and expects to continue to experience significant net
losses on a quarterly and annual basis for the forseeable future, including a
decline in gross margin at least through fiscal 1999.

Since the Company's inception, it has experienced operating losses and
negative cash flows from operations in each quarterly and annual period. As of
June 30, 1998, the Company had an accumulated deficit of approximately $16.7
million. The revenue and income potential of the Company's business and market
is unproven, and the Company's limited operating history makes an evaluation
of the Company and its prospects difficult. The Company and its prospects must
be considered in light of the risks, expenses and difficulties encountered by
companies in the new and rapidly evolving market for Internet system and
network management solutions. To address these risks, among other things, the
Company must market its brand name effectively,

22
<PAGE>

provide scaleable, reliable and cost-effective services, continue to grow its
infrastructure to accommodate new Network Security Centers and increased
bandwidth use of its network, expand its channels of distribution, retain and
motivate qualified personnel and continue to respond to competitive
developments. Failure of the Company to achieve market acceptance of its
services would have a material adverse effect on the Company's business,
results of operations and financial condition. There can be no assurance that
the Company will ever achieve profitability on a quarterly or an annual basis
or will sustain profitability if achieved. See "Risk Factors--Limited
Operating History; History of Losses."

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the percentage
relationship of certain items from the Company's statement of operations to
service revenues.

<TABLE>
<CAPTION>
THREE MONTHS
ENDED JUNE 30,
YEAR ENDED MARCH 31, (UNAUDITED)
------------------------ -----------------
1996 1997 1998 1997 1998
------ ------ ------ ------- -------
<S> <C> <C> <C> <C> <C>
Service revenues................ 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of service revenues........ 56.4 66.4 86.8 70.9 108.1
------ ------ ------ ------- -------
Gross margin.................... 43.6 33.6 13.2 29.1 (8.1)
Operating expenses:
Sales and marketing........... 71.0 49.3 38.1 35.3 57.4
Engineering and development... 6.4 4.4 7.1 5.7 8.0
General and administrative.... 30.3 16.9 13.6 13.9 18.5
------ ------ ------ ------- -------
Total operating expenses.... 107.7 70.6 58.8 54.9 83.9
------ ------ ------ ------- -------
Operating loss.................. (64.1) (37.0) (45.6) (25.8) (92.0)
Interest expense, net........... (5.2) (5.1) (4.2) (3.4) (5.6)
------ ------ ------ ------- -------
Net loss........................ (69.3)% (42.1)% (49.8)% (29.2)% (97.6)%
====== ====== ====== ======= =======
</TABLE>

FISCAL YEARS ENDED MARCH 31, 1996, 1997 AND 1998

Service revenues. Service revenues consist of monthly fees for installation,
recurring services and, to a lesser extent, one-time fees for management and
consulting services such as security audits. The Company's service revenues
increased 150% from $2.5 million in fiscal 1996 to $6.3 million in fiscal 1997
and increased an additional 80% to $11.3 million in fiscal 1998. The growth in
the Company's service revenues over this period resulted primarily from an
increase in the number of customers and to a lesser extent from increases in
the number of service offerings and in service revenues per customer. To date,
a substantial majority of the Company's revenues have been derived from its
secure access, gateway and hosting services.

Cost of service revenues. The Company's cost of service revenues is
comprised primarily of the Company's costs for network bandwidth, equipment
costs and salaries and benefits for the Company's customer service and
operations personnel, including its network engineers, backbone engineers,
network management and systems and installation personnel. Network bandwidth
consists of costs for access to and use of third-party communications
networks.

Cost of service revenues increased from $1.4 million in fiscal 1996 to $4.2
million in fiscal 1997 and to $9.8 million in fiscal 1998. The Company's cost
of service revenues as a percentage of service revenues increased from 56.4%
in fiscal 1996 to 66.4% in fiscal 1997, and to 86.8% in fiscal 1998. The
increases in cost of service revenues in absolute dollars and as a percentage
of service revenues were due to increased costs

23
<PAGE>

associated with the build-out and operation of the Company's Network Security
Centers, including increased costs for its network bandwidth, equipment costs
and salaries and benefits for its customer service and operations personnel.
As discussed above, the Company expects cost of service revenues to increase
on an absolute basis and as a percentage of revenues at least through fiscal
1999 as a result of the planned expansion of the Company's Network Security
Centers.

Sales and marketing. The Company's marketing and sales expenses are
comprised primarily of salaries, commissions and benefits for the Company's
marketing and sales personnel and marketing expenses for items such as trade
shows and product literature. The Company's sales and marketing expenses
increased from $1.8 million in fiscal 1996 to $3.1 million in fiscal 1997 and
to $4.3 million in fiscal 1998. These increases were primarily the result of
hiring additional marketing and sales personnel and expanding marketing
programs in connection with the Company's expansion of its operations. The
Company expects that marketing and sales expenses will continue to increase in
absolute dollars but may begin to decline as a percentage of total revenues to
the extent recurring revenues from current customers, which tend to have lower
marketing and sales expenses, increase as a percentage of total revenues.

Engineering and development. The Company's engineering and development
expenses are comprised primarily of salaries and benefits for its engineering
and development personnel and fees paid to consultants. These individuals work
on day-to-day security operations, development of new processes and
methodologies, and integration of best-of-breed components into the Company's
secure operating environment. The Company's engineering and development
expenses increased from $162,000 in fiscal 1996 to $275,000 in fiscal 1997 and
to $799,000 in fiscal 1998. The Company's security and services development
expenses grew between the comparison periods primarily due to the addition of
engineering personnel required to support the Company's expanded service
offerings. The Company expects that engineering and development expenses will
continue to increase in absolute dollars as the Company makes additional
investments in developing its secure electronic commerce services.

General and administrative. The Company's general and administrative
expenses are comprised primarily of salaries and benefits for the Company's
general management and administrative personnel as well as fees paid for
professional services. The Company's general and administrative expenses
increased from $766,000 in fiscal 1996 to $1.1 million in fiscal 1997 and to
$1.6 million in fiscal 1998. These increases were primarily the result of
increased hiring of general and administrative personnel, and costs for
consultants and professional services providers. These increased expenses
reflected the Company's need for additional general and administrative
personnel to handle the expansion of the Company's operations. General and
administrative costs are expected to increase significantly in absolute
dollars to the extent the Company expands its operations and as a result of
costs associated with being a public company.

Interest expense, net. The Company's net interest expense increased from
$131,000 in fiscal 1996 to $323,000 in fiscal 1997 and to $471,000 in fiscal
1998. The increases in net interest expense between the comparison periods
were primarily the result of increased borrowings as the Company entered into
equipment loans and lease agreements to finance the construction of its
Network Security Centers.

Income tax benefit. There has been no provision for income taxes in fiscal
1996, 1997 and 1998 due to the Company's net losses. As of March 31, 1998, the
Company has approximately $9.5 million of operating loss carryforwards for
federal tax purposes. These expire at various periods through the year 2012.
Because of the uncertainties surrounding the Company's ability to utilize
those tax losses in future periods, the Company does not carry a corresponding
net tax asset in its financial statements.

Net loss attributable to common stockholders. Net loss per share reflects a
charge for accretion on redeemable convertible preferred stock of $263,000 in
fiscal 1996, $478,000 in fiscal 1997 and $1,069,000 in fiscal 1998. The
Company will no longer record a charge for accretion on redeemable convertible
preferred stock upon conversion of all outstanding Preferred Stock of the
Company at the closing of this Offering.

24
<PAGE>

QUARTERLY RESULTS OF OPERATIONS

The following table sets forth certain unaudited statements of operations
data of the Company for each of the five quarters for the period ended June
30, 1998, as well as such data expressed as a percentage of the Company's net
revenues for the quarters presented. This information has been derived from
the Company's unaudited financial statements, which, in management's opinion,
have been prepared on substantially the same basis as the audited financial
statements and include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the financial information
for the quarters presented. This information should be read in conjunction
with the Financial Statements and Notes thereto included elsewhere in this
Prospectus. The operating results in any quarter are not necessarily
indicative of the results for any future period.

<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------
JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30,
1997 1997 1997 1998 1998
-------- --------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Service revenues........ $2,461 $ 2,774 $ 2,977 $ 3,105 $ 3,720
Cost of service
revenues............... 1,745 2,290 2,623 3,167 4,023
------ ------- ------- ------- -------
Gross margin............ 716 484 354 (62) (303)
Operating expenses:
Sales and marketing.... 867 850 1,082 1,507 2,134
Engineering and
development........... 143 184 243 229 299
General and
administrative........ 341 390 435 385 688
------ ------- ------- ------- -------
Operating expenses..... 1,351 1,424 1,760 2,121 3,121
------ ------- ------- ------- -------
Operating loss.......... (635) (940) (1,406) (2,183) (3,424)
Interest expense, net... (83) (94) (145) (149) (208)
------ ------- ------- ------- -------
Net loss................ $ (718) $(1,034) $(1,551) $(2,332) $(3,632)
====== ======= ======= ======= =======
AS A PERCENTAGE OF
REVENUES:
Service revenues........ 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of service
revenues............... 70.9 82.6 88.1 102.0 108.1
------ ------- ------- ------- -------
Gross margin............ 29.1 17.4 11.9 (2.0) (8.1)
Operating expenses:
Sales and marketing.... 35.3 30.6 36.3 48.5 57.4
Engineering and
development........... 5.7 6.6 8.2 7.4 8.0
General and
administrative........ 13.9 14.1 14.6 12.4 18.5
------ ------- ------- ------- -------
Operating expenses..... 54.9 51.3 59.1 68.3 83.9
------ ------- ------- ------- -------
Operating loss.......... (25.8) (33.9) (47.2) (70.3) (92.0)
Interest expense, net... (3.4) (3.4) (4.9) (4.8) (5.6)
------ ------- ------- ------- -------
Net loss................ (29.2)% (37.3)% (52.1)% (75.1)% (97.6)%
====== ======= ======= ======= =======
</TABLE>

Service revenues. The Company's revenues increased sequentially each
quarter. This growth in revenues resulted primarily from increases in the
number of customers and to a lesser extent increases in the number of service
offerings and in revenues per customer.

Cost of service revenues. The Company's cost of service revenues increased
in absolute dollars and as a percentage of revenues sequentially each quarter.
These increases in cost of service revenues in absolute dollars and as a
percentage of service revenues were primarily the result of costs associated
with expanding the Company's network to provide both broader geographic
coverage as well as increased types of services. Additionally, the Company
incurred higher than usual expenses in the quarters ended March 31 and June
30, 1998 due to the conversion of its backbone network from a "frame relay"
network to an ATM network. This new protocol will allow the Company to more
efficiently and cost effectively expand its communications bandwidth. The
increases in costs for the quarter ended June 30, 1998 also resulted from
increased costs for salaries, telecommunications, recruiting, temporary help
and depreciation associated with preparations to open four new Network
Security Centers. The Company expects that its cost of service revenues as a
percentage of service revenues may remain above 100% through at least fiscal
1999.

25
<PAGE>

Sales and marketing. Sales and marketing expenses as a percentage of total
revenues fluctuated from quarter to quarter primarily due to increases in
personnel, the timing of sales compensation and the timing of promotional
activities. The increase in sales and marketing expenses in the three quarters
for the period ended June 30, 1998 is largely the result of an increase in
sales and marketing personnel from 17 to 38 people during that period.

Engineering and development. Engineering and development expenses have
increased in absolute dollars and as a percentage of revenue as a result of
continuing efforts to develop new security methodologies, integrate and
enhance best-of-breed third-party technologies to support the Company's
security and add new service offerings.

General and administrative. General and administrative expenses have
generally increased primarily as a result of additional personnel, recruiting
fees and consulting costs. The increases in costs for the quarter ended June
30, 1998 resulted from increases in professional fees, business taxes,
salaries and amortization of deferred compensation. The Company expects that
general and administrative expenses will continue to increase in absolute
dollars.

DEFERRED COMPENSATION EXPENSE

Through June 1998, the Company recorded aggregate deferred stock
compensation of $3.2 million in connection with stock options granted during
that period. This deferred compensation is generally being amortized over 48
months in an accelerated manner consistent with Financial Accounting Standards
Board (FASB) Interpretation No. 28. The Company recognized approximately
$459,000 in deferred stock compensation expense through June 1998. The Company
expects total amortization of approximately $1.5 million during fiscal 1999,
$900,000 during fiscal 2000, $500,000 during fiscal 2001 and $200,000 during
fiscal 2002 as a result of deferred compensation expense recorded in fiscal
1998 and the first quarter of fiscal 1999. These amortization amounts will be
allocated to cost of service revenues, sales and marketing, engineering and
development and general and administrative costs based on the applicable job
function of each optionee. See Note 5 of Notes to Financial Statements.

FACTORS AFFECTING RESULTS OF OPERATIONS

The Company derives revenue from its customers primarily through initial set
up fees and ongoing monthly service charges. For each new customer, the
Company must incur costs in anticipation of the customer's decision to use the
Company's services and in advance of the receipt of sufficient revenues to
repay these costs and provide a return on the Company's investment. As a
result, a relatively large portion of the Company's expenditures are fixed in
the short term, and the Company's success is substantially dependent on the
continuous growth in its customer base and the retention of its customers for
sufficient periods to provide returns on the Company's expenditures. The
Company's customers generally enter into one year contracts with the Company,
with renewal periods, and there can be no assurance that the Company's
customers will maintain or renew their commitments to use the Company's
services. The Company typically experiences a lengthy sales cycle for its
services, particularly given the importance to customers of adequately
securing Internet connectivity for electronic commerce and the need to educate
them regarding the requirements for effective network security. Any change in
the sales cycle for the Company's services, particularly as the Company
expands its customer base, could have a significant impact on the Company's
periodic results of operations. Changes in the rate of growth in the Company's
customer base and the customer renewal rates have caused, and are expected to
continue to cause, significant fluctuations in the Company's results of
operations on a quarterly and an annual basis.

The Company expects to continue to experience significant fluctuations in
its future quarterly and annual results of operations due to a variety of
factors, many of which are outside the Company's control, including: demand
for and market acceptance of the Company's services and enhancements; the
timing of customer installations; provisions for customer discounts and
credits; the mix of services sold by the Company; introductions of services or
enhancements by the Company and its competitors; the length of sales cycles;
customer retention; the timing and success of marketing efforts and service
introductions by the Company; the

26
<PAGE>

timely expansion of existing Network Security Centers and completion of new
Network Security Centers; the timing and magnitude of capital expenditures,
including construction costs relating to the expansion of operations; capacity
utilization of its Network Security Centers; the introduction by third parties
of new security, Internet and networking technologies; increased competition
in the Company's markets; changes in the pricing policies of the Company and
its competitors; reliable security, continuity of service and network
availability; the ability to increase bandwidth as necessary; fluctuations in
bandwidth used by customers and fluctuations in the cost of such bandwidth;
the retention of key personnel; economic conditions specific to the Internet
and Internet security industries; and other general economic factors. In
addition, although the Company has not encountered significant difficulties in
collecting upon accounts receivable in the past, there can be no assurance
that the Company will be able to collect receivables on a timely basis.

The market for security monitoring, detection and defense services in
general is new and rapidly evolving. Growth of this market will depend, in
large part, upon the public recognition of the potential threat posed by
computer attackers and other unauthorized users, the increased use of the
Internet and corporate intranets for electronic commerce and business
communications, the ability of network infrastructures to support an
increasing number of users and services, and the continued development of new
and improved services for implementation across the Internet and between the
Internet and corporate intranets. If the necessary network infrastructure or
complementary products and services are not developed in a timely manner and,
consequently, the market for network security solutions fails to grow or grows
more slowly than the Company currently anticipates, the Company's business,
operating results and financial condition would be materially and adversely
affected. Moreover, to date, most businesses have purchased and managed their
own network security solutions and have not sought to outsource network
security to a third party service provider. As a result, customer acceptance
of outsourcing network security services is extremely limited. The Company has
spent, and intends to continue to spend, considerable resources educating
potential customers about the value of outsourcing services provided by the
Company. To date, the Company has experienced lengthy sales cycles for its
services. There can be no assurance that such expenditures will increase
market acceptance of the Company's services, or that such sales cycles will
shorten. If the market for such services fails to grow or grows more slowly
than the Company currently anticipates, the Company's business, operating
results and financial condition would be materially and adversely affected.
See "Risk Factors--Competition."

YEAR 2000 RISKS

Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. This could result in system failures or miscalculations
causing disruptions of operations including, among other things, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activities. As a result, many companies' software and computer
systems may need to be upgraded or replaced in order to comply with such "Year
2000" requirements. The Company has established procedures for evaluating and
managing the risks and costs associated with this problem and believes that
its computer systems are currently Year 2000 compliant. However, many of the
Company's customers maintain their Internet operations on commercially
available operating systems, which may be impacted by Year 2000 complications.
In addition, the Company relies on third party vendors for certain equipment
and software included within the Company's services which may not be Year 2000
compliant. The Company is in the early stages of conducting an audit of its
third-party suppliers as to the Year 2000 compliance of their systems. To
date, the Company has not incurred significant incremental costs in order to
comply with Year 2000 requirements and does not believe it will incur
significant incremental costs in the foreseeable future. However, failure of
the Company's internal computer systems or of such third-party equipment or
software, or of systems maintained by the Company's suppliers, to operate
properly with regard to the Year 2000 and thereafter could require the

27
<PAGE>

Company to incur significant unanticipated expenses to remedy any problems and
could have a material adverse effect on the Company's customers, which could
have a material adverse effect on the Company's business, financial condition
and results of operations. The Company, however, is not aware of any
significant suppliers that anticipate Year 2000 problems.

LIQUIDITY AND CAPITAL RESOURCES

Since inception, the Company has financed its operations primarily through
private sales of capital stock totaling $10.6 million and through various
types of equipment loans and lease lines and working capital lines of credit.
At June 30, 1998, the principal source of liquidity for the Company was $6.2
million of cash and cash equivalents.

As of June 30, 1998, the Company also had an $8.0 million equipment line of
credit and lease facility with Transamerica Business Credit Corporation with
interest rates of approximately 14.5% and an unused balance of $3.5 million,
of which $500,000 is immediately available. In May 1998, the Company obtained
a $1.5 million working capital line of credit with Transamerica Business
Credit Corporation with a minimum interest rate of 11%. As of June 30, 1998,
the Company had borrowed an aggregate of $5.5 million under these lines of
credit and lease facilities. See Note 6 of Notes to Financial Statements.

In June 1998, the Company consummated a borrowing agreement with two lenders
providing an additional $6.0 million of short term financing. The loan expires
in June 1999 and bears interest at 13.5% per year. The loan may be pre-paid at
the Company's option after 6 months and at the option of the lenders at any
time after the closing of this Offering. As additional consideration, the
Company issued 150,000 warrants to purchase Common Stock at an exercise price
of $11.20 per share. The Company has determined that the warrants have a fair
market value of $1.2 million. The Company has capitalized the cost of the
warrants and expects to write off such amount over the one-year term of the
loan.

Since the Company began to offer its services in 1993, the Company has
experienced significant negative cash flows from operating activities. Net
cash used for operating activities was $806,000, $511,000 and $1.9 million in
fiscal 1996, fiscal 1997 and fiscal 1998, respectively. Net cash used for
operating activities in each of these periods was primarily the result of net
losses, and to a lesser extent increases in trade receivables, offset in part
by increases in depreciation and amortization, accounts payable and accrued
expenses. Net cash used for investing activities was $597,000, $651,000 and
$1.5 million in fiscal 1996, fiscal 1997 and fiscal 1998, respectively. Net
cash used for investing activities in these periods was almost entirely the
result of capital expenditures for the construction of Network Security
Centers, leasehold improvements, furniture and fixtures, and computers and
other equipment.

Net cash provided by financing activities in fiscal 1996, fiscal 1997 and
fiscal 1998 was $675,000, $3.8 million and $1.8 million, respectively. Of
these amounts, $903,000, $4.5 million and $3.0 million in fiscal 1996, fiscal
1997 and fiscal 1998, respectively, resulted from the issuance of preferred
stock, net of issuance costs and related warrants.

The Company's capital expenditures for fiscal 1998 were approximately $4.8
million. The Company plans to incur substantial additional capital
expenditures, primarily for additions to and expansions of its Network
Security Centers. Assuming the conversion of the Company's Redeemable
Preferred Stock, as of March 31, 1998 the Company's aggregate payment
commitments under bank borrowings, debt and capital lease obligations, and
noncancelable operating leases were $3.3 million, $3.0 million, $2.0 million
and $1.1 million in fiscal 1999, fiscal 2000, fiscal 2001 and fiscal 2002,
respectively.

28
<PAGE>

flow from operations or additional borrowings, it may be required to sell
assets, scale down its operations and expansion plans, refinance all or a
portion of its existing indebtedness or obtain other sources of financing
earlier than planned, any of which could have a material adverse effect on the
Company's business, results of operations and financial condition. There can
be no assurance that any such refinancing would be available on commercially
reasonable terms, or at all, or that any other financing could be obtained.
See "Use of Proceeds" and Notes 3 and 6 of Notes to Financial Statements.

29
<PAGE>

BUSINESS

OVERVIEW

Pilot provides comprehensive security services that incorporate high-
bandwidth connectivity and enable secure electronic commerce over the
Internet. The Company provides a broad range of security services for a fixed
monthly fee on an annual subscription-basis. The Company's services include
secure access and gateway services that enable secure connectivity between a
corporate network and the Internet, secure hosting of customer Internet
servers at company locations and electronic commerce services, and secure
extranet and virtual private networking services that enable remote users or
networks to securely communicate over the Internet with a local network. The
Company offers a scalable solution that allows customers to quickly deploy and
expand electronic commerce capabilities by subscribing to Pilot's secure
Internet services.

Pilot's subscription-based secure Internet services allow customers to avoid
the risks associated with traditional approaches to Internet security.
Customers can also avoid extensive costs associated with implementing an in-
house solution, including set-up costs for security and systems design,
hardware, software, Internet access services provided by Internet Service
Providers ("ISPs") and labor, and ongoing costs for telecommunications,
staffing, maintenance and upgrades.

The foundation of Pilot's solution is its Dynamic Security Infrastructure,
an Internet security approach developed by Pilot to continuously manage and
monitor Internet traffic to and from customer networks in order to respond in
real-time to security threats. The Dynamic Security Infrastructure consists of
a multi-layered defensive architecture and around-the-clock security
operations delivered through geographically dispersed Pilot customer centers
called Network Security Centers that are connected to customer networks via
dedicated, high-speed data lines. The Pilot solution aggregates the experience
gained from protecting each customer against attacks and leverages such
experience for the collective benefit of all customers. The Dynamic Security
Infrastructure offers benefits over other security approaches by eliminating
single points of failure, enhancing attack detection, delivering real-time
defenses, and adapting continuously to external conditions. Customers can
concentrate on their core business because the secure infrastructure for
electronic commerce is provided by Pilot.

INDUSTRY BACKGROUND

Over the past several years, the Internet has become an increasingly
important means of communications. International Data Corporation (IDC)
estimates that the number of World Wide Web ("Web") users was approximately 69
million at the end of 1997 and will grow to 320 million users by the end of
2002. The explosive growth of the Internet is being driven not only by its
global reach, easy accessibility and use of open standards, but also by its
promise to greatly improve the cost efficiency and quality of communications.

To date, Internet growth has been fueled primarily by the use of general
applications such as electronic mail, chat and Web browsing. The Internet's
potential for more cost-efficient and higher quality communications has made
it an increasingly attractive platform for complex business applications such
as marketing and sales, contract negotiations and customer support. As a
result, an increasing number of businesses seek to use the Internet as a means
for extending their traditional business activities. Business activities over
the Internet involve not only commercial transactions, but also general
business communications. These communications include running mission-critical
applications across geographically dispersed facilities, exchanging highly
sensitive information and linking customers, remote employees and business
partners in extended business networks.

These business activities have become known as electronic commerce. Use of
the Internet for electronic commerce is expected to grow substantially. For
example, IDC estimates that the value of electronic commerce will grow from
$12 billion in 1997 to $426 billion in 2002.

Despite the advantages of conducting business on the Internet, lack of
Internet security is a significant inhibitor to the adoption and growth of
electronic commerce. The Internet is inherently vulnerable to security

30
<PAGE>

breaches due to its easy accessibility, use of open standards and lack of
centralized management. As the Internet has developed into an increasingly
complex computing environment with multiple hardware, operating systems,
networking protocols and applications supplied by different vendors, it has
become even more vulnerable to security breaches. Although losses due to
computer crime and security breaches are difficult to estimate, independent
industry sources estimate such losses were between $3 billion and $5 billion
in 1997. These intrusions draw unwelcome attention from the press and
financial community. As a result of security concerns, businesses are
investing substantial amounts of money in security technology. According to
market research firm INPUT, the total worldwide market for firewall software
and services alone is predicted to grow from $1.1 billion in 1995 to $16.2
billion in 2000.

Limitations of Existing Security Approaches

To date, much of the investment in security technology has been directed to
"point" products specifically designed to address only a single aspect of
Internet security. Perhaps the most widely used point product is the firewall,
which provides a barrier between a company and the Internet. Although there
are dozens of commercially available firewall software packages, they are
often difficult to install and must be configured and constantly maintained by
skilled personnel. Other popular point product technologies include encryption
(which protects information during transmission) and access security
mechanisms (such as user authentication and passwords). There are more than 15
different point products that companies can purchase and integrate to enhance
security.

However, even if all of these technologies are properly implemented, it is
often still possible for computer attackers to successfully breach security.
For example, in a 1995 study conducted by the FBI and the Computer Security
Institute, 30 percent of all reported successful break-ins involving the
Internet took place despite the presence of a firewall. This is possible
largely because point products typically provide only a static, single point
of defense which can fail if computer attackers find new loopholes to exploit.
Point products also suffer from being difficult to integrate and manage as a
single solution because they are generally developed by different vendors.
Finally, even if companies are successful in installing an integrated set of
point products, maintaining them requires companies to continuously invest in
updating current versions and training its security administrators.

To mitigate this complexity, some vendors have combined multiple point
products in an effort to provide more integrated product offerings. However,
customers using these products are often forced to make a trade-off between
selecting the best-of-breed products regardless of vendor, or installing a set
of point products that are integrated but not best-of-breed. Moreover, neither
stand-alone nor integrated product offerings address the inherent limitations
of static approaches, which do not evolve rapidly in response to the
increasing sophistication of attackers, the evolution of networks and the
increasing complexity and value of Internet applications. Fundamentally, such
offerings fail to effectively address security as a process, which is
characterized by the need to evolve with and respond rapidly to a continuously
changing network environment.

To address these concerns, some companies have outsourced the management of
their Internet security infrastructure to Internet Service Providers (ISPs)
and Web hosting services. However, ISPs and Web hosting services have
traditionally focused on providing high-bandwidth access and Web design
services and have generally addressed security concerns secondarily, if at
all, through outsourced administration of point product offerings.

THE PILOT SOLUTION

Pilot offers services designed to combine the highest level of commercially
available security with high bandwidth connectivity to enable secure
electronic commerce over the Internet. The foundation of Pilot's solution is
its Dynamic Security Infrastructure, consisting of a multi-layered defensive
architecture and security operations 24 hours a day, 7 days a week (24x7)
delivered through geographically dispersed Network Security Centers. This
infrastructure allows Pilot to continuously manage and monitor Internet
traffic to and from

31
<PAGE>

customer networks in order to respond in real-time to security threats. The
Pilot solution aggregates the experience gained from protecting each customer
against attacks and leverages such experience for the collective benefit of
all customers. As illustrated below, the Dynamic Security Infrastructure
offers benefits over other security approaches by eliminating single points of
failure, enhancing attack detection, delivering real-time defenses, and
adapting continuously to external conditions.

[Graphic depicts two charts, side-by-side. The chart in the left of the graphic
depicts Static Security Products. The left chart shows a gray cloud
representing the Internet. A line of data passes through a transparent box
representing an Internet Service Provider and enters directly into a Customer
Network. The left chart states "Must be precisely configured and constantly
upgraded by dedicated in-house staff" and "Must be continuously monitored and
acted upon by customer." The chart in the right of the graphic depicts Pilot's
Dynamic Security Infrastructure. It depicts the same gray cloud and line of
data. However, before reaching the Customer Network, the line of data passes
through Pilot's Dynamic Security Infrastructure. The Dynamic Security
Infrastructure contains active arrows indicating the action and responsive
change that the Pilot service provides. The right chart states "Fully
configured and upgraded by Pilot," "Statistical and event-based monitoring
(24x7) by security engineers" and "Multi-layer, fully redundant technology."]

STRATEGY

The Company's strategy is to become the leading supplier of secure
electronic commerce services for businesses worldwide. Key elements of the
Company's strategy include:

Maintain Leadership in Security and Electronic Commerce Services. Pilot
intends to maintain and enhance its technological leadership in security and
electronic commerce services. Pilot's Dynamic Security Infrastructure is the
first dynamic, multi-layered service with built-in security for corporate
Internet protection against computer attackers. It consists of proprietary
security processes incorporating third-party best-of-breed components. To
improve and upgrade its Dynamic Security Infrastructure the Company
continuously develops new software, methodologies and approaches, and
evaluates new security technologies. The Company intends to hire additional
network and Internet security experts to expand its database of security
knowledge and experience, and continue to invest in new electronic commerce
services.

Strengthen Marketing and Distribution Channels Through Strategic
Relationships. Pilot intends to expand the marketing and distribution of its
service offerings by pursuing strategic relationships with systems integrators
and consultants. The Company has established a strategic marketing
relationship with Arthur Andersen LLP

32
<PAGE>

("Arthur Andersen") and is expanding its relationship with GE Capital
Information Technology Solutions, Inc. ("GE Capital ITS"). In addition, the
Company has engaged in joint-marketing activities with many of its vendors,
such as Sun Microsystems and Cisco Systems. The Company also intends to build
relationships with other market leaders, such as telecommunications carriers,
that can benefit from and leverage its secure communications infrastructure.

Expand Global Presence. Pilot's mission is to make its service offerings
available on a global scale. The Company's services are currently offered
nationwide through Network Security Centers located in the San Francisco, Los
Angeles, New York and Chicago metropolitan areas. Pilot plans to expand its
Network Security Centers both nationally and internationally. Pilot is
commencing operations at Network Security Centers in the Boston, Minneapolis,
Washington, D.C. and London metropolitan areas during 1998. An important
element of Pilot's international expansion strategy is forming strategic
partnerships with companies which have established marketing and distribution
infrastructures in foreign markets, including systems integrators and
telecommunications carriers.

Offer Emerging Secure Electronic Commerce Services. Pilot's proprietary
Dynamic Security Infrastructure establishes a secure platform for electronic
commerce and business communications. Pilot plans to expand its offering of
electronic commerce services to include broad market applications that
leverage its secure network, such as electronic data interchange (EDI), secure
messaging, payment processing, bill presentment, electronic wallets,
micropayments and public key infrastructure (PKI) management, and specialized
vertical market applications in the transportation, financial services,
consumer, entertainment, and high-tech industries. Pilot plans to offer these
applications through continued enhancement of its core network and security
service offerings as well as through partnering with best-of-breed vendors.

SERVICES

The Company offers three categories of services: secure access and gateway
services; secure hosting and electronic commerce services; and secure extranet
and virtual private networking services. Customers subscribe to the Company's
services for an initial installation fee and a fixed monthly fee. The
Company's contracts with its customers are generally based on a one-year term
with renewal periods. Service fees vary according to the services selected by
the customer. The minimum first-year commitment is $62,000 consisting of
installation fees of $6,000 in each of the first two months of service
followed by a recurring fee of $5,000 per month for ten months. In fiscal
1998, the average new customer first-year commitment was $81,000.

Secure Access and Gateway Services. The Company provides secure access and
gateway services that enable secure connectivity between a corporate network
and the Internet. Services range from secure access to electronic mail
gateways and Web servers to custom electronic commerce offerings.

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

Secure Internet Provides continuously monitored, secure
Services connectivity between an enterprise network and the
Internet at speeds of T-1 (1.5Mbps) to T-3
(45Mbps). These services include telecommunications
connectivity, selected gateway services and custom
security policy configuration to protect a
customer's internal network from unauthorized
access from the Internet.

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

Authentication Provides user and network device authentication,
Services including options for hardware-based token
authentication, Web traffic filtering or reporting
and virus scanning.

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

Secure Telecommuting Enables secure, high-performance telecommuting
Services between a remote user in a fixed-location and an
enterprise network.

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

Auxiliary Services Includes options for back-up communications and for
defining security zones within an enterprise
network.

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

33
<PAGE>

Secure Hosting and Electronic Commerce Services. The Company provides secure
hosting and electronic commerce services that combine high-throughput data
transmission (10Mbps and higher) and comprehensive host security.

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

Secure Hosting Includes hosting of FTP, World Wide Web and News
Services servers at Pilot's Network Security Centers.
Industry-standard hardware and software for these
services are dedicated to individual customers.

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

Secure Commerce Web Provides a secure operating system and network
infrastructure for Web-based and electronic
commerce applications. Dedicated Internet
bandwidth, extra database protection, and
monitoring software enable mission-critical systems
deployment.

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

Secure Flex Web Provides a secure network infrastructure for Web-
based and electronic commerce applications,
allowing customers to physically maintain some or
all of their application/Web servers at a Pilot
Network Security Center while retaining the ability
to directly maintain and manage the servers from
their location over a secure link. The Company
supports Windows NT and UNIX-based Internet
applications.

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

Secure Extranet and Virtual Private Network Services. The Company provides
secure extranet and virtual private network services that combine integrated
security and bandwidth to enable remote users or networks to communicate with
a local network. These services include encryption, authentication and access
control technologies to protect both the information in transit as well as the
security of the network.

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

Secure Road Warrior Provides authenticated, encrypted access to
internal networks over the Internet, for mobile
employees or business partners. This service cost-
effectively supports connectivity over any Internet
connection worldwide and protects against
eavesdropping and unauthorized access.

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

Corporate Partner Allows secure network-to-network worldwide
Privacy connectivity between a customer's enterprise
network and networks of business partners,
subsidiaries or branch offices.

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

See "Risk Factors--Risks Associated with the Emerging Market for Outsourced
Network Security Services."

PILOT DYNAMIC SECURITY INFRASTRUCTURE

The Pilot Dynamic Security Infrastructure consists of a multi-layered
defensive architecture, and 24x7 security operations provided through
geographically dispersed Network Security Centers.

Proprietary Architecture

Proprietary Security Processes. The Company has developed a set of
technology-based processes, including secure networking, a layered defense,
real-time data collection and analysis, and a feedback loop that continuously
updates a database of security threats and responses. ISPs typically permit
all traffic that is not explicitly restricted, while Pilot's secure network
blocks all traffic that is not explicitly permitted, greatly reducing the risk
of an attack. Legitimate inbound traffic from the Internet passes through a
number of increasingly protective defensive layers on its way to a customer.
Each layer provides a different type of protection, and combined, these layers
implement customer-specific security policies. This layered defense gives the
Company time to detect, analyze, plan and defend, thereby reducing the
probability of and minimizing the potential damage from an attack. Data
collection and analysis processes include security logging, monitoring and

34
<PAGE>

analysis and authentication. The data from these processes is then analyzed by
proprietary software that applies policy rules and statistical analysis to
identify patterns which could signal an attack in progress. This data along
with ongoing research into current attack methods is continuously used to
update the Company's defense databases and processes, resulting in a system
that learns from its experiences and adapts defenses to respond to emerging
attack techniques. This process allows the Company to aggregate the experience
gained from protecting each individual customer and leverage such experience
for the collective benefit of all customers.

Multi-Layered, Distributed Architecture. Pilot's multi-layered defense
distributes specific functions across separate devices. This adds isolation,
in which the breach of one device does not compromise another; detectability,
in which the time required to attack (and the time available to detect an
attack) is increased; and performance, in which the performance and
measurability of each device can be tailored for its particular purpose. In
contrast, a traditional firewall software package requires many services, such
as electronic mail, telnet, DNS, and FTP, to pass through a single device.
This complexity makes it difficult to rule out inadvertant interactions
between one type of service and another within the same device. Pilot's
distributed defense eliminates these interactions and simplifies attack
detection by distributing each function across separate devices. In addition,
the Company continuously evaluates new technologies to ensure that it
incorporates best-of-breed hardware and software into its infrastructure.

Security Operations

Trained Security Personnel. Pilot's security team includes expert engineers
with significant security experience. The Security Team consists of four
groups: (i) Security Operations, which handles the day-to-day management of
the Pilot Dynamic Security Infrastructure, manages incident investigation and
response, and applies standard procedures regarding changes to Pilot's systems
and services, (ii) Security Engineering, which is responsible for incident
analysis and escalation, attack pattern research, defense design, and service
extension, as well as the creation of new automated methodologies, (iii)
Security Infrastructure, which is responsible for the acquisition and
maintenance of security tools and the development of internal tools, and (iv)
the New Services Group, which incorporates Pilot's security processes into new
services introduced to customers.

Dynamic 24x7 Monitoring and Management. The Pilot Dynamic Security
Infrastructure provides a flexible, dynamic and rapid response capability, 24
hours per day, seven days per week, through its Security Team and the
monitoring and management methods illustrated below. All systems within the
Pilot Dynamic Security Infrastructure log their status and activities in
detail. Using sophisticated display and analysis packages developed by Pilot,
the Security Team detects and stores patterns indicative of an attack and
blocks attackers from further attempts. Patterns of actual and potential
attacks are collected in a centralized security database. Pilot's monitoring
and management methods allow it to protect customers by blocking new attacks
on a real-time basis and rapidly adapting and automating its security
defenses.

[GRAPHIC OF PILOT SECURITY NETWORK APPEARS HERE]

[Chart shows an arrow representing data moving out of a gray symbol of the
Internet through an oval representing the Pilot Security Network. It passes
from the cloud through symbols of Log Servers, Analysis Servers, a Security
Database and finally travels through symbols of Security Engineers performing
Monitoring and Management functions before traveling back through the Pilot
Security Network to a symbol of the Company's customers.]

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<PAGE>

Third-Party Audits. Pilot regularly engages independent third-party security
experts to audit its Dynamic Security Infrastructure. Such auditors prepare a
detailed technical report for Pilot's internal use, and an executive summary
available to Pilot's current and potential customers. The most recent audit
was conducted by Trident Data Systems in April 1998.

The Company's engineering and development efforts have primarily focused on
the development of its proprietary architecture and security operations and
have been funded almost exclusively by the Company. Engineering and
development expenses of the Company were $162,000, $275,000, $799,000 and
$299,000 in fiscal 1996, 1997 and 1998 and the first quarter of fiscal 1999,
respectively. Funding of engineering and development efforts by customers has
not been material.

Network Infrastructure

Network Security Centers. The Company provides its services to customers by
connecting their networks to the Internet through its regional Network
Security Centers via dedicated, high-speed data lines. The Company currently
has Network Security Centers located in the San Francisco, Los Angeles, New
York and Chicago metropolitan areas. Pilot is commencing operations at Network
Security Centers in the Boston, Minneapolis, Washington D.C. and London
metropolitan areas during 1998. Each Network Security Center establishes
interconnections with other global and local Internet service providers. The
Company currently connects directly to the Internet at four major network
access points: Pacific Bell and Palo Alto Exchange in Northern California;
Sprint in New York; and Ameritech in Chicago. The Company also maintains
private connections from each Network Security Center to MCI and Sprint and
from two centers to UUNET. Each Network Security Center is also connected to
Pilot's Secure Asynchronous Transfer Mode (ATM) Backbone. As a result,
customer connectivity to various Internet sites can be improved by routing
traffic through Pilot's Secure ATM Backbone in addition to direct Internet
interconnections.

The distributed design of the Company's architecture allows Pilot to scale
security and electronic commerce services relatively easily. Additional
servers, telecommunications capacity and Pilot services can easily be added to
meet customer demand. In the event of equipment failure, operations are
disrupted only for the components involved, and not across all services.
Because of Pilot's standardized operations, internal monitoring and backup
equipment, a failure can be detected and a replacement operation scheduled
rapidly, minimizing downtime. Each Network Security Center is staffed by
technical, sales and customer support personnel, and operates as a physically
secured facility for Pilot and customer equipment. Each Network Security
Center is constructed with high-availability power supplies, fire suppression,
computer cooling systems and braced racks.

Pilot Secure ATM Backbone. In addition to bandwidth management, the Pilot
Secure ATM Backbone is used for Pilot-specific traffic, such as security
management and monitoring, and customer-specific traffic, such as secured
traffic between multiple Pilot customers. Unlike backbone networks of most
other providers, this network blocks all traffic except for traffic that is
specifically allowed. The Pilot Secure ATM Backbone also supports a wide
variety of encryption options, so that traffic between customers can be
secured at multiple levels.

The operation and expansion of the Company's network infrastructure is
subject to a number of risks, including those set forth in "Risk Factors--
Risks Associated with Security Breaches," "--Risks of Business Expansion and
Management Growth," "--Risks of System Failure," "--Dependence Upon
Scalability of the Company's Network" and "--Dependence on Third-Party Network
Infrastructure Providers."

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<PAGE>

CUSTOMERS

The Company's customers span a diverse range of industries. The Company's
services are suitable for any organization building or maintaining Internet-
based connectivity for their networks or applications at or above the Company's
minimum bandwidth requirements. The following is a representative list of
customers who as of May 31, 1998 have entered into annual commitments to
purchase more than $50,000 of services from the Company. No single customer
accounted for more than 5% of the Company's total revenues for the year ended
March 31, 1998.

FINANCIAL AND HIGH-TECHNOLOGY CONSUMER,
PROFESSIONAL SERVICES ENTERTAINMENT,
Altera Corporation EDUCATION AND MEDIA
A.M. Best Company AVCOM Technologies,
American Bar Inc. 20th Century Fox, Inc.
Association Cogit Corporation American Stores Company
American Medical Computer Adaptive The Good Guys, Inc.
Association Technology Los Angeles Times
American Stock E-Stamp, Inc. Playboy Enterprises,
Exchange, Inc. Lucent Technologies Inc.
C.E. Unterberg, Towbin PeopleSoft, Inc. PR Newswire, Inc.
Co. Xilinx, Inc. Rainbow Media Holdings,
First Data Corporation Inc.
Gibson, Dunn & Crutcher INDUSTRIAL AND Saban Entertainment,
LLP MANUFACTURING Inc.
Graham & James, LLP Wilson Sporting Goods
Memorial Health Continental Grain Co.
Services Company Ziff-Davis Comdex &
Morrison & Foerster, Global Marine, Inc. Forums
LLP JM Huber Corporation
Troop Meisinger Steuber Kaiser Aluminum &
& Pasich, LLP Chemical Corporation
Pacific Enterprises
(parent of Southern
California Gas)
QST Industries, Inc.

The following are examples of actual uses of the Company's services by
representative customers:

PeopleSoft, Inc. PeopleSoft, Inc., a leading provider of enterprise
application software products, selected Pilot to provide secure, high-bandwidth
access between its worldwide network and the Internet. Network availability
requirements will become increasingly significant for PeopleSoft as its
products incorporate the Internet and use it for product demonstrations and
deployment. Pilot engineered the integration of high-speed fiber connections,
the associated routing and the security infrastructure components to create
secure Internet connections for PeopleSoft. Secure connectivity and Pilot's
ongoing security services enable PeopleSoft to protect its critical internal
engineering and business networks from electronic intruders.

E-Stamp, Inc. E-Stamp, Inc. is the first company to be granted permission by
the United States Postal Service (USPS) to field test an Internet postage
solution. E-Stamp's products and services give users with a PC, printer and
Internet access the ability to easily and securely purchase and print postage.
In 1997, E-Stamp selected Pilot to provide Internet security and connectivity
services for its ESTAMP.COM(TM) commerce servers. The Pilot solution for E-
Stamp incorporates several distinct security elements, including encryption and
authentication components, secure data replication services, telecommunications
connections, physical security, high-availability features and protection
against a number of denial-of-service attack techniques. Pilot helped E-Stamp
design its network infrastructure and worked with the USPS and other auditor
groups to ensure adherence to security requirements.

20th Century Fox, Inc. 20th Century Fox, Inc. ("Fox"), a division of News
Corporation, is a leading media and entertainment enterprise. Pilot provides a
variety of electronic commerce and secure access services to Fox. Since 1995,
Fox has used Pilot's secure Internet services to connect its internal networks
to the Internet. More recently, Pilot has provided hosting services for Web
sites associated with Fox's "The X-Files" television show (www.thex-files.com)
and "Titanic" motion picture (www.titanicmovie.com). These sites are
particularly

37
<PAGE>

vulnerable to electronic attack due to their content and high traffic levels.
For example, the site for "Titanic" initially received an average load of
several million hits per day, with an immediate 50% increase in the week
following the Academy Awards. Fox selected Pilot to provide Web hosting
services because of Pilot's expertise both in securing high-profile Web sites
and in providing high-performance connectivity and availability.

PR Newswire, Inc. PR Newswire, Inc., a leading distributor of full-text news
to the media and financial communities, requires immediate, highly-reliable
information flow between its regional offices and to newsmakers, news media
and Internet news consumers. PR Newswire selected Pilot in early 1997 to
provide secure connectivity between its worldwide WAN and the Internet. More
recently, PR Newswire has had discussions with Pilot regarding the addition of
independent connections from multiple cities to Pilot's backbone, in order to
establish a high bandwidth, high performance, secure virtual private network.

SALES, MARKETING AND CUSTOMER SUPPORT

The Company's sales, marketing, and customer support efforts are designed to
achieve broad market penetration by targeting enterprises that depend upon the
Internet for electronic commerce and business communications. The Company also
intends to build a recurring revenue base from such enterprises by continuing
to provide value-added services and through active account management.

As of June 30, 1998, the Company had 55 employees in sales, marketing, and
customer support. The Company's sales force is organized into separate groups
consisting of field sales (account generation), strategic accounts (account
retention and expansion), partnerships and alliances (channel and OEM sales),
and telesales. Each of these groups is further divided into geographical
regions within the United States. The Company's sales, marketing and customer
support employees are located at the Company's headquarters in Alameda,
California, and in most of the Company's other Network Security Centers.

To date, most of the Company's sales have been derived directly through the
efforts of its sales force. The Company is actively seeking to increase its
sales and marketing capabilities and coverage in the United States and to
expand internationally as new Network Security Centers are established outside
of the United States. See "Risk Factors--Risks of Business Expansion and
Management of Growth."

A key element of the Company's sales and marketing strategy is to strengthen
relationships with partners in order to generate an increasing percentage of
total sales through partners. The Company is building joint-marketing
relationships with strategic partners, such as Arthur Andersen and GE Capital
ITS, electronic commerce vendors, such as BroadVision, Open Market and
VeriSign, technology vendors such as Cisco Systems, Inc., Sun Microsystems,
Oracle Corporation, VPNet Technologies, IPass, and TrendMicro and selected
telecommunications partners. See "Risk Factors--Dependence on Other Third-
Party Relationships."

The Company's marketing organization is responsible for new service
introductions, public relations and marketing communications. New service
introductions include strategy, definition, pricing, competitive analysis,
launches, and partner program management. The Company stimulates demand for
its services through a broad range of marketing communications and public
relations activities, including co-marketing efforts with the Company's
marketing partners. Primary marketing communications vehicles include Web
banner and direct mail promotions, telemarketing, trade shows and seminars,
event sponsorship and management of the Company's Web site. Public relations
focuses on cultivating industry analyst and media relationships with the goal
of obtaining media coverage and public recognition of the Company's leadership
position in the market for secure electronic commerce and business
communications services.

The Company's account management and customer support organization provides
cross-functional teams for customers consisting of account management,
customer service and operations personnel. The Company regularly conducts
account reviews internally with customers to measure satisfaction. Pilot's
customer base provides revenue growth opportunities in the form of referrals,
recurring revenue, and new services. Customers generally enter into one year
contracts with the Company, with renewal periods. However, there can be no
assurance that the Company's customers will continue or renew their
commitments to use the Company's services.

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<PAGE>

STRATEGIC RELATIONSHIPS

The Company continues to establish strategic relationships with leading
firms which act as marketing partners, electronic commerce vendors, technology
vendors and telecommunications carriers.

Marketing Partners. The Company's marketing partners assist the Company in
introducing, marketing and selling the Company's services alongside their own
complementary services. The Company works with Arthur Andersen to identify and
develop mutual information security and electronic commerce opportunities. The
Company and Arthur Andersen executed several joint marketing programs between
June 1997 and June 1998, including fax and direct mail campaigns, seminars and
joint customer calls. In addition, the Company is expanding its relationship
with GE Capital ITS whereby GE Capital ITS will assist the Company in
marketing the Company's services to its corporate clients nationwide. GE
Capital ITS was formed in 1996 as a result of the acquisition of Ameridata
Technologies, Inc. by General Electric Capital Corporation, and resells
information technology products and services. Arthur Andersen and General
Electric Capital Corporation, the parent of GE Capital ITS, are also
stockholders of the Company, and certain General Electric business units are
subscribers to the Company's services. See "Certain Transactions."

Electronic Commerce Vendors. The Company is currently building relationships
with electronic commerce vendors, including BroadVision, Open Market and
VeriSign, that provide complementary technologies for assisting customers in
developing and deploying complete, high-performance electronic commerce
solutions. BroadVision and Open Market provide software applications for which
security, high availability, manageability and high performance are critical.
By focusing on a limited number of leading vendors, the Company builds
stronger technical and operational expertise with respect to these particular
technologies in order to provide better security and management services to
customers working with those vendors. The Company has mutual customers with
both BroadVision and Open Market and plans to engage in joint marketing and
cross-selling programs to these partners' customer and prospect bases. The
Company embeds digital certificates in its electronic commerce services to
provide increased data integrity and authentication. The generation and
distribution of these certificates is provided by VeriSign and included
transparently in the Company's services where appropriate.

Technology Vendors. The Company's technology vendors provide industry-
standard hardware, software or service components to the Company at favorable
prices with back-up support, which assists the Company in delivering its
services. In many cases the Company has executed or plans to execute co-
marketing or lead generation programs with these vendors. The Company's
principal technology vendors are Cisco Systems, Sun Microsystems, VPNet
Technologies, iPass, Oracle Corporation, Netscape Communications Corporation,
RSA Data Security and Trend Micro. The Company is a member of the "Cisco
Powered Network" branding program and carries the exclusive "innovator"
designation. Cisco Systems provides a market development fund consisting of a
portion of the Company's equipment spending with Cisco Systems to fund
marketing programs. In the fall of 1997, Cisco Systems, Pilot, and Arthur
Andersen conducted a six-city seminar program focused on electronic commerce
applications. Sun Microsystems provides hardware and system software for
internal operations and electronic commerce hosting services, and engages in
joint-marketing programs with the Company. The Company has engaged in close
technical development and joint-selling efforts with VPNet Technologies, a
leading developer of industry-standard, high-performance encryption hardware
and software, and iPass, a leading provider of Internet dial-up roaming
settlement services. The Company has entered into a relationship with Oracle
whereby Pilot can sublicense certain Oracle products to Pilot's electronic
commerce and hosting customers at discounted prices. The Company also uses
Oracle technology for security and ongoing operations tracking. Finally, the
Company employs certain products and support services from Netscape, RSA Data
Security and Trend Micro.

Telecommunications Carriers. Pilot intends to establish relationships with
telecommunications carriers to expand its service offerings, while providing
such carriers with value-added services. Because Pilot's secure Internet
access and gateway services and electronic commerce services are provided
through its Network Security Centers, which operate independently of the
source of bandwidth, Pilot can treat different sources of bandwidth

39
<PAGE>

as distinct distribution channels for its secure services. Pilot believes this
strategy can be implemented either through providing a discrete, outsourcing
solution at existing Pilot Network Security Centers for pass-through traffic
from a telecommunications carrier partner, or establishing a security center
within the operations of the telecommunications carrier partner which would be
supported by Pilot.

COMPETITION

The market served by the Company is new, rapidly evolving, highly
competitive and largely undefined. There are few substantial barriers to
entry, and the Company expects that it will face additional competition from
existing competitors and new market entrants in the future. The Company
believes that this market is characterized by a limited period of time during
which participants must grow rapidly and achieve a significant presence in the
market in order to compete effectively. The principal competitive factors in
this market include Internet system and security engineering expertise,
customer service, network and security capabilities, reliability, quality and
scalability of service, broad geographic presence, brand name, technical
expertise and functionality, the variety of services offered, the ability to
maintain and expand distribution channels, customer support, price, the timing
of introductions of new services, financial resources and conformity with
industry standards. There can be no assurance that the Company will have the
resources or expertise to compete successfully in the future.

The Company also competes with third party service providers that offer
Internet hosting and access services, including (i) providers of server
hosting services, such as Exodus Communications and PSI Net; (ii) national and
regional ISPs such as Concentric Network Corp., UUNET, certain subsidiaries of
GTE Corporation and Global Center, which was recently acquired by Frontier
Corporation; and (iii) global, regional and local telecommunications companies
such as MCI, Sprint and WorldCom, and regional bell operating companies. The
Company also competes with information technology service firms providing
either outsourcing or systems integration services such as International
Business Machines Corporation and Electronic Data Systems. Although these
third party service providers often add security features to their service
offerings, either through internal development efforts or through the
incorporation of products purchased from vendors of stand-alone point
solutions, the Company believes that generally these competitors do not offer
the same level of security in their services as the Company. However, the
Company expects competition to intensify as third party service providers
incorporate a broader range of security, electronic commerce and secure
Internet networking services and products into their service offerings.
Furthermore, the Company may face competition from its vendors and other
partners. The Company's agreements with its vendors and other partners
generally do not limit or restrict those parties from selling similar products
and services directly to the Company's customers or its competitors, thereby
enabling such parties to compete against the Company. There can be no
assurance that such vendors or other partners will not compete with the
Company in the future.

40
<PAGE>

joint ventures or consortiums to provide additional services competitive with
those provided by the Company. Certain of the Company's competitors may be
able to provide customers with additional benefits in connection with their
Internet system and network management solutions, including reduced
communications costs, which could reduce the overall costs of their services
relative to the Company's. There can be no assurance that the Company will be
able to offset the effects of any resulting price reductions. In addition, the
Company believes that the businesses in which the Company competes are likely
to encounter consolidation in the near future, which could result in increased
price and other competition that could have a material adverse effect on the
Company's business, results of operations and financial condition.

INTELLECTUAL PROPERTY RIGHTS

The Company has entered into confidentiality and invention assignment
agreements with its employees and contractors, and nondisclosure agreements
with its suppliers, distributors and appropriate customers in order to limit
access to and disclosure of its proprietary information. There can be no
assurance that these contractual arrangements or the other steps taken by the
Company to protect its intellectual property will prove sufficient to prevent
infringement of or misappropriation of the Company's technology or to deter
independent third-party development of similar technologies. Any such
infringement or misappropriation, should it occur, could have a material
adverse effect on the Company's business, results of operation and financial
condition. Furthermore, litigation may be necessary to enforce the Company's
intellectual property rights, to protect the Company's trade secrets, to
determine the validity and scope of the proprietary rights of others, or to
defend against claims of infringement or invalidity. Such litigation could
result in substantial costs and diversion of resources and could have a
material adverse effect on the Company's business, results of operations and
financial condition.

GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES

41
<PAGE>

security and the convergence of traditional telecommunications services with
Internet communications. Moreover, a number of laws and regulations have been
proposed and are currently being considered by federal, state and foreign
legislatures with respect to such issues. The nature of any new laws and
regulations and the manner in which existing and new laws and regulations may
be interpreted and enforced cannot be fully determined. Therefore, such laws
and regulations could decrease the growth of the Internet, decrease demand for
the Company's services, restrict the Company's activities, impose taxes or
other costly technical requirements, subject the Company and/or its customers
to potential liability or otherwise adversely affect the Company or its
customers, each of which could have a material adverse effect on the Company's
business, results of operations and financial condition. For example, because
the Company's services are available over the Internet in multiple states and
foreign countries, and as the Company facilitates sales by its customers to
end users located in such states and foreign countries, such jurisdictions may
claim that the Company is required to qualify to do business as a foreign
corporation in each such state or foreign country, which could have a material
adverse effect on the Company's business, results of operations and financial
condition.

FACILITIES

The Company's executive, sales and administrative offices are located in
Alameda, California. The Company's Network Security Centers are located in the
San Francisco, Los Angeles, New York and Chicago metropolitan areas. The
Company's leases for its executive, sales and administrative offices and its
Network Security Centers expire from June 2000 to September 2004 (including
options to renew), and cover an aggregate of approximately 38,250 gross square
feet.

Most of the Company's leases provide for a renewal option upon the
expiration of the initial term. The Company believes that these existing
facilities are adequate to meet its current foreseeable requirements or that
suitable additional or substitute space will be available on commercially
reasonable terms. Pilot plans to expand its Network Security Centers both
nationally and internationally. The Company is commencing operations at
Network Security Centers in the Boston, Minneapolis, Washington, D.C. and
London metropolitan areas during 1998.

EMPLOYEES

As of June 30, 1998, the Company had 116 full-time employees, including 41
people in security implementation and operations, 8 people in security
engineering, 55 people in sales, marketing and customer support and 12 people
in finance and administration. The Company's success depends to a significant
degree upon the continued contribution of its executive management and
security operations and engineering teams. See "Risk Factors--Dependence on
Key Personnel" and "--Risks of Business Expansion and Management of Growth."

LITIGATION

The Company is currently not a party to any material legal proceedings.

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<PAGE>

MANAGEMENT

EXECUTIVE OFFICERS AND DIRECTORS

The following table sets forth certain information regarding the executive
officers and directors of the Company as of June 30, 1998.

<TABLE>
<CAPTION>
NAME AGE POSITION(S) WITH COMPANY
- ---- --- ------------------------
<S> <C> <C>
M. Marketta Silvera..... 55 Chairman of the Board of Directors,
President and Chief Executive Officer
William C. Leetham...... 45 Senior Vice President, Finance and Administration,
Chief Financial Officer, Treasurer and Secretary
Peter Liebowitz......... 51 Senior Vice President, Sales and Marketing
Thomas A. Wadlow........ 41 Vice President, Engineering and Development
Michael Millikin........ 44 Vice President, Operations and Business Development
Robert G. Carrade....... 36 Vice President, Finance and Administration
Shanda Bahles(1)(2)..... 42 Director
William B. Elmore(1).... 45 Director
K. Flynn McDonald....... 45 Director
Thomas O'Rourke(1)(2)... 74 Director
</TABLE>
- --------
(1) Member of Audit Committee
(2) Member of Compensation Committee

M. MARKETTA SILVERA is the founder of the Company and has served as its
President and Chief Executive Officer since June 1993, and as a director of
the Company since July 1993. From June 1991 to January 1993, Ms. Silvera
served as President of VoiceCom Systems, Inc., a voice processing services
company. From May 1989 to June 1991, she served as President of Votan
Corporation, a voice recognition technology company. Ms. Silvera served as
Vice President of Sales and Marketing at Granite Systems, a voice technology
systems developer, and Votan from 1986 to 1989. Ms. Silvera is also a director
of AVIOS, a voice and data technology organization, and has previously served
as its President.

WILLIAM C. LEETHAM has served as Senior Vice President, Finance and
Administration, Chief Financial Officer, Treasurer, and Secretary of the
Company since May 1998. From December 1996 to May 1998, Mr. Leetham served as
Chief Financial Officer of Success Factor Systems, Inc., a human resources
software applications company. From March 1995 to September 1996, Mr. Leetham
served as Chief Financial Officer of Scopus Technology, Inc., an information
management software company. From November 1992 to March 1995, he served as
Chief Financial Officer of Berkeley Systems, Inc., a consumer software vendor.
From August 1984 to November 1992, he held various positions at Candle
Corporation, a system performance software company, most recently serving as
Vice President, Financial Operations.

PETER LIEBOWITZ has served as the Senior Vice President, Sales and Marketing
of the Company since January 1998. From July 1996 to December 1997, he served
as Vice President and General Manager of the Telecommunications Business Unit
at Sybase Inc., a database software company. From January 1995 to July 1996,
Mr. Liebowitz served as Vice President of Sales and Support at Onstream
Networks, Inc., a networking systems corporation. From June 1993 to December
1994, he served as Vice President of Sales and Service at Pulsecom Inc., a
telecommunications company. Mr. Liebowitz was President of Liebowitz
Associates, a telecom consulting firm, from September 1992 to May 1993.

THOMAS A. WADLOW has served as Vice President, Engineering and Development
of the Company since January 1996, and Director of Engineering from September
1993 to January 1996. From 1989 to September 1993, he served as Research
Network Architect at Sun Microsystems Laboratories, Inc., a workstation
manufacturer. From 1988 to 1989, Mr. Wadlow served as Systems and Network
Manager of ParcPlace Systems,

43
<PAGE>

an object oriented software developer. From 1987 to 1988, Mr. Wadlow served as
an engineer of the Smalltalk Group of Xerox Palo Alto Research Center, a
computer science research laboratory. Prior to 1988 Mr. Wadlow served in
various senior technical staff positions at Schlumberger Limited, a petroleum
exploration and research company, and Lawrence Livermore National
Laboratories, a national defense contractor.

MICHAEL MILLIKIN has served as Vice President, Operations and Business
Development of the Company since February 1998, and as Vice President,
Business Development since January 1998. From June 1992 to December 1997, Mr.
Millikin served in various senior management positions with Softbank Forums, a
conference and voice event management company, including Senior Vice
President, Worldwide Content from December 1996 to December 1997, and Senior
Vice President and General Manager, Networld+Interop, an exposition company,
from November 1994 to December 1996. Mr. Millikin is also the founder of
Gunstock Hill Associates, an information technology consulting firm which he
founded in June 1991 and with which he remained until June 1992.

ROBERT G. CARRADE has served as the Vice President, Finance and
Administration of the Company since April 1997, and Director of Finance and
Administration from February 1994 to April 1997. From May 1993 to February
1994 he was an independent financial consultant. From November 1991 to May
1993 he served as a corporate finance associate with Berkeley International
Capital Corporation. Mr. Carrade is a certified public accountant in
California.

SHANDA BAHLES has served as director of the Company since January 1994. Ms.
Bahles has served as a General Partner of El Dorado Ventures (El Dorado), a
venture capital firm focused on early stage investments in information
technology companies, since May 1991, and joined El Dorado as an associate in
July 1987. From 1979 to 1985 Ms. Bahles held various engineering, marketing
and management positions with Millennium Systems, a systems integration
company, and Fortune Systems Corporation, a workstation manufacturer. Ms.
Bahles also serves as a director of several privately held information
technology companies.

WILLIAM B. ELMORE has served as a director of the Company since July 1993.
Mr. Elmore has served as a General Partner of Foundation Capital Management,
LLC ("Foundation Capital"), a venture capital firm focused on early stage
information technology companies, since December 1995, and is a founder of
Foundation Capital. From 1987 to 1995, Mr. Elmore served as a General Partner
of Inman and Bowman, a venture capital firm. Mr. Elmore also serves as a
director of Wind River Systems, Inc., a software operating systems company,
and several privately held information technology companies. Mr. Elmore plans
to resign from the Company's Board of Directors within several months of this
Offering.

K. FLYNN MCDONALD has served as a director of the Company since March 1995.
Ms. McDonald has been a Managing Director of Vector Fund Management, L.P. and
a General Partner of Vector Later-Stage Equity Fund, L.P. since November 1995.
From December 1993 to October 1995, Ms. McDonald served as Vice President of
Investments at Technology Funding, Inc., a venture capital firm focused on
technology and health care companies. From 1986 to 1993, she held various
positions at Raychem Corporation, a material sciences company, including Vice
President of Raychem Ventures, Inc. Ms. McDonald is a Director of LifeCell
Corporation, a biotechnology company.

THOMAS O'ROURKE has served as a Director of the Company since November 1995.
Mr. O'Rourke has served as the President and Chairman of the Board of O'Rourke
Investment Corporation, an investment company, since 1989. From January 1985
to April 1988, Mr. O'Rourke was a General Partner of Hambrecht and Quist
Venture Partners, a venture capital firm. From 1966 to 1985, he was the
founder, President and Chairman of the Board of Tymshare, Inc., a computer
services company.

EXECUTIVE OFFICERS

The Company's executive officers are appointed by, and serve at the
discretion of, the Board of Directors. Each executive officer is a full-time
employee of the Company.

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<PAGE>

BOARD COMPOSITION

The Company currently has authorized five directors. Each director is
elected for a period of one year and serves until his or her successor is duly
elected and qualified. Each of the Company's directors, excluding non-employee
directors, devotes substantially full time to the affairs of the Company. The
Company's non-employee directors devote such time to the affairs of the
Company as is necessary to discharge their duties. There are no family
relationships among any of the directors, officers or key employees of the
Company. See "Certain Relationships and Related Transactions." The Company is
seeking to appoint one or two new directors with relevant industry experience.

BOARD COMMITTEES

The Board of Directors has two committees, an Audit Committee and a
Compensation Committee. The Board's Audit Committee currently consists of Mr.
Elmore, Ms. Bahles and Mr. O'Rourke. The Audit Committee reviews the Company's
annual audit and meets with the Company's independent auditors to review the
Company's internal accounting procedures and financial management practices.
The Compensation Committee currently consists of Ms. Bahles and Mr. O'Rourke.
The Compensation Committee recommends compensation and benefits for certain of
the Company's executive officers to the Board, reviews general policy relating
to compensation and benefits of employees of the Company, and administers the
Company's Stock Plans.

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

None of the members of the Compensation Committee of the Board is currently
or has been, at any time since the formation of the Company, an officer or
employee of the Company. No executive officer of the Company serves as a
member of the Board of Directors or compensation committee of any entity that
has one or more executive officers serving on the Company's Board or
Compensation Committee.

In December 1995 and January 1996, the Company issued an aggregate of
1,179,246 shares of Series C Preferred Stock to directors and entities
affiliated with directors upon the exercise of outstanding warrants to
purchase Series C Preferred Stock at an exercise price of $0.37 per share,
comprised of 1,027,396 shares to entities affiliated with El Dorado Venture
Partners, of which Shanda Bahles, a director of the Company, is affiliated,
and 151,850 shares to William B. Elmore. Mr. Elmore subsequently sold 27,400
shares to K. Flynn McDonald for $0.73 per share pursuant to a stock transfer
agreement dated September 14, 1996. In July 1996, the Company sold an
aggregate of 580,180 shares of Series E Preferred Stock at a price of $2.00
per share to entities affiliated with directors, comprised of 500,000 shares
to entities affiliated with El Dorado Venture Partners and 80,180 shares to
O'Rourke Investment Corporation, of which Tomas O'Rourke, a director of the
Company, owns a majority of the outstanding voting shares and is a director.

On June 15, 1996, M. Marketta Silvera, the Company's President and Chief
Executive Officer, purchased 60,000 shares of Common Stock at a purchase price
of $0.20 per share, and pursuant to the terms of a Restricted Stock Purchase
Agreement, the Company has the right to repurchase the shares with such right
expiring as to 25% of the shares on the first anniversary of the vesting
commencement date and the remaining shares in equal monthly installments over
the following three years. On April 15, 1997, the Company granted to Ms.
Silvera an option to purchase 60,000 shares of Common Stock at an exercise
price of $0.75 per share, and pursuant to the terms of these options, 25% of
the shares issuable upon exercise of such options vest on the first
anniversary of the vesting commencement date, with the remaining shares
vesting in equal monthly installments over the following three years. On
April 24, 1998, the Company granted to Ms. Silvera an option to purchase
60,000 shares of Common Stock at an exercise price of $3.30 per share, and
pursuant to the terms of these options, 25% of the shares issuable upon
exercise of such options vest on the first anniversary of the vesting
commencement date, with the remaining shares vesting in equal monthly
installments over the following three years.

On June 12, 1997, the Company approved an option to K. Flynn McDonald to
purchase 20,000 shares of Common Stock at an exercise price of $13.00 per
share. The option granted to Ms. McDonald was fully vested upon grant and has
a term of three years.

45
<PAGE>

DIRECTOR COMPENSATION

Directors of the Company do not receive cash compensation for their services
as directors or members of committees of the Board of Directors, but are
reimbursed for their reasonable expenses incurred in attending meetings of the
Board of Directors. Employee Directors are eligible to participate in the
Company's 1994 Stock Plan and 1998 Stock Option Plan. Non-employee Directors
are eligible to participate in the Company's 1998 Stock Option Plan and 1998
Directors' Stock Option Plan. See "--Compensation Committee Interlocks and
Insider Participation" for stock option grants to directors.

LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS

The Company's Certificate of Incorporation limits the liability of directors
to the full extent permitted by Delaware law. Delaware law provides that a
corporation's certificate of incorporation may contain a provision eliminating
or limiting the personal liability of directors for monetary damages for
breach of their fiduciary duties as directors, except for liability (i) for
any breach of their duty of loyalty to the corporation or its stockholders,
(ii) for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law, (iii) for unlawful payments of
dividends or unlawful stock repurchases or redemptions as provided in Section
174 of the Delaware General Corporation Law (the "DGCL"), or (iv) for any
transaction from which the director derived an improper personal benefit. The
Company's Bylaws provide that the Company shall indemnify its directors and
officers and may indemnify its employees and agents to the fullest extent
permitted by law. The Company believes that indemnification under its Bylaws
covers at least negligence and gross negligence on the part of indemnified
parties.

The Company intends to enter into agreements which indemnify its directors
and executive officers. These agreements, among other things, indemnify the
Company's directors and officers for certain expenses (including attorneys'
fees), judgments, fines and settlement amounts incurred by such persons in any
action or proceeding, including any action by or in the right of the Company,
arising out of such person's services as a director or officer of the Company,
any subsidiary of the Company or any other company or enterprise to which the
person provides services at the request of the Company. The Company believes
that these provisions and agreements are necessary to attract and retain
qualified directors and officers.

At present, there is no pending litigation or proceeding involving any
director, officer, employee or agent of the Company where indemnification will
be required or permitted. The Company is not aware of any threatened
litigation or proceeding that might result in a claim for such
indemnification.

46
<PAGE>

EXECUTIVE COMPENSATION

The following table sets forth certain estimated compensation awarded or paid
by the Company during the fiscal year ended March 31, 1998 ("Last Fiscal Year")
to (i) the Company's President and Chief Executive Officer, (ii) the Company's
Vice President, Finance and Administration, (iii) the Company's Vice President,
Engineering and Development, and (iv) two individuals who would have been
included as the Company's four most highly compensated executive officers
(other than the Chief Executive Officer), each of whose aggregate compensation
during the Last Fiscal Year exceeded $100,000, but were not serving as
executive officers of the Company at the end of the Last Fiscal Year
(collectively, the "Named Executive Officers"):

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
------------
ANNUAL COMPENSATION AWARDS
---------------------------------------- ------------
SECURITIES
NAME AND PRINCIPAL OTHER ANNUAL UNDERLYING ALL OTHER
POSITION(1) SALARY ($) BONUS ($) COMPENSATION ($) OPTIONS (#) COMPENSATION ($) (2)
- ------------------ ---------- --------- ---------------- ------------ --------------------
<S> <C> <C> <C> <C> <C>
M. Marketta Silvera......... $205,000 $43,650 -- 60,000 $237
President and Chief
Executive Officer
Robert G. Carrade........... 115,000 18,188 -- 30,000 230
Vice President, Finance and
Administration
Thomas A. Wadlow............ 110,000 18,188 -- 30,000 178
Vice President, Engineering
and Development
Wister Walcott.............. 90,000 14,550 -- 20,000 213
Vice President, Marketing
Jeffrey Gall (3)............ 94,541 26,911 (4) -- 30,000 179
Vice President, Sales
</TABLE>
- --------
(1) In January 1998, the Company hired Peter Liebowitz as its Senior Vice
President, Sales and Marketing at an annual salary for the 1999 fiscal year
of $150,000. In January 1998, the Company hired Michael Millikin as its
Vice President, Operations and Business Development at an annualized salary
for the 1999 fiscal year of $150,000. In May 1998, the Company hired
William C. Leetham as its Senior Vice President, Finance and
Administration, Chief Financial Officer, Treasurer and Secretary at an
annualized salary for the 1999 fiscal year of $150,000.
(2) Amounts listed represent term life insurance premiums paid by the Company
on behalf of the listed Named Executive Officer.
(3) Mr. Gall terminated his employment with the Company on January 15, 1998.
(4) Consists of $26,911 earned by Mr. Gall as sales commissions.

47
<PAGE>

OPTION GRANTS

The following table provides certain information regarding stock options
granted to the Named Executive Officers during the Last Fiscal Year.

OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
------------------------------------------------------
POTENTIAL REALIZABLE
VALUE AT ASSUMED
ANNUAL RATES OF
NUMBER OF PERCENTAGE OF STOCK PRICE
SECURITIES TOTAL OPTIONS EXERCISE APPRECIATION FOR
UNDERLYING GRANTED TO PRICE OPTION TERM(3)(4)
OPTIONS EMPLOYEES IN PER SHARE EXPIRATION -----------------------------
NAME GRANTED(1)(5) 1998 FISCAL YEAR(2) ($/SH) DATE 0%($) 5%($) 10%($)
- ---- ------------- ------------------- --------- ---------- ------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
M. Marketta Silvera..... 60,000 6.0% $0.75 4/15/07 $12,750 $1,258,116 $1,935,676
Robert G. Carrade....... 30,000 3.0 0.75 4/15/07 6,375 629,058 967,838
Thomas A. Wadlow........ 30,000 3.0 0.75 4/15/07 6,375 629,058 967,838
Wister Walcott.......... 20,000 2.0 0.75 4/15/07 4,250 419,372 645,225
Jeffrey Gall............ 30,000 3.0 0.75 4/15/07 6,375 629,058 967,838
</TABLE>
- --------
(1) 25% of the shares issuable upon exercise of such options vest on the first
anniversary of the vesting commencement date, with the remaining shares
vesting in equal monthly installments over the following three years.
(2) Based on an aggregate of 1,008,000 options granted to employees during the
fiscal year ended March 31, 1998.
(3) The 0% assumed annual rate of compounded stock price appreciation is
mandated by the rules of the SEC. The amount represents the difference
between the exercise price and the fair value used by the Company for
accounting purposes on the date of each option grant. See Note 5 of Notes
to Consolidated Financial Statements.
(4) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by the rules of the SEC. There can be no assurance that the
actual stock price appreciation over the five-year option term will be at
the assumed 5% and 10% levels or at any other defined level. Unless the
market price of the Common Stock appreciates over the option term, no
value will be realized from the option grants made to the Named Executive
Officers. The potential realizable value is calculated by assuming that
the initial public offering price of $14.00 per share appreciates at the
indicated rate for the entire term of the option and that the option is
exercised at the exercise price and sold on the last day at the
appreciated price.
(5) In December 1997, Mr. Liebowitz received an option to acquire 150,000
shares of Common Stock at an exercise price of $0.75 per share. In
December 1997, Mr. Millikin received an option to acquire 100,000 shares
of Common Stock at an exercise price of $0.75 per share. In May 1998, Mr.
Leetham received an option to acquire 150,000 shares of Common Stock at an
exercise price of $6.00 per share.

48
<PAGE>

OPTION EXERCISES AND FISCAL YEAR-END VALUES

The following table provides certain summary information concerning the
shares of Common Stock represented by outstanding stock options held by each
of the Named Executive Officers in the Last Fiscal Year as of March 31, 1998.

<TABLE>
<CAPTION>
NUMBER OF VALUE OF
SECURITIES UNDERLYING UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
SHARES MARCH 31, 1998 (#) MARCH 31, 1998($)(2)
ACQUIRED ON VALUE ------------------------- -------------------------
NAME EXERCISE(#) REALIZED($)(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- -------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
M. Marketta Silvera..... -- $ -- -- 60,000 $ -- $795,000
Robert G. Carrade....... 8,958 5,683 938 35,104 13,013 468,210
Thomas A. Wadlow........ -- -- 9,896 35,104 137,390 468,210
Wister Walcott.......... -- -- 4,790 25,210 66,629 337,471
Jeffrey Gall(3)......... 9,272 5,879 -- -- -- --
</TABLE>
- --------
(1) The amount set forth represents the difference between the fair market
value of the shares on the date of exercise as determined by the Board of
Directors and the exercise price of the option.
(2) Value of unexercised in-the-money options is based on a value of $14.00
per share of the Company's Common Stock, the initial public offering
price. Amounts reflected are based on the assumed value minus the exercise
price multiplied by the number of shares acquired on exercise.
(3) All of Mr. Gall's unexercised options have expired.

STOCK PLANS

1998 Stock Option Plan. The Company's 1998 Stock Option Plan (the "Option
Plan") was adopted by the Board of Directors in June 1998 and was approved by
the stockholders in July 1998. A total of 1,000,000 shares of Common Stock has
been reserved for issuance under the Option Plan, plus an automatic annual
increase on the first day of each of the Company's fiscal years commencing in
1999, 2000, 2001, 2002 and 2003 equal to the lesser of 500,000 shares, 3% of
the Company's outstanding Common Stock on the last day of the immediately
preceding fiscal year or such lesser number of shares as the Board of
Directors determines. As of June 30, 1998, options to purchase 20,000 shares
of Common Stock had been granted under the Option Plan.

The purposes of the Option Plan are to attract and retain the best available
personnel to the Company, to provide additional incentives to the Company's
employees and consultants and to promote the success of the Company's
business. The Option Plan provides for the granting to employees, including
officers and directors, of incentive stock options within the meaning of
Section 422 of the Internal Revenue Code of 1986, as amended (the "Code") and
for the granting to employees and consultants including nonemployee directors
of nonstatutory stock options. To the extent an optionee would have the right
in any calendar year to exercise for the first time one or more incentive
stock options for shares having an aggregate fair market value (under all
plans of the Company and determined for each share as of the date the option
to purchase the shares was granted) in excess of $100,000, any such excess
options shall be treated as nonstatutory stock options. If not terminated
earlier, the Option Plan will terminate in June 2008.

The Option Plan may be administered by the Board of Directors or a committee
of the Board (the "Administrator"). The Option Plan is currently administered
by the Compensation Committee. The Administrator determines the terms of
options granted under the Option Plan, including the number of shares subject
to the option, exercise price, term and exercisability. In no event, however,
may an individual employee receive option grants for more than 1,000,000
shares under the Option Plan in any fiscal year. The exercise price of all
incentive stock options granted under the Option Plan must be at least equal
to the fair market value of the Common Stock of the Company on the date of
grant. The exercise price of any incentive stock option granted to an optionee
who owns stock representing more than 10% of the total combined voting power
of all classes of outstanding capital stock of the Company or any parent or
subsidiary corporation of the Company (a "10% Stockholder") must equal at
least 110% of the fair market value of the Common Stock on the date of grant.
The

49
<PAGE>

exercise price of all nonstatutory stock options granted after the Company's
Common Stock is designated or approved for designation on the Nasdaq National
Market must equal at least 85% of the fair market value of the Common Stock on
the date of grant; provided, however, that the exercise price of any
nonstatutory stock option granted to the Company's Chief Executive Officer or
its four other most highly compensated officers must equal at least 100% of
the fair market value of the Common Stock on the date of grant. Payment of the
exercise price may be made in cash or other consideration as determined by the
Administrator.

The Administrator determines the term of options, which may not exceed 10
years (5 years in the case of an incentive stock option granted to a 10%
Stockholder). No option may be transferred by the optionee other than by will
or the laws of descent or distribution, except in the case of nonstatutory
stock options granted after the Company's Common Stock is designated or
approved for designation on the Nasdaq National Market with respect to which
the Administrator may allow limited transferability in certain circumstances.
Each option may be exercised during the lifetime of the optionee only by such
optionee. The Administrator determines when options become exercisable.
Options granted under the Option Plan generally become exercisable at the rate
of 1/4th of the total number of shares subject to an option twelve months
after the date of grant of such option, and 1/48th of the total number of
shares subject to the option each month thereafter.

In the event of the sale of all or substantially all of the assets of the
Company, or the merger, consolidation or other capital reorganization of the
Company (other than one in which holders of more than 50% of the Company's
capital stock outstanding before such transaction continue to hold more than
50% of the total voting power after such transaction), then each option may be
assumed or an equivalent option substituted by the successor corporation. In
lieu thereof, the Administrator may in its discretion elect to accelerate the
exercisability of each option effective upon the consummation of such
transaction. The Administrator has the authority to amend or terminate the
Option Plan as long as such action does not adversely affect any outstanding
option and provided that stockholder approval shall be required for an
amendment to increase the number of shares subject to the Option Plan, to
change the designation of the class of persons eligible to be granted options,
or to change the limitation on grants to individual employees.

1994 Stock Plan. The Company's 1994 Stock Plan (the "1994 Stock Plan") was
adopted by the Board of Directors in July 1994 and approved by the
stockholders in September 1994. The 1994 Stock Plan provides for the granting
of incentive stock options to employees, officers and employee directors and
the granting of nonstatutory stock options and stock purchase rights to
employees, officers, directors (including nonemployee directors) and
consultants. A total of 3,400,000 shares of Common Stock has been reserved for
issuance under the 1994 Stock Plan plus an automatic annual increase on the
first day of the Company's fiscal years commencing in 1999, 2000, 2001 and
2002 equal to the lesser of 300,000 shares or 3% of the Company's outstanding
stock on the last day of the preceding fiscal year. As of June 30, 1998,
options to purchase 331,742 shares of Common Stock had been exercised, options
to purchase a total of 1,556,940 shares at a weighted average exercise price
of $1.99 per share were outstanding, and 840,914 shares of Common Stock have
been issued upon exercise of stock purchase rights at a weighted average
purchase price of $0.06 per share. The Company does not intend to issue any
additional options or purchase rights pursuant to the 1994 Stock Plan, and as
a result future automatic annual increases under the plan will not be
effected.

The terms of options issued under the 1994 Stock Plan are generally the same
as those which may be issued under the Option Plan, except that the 1994 Stock
Plan does not impose a maximum number of shares which may be subject to
options issued to an individual in any fiscal year. The restricted stock
purchase agreements reflecting stock purchase rights issued pursuant to the
1994 Stock Plan generally provide that the Company shall have a repurchase
option exercisable upon the voluntary or involuntary termination of the
purchaser's employment with the Company for any reason (including death or
disability), unless the relevant administrator determines otherwise. The
Company's repurchase right generally lapses at a rate of 1/4th of the total
number of shares twelve months after the date of grant, and 1/48th of the
total number of shares each month thereafter.

In addition, the 1994 Stock Plan provides that, in the event of a merger of
the Company with or into another corporation where the successor corporation
issues its securities to the Company's stockholders, or a sale of all

50
<PAGE>

or substantially all of the Company's assets, unexercised options and purchase
rights outstanding under the 1994 Stock Plan will be assumed or substituted by
the successor corporation or, in the event the successor corporation refuses
to assume or substitute the options, outstanding options and purchase rights
shall terminate upon consummation of such transaction.

1998 Directors' Stock Option Plan. The 1998 Directors' Stock Option Plan
(the "Directors' Plan") was adopted by the Board of Directors in June 1998 and
was approved by the stockholders in July 1998. A total of 200,000 shares of
Common Stock has been reserved for issuance under the Directors' Plan. As of
June 30, 1998, no options to purchase shares of Common Stock have been issued
under the Directors' Plan. The Directors' Plan provides for the grant of
nonstatutory stock options to nonemployee directors of the Company and is
designed to work automatically without administration; however, to the extent
administration is necessary, it will be performed by the Board of Directors.
To the extent they arise, it is expected that conflicts of interest will be
addressed by abstention of any interested director from both deliberations and
voting regarding matters in which such director has a personal interest.

The Directors' Plan provides that each person who becomes a nonemployee
director of the Company after the date of the closing of this Offering will be
granted a nonstatutory stock option to purchase 25,000 shares of Common Stock
(the "First Option") on the date on which the optionee first becomes a
nonemployee director of the Company. The First Option shall become exercisable
in installments as to 25% of the total number of shares subject to the First
Option on each of the first, second, third and fourth anniversaries of the
date of grant of the First Option. The First Option will not be granted to
individuals serving as nonemployee directors as of the date of this Offering.
Instead, each person who is a nonemployee director of the Company on the date
of this Offering will be granted a nonstatutory option to purchase 5,000
shares which shall become exercisable as to 100% of such shares on the first
anniversary of the date of grant. Thereafter, on the date of each of the
Company's Annual Stockholders Meetings following which a nonemployee director
is serving on the Board of Directors, each such nonemployee director
(including nonemployee directors who were not granted a First Option prior to
the date of such Annual Meeting) will be granted an additional option to
purchase 5,000 shares of Common Stock (a "Subsequent Option") if, on such
date, he or she has served on the Company's Board of Directors for at least
six months. Each Subsequent Option shall become exercisable as to 100% of such
shares on the first anniversary of the date of grant.

The Directors' Plan sets neither a maximum nor a minimum number of shares
for which options may be granted to any one nonemployee director, but does
specify the number of shares that may be included in any grant and the method
of making a grant. No option granted under the Directors' Plan is transferable
by the optionee other than by will or the laws of descent or distribution or
pursuant to a qualified domestic relations order, and each option is
exercisable, during the lifetime of the optionee, only by such optionee. If a
nonemployee Director ceases to serve as a Director for any reason other than
death or disability, he or she may, but only within 90 days after the date he
or she ceases to be a Director of the Company, exercise options granted under
the Directors' Plan to the extent that he or she was entitled to exercise it
at the date of such termination. To the extent that he or she was not entitled
to exercise any such option at the date of such termination, or if he or she
does not exercise such option (which he or she was entitled to exercise)
within such 90 day period, such option shall terminate. The exercise price of
all stock options granted under the Directors' Plan shall be equal to the fair
market value of a share of the Company's Common Stock on the date of grant of
the option, except for the options granted to non-employee directors on the
date of this Offering, which shall have an exercise price equal to the initial
public offering price. Options granted under the Directors' Plan have a term
of ten years.

In the event of the dissolution or liquidation of the Company, a sale of all
or substantially all of the assets of the Company, or the merger,
consolidation or other capital reorganization of the Company (other than one
in which holders of more than 50% of the Company's capital stock outstanding
before such transaction continue to hold more than 50% of the total voting
power after such transaction), (1) each nonemployee director shall have the
right to exercise the option, including any part of the option that would not
otherwise be exercisable, prior to the effectiveness of such dissolution,
liquidation, sale, merger or reorganization, and (2) the option shall be
assumed or substituted by the successor corporation or, if such successor
corporation refuses to agree to such

51
<PAGE>

assumption or substitution, the option shall terminate upon consummation of
such transaction. The Board of Directors may amend or terminate the Directors'
Plan; provided, however, that no such action may adversely affect any
outstanding option, and the provisions regarding the grant of options under
the plan may be amended only once in any six-month period, other than to
comport with changes in the Code. If not terminated earlier, the Directors'
Plan will have a term of ten years.

1998 Employee Stock Purchase Plan. The Company's 1998 Employee Stock
Purchase Plan (the "Purchase Plan") was adopted by the Board of Directors in
June 1998 and was approved by the stockholders in July 1998. A total of
200,000 shares of Common Stock has been reserved for issuance under the
Purchase Plan, plus an automatic annual increase on the first day of each of
the Company's fiscal years in 1999, 2000, 2001, 2002 and 2003 equal to the
lesser of 100,000 shares, 1/2% of the Company's outstanding Common Stock on
the last day of the immediately preceding fiscal year, or such lesser number
of shares as the Board of Directors shall determine.

The Purchase Plan, which is intended to qualify under Section 423 of the
Code, will be implemented by a series of overlapping offering periods of 24
months' duration, with new offering periods (other than the first offering
period) commencing on May 1 and November 1 of each year. Each offering period
will consist of four consecutive purchase periods of six months' duration. The
initial offering period is expected to commence on the date of this Offering
and end on October 31, 2000; the initial purchase period is expected to end on
April 30, 1999. The Purchase Plan will be administered by the Board of
Directors or by a committee appointed by the Board of Directors. Employees
(including officers and employee directors) of the Company, or of any
majority-owned subsidiary designated by the Board of Directors, are eligible
to participate in the Purchase Plan if they are employed by the Company or any
such subsidiary for at least 20 hours per week and more than five months per
year. The Purchase Plan permits eligible employees to purchase Common Stock
through payroll deductions, which may not exceed 10% of an employee's
compensation, at a price equal to the lower of 85% of the fair market value of
the Company's Common Stock at the beginning of each offering period or at the
end of each purchase period. The Board of Directors shall have the discretion
to increase, prior to the beginning of an offering period, the percentage of
participants' compensation that may be withheld through the Purchase Plan,
provided that such percentage may not exceed 20%. No employee shall be granted
an option under the Purchase Plan if immediately after the grant such employee
would own stock and/or hold outstanding options to purchase stock possessing
five percent (5%) or more of the total voting power or value of all classes of
stock of the Company or its subsidiaries, or if such option would permit an
employee to purchase stock under all employee stock purchase plans of the
Company and its subsidiaries to accrue at a rate which exceeds $25,000 of fair
market value of such stock for each calendar year in which such option is
outstanding at any time. If the fair market value of the Common Stock on a
purchase date is less than the fair market value at the beginning of the
offering period, a new twenty-four month offering period will automatically
begin on the first business day following the purchase date with a new fair
market value. Employees may end their participation in the offering at any
time during the offering period, and participation ends automatically on
termination of employment with the Company. The Purchase Plan may be
terminated by action of the Board of Directors. If not terminated earlier, the
Purchase Plan will have a term of 20 years.

The Purchase Plan provides that in the event of a sale of all or
substantially all of the Company's assets, or a merger, consolidation or other
capital reorganization of the Company (other than one in which holders of more
than 50% of the Company's capital stock outstanding before such transaction
continue to hold more than 50% of the total voting power after such
transaction), each right to purchase stock under the Purchase Plan will be
assumed or an equivalent right substituted by the successor corporation unless
the Board of Directors shortens the offering period so that employees' rights
to purchase stock under the Purchase Plan are exercised prior to the merger or
sale of assets. The Board of Directors has the power to amend or terminate the
Purchase Plan as long as such action does not adversely affect any outstanding
rights to purchase stock thereunder.

401(k) RETIREMENT PLAN

52
<PAGE>

provides for voluntary employee contributions from 1% to 15% of annual
compensation, subject to a maximum limit allowed by Internal Revenue Service
guidelines ($10,000 for 1998). The Company may contribute such amounts to the
accounts of participants in the Retirement Plan as determined by the Board of
Directors. However, to date, the Company has not made any contribution to the
Retirement Plan, and does not anticipate making any contribution to the
Retirement Plan in the foreseeable future.

MANAGEMENT BONUS PLAN

In April 1998, the Company adopted a management bonus plan (the "Bonus
Plan") pursuant to which key members of Company management will be eligible to
receive cash bonuses during the fiscal year ending March 31, 1999 if the
Company meets certain financial objectives during that year. Each eligible
employee has been assigned an individual fixed-dollar bonus base amount, which
amount was determined based upon various factors, including the individual
employee's annual salary. The amount of bonus that an individual employee may
receive under the Bonus Plan is calculated as a percentage of his or her bonus
base amount, which percentage is determined based upon the degree to which the
Company achieves certain objective revenue (80% of the bonus) and operating
income (20% of the bonus) goals established by the Board of Directors.

53
<PAGE>

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Since April 1, 1995, the Company has issued in private placement
transactions shares of Preferred Stock as follows: an aggregate of 783,118
shares of Series E Preferred Stock at $2.00 per share in July 1996 and an
aggregate of 1,220,000 shares of Series F Preferred Stock at $5.00 per share
in March 1997, December 1997 and February 1998. In addition, in December 1995
and January 1996, the Company issued an aggregate of 1,210,068 shares of
Series C Preferred Stock upon the exercise of outstanding Series C Preferred
Stock warrants at an exercise price of $0.73 per share. Each share of Series
C, Series E and Series F Preferred Stock is convertible into one share of
Common Stock. The purchasers of the Series C Preferred Stock, Series E
Preferred Stock and Series F Preferred Stock included, among others, the
following executive officers, directors and 5% stockholders of the Company,
and persons and entities associated with them:

<TABLE>
<CAPTION>
SERIES C SERIES E SERIES F
DIRECTORS AND PREFERRED PREFERRED PREFERRED
ENTITIES AFFILIATED WITH DIRECTORS STOCK STOCK STOCK
- ---------------------------------- --------- --------- ---------
<S> <C> <C> <C>
Entities affiliated with El Dorado Venture
Partners
(Shanda Bahles)(1) ........................... 1,027,396 500,000 --
William B. Elmore(2)........................... 151,850 -- --
K. Flynn McDonald(2)........................... 27,400 -- --
O'Rourke Investment Corporation (Thomas
O'Rourke)..................................... -- 80,180 --
OTHER 5% STOCKHOLDERS
- ---------------------
Technology Funding Venture Partners V, and
Aggressive Growth Fund, L.P. ................. -- 147,940 --
The Trustees of the General Electric Pension
Trust......................................... -- -- 900,000(3)
General Electric Capital Corporation........... -- -- 600,000(4)
Jeffrey Webber................................. 30,822 -- --
</TABLE>
- --------
(1) Includes shares held by El Dorado Ventures III, L.P., a California limited
partnership, El Dorado Technology IV, L.P. and El Dorado C&L Fund, L.P.
(2) William B. Elmore subsequently sold 27,400 shares to K. Flynn McDonald for
$0.73 per share pursuant to a stock transfer agreement dated September 14,
1996.
(3) Includes warrants to purchase 300,000 shares of Series F Preferred Stock.
(4) Includes warrants to purchase 200,000 shares of Series F Preferred Stock.

On April 19, 1996, the Company granted to Robert G. Carrade, its Vice
President, Finance and Administration, an option to purchase 5,000 shares of
Common Stock at an exercise price of $0.20 per share, and pursuant to the
terms of these options, 25% of the shares issuable upon exercise of such
options vest on the first anniversary of the vesting commencement date, with
the remaining shares vesting in equal monthly installments over the following
three years. On April 15, 1997, the Company granted to Mr. Carrade an option
to purchase 30,000 shares of Common Stock at an exercise price of $0.75 per
share, and pursuant to the terms of these options, 25% of the shares issuable
upon exercise of such options vest on the first anniversary of the vesting
commencement date, with the remaining shares vesting in equal monthly
installments over the following three

54
<PAGE>

years. On April 24, 1998, the Company granted to Mr. Carrade an option to
purchase 35,000 shares of Common Stock at an exercise price of $3.00 per
share, and pursuant to the terms of these options, 25% of the shares issuable
upon exercise of such options vest on the first anniversary of the vesting
commencement date, with the remaining shares vesting in equal monthly
installments over the following three years. With respect to options granted
to Mr. Carrade, on December 23, 1997 and April 15, 1998, Mr. Carrade exercised
options to purchase 8,958 and 8,750 shares of Common Stock, respectively.

On April 19, 1996, the Company granted to Thomas A. Wadlow, its Vice
President, Engineering and Development, an option to purchase 5,000 shares of
Common Stock at an exercise price of $0.20 per share, and pursuant to the
terms of these options, 25% of the shares issuable upon exercise of such
options vest on the first anniversary of the vesting commencement date, with
the remaining shares vesting in equal monthly installments over the following
three years. On April 15, 1997, the Company granted to Mr. Wadlow an option to
purchase 30,000 shares of Common Stock at an exercise price of $0.75 per
share, and pursuant to the terms of these options, 25% of the shares issuable
upon exercise of such options vest on the first anniversary of the vesting
commencement date, with the remaining shares vesting in equal monthly
installments over the following three years.

On December 23, 1997, the Company granted to Peter Liebowitz, its Senior
Vice President, Sales and Marketing, an option to purchase 150,000 shares of
Common Stock at an exercise price of $0.75 per share. Pursuant to the terms of
this option, 25% of the shares issuable upon exercise of such option vest on
the first anniversary of the vesting commencement date, with the remaining
shares vesting in equal monthly installments over the following three years.
On April 21, 1998, the Board of Directors approved 75,000 shares to become
immediately exercisable, subject to the Company's right to repurchase such
shares with such right expiring as to 25% of the shares on the first
anniversary of the vesting commencement date and the remaining shares in equal
monthly installments over the following three years. Mr. Liebowitz purchased
75,000 shares on April 27, 1998, subject to such repurchase right.

On December 23, 1997, the Company granted to Michael Millikin, its Vice
President, Operations and Business Development, an option to purchase 100,000
shares of Common Stock at an exercise price of $0.75 per share. Pursuant to
the terms of these options, 25% of the shares issuable upon exercise of such
options vest on the first anniversary of the vesting commencement date, with
the remaining shares vesting in equal monthly installments over the following
three years. On April 21, 1998, the Board of Directors approved 50,000 shares
to become immediately exercisable subject to the Company's right to repurchase
such shares with such right expiring as to 25% of the shares on the first
anniversary of the vesting commencement date and the remaining shares in equal
monthly installments over the following three years. Mr. Millikin purchased
50,000 shares on April 28, 1998, subject to such repurchase right.

On May 20, 1998, the Company granted William C. Leetham, its Senior Vice
President, Finance and Administration, Chief Financial Officer, Treasurer and
Secretary an option to purchase 150,000 shares of Common Stock at an exercise
price of $6.00 per share. Pursuant to the terms of these options, (i) 17,000
shares are immediately exercisable, subject to the Company's right to
repurchase such shares in the event of termination of Mr. Leetham's employment
with the Company, with such right expiring on the first anniversary of the
vesting commencement date; (ii) 20,500 shares vest on the first anniversary of
the vesting commencement date and (iii) the remaining shares vest in equal
monthly installments over the following three years. In the event the Company
is acquired and Mr. Leetham's employment is terminated without cause within 12
months after such acquisition, then 50% of the unvested portion of his option
shall immediately become fully vested at the time of such termination.

See "Management--Executive Compensation" and "--Compensation Committee
Interlocks and Insider Participation" for additional information with respect
to stock option grants to directors and executive officers of the Company.

On June 18, 1996, the Company entered into an agreement with AmeriData
Technologies Inc. ("AmeriData") whereby the Company granted AmeriData options
to purchase 200,000 shares of the Company's

55
<PAGE>

Common Stock at $2.00 per share and AmeriData agreed to sell the Company's
Internet security service to AmeriData customers in exchange for a commission
on the first two years of revenue from those customers. The Company and
AmeriData also agreed to cooperate in areas such as training and marketing. In
June 1996, Ameridata was acquired by GE Capital Corp., a subsidiary of General
Electric Company, and is now GE Capital Information Technologies Solutions,
Inc.

The Company intends to enter into indemnification agreements with its
executive officers and directors containing provisions which may require the
Company, among other things, to indemnify its executive officers and directors
against certain liabilities that may arise by reason of their status or
service as executive officers and directors (other than liabilities arising
from willful misconduct of a culpable nature) and to advance their expenses
incurred as a result of any proceeding against them as to which they could be
indemnified. The Company also intends to execute such agreements with its
future directors and executive officers. See "Management--Limitation of
Liability and Indemnification Matters."

56
<PAGE>

PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of June 30, 1998 and as adjusted to
reflect the sale of the Common Stock offered by this Prospectus by (i) each
stockholder who is known by the Company to own beneficially more than 5% of
the Common Stock, (ii) each executive officer of the Company, (iii) each
director of the Company, and (iv) all directors and executive officers of the
Company as a group.

<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED OWNED
PRIOR TO OFFERING(1) AFTER OFFERING (1)
OFFICERS, DIRECTORS AND -------------------- SHARES --------------------
PRINCIPAL STOCKHOLDERS NUMBER PERCENT(2) OFFERED NUMBER PERCENT(2)
- ----------------------- --------- ---------- ------- --------- ----------
<S> <C> <C> <C> <C> <C>
Entities affiliated with
El Dorado Ventures(3)....... 3,011,546 28.3% -- 3,011,546 21.9%
2400 Sand Hill Road
Menlo Park, CA 94025
M. Marketta Silvera(4)....... 1,330,000 12.5 60,000 1,270,000 9.3
William B. Elmore............ 1,026,916 9.7 -- 1,026,916 7.5
Technology Funding Venture
Partners V.................. 891,054 8.4 -- 891,054 6.5
an Aggressive Growth
Fund, L.P.
2000 Alameda de las Pulgas
San Mateo, CA 94403
The Trustees of the General --
Electric Pension Trust(5)... 900,000 8.5 900,000 6.6
P.O. Box 7900
3003 Summer Street
Stamford, CT 06904-6092
Jeffrey Webber............... 771,918 7.3 80,000 691,918 5.1
R.B. Webber & Company
1717 Embarcadero Road, Suite
2000
Palo Alto, CA 94303
GE Electric Capital
Corporation(6).............. 700,000 6.5 -- 700,000 5.1
120 Long Ridge Road
Stamford, CT 06927
Shanda Bahles(7)............. 3,011,546 28.3 -- 3,011,546 21.9
Thomas O'Rourke(8)........... 394,580 3.7 -- 394,580 2.9
Thomas A. Wadlow(9).......... 227,082 2.1 -- 227,082 1.7
Robert G. Carrade(10)........ 131,124 1.2 -- 131,124 1.0
Jeffrey Gall(11)............. 86,380 * -- 86,380 *
39 Woodhill Drive
Redwood City, CA 94061
Peter Liebowitz.............. 75,000 * -- 75,000 *
Michael Millikin............. 50,000 * -- 50,000 *
K. Flynn McDonald(12)........ 47,400 * -- 47,400 *
William C. Leetham(13)....... 17,000 * -- 17,000 *
All directors and executive
officers as a group
(10 persons)(14)............ 6,310,648 58.9% 60,000 6,250,648 46.1%
</TABLE>
- --------
* Represents beneficial ownership of less than 1% of the Company's common
Stock.

57
<PAGE>

(1) Except pursuant to applicable community property laws or as indicated in
the footnotes of this table, to the Company's knowledge, each stockholder
identified in the table possesses sole voting and investment power with
respect to all shares of Common Stock shown as beneficially owned by such
stockholder.
(2) Applicable percentage of ownership for each stockholder is based on
10,635,686 shares of Common Stock outstanding as of June 30, 1998,
together with applicable options and warrants for such stockholders.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. The number of shares beneficially
owned by a person includes shares of Common Stock subject to options held
by that person that are currently exercisable within 60 days of June 30,
1998. Such shares issuable pursuant to such options are deemed
outstanding for computing the percentage ownership of the person holding
such options but are not deemed outstanding for the purposes of computing
the percentage ownership of each other person. Unless otherwise
indicated, the address of each of the individuals named above is: c/o
Pilot Network Services, Inc., 1080 Marina Village Parkway, Alameda, CA
94501.
(3) Consists of 52,932 shares held by El Dorado C&L Fund, L.P., 100,230
shares held by El Dorado Technology IV, L.P., and 2,858,384 shares held
by El Dorado Ventures III, L.P. (collectively, the "El Dorado Entities").
(4) Includes 20,000 shares issuable upon exercise of stock options that are
exercisable within 60 days of June 30, 1998.
(5) Assumes exercise of Series F warrants to purchase 300,000 shares.
(6) Assumes exercise of Series F warrants to purchase 200,000 shares and
includes 100,000 shares issuable upon exercise of stock options that are
exercisable within 60 days of June 30, 1998 held by AmeriData, which was
acquired in June 1996 by GE Capital Corp., a subsidiary of General
Electric Company, and is now GE Capital Information Technologies
Solutions, Inc.
(7) Represents 3,011,546 shares held by the El Dorado Entities. Ms. Bahles, a
Director of the Company and a General Partner to each of the El Dorado
Entities, disclaims beneficial ownership of the shares held by the El
Dorado Entities, except for her proportional pecuniary interest therein,
if any.
(8) Consists of 394,580 shares held by O'Rourke Investment Corporation
("OIC"). Mr. O'Rourke, a Director of the Company and Chairman and CEO of
OIC, owns a majority of the outstanding voting shares of OIC and is a
director of OIC.
(9) Includes 21,458 shares issuable upon exercise of stock options that are
exercisable within 60 days of June 30, 1998.
(10) Includes 3,750 shares issuable upon exercise of stock options that are
exercisable within 60 days of June 30, 1998.
(11) Mr. Gall terminated his employment with the Company on January 15, 1998.
(12) Includes 20,000 shares issuable upon exercise of stock options that are
exercisable within 60 days of June 30, 1998.
(13) Includes 17,000 shares issuable upon exercise of stock options that are
exercisable within 60 days of June 30, 1998.
(14) Includes 82,208 shares issuable upon exercise of stock options that are
exercisable within 60 days of June 30, 1998.

58
<PAGE>

DESCRIPTION OF CAPITAL STOCK

Upon the completion of this Offering, the authorized capital stock of the
Company will consist of forty million shares of Common Stock, $0.001 par value
per share, and two million shares of undesignated Preferred Stock, $0.001 par
value per share.

COMMON STOCK

As of June 30, 1998, there were 10,635,686 shares of Common Stock
outstanding (including shares issuable upon conversion of all outstanding
Preferred Stock and the exercise of warrants to purchase Series F Preferred
Stock, which are convertible into an aggregate of 600,000 shares of Common
Stock), held of record by 52 stockholders, and options to purchase an
aggregate of 1,756,940 shares of Common Stock and warrants to purchase an
aggregate of 150,000 shares of Common Stock were also outstanding. There will
be 13,745,686 shares of Common Stock outstanding after this Offering (assuming
no exercise of the Underwriter's overallotment option, no exercise of
outstanding warrants to purchase Series B Preferred Stock, Series D Preferred
Stock and Common Stock, and no exercise of outstanding options after June 30,
1998) after giving effect to the sale of the shares of Common Stock to the
public offered hereby.

The holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. Subject to
preferential rights with respect to any outstanding Preferred Stock, holders
of Common Stock are entitled to receive ratably such dividends as may be
declared by the Board of Directors out of funds legally available therefor.
See "Dividend Policy." In the event of liquidation, dissolution or winding up
of the Company, the holders of Common Stock are entitled to share ratably in
all assets remaining after payment of liabilities and satisfaction of
preferential rights of any outstanding Preferred Stock. The Common Stock has
no preemptive or conversion rights or other subscription rights. The
outstanding shares of Common Stock are, and the shares of Common Stock to be
issued upon completion of this Offering will be, fully paid and non-
assessable.

PREFERRED STOCK

Effective upon the closing of this Offering, each outstanding share of
Preferred Stock will be converted into one share of Common Stock and
automatically retired. Thereafter, the Board of Directors is authorized to
issue up to two million shares of Preferred Stock in one or more series and to
fix the rights, preferences, privileges and restrictions thereof, including
dividend rights, dividend rates, conversion rights, voting rights, terms of
redemption, redemption prices, liquidation preferences and the number of
shares constituting any series or the designation of such series, without
further vote or action by the stockholders.

The issuance of Preferred Stock may have the effect of delaying, deferring
or preventing a change in control of the Company without further action by the
stockholders. The issuance of preferred stock with voting and conversion
rights may adversely affect the voting power of the holders of Common Stock,
including voting rights, of the holders of Common Stock. In certain
circumstances, such issuance could have the effect of decreasing the market
price of the Common Stock. As of the closing of this Offering, no shares of
Preferred Stock will be outstanding and the Company currently has no plans to
issue any shares of Preferred Stock.

WARRANTS

As of June 30, 1998, the Company had outstanding exercisable warrants to
purchase 27,124 shares of Series B Preferred Stock at $0.365 per share; 48,286
shares of Series D Preferred Stock at $0.875 per share and 67,500 shares of
Series D Preferred Stock at $2.00 per share; 600,000 shares of Series F
Preferred Stock at $6.00 per share; and 150,000 shares of Common Stock (the
"Common Stock Warrants") at $11.20 per share. All unexercised warrants to
purchase Series F Preferred Stock will terminate upon the closing of the
Offering. All warrants to purchase Series B Preferred Stock, Series D
Preferred Stock and Common Stock contain net exercise provisions. Warrants
that remain outstanding after the Offering will expire between June 30, 2002
and March 10, 2007. Following the automatic conversion of all classes of
Preferred Stock into Common Stock that will take place in connection with the
Offering, pursuant to the terms of each respective warrant all remaining
warrants will become exercisable for Common Stock.

59
<PAGE>

REGISTRATION RIGHTS

Following this Offering, the holders of 9,582,828 shares of Common Stock
(the "Registrable Securities") or their transferees will be entitled to
certain rights with respect to the registration of such shares under the
Securities Act. These rights are provided under the terms of an agreement
between the Company and the holders of the Registrable Securities. Subject to
certain limitations in the agreement, the holders of at least 25% of the
Registrable Securities may require, on two occasions beginning after the
earlier of March 15, 1999 or six months after the effective date of this
Offering, that the Company use its best efforts to register the Registrable
Securities for public resale. If the Company registers any of its Common Stock
either for its own account or for the account of other security holders, the
holders of Registrable Securities are entitled to include their shares of
Common Stock in such registration, subject to the ability of the underwriters
to limit the number of shares included in such offering. The holders of at
least 20% of the Registrable Securities, excluding such shares held by M.
Marketta Silvera, may also require the Company (not more than one time in any
twelve-month period) to register all or a portion of their Registrable
Securities on Form S-3 when use of such forms becomes available to the
Company, provided, among other limitations, that the proposed aggregate
selling price (net of any underwriters' discounts or commissions) is at least
$500,000. All registration expenses must be borne by the Company. However, all
registration expenses incurred in effecting any Forms S-1 or S-2 Registration
Statements after the second such Registration Statements or more than one (1)
Form S-3 Registration Statement in any twelve (12) month period shall be borne
pro rata by the holders of the Registrable Securities included in such
registration, in accordance with the number of shares being sold in such
registration. These rights shall terminate either (i) seven years following
the consummation of the Offering or (ii) for each individual holder, at such
time as the holder holds less than 1% of the voting securities of the Company.
In addition, commencing 180 days after the effective date of this Offering and
prior to June 30, 1999, the holders of warrants to purchase an aggregate of
150,000 shares of Common Stock have the right to require the Company to
register under the Securities Act shares issuable upon exercise of such
warrants.

DELAWARE LAW AND CERTAIN CHARTER PROVISIONS

Certain provisions of Delaware law and the Company's Restated Certificate of
Incorporation could make more difficult the acquisition of the Company by
means of a tender offer, a proxy contest or otherwise and the removal of
incumbent officers and directors. These provisions are expected to discourage
certain types of coercive takeover practices and inadequate takeover bids and
to encourage persons seeking to acquire control of the Company to first
negotiate with the Company. The Company believes that the benefits of
increased protection of the Company's potential ability to negotiate with the
proponent of an unfriendly or unsolicited proposal to acquire or restructure
the Company outweigh the disadvantages of discouraging such proposals because,
among other things, negotiation of such proposals could result in an
improvement of their terms.

The Company is subject to the provisions of Section 203 of the Delaware law.
In general, the statute prohibits a publicly held Delaware corporation from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date that the person became an interested
stockholder unless (with certain exceptions) the business combination or the
transaction in which the person became an interested stockholder is approved
in a prescribed manner. Generally, a "business combination" includes a merger,
asset or stock sale, or other transaction resulting in a financial benefit to
the stockholder. Generally, an "interested stockholder" is a person who,
together with affiliates and associates, owns (or within three years prior,
did own) 15% or more of the corporation's voting stock. This provision may
have the effect of delaying, deferring or preventing a change in control of
the Company without further action by the Company's stockholders.

Commencing at the first annual meeting of stockholders following the annual
meeting of stockholders when the Company shall have had at least 800
stockholders, the Restated Certificate of Incorporation of the Company
provides for the Board of Directors to be divided into two classes, with
staggered two-year terms. As a result, only one class of directors will be
elected at each annual meeting of stockholders of the Company, with the other
class continuing for the remainder of its respective two-year term.
Thereafter, stockholders shall no longer have cumulative voting rights and the
Company's stockholders representing a majority of the shares of Common Stock

60
<PAGE>

outstanding will be able to elect all of the directors. The classification of
the Board of Directors and elimination of cumulative voting make it more
difficult for the Company's existing stockholders to replace the Board of
Directors as well as for another party to obtain control of the Company by
replacing the Board of Directors. Since the Board of Directors has the power
to retain and discharge officers of the Company, these provisions could also
make it more difficult for existing stockholders or another party to effect a
change in management. See "Management--Executive Officers and Directors--Board
of Directors."

The Company's Restated Certificate of Incorporation provides that
stockholder action can be taken only at an annual or special meeting of
stockholders and may not be taken by written consent. The Bylaws provide that
special meetings of stockholders can be called only by the Board of Directors,
the Chairman of the Board, if any, the President of the Company and holders of
10% of the votes entitled to be cast at a meeting. Moreover, the business
permitted to be conducted at any special meeting of stockholders is limited to
the business brought before the meeting by the Board of Directors, the
Chairman of the Board, if any, the President of the Company or any such 10%
holder. The Bylaws set forth an advance notice procedure with regard to the
nomination, other than by or at the direction of the Board of Directors, of
candidates for election as directors and with regard to business to be brought
before a meeting of stockholders of the Company.

The Company's Restated Certificate of Incorporation contains a provision
requiring the affirmative vote of the holders of at least two-thirds of the
voting stock of the Company to amend the foregoing provisions of the Restated
Certificate of Incorporation and Bylaws.

The foregoing provisions could have the effect of making it more difficult
for a third party to effect a change in the control of the Board of Directors.
In addition, these provisions could have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
attempting to acquire, a majority of the outstanding voting stock of the
Company. See "Risk Factors--Anti-Takeover Provisions."

TRANSFER AGENT AND REGISTRAR

The Transfer Agent and Registrar for the Common Stock is U.S. Stock Transfer
Corporation. Its telephone number is (800) 835-8778.

61
<PAGE>

SHARES ELIGIBLE FOR FUTURE SALE

Prior to this Offering, there has not been any public market for the Common
Stock of the Company. Future sales of substantial amounts of Common Stock in
the public market could adversely affect prevailing market prices from time to
time. Furthermore, since only a limited number of shares will be available for
sale shortly after this Offering because of certain contractual and legal
restrictions on resale (as described below), sales of substantial amounts of
Common Stock of the Company in the public market after the restrictions lapse
could adversely affect the prevailing market price and the ability of the
Company to raise equity capital in the future.

Upon completion of this Offering, based on the number of shares outstanding
as of June 30, 1998, the Company will have outstanding an aggregate of
13,745,686 shares of Common Stock assuming no exercise of warrants or options
to purchase Common Stock outstanding as of June 30, 1998, but including the
600,000 shares to be issued upon exercise of the Series F Warrants prior to
the closing of the Offering. Of these shares, the 3,250,000 shares sold in
this Offering will be freely tradable without restriction or further
registration under the Securities Act, unless such shares are purchased by an
existing "affiliate" of the Company as that term is defined in Rule 144 under
the Securities Act (an "Affiliate"). The remaining shares of Common Stock held
by existing stockholders are "restricted securities" as that term is defined
in Rule 144 under the Securities Act ("Restricted Shares"). As of such date,
no Restricted Shares will be eligible for sale in the public market. Following
the expiration of the 180-day Lock-up Period with the representatives of the
Underwriters or the Company, (i) 2,507,246 of the Restricted Shares will be
eligible for immediate sale without restriction under Rules 144(k) or 701
under the Securities Act, (ii) 7,188,440 of the Restricted Shares will be
eligible for sale subject to compliance with the volume and other restrictions
of Rule 144, and (iii) 800,000 of the Restricted Shares (including 600,000
shares to be issued upon exercise of the Series F Warrants prior to the
closing of the Offering) will become eligible for sale at various times after
the Lock-up Period upon expiration of applicable holding periods under Rule
144, subject in some cases to the volume and other restrictions of Rule 144.
In addition, as of June 30, 1998, there were outstanding 1,756,940 options and
292,910 warrants to purchase shares of the Company (excluding 600,000 shares
which are to be issued upon exercise of the Series F Warrants prior to the
closing of the Offering) and all of such options and warrants will be subject
to 180-day lock-up agreements with the representatives of the Underwriters or
the Company. Following the expiration of the Lock-up Period, all of the
warrants will be exercisable and 369,518 of such options will be exercisable.

All of the officers and directors and certain stockholders of the Company
have entered into lock-up agreements generally providing that they will not
offer, pledge, sell, offer to sell, contract to sell, sell any option or
contract to purchase, purchase any option to sell, grant any option, right or
warrant to purchase, or otherwise transfer or dispose of, directly or
indirectly, any of the shares of Common Stock or any securities convertible
into, or exercisable or exchangeable for, Common Stock owned by them, or enter
into any swap or other arrangement that transfers to another, in whole or in
part, any of the economic consequences of ownership of the Common Stock, or
any securities convertible into, or exercisable or exchangeable for, shares of
Common Stock, for a period of 180 days after the date of this Prospectus,
without the prior written consent of Credit Suisse First Boston Corporation,
subject to certain limited exceptions. Credit Suisse First Boston Corporation
may, in its sole discretion and at any time without notice, release all or any
portion of the securities subject to lock-up agreements. Credit Suisse First
Boston Corporation currently has no plans to release any portion of the
securities subject to lock-up agreements. When determining whether or not to
release shares from the lock-up agreements, Credit Suisse First Boston
Corporation will consider, among other factors, the stockholder's reasons for
requesting the release, the number of shares for which the release is being
requested and market conditions at the time.

In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, a person (or persons whose shares are aggregated)
who has beneficially owned Restricted Shares for at least one year (including
the holding period of any prior owner except an Affiliate) would be entitled
to sell within any three-month period a number of shares that does not exceed
the greater of: (i) one percent of the number of shares of Common Stock then
outstanding (which will equal approximately 137,500 shares immediately after
this Offering); or (ii) the average weekly trading volume of the Common Stock
on the Nasdaq National Market

62
<PAGE>

during the four calendar weeks preceding the filing of a notice on Form 144
with respect to such sale. Sales under Rule 144 are also subject to certain
manner of sale provisions, notice requirements and to the availability of
current public information about the Company. Under Rule 144(k), a person who
is not deemed to have been an Affiliate of the Company at any time during the
90 days preceding a sale, and who has beneficially owned the shares proposed
to be sold for at least two years (including the holding period of any prior
owner except an Affiliate), is entitled to sell such shares without complying
with the manner of sale, public information, volume limitation or notice
provisions of Rule 144. Accordingly, unless otherwise restricted, "144(k)
shares" may be sold immediately upon the completion of this Offering.

Subject to certain limitations on the aggregate offering price of a
transaction and other conditions, Rule 701 may be relied upon with respect to
the resale of securities originally purchased from the Company by its
employees, directors, officers, consultants or advisors prior to the date the
issuer becomes subject to the reporting requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), pursuant to written
compensatory benefit plans or written contracts relating to the compensation
of such persons. In addition, the SEC has indicated that Rule 701 will apply
to typical stock options granted by an issuer before it becomes subject to the
reporting requirements of the Exchange Act, along with the shares acquired
upon exercise of such options (including exercises after the date of this
Offering). Securities issued in reliance on Rule 701 are restricted securities
and, subject to the contractual restrictions described above, beginning 90
days after the date of this Prospectus, may be sold (i) by persons other than
Affiliates, subject only to the manner of sale provisions of Rule 144 and (ii)
by Affiliates, under Rule 144 without compliance with its one-year minimum
holding period requirements.

Following this Offering, the Company intends to file a registration
statement under the Securities Act covering approximately 2,956,940 shares of
Common Stock, subject to outstanding options or reserved for issuance under
the Company's stock plans. See "Management--Stock Plans." Accordingly, shares
registered under such registration statement will, subject to Rule 144 volume
limitations applicable to Affiliates, be available for sale in the open
market, except to the extent that such shares are subject to vesting
restrictions with the Company.

Upon completion of this Offering, the holders of approximately 9,732,828
shares of Registrable Securities or the transferees will be entitled to
certain rights with respect to registration of such shares under the
Securities Act. Registration of such shares under the Securities Act would
result in such shares becoming freely tradable without restriction under the
Securities Act (except for shares purchased by Affiliates of the Company)
immediately upon the effectiveness of such registration. See "Description of
Capital Stock--Registration Rights."

63
<PAGE>

UNDERWRITING

Under the terms and subject to the conditions contained in an Underwriting
Agreement dated the date of this Prospectus (the "Underwriting Agreement") the
underwriters named below (the "Underwriters"), for whom Credit Suisse First
Boston Corporation, BancAmerica Robertson Stephens and Hambrecht & Quist LLC
are acting as representatives (the "Representatives"), have severally but not
jointly agreed to purchase from the Company and the Selling Stockholders, the
following respective numbers of shares of Common Stock:

<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
----------- ---------
<S> <C>
Credit Suisse First Boston Corporation............................. 1,137,500
BancAmerica Robertson Stephens..................................... 1,056,250
Hambrecht & Quist LLC.............................................. 1,056,250
---------
Total.......................................................... 3,250,000
=========
</TABLE>

The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will be
obligated to purchase all of the shares of Common Stock offered hereby (other
than those shares covered by the over-allotment option described below) if any
are purchased. The Underwriting Agreement provides, that, in the event of a
default by an Underwriter, in certain circumstances the purchase commitments
of non-defaulting Underwriters may be increased or the Underwriting Agreement
may be terminated.

The Company and the Selling Stockholders have granted to the Underwriters an
option, expiring at the close of business on the 30th day after the date of
this Prospectus, to purchase up to 487,500 additional shares of Common Stock
at the initial public offering price, less the underwriting discounts and
commissions, all as set forth on the cover page of this Prospectus. Such
option may be exercised only to cover over-allotments in the sale of the
shares of Common Stock. To the extent that such option is exercised, each
Underwriter will become obligated, subject to certain conditions, to purchase
approximately the same percentage of such additional shares of Common Stock as
it was obligated to purchase pursuant to the Underwriting Agreement.

The Company and the Selling Stockholders have been advised by the
Representatives that the Underwriters propose to offer the shares of Common
Stock to the public initially at the public offering price set forth on the
cover page of this Prospectus and, through the Representatives, to certain
dealers at such price less a concession of $0.59 per share and the
Underwriters and such dealers may allow a discount of $0.10 per share on sales
to certain other dealers. After the Offering, the public offering price and
concession and discount to dealers may be changed by the Representatives.

The Representatives have informed the Company and the Selling Stockholders
that they do not expect discretionary sales by the Underwriters to exceed 5%
of the shares being offered hereby.

The Company and certain of its directors, officers and stockholders have
agreed that they will not publicly announce any intention to, will not allow
any affiliate or subsidiary to, and will not itself, without the prior written
consent of Credit Suisse First Boston Corporation on behalf of the
Underwriters, (i) offer, pledge, sell, offer to sell, contract to sell, sell
any option or contract to purchase, purchase any option to sell, grant any
option right or warrant to purchase, or otherwise transfer or dispose of,
directly or indirectly, any of the shares of Common Stock or any securities
convertible into, or exercisable or exchangeable for, Common Stock, or (ii)
enter into any swap or other agreement that transfers, in whole or in part,
any of the economic consequences of ownership of the shares of Common Stock or
any securities convertible into, or exercisable or exchangeable for, shares of
Common Stock (whether any such transaction described in clause (i) or (ii)
above is to be settled by delivery of the Shares or other such securities, in
cash or otherwise), in each case, beneficially owned (within the meaning of
Rule 13d-3 under the Securities Exchange Act of 1934, as amended) or otherwise
controlled by the undersigned on the date hereof or hereafter acquired, for a
period beginning from the date of execution of the Underwriting Agreement and
continuing to and including the date 180 days after the effective date of the
Registration Statement.

64
<PAGE>

The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including civil liabilities under
the Securities Act, or contribute to payments that the Underwriters may be
required to make in respect thereof.

The shares of Common Stock have been approved for quotation on the Nasdaq
Stock Market's National Market under the symbol "PILT."

Prior to the Offering, there has been no public market for the Common Stock.
The initial public offering price has been negotiated between the Company and
the Representatives. Among the material factors considered in determining the
initial public offering price of the Common Stock, in addition to the
prevailing market conditions, was the Company's historical performance,
capital structure, estimates of the business potential, revenues and earnings
prospects of the Company, an assessment of the Company's management and
consideration of the above factors in relation to the market values of
companies in related businesses. There can be no assurance that the initial
public offering price of the Common Stock will correspond to the price at
which the Common Stock will trade in the public market subsequent to the
Offering or that an active public market for the Common Stock will develop or
continue after the Offering. See "Risk Factors --No Prior Market for Common
Stock."

The Representatives, on behalf of the Underwriters, may engage in over-
allotment, stabilizing transactions, syndicate covering transactions, and
penalty bids in accordance with Regulation M under the Securities Exchange Act
of 1934 (the "Exchange Act"). Over-allotment involves syndicate sales in
excess of the offering size, which creates a syndicate short position.
Stabilizing transactions permit bids to purchase the underlying security so
long as the stabilizing bids do not exceed a specified maximum. Syndicate
covering transactions involve purchase of the shares of Common Stock in the
open market after the distribution has been completed in order to cover
syndicate short positions. Penalty bids permit the Representatives to reclaim
a selling concession from a syndicate member when the shares of Common Stock
originally sold by such syndicate member are purchased in a syndicate covering
transaction to cover syndicate short positions. Such stabilizing transactions,
syndicate covering transactions and penalty bids may cause the price of the
Common Stock to be higher than it would otherwise be in the absence of such
transactions.

65
<PAGE>

NOTICE TO CANADIAN RESIDENTS

RESALE RESTRICTIONS

The distribution of the Common Stock in Canada is being made only on a
private placement basis exempt from the requirement that the Company and the
Selling Stockholders prepare and file a prospectus with the securities
regulatory authorities in each province where trades of Common Stock are
effected. Accordingly, any resale of the Common Stock in Canada must be made
in accordance with applicable securities laws which will vary depending on the
relevant jurisdiction not listed on a Canadian exchange, and which may require
resales to be made in accordance with available statutory exemptions or
pursuant to a discretionary exemption granted by the applicable Canadian
securities regulatory authority. Purchasers are advised to seek legal advice
prior to any resale of the Common Stock.

REPRESENTATIONS OF PURCHASERS

Each purchaser of Common Stock in Canada who receives a purchase
confirmation will be deemed to represent to the Company, the Selling
Stockholders and the dealer from whom such purchase confirmation is received
that (i) such purchaser is entitled under applicable provincial securities
laws to purchase such Common Stock without the benefit of a prospectus
qualified under such securities laws, (ii) where required by law, that such
purchaser is purchasing as principal and not as agent, and (iii) such
purchaser has reviewed the text above under "--Resale Restrictions."

RIGHTS OF ACTION (ONTARIO PURCHASERS)

The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
section 32 of the Regulation under the Securities Act (Ontario). As a result,
Ontario purchasers must rely on other remedies that may be available,
including common law rights of action for damages or recission or rights of
action under the civil liability provision of the U.S. federal securities
laws.

ENFORCEMENT OF LEGAL RIGHTS

All of the issuer's directors and officers as well as the experts named
herein and the Selling Stockholders may be located outside of Canada, and as a
result, it may not be possible for Canadian purchasers to effect service of
process within Canada upon the issuer or such persons. All or a substantial
portion of the assets of the issuer and such persons may be located outside of
Canada and, as a result, it may not be possible to satisfy a judgment against
the Company or such persons in Canada or to enforce a judgment obtained in
Canadian courts against such issuer or persons outside of Canada.

NOTICE TO BRITISH COLUMBIA RESIDENTS

Purchasers of Common Stock to whom the Securities Act (British Columbia)
applies is advised that such purchasers are required to file with the British
Columbia Securities Commission a report within ten days of the sale of any
Common Stock acquired by such purchaser pursuant to the Offering. Such report
must be in the form attached to British Columbia Securities Commission Blanket
Order BOR #95/17, a copy of which may be obtained from the Company. Only one
such report must be filed in respect of Common Stock acquired on the same date
and under the same prospectus exemption.

TAXATION AND ELIGIBILITY FOR INVESTMENT

Canadian purchasers of Common Stock should consult their own legal and tax
advisors with respect to the tax consequences of an investment in the Common
Stock in their particular circumstances and with respect to the eligibility of
the Common Stock for investment by the purchaser under relevant Canadian
legislation.

66
<PAGE>

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Company by Venture Law Group, A Professional Corporation, Menlo Park,
California. Certain legal matters relating to this Offering will be passed
upon for the Underwriters by Gunderson Dettmer Stough Villenueve Franklin &
Hachigian, LLP, Menlo Park, California.

EXPERTS

The financial statements of the Company as of March 31, 1997 and 1998, and
for each of the years in the three-year period ended March 31, 1998, have been
included in the Registration Statement in reliance upon the report of KPMG
Peat Marwick LLP, independent auditors, appearing elsewhere herein, and upon
the authority of said firm as experts in accounting and auditing.

ADDITIONAL INFORMATION

The Company has filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement (which term shall include any
amendments thereto) on Form S-1 under the Securities Act with respect to the
Common Stock offered hereby. This Prospectus, which constitutes a part of the
Registration Statement, does not contain all of the information set forth in
the Registration Statement, certain items of which are contained in exhibits
to the Registration Statement as permitted by the rules and regulations of the
Commission. For further information with respect to the Company and the Common
Stock offered hereby, reference is made to the Registration Statement,
including the exhibits thereto, and the financial statements and notes filed
as a part thereof. Statements made in this Prospectus concerning the contents
of any exhibit referred to herein are not necessarily complete. With respect
to each such document filed with the Commission as an exhibit to the
Registration Statement, reference is made to the exhibit for a more complete
description of the matter involved. The Registration Statement, including
exhibits thereto and the financial statements and notes filed as a part
thereof, as well as such reports and other information filed with the
Commission, may be inspected without charge at the public reference facilities
maintained by the Commission at 450 Fifth Street, N.W., Washington, D.C.
20549, and at the regional offices of the Commission located at Seven World
Trade Center, 13th Floor, New York, NY 10048, and the Northwestern Atrium
Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies
of all or any part thereof may be obtained from the Commission upon payment of
certain fees prescribed by the Commission. Such reports and other information
may also be inspected without charge at a Web site maintained by the
Commission. The address of such site is http://www.sec.gov.

67
<PAGE>

PILOT NETWORK SERVICES

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<S> <C>
Independent Auditors' Report................................................ F-2
Balance Sheets.............................................................. F-3
Statements of Operations.................................................... F-4
Statement of Stockholders' Deficit.......................................... F-5
Statements of Cash Flows.................................................... F-6
Notes to Financial Statements............................................... F-7
</TABLE>

F-1
<PAGE>

INDEPENDENT AUDITORS' REPORT

The Board of Directors
Pilot Network Services, Inc.:

We have audited the accompanying balance sheets of Pilot Network Services,
Inc. (the "Company") as of March 31, 1997 and 1998, and the related statements
of operations, stockholders' deficit and cash flows for each of the years in
the three-year period ended March 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Pilot Network Services,
Inc. as of March 31, 1997 and 1998, and the results of its operations and its
cash flows for each of the years in the three-year period ended March 31,
1998, in conformity with generally accepted accounting principles.

KPMG Peat Marwick LLP

Oakland, California
May 29, 1998, except for Note 6 which is
as of August 4, 1998

F-2
<PAGE>

PILOT NETWORK SERVICES, INC.

BALANCE SHEETS

<TABLE>
<CAPTION>
MARCH 31,
------------------------- JUNE 30,
1997 1998 1998
----------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........... $ 3,081,270 $ 1,446,711 $ 6,176,153
Trade receivables, less allowance
for doubtful accounts of $12,000 in
1997 and $111,000 in March 1998 and
$148,000 in June 1998 ............. 725,211 1,066,560 2,240,252
Prepaid and other current assets.... 120,064 272,902 413,967
----------- ------------ ------------
Total current assets.............. 3,926,545 2,786,173 8,830,372
Property and equipment, net........... 3,478,705 5,993,848 7,612,044
Financing costs....................... -- -- 1,200,000
Other assets, net..................... 33,950 142,286 280,963
----------- ------------ ------------
$ 7,439,200 $ 8,922,307 $ 17,923,379
=========== ============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable.................... $ 581,737 $ 2,056,689 $ 3,708,715
Accrued expenses.................... 479,329 601,040 1,206,881
Line of Credit...................... -- -- 1,055,725
Term Loan........................... -- -- 6,000,000
Current portion of capital lease
obligations........................ 972,579 1,549,585 1,771,690
Deferred revenue.................... 1,257,559 1,541,635 2,017,205
----------- ------------ ------------
Total current liabilities......... 3,291,204 5,748,949 15,760,216
Capital lease obligations, net of cur-
rent portion......................... 1,945,663 3,444,217 4,429,091
----------- ------------ ------------
Total liabilities................. 5,236,867 9,193,166 20,189,307
Commitments
Redeemable convertible preferred
stock, $0.001 par value; 7,432,810
shares authorized; 5,763,030 shares
issued and outstanding as of March
31, 1997 and 6,363,030 shares issued
and outstanding as of March 31, 1998
and June 30, 1998; aggregate
liquidation preference of $10,458,261
in 1998.............................. 8,084,068 12,143,303 12,480,047
Stockholders' deficit:
Convertible Series A preferred
stock; $0.001 par value; 1,400,000
shares authorized, issued and
outstanding; aggregate liquidation
preference of $49,000 as of
March 31, 1997, 1998 and June 30,
1998............................... 1,400 1,400 1,400
Common stock, $0.001 par value;
40,000,000 shares authorized;
2,001,722 and 2,050,536 shares
issued and outstanding as of March
31, 1997 and 1998, respectively and
2,272,656 shares issued and
outstanding as of June 30, 1998.... 2,002 2,051 2,273
Additional paid-in capital.......... 105,897 1,168,148 4,685,942
Deferred stock compensation......... -- (890,943) (2,771,677)
Accumulated deficit................. (5,991,034) (12,694,818) (16,663,913)
----------- ------------ ------------
Total stockholders' deficit....... (5,881,735) (12,414,162) (14,745,975)
----------- ------------ ------------
$ 7,439,200 $ 8,922,307 $ 17,923,379
=========== ============ ============
</TABLE>

See accompanying notes to financial statements.

F-3
<PAGE>

PILOT NETWORK SERVICES, INC.

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED MARCH 31, JUNE 30,
------------------------------------- -----------------------
1996 1997 1998 1997 1998
----------- ----------- ----------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Service revenues........ $ 2,524,965 $ 6,300,238 $11,317,302 $2,461,557 $ 3,720,166
Cost of service
revenues............... 1,424,068 4,181,426 9,825,413 1,745,575 4,023,569
----------- ----------- ----------- ---------- -----------
Gross margin............ 1,100,897 2,118,812 1,491,889 715,982 (303,403)
Operating costs and
expenses:
Sales and marketing... 1,791,823 3,109,058 4,306,466 867,584 2,133,917
Engineering and
development.......... 162,236 274,627 798,687 141,745 298,508
General and
administrative....... 765,549 1,064,401 1,550,562 340,604 688,336
----------- ----------- ----------- ---------- -----------
Operating expenses.. 2,719,608 4,448,086 6,655,715 1,349,933 3,120,761
----------- ----------- ----------- ---------- -----------
Operating loss...... (1,618,711) (2,329,274) (5,163,826) (633,951) (3,424,164)
Interest income......... 20,234 27,620 96,949 32,047 12,250
Interest expense........ (151,832) (350,012) (567,673) (115,524) (220,437)
----------- ----------- ----------- ---------- -----------
Net loss............ (1,750,309) (2,651,666) (5,634,550) (717,428) (3,632,351)
Accretion on redeemable
convertible preferred
stock.................. (262,593) (478,304) (1,069,234) (132,156) (336,744)
----------- ----------- ----------- ---------- -----------
Net loss attributable to
common stockholders.... $(2,012,902) $(3,129,970) $(6,703,784) $ (849,584) $(3,969,095)
=========== =========== =========== ========== ===========
Basic and diluted net
loss per share......... $ (1.07) $ (1.58) $ (3.31) (0.42) (1.81)
=========== =========== =========== ========== ===========
Shares used in computing
basic and diluted net
loss per share......... 1,889,048 1,982,422 2,025,470 2,005,398 2,197,882
=========== =========== =========== ========== ===========
</TABLE>

See accompanying notes to financial statements.

F-4
<PAGE>

PILOT NETWORK SERVICES, INC.

STATEMENT OF STOCKHOLDERS' DEFICIT

YEARS ENDED MARCH 31, 1996, 1997 AND 1998
AND THREE MONTHS ENDED JUNE 30, 1998

<TABLE>
<CAPTION>
SERIES A
CONVERTIBLE COMMON TOTAL
PREFERRED STOCK STOCK ADDITIONAL DEFERRED STOCKHOLDERS'
---------------- ----------------- PAID-IN STOCK ACCUMULATED EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION DEFICIT (DEFICIT)
--------- ------ --------- ------ ---------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance as of March 31,
1995................... 1,400,000 $1,400 1,777,390 $1,778 $ 79,331 $ -- $ (848,162) $ (765,653)
Issuance of common
stock................. -- -- 182,250 182 16,221 -- -- 16,403
Accretion on Series B,
C, D, E, and F
redeemable convertible
preferred stock....... -- -- -- -- -- -- (262,593) (262,593)
Net loss............... -- -- -- -- -- -- (1,750,309) (1,750,309)
--------- ------ --------- ------ ---------- ----------- ------------ ------------
Balance as of March 31,
1996................... 1,400,000 $1,400 1,959,640 $1,960 $ 95,552 $ -- $ (2,861,064) $ (2,762,152)
Issuance of common
stock................. -- -- 96,916 97 15,225 -- -- 15,322
Repurchase of common
stock................. -- -- (54,834) (55) (4,880) -- -- (4,935)
Accretion on Series B,
C, D, E, and F
redeemable convertible
preferred stock....... -- -- -- -- -- -- (478,304) (478,304)
Net loss............... -- -- -- -- -- -- (2,651,666) (2,651,666)
--------- ------ --------- ------ ---------- ----------- ------------ ------------
Balance as of March 31,
1997................... 1,400,000 $1,400 2,001,722 $2,002 $ 105,897 $ -- $ (5,991,034) $ (5,881,735)
Issuance of common
stock................. -- -- 72,706 73 8,815 -- -- 8,888
Repurchase of common
stock................. -- -- (23,892) (24) (1,844) -- -- (1,868)
Accretion on Series B,
C, D, E, and F
redeemable convertible
preferred stock....... -- -- -- -- -- -- (1,069,234) (1,069,234)
Deferred compensation
related to grant of
common stock options.. -- -- -- -- 1,055,280 (1,055,280) -- --
Amortization of
deferred
compensation.......... -- -- -- -- -- 164,337 -- 164,337
Net loss............... -- -- -- -- -- -- (5,634,550) (5,634,550)
--------- ------ --------- ------ ---------- ----------- ------------ ------------
Balance as of March 31,
1998................... 1,400,000 $1,400 2,050,536 $2,051 $1,168,148 $ (890,943) $(12,694,818) $(12,414,162)
Issuance of common
stock(1).............. -- -- 222,120 222 142,794 -- -- 143,016
Accretion on Series B,
C, D, E, and F
redeemable convertible
preferred stock(1).... -- -- -- -- -- -- (336,744) (336,744)
Issuance of common
stock warrants in
connection with bridge
financing(1).......... -- -- -- -- 1,200,000 -- -- 1,200,000
Deferred compensation
related to grant of
common stock
options(1)............ -- -- -- -- 2,175,000 (2,175,000) -- --
Amortization of
deferred
compensation.......... -- -- -- -- -- 294,266 -- 294,266
Net loss(1)............ -- -- -- -- -- -- (3,632,351) (3,632,351)
--------- ------ --------- ------ ---------- ----------- ------------ ------------
Balance as of June 30,
1998(1)................ 1,400,000 $1,400 2,272,656 $2,273 $4,685,942 $(2,771,677) $(16,663,913) $(14,745,975)
========= ====== ========= ====== ========== =========== ============ ============
</TABLE>
- --------
(1) Unaudited

See accompanying notes to financial statements.

F-5
<PAGE>

PILOT NETWORK SERVICES, INC.

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEARS ENDED MARCH 31, THREE MONTHS ENDED JUNE 30,
------------------------------------- -----------------------------
1996 1997 1998 1997 1998
----------- ----------- ----------- ------------- --------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from
operating activities:
Net loss.............. $(1,750,309) $(2,651,666) $(5,634,550) $ (717,428) $ (3,632,351)
Adjustments to
reconcile net loss to
net cash used in
operating activities:
Depreciation and
amortization......... 449,649 1,221,919 2,273,612 451,581 851,947
Amortization of
deferred
compensation......... -- -- 164,337 5,795 294,266
Changes in operating
assets and
liabilities:
Trade receivables.... (323,213) (238,528) (341,349) (722,741) (1,173,692)
Prepaid and other
assets.............. (172,743) 78,428 (261,174) (12,947) (279,742)
Accounts payable..... 106,037 352,460 1,474,952 (134,773) 1,652,026
Accrued expenses..... 224,208 197,650 121,711 150,538 605,841
Deferred revenue..... 660,033 528,376 284,076 899,683 475,570
----------- ----------- ----------- ------------- --------------
Net cash used in
operating
activities......... (806,338) (511,361) (1,918,385) (80,292) (1,206,135)
----------- ----------- ----------- ------------- --------------
Cash flows used in
investing activities--
capital expenditures.. (596,609) (650,865) (1,470,162) (16,061) (768,220)
----------- ----------- ----------- ------------- --------------
Cash flows from
financing activities:
Net proceeds from sale
of redeemable
convertible preferred
stock................ 902,700 4,501,266 2,990,000 -- --
Principal payments of
obligations under
capital leases....... (244,507) (688,616) (1,243,032) (260,982) (494,944)
Proceeds from working
capital line of
credit............... -- -- -- -- 1,055,725
Proceeds from term
loan................. -- -- -- -- 6,000,000
Proceeds from the
issuance of common
stock................ 16,403 15,322 8,888 378 143,016
Repurchase of common
stock................ -- (4,935) (1,868) -- --
----------- ----------- ----------- ------------- --------------
Net cash provided by
financing
activities......... 674,596 3,823,037 1,753,988 (260,604) 6,703,797
----------- ----------- ----------- ------------- --------------
Net increase (decrease)
in cash and cash
equivalents........... (728,351) 2,660,811 (1,634,559) (356,957) 4,729,442
Cash and cash
equivalents at
beginning of period... 1,148,810 420,459 3,081,270 3,081,270 1,446,711
----------- ----------- ----------- ------------- --------------
Cash and cash
equivalents at end of
period................ $ 420,459 $ 3,081,270 $ 1,446,711 $ 2,724,313 $ 6,176,153
=========== =========== =========== ============= ==============
Supplemental disclosure
of cash flow
information:
Cash paid during the
period-interest...... $ 136,413 $ 330,407 $ 567,673 $ 115,524 $ 220,439
=========== =========== =========== ============= ==============
Noncash financing
activities:
Assets acquired under
capital lease
obligations.......... $ 1,319,530 $ 2,244,512 $ 3,318,592 $ 498,762 $ 1,629,407
=========== =========== =========== ============= ==============
Accretion of
redeemable preferred
stock................ $ 262,593 $ 478,304 $ 1,069,234 $ 132,156 $ 336,744
=========== =========== =========== ============= ==============
</TABLE>

See accompanying notes to financial statements.

F-6
<PAGE>

PILOT NETWORK SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS

(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of Business

Pilot Network Services, Inc. (the Company), was incorporated in California
on August 6, 1992. Pilot Network Services provides comprehensive security
services that incorporate high-bandwidth connectivity and enable secure
electronic commerce over the Internet.

Interim Financial Information

The financial information presented as of June 30, 1998 and for the three
months ended June 30, 1997 and June 30, 1998 is unaudited. In the opinion of
management, this unaudited financial information contains all adjustments
(which consist only of normal, recurring adjustments) necessary for a fair
presentation. Operating results for the three months ended June 30, 1998 are
not necessarily indicative of results that may be expected for the full year.

Revenue Recognition

Revenues consist primarily of monthly fees for secure access and hosting
services, installation and management services. Secure access and hosting
service fees are recognized ratably over the term of the contract, generally
one year. Installation fees are recognized over the installation period,
generally 60 days. Management services, which include security audits and
consulting arrangements, are recognized as the service is performed.

Cash Equivalents

The Company considers all highly liquid instruments with a remaining
maturity of 90 days or less at the date of purchase to be cash equivalents.

Property and Equipment

Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method based on estimated useful lives, generally over three
years. Depreciation expense includes amortization of assets recorded under
capital lease. Equipment held under capital leases is amortized over the
shorter of the lease term or the estimated useful life of the asset.

Software Development Costs

Software development costs are expensed as incurred until the technological
feasibility of the related product has been established. After technological
feasibility is established, any additional software development costs would be
capitalized in accordance with Financial Accounting Standards Board Statement
of Financial Accounting Standards ("SFAS") No. 86, Capitalization of Software
Development Costs. Through March 31, 1998, the Company's process for
developing software was essentially completed concurrently with the
establishment of technological feasibility in the form of a working model,
and, accordingly, no software costs have been capitalized to date. Software
development costs incurred prior to achieving technological feasibility are
charged to engineering and development expense as incurred.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years that those differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period
that includes the enactment date.

Accounting for Stock-Based Compensation

The Company uses the intrinsic value method to account for its stock-based
employee compensation plans. Compensation expense, if any, is amortized on an
accelerated basis over the vesting period of the individual options, generally
four years.

F-7
<PAGE>

PILOT NETWORK SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of

The Company evaluates the recoverability of its identifiable tangible assets
under SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. This statement requires identifiable
assets to be evaluated for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable. If an asset is considered to be impaired, the carrying amount of
that asset is reduced to its fair value, resulting in a charge to income.
Assets to be disposed of are reported at the lower of the carrying amounts or
fair value less costs to sell. As of March 31, 1998, the Company did not
consider any of its assets to be impaired.

Advertising

Advertising costs are expensed as incurred and are included in sales and
marketing expense. The Company had no advertising expense for the years ended
March 31, 1996 and 1997, and approximately $24,000 during the year ended March
31, 1998.

Net Loss Per Share

Basic net loss per share is computed using the weighted average number of
common shares outstanding during the period. Diluted net loss per share is
computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period, using either the as-if-
converted method for convertible preferred stock or the treasury stock method
for options and warrants. The effect of including convertible preferred stock,
options and warrants would have been antidilutive during all periods presented
and, as a result, such effect has been excluded from the computation of
diluted net loss per share. Pursuant to SEC Staff Accounting Bulletin No. 98,
common stock and convertible preferred stock issued for nominal consideration
and options and warrants granted for nominal consideration prior to the
anticipated effective date of the initial public offering (IPO) are included
in the calculation of basic and diluted net loss per share, as if they were
outstanding for all periods presented. To date, the Company has not had any
issuances or grants for nominal consideration.

Excluded from the computation of diluted earnings per share for the year
ended March 31, 1998 are options to acquire 1,125,312 shares of Common Stock
with a weighted-average exercise price of $0.68 because their effects would be
anti-dilutive. Also excluded from the computation of diluted earnings per
share for the year ended March 31, 1998 are 7,329,696 common share equivalents
resulting from the assumed conversion of the Series A, B, C, D, E and F
preferred stock because their effects would be anti-dilutive.

F-8
<PAGE>

PILOT NETWORK SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

Had the outstanding shares of Redeemable Convertible Preferred Stock and the
Series A Preferred Stock converted to common stock as of April 1, 1997 or the
date of issuance, if later, pro forma basic and diluted earnings per share
would have been as follows:

<TABLE>
<CAPTION>
UNAUDITED
---------------------------------------
YEAR ENDED MARCH 31, 1998
AND THREE MONTHS ENDED JUNE 30, 1998
---------------------------------------
WEIGHTED AVERAGE
NET LOSS SHARES PER SHARE
----------- ---------------- ---------
<S> <C> <C> <C>
MARCH 31, 1998
Basic and diluted loss per share...... $(6,703,784) 2,025,470 $(3.31)
Pro forma adjustment for accretion and
conversion of preferred stock........ 1,069,234 7,329,696 --
----------- --------- ------
Pro forma basic and diluted loss per
share................................ $(5,634,550) 9,355,166 $(0.60)
=========== ========= ======
JUNE 30, 1998
Basic and diluted loss per share...... $(3,969,095) 2,197,882 $(1.81)
Pro forma adjustment for accretion and
conversion of preferred stock........ 336,744 7,763,030 --
----------- --------- ------
Pro forma basic and diluted loss per
share................................ $(3,632,351) 9,960,912 $(0.36)
=========== ========= ======
</TABLE>

Concentration of Risk

The Company provides its services throughout the United States to a wide
user base. During the years presented no single customer accounted for greater
than 5% of total service revenue. The Company performs credit evaluations of
its customers' financial condition and, generally, does not require collateral
from its customers. Management makes estimates as to its credit losses and to
date its estimates have not differed materially from actual results. Overall,
credit risk is limited due to the large number of customers in differing
industries and geographic areas.

The Company purchases its network management hardware from a limited number
of suppliers.

Fair Value of Financial Instruments

The carrying value of cash, cash equivalents, accounts receivable, accounts
payable and accrued liabilities approximate fair value due to the short
maturity of those instruments.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Recent Accounting Pronouncements

The Financial Accounting Standards Board ("FASB") recently issued SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for
reporting and displaying comprehensive income and its components in financial
statements. It does not, however, require a specific format, but requires the
Company to display an amount representing total comprehensive income for the
period in its financial

F-9
<PAGE>

PILOT NETWORK SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

statements. The Company is in the process of determining its preferred format.
SFAS No. 130 is effective for fiscal years beginning after December 15, 1997.

The FASB also recently issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information." SFAS No. 131 establishes standards for
the way public business enterprises are to report information about operating
segments in annual financial statements and requires those enterprises to
report selected information about operating segments in interim financial
reports. SFAS No. 131 is effective for financial statements for fiscal years
beginning after December 15, 1997. The Company sells its services in one
industry segment. Therefore, the Company has determined that it currently does
not have any separately reportable business segments.

(2) PROPERTY AND EQUIPMENT

Property and equipment consisted of the following:

<TABLE>
<CAPTION>
MARCH 31,
---------------------- JUNE 30,
1997 1998 1998
---------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Network and computer equipment.......... $4,616,932 $ 8,273,673 $ 9,450,321
Furniture and fixtures.................. 265,116 456,829 529,744
Purchased software...................... 162,271 576,712 761,361
Leasehold improvements.................. 200,901 718,941 1,754,879
---------- ----------- -----------
5,245,220 10,026,155 12,496,305
Less accumulated depreciation and
amortization........................... 1,766,515 4,032,307 4,884,261
---------- ----------- -----------
$3,478,705 $ 5,993,848 $ 7,612,044
========== =========== ===========
</TABLE>

The gross amount of capitalized leased assets included in property and
equipment was approximately $3,856,000 and $4,994,000 and related accumulated
amortization was approximately $1,445,000 and $3,182,000 as of March 31, 1997
and 1998, respectively.

(3) COMMITMENTS

Leases

The Company has entered into equipment leases with various leasing
institutions providing for financing of equipment purchases of up to
$5,000,000 at varying interest rates. Borrowings under the leases are
generally repayable in monthly installments over periods ranging from 36 to 48
months and a mandatory buyout, and are secured by a lien on the leased
equipment.

The Company is obligated under certain noncancelable operating leases for
office space and equipment expiring at various dates through 2001. Rent
expense for the years ended March 31, 1996, 1997 and 1998 was $201,519,
$464,503 and $636,031, respectively.

F-10
<PAGE>

PILOT NETWORK SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

The following is a schedule of future minimum payments required under
capital and operating leases that have initial or remaining noncancelable
lease terms in excess of one year as of March 31, 1998:

<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
---------- ----------
<S> <C> <C>
YEAR ENDING MARCH 31:
1999............................................... $2,206,861 $1,104,225
2000............................................... 1,844,261 1,127,691
2001............................................... 1,366,650 622,669
2002............................................... 847,931 291,928
2003............................................... 52,039 219,461
Thereafter......................................... -- 752,501
---------- ----------
Total minimum lease payments..................... 6,317,742 $4,118,475
==========
Less amount representing interest (at rates ranging
from 14.5% to 14.7%).............................. 1,323,940
----------
4,993,802
Less current portion of capital lease obligations.. 1,549,585
----------
Capital lease obligations, net of current portion.. $3,444,217
==========
</TABLE>

Agreement

On June 18, 1996, the Company entered into an agreement with AmeriData
Technologies Inc. (Subsequently purchased by GE Capital Information
Technologies Solutions, Inc.) ("AmeriData") whereby the Company granted
AmeriData options to purchase 200,000 shares of the Company's Common Stock at
$2.00 per share and AmeriData agreed to sell the Company's secure Internet
services to AmeriData customers in exchange for a commission on the monthly
recurring revenue received in the first two years of these new customer
contract. The commissions incurred through March 31, 1998 have not been
material. The fair value of the options granted to AmeriData was immaterial
using the following assumptions: no dividend yield; risk free interest rate of
6.5%: volatility of 60%; expected life for the option of five years; and a
fair value of common stock of $0.40.

401(k) Retirement Plan

Effective July 1, 1995 the Company established a 401(k) defined contribution
retirement plan (the "Retirement Plan") covering all full-time employees with
greater than one months' service. The Retirement Plan provides for voluntary
employee contributions from 1% to 15% of annual compensation, subject to a
maximum limit allowed by Internal Revenue Service guidelines. The Company may
contribute such amounts to the accounts of participants in the Retirement Plan
as determined by the Board of Directors. However, to date, the Company has not
made any contribution to the Retirement Plan.

F-11
<PAGE>

PILOT NETWORK SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

(4) INCOME TAXES

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities are presented below:

<TABLE>
<CAPTION>
MARCH 31,
------------------------
1997 1998
----------- -----------
<S> <C> <C>
Deferred tax assets (liabilities):
Net operating loss carryforwards................ $ 1,816,595 $ 3,522,247
Plant and equipment--depreciation differences... (13,855) 48,932
Research credit carryforwards................... -- 34,070
Other reserves and accruals..................... 207,164 200,050
----------- -----------
Total gross deferred tax assets............... 2,009,904 3,805,299
Less valuation allowance........................ (2,009,904) (3,805,299)
----------- -----------
Net deferred tax assets....................... $ -- $ --
=========== ===========
</TABLE>

The net increase in the valuation allowance was approximately $1,150,000 and
$1,795,000 for the years ended March 31, 1997 and 1998, respectively. Due to
recent operating losses the Company believes that sufficient uncertainty
exists with respect to future realization of these deferred tax assets;
therefore, it has established a valuation allowance against all net deferred
tax assets.

The Company has net operating loss carryforwards for federal income tax
return purposes of approximately $9,500,000 which can be used to reduce future
taxable income. These carryforwards expire in 2008 through 2012. As of March
31, 1998, the Company had California operating loss carryforwards of
approximately $3,800,000 available to offset future income subject to
California franchise tax. The difference between the federal loss
carryforwards and the California loss carryforwards results primarily from a
50% limitation on California loss carryforwards, and certain research and
development costs that were deferred for California tax purposes. The
California net operating loss carryforwards expire in various amounts from
1998 through 2002. The Company also has federal and California tax credit
carryforwards of approximately $20,000 and $14,000, respectively, as of March
31, 1998. These tax credits expire through 2012.

Under the Tax Reform Act of 1986, the amounts of any benefit from net
operating losses and credits that can be carried forward may be limited in the
event of an ownership change as defined in the Internal Revenue Code, Section
382.

(5) STOCKHOLDERS' DEFICIT

Convertible Preferred Stock and Redeemable Convertible Preferred Stock

The Company has outstanding six series of preferred stock: Series A, B, C,
D, E and F. Each share of preferred stock is convertible, at the option of the
holder, into fully paid shares of common stock. The conversion rate is one-
for-one, subject to adjustments for stock dividends, stock splits and capital
reorganizations and dilution.

In January 1994 the Company issued 1,661,646 shares of Series B Redeemable
Convertible Preferred Stock at $0.365 per share. In March 1995, the Company
issued 1,488,200 shares of Series D Redeemable Convertible Preferred Stock at
$0.875 per share. In December 1995 and January 1996, the Company issued
1,210,068 shares of Series C Redeemable Convertible Preferred Stock at $0.73
per share upon the exercise of warrants outstanding. In July 1996, the Company
issued 783,118 shares of Series E Redeemable Convertible Preferred

F-12
<PAGE>

PILOT NETWORK SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

Stock at $2.00 per share. From March 1997 through February 1998, the Company
issued 1,220,000 shares of Series F Redeemable Convertible Preferred Stock and
warrants to purchase 600,000 shares of Series F Preferred Stock for $5.00 per
share and an exercise price on the warrants of $6.00 per share.

The preferred stock automatically converts to common stock upon the closing
of an underwritten public offering of shares of the Company's common stock
resulting in total proceeds of at least $7,500,000 and with a minimum share
price of at least $5.00. The holders of the preferred stock are entitled to
vote on an "as if converted" basis on all matters brought to a vote of the
Company's stockholders.

The Series B, C, D, E and F preferred stock are redeemable after January 28,
1999 upon written request of the holders of the majority of such shares,
acting as a single class. The redemption price is equal to the original
purchase price plus 12% per annum for the period the preferred stock was
outstanding, less dividends previously paid.

Shares of Series A, B, C, D, E and F preferred stock have liquidation
preferences of $0.035, $0.365, $0.73, $0.875, $2.00 and $5.00, respectively,
plus all declared but unpaid dividends.

The holders of Series A, B, C, D, E and F preferred stock are entitled to
noncumulative dividends at annual rates of $0.005, $0.03, $0.06, $0.088, $0.20
and $0.50 per share, respectively, when and if declared by the Board of
Directors.

In the event of a liquidation, consolidation, merger or winding up of the
Company prior to conversion, holders of preferred stock are entitled to
receive, in preference to the holders of common stock, an amount equal to
their liquidation preference or a pro rata share of the remaining assets,
based on their ownership of the Company.

Preferred stock issued and outstanding as of March 31, 1998 was as follows:

<TABLE>
<CAPTION>
SHARES ISSUED
SHARES AND REDEMPTION
DESIGNATED OUTSTANDING AMOUNT
---------- ------------- -----------
<S> <C> <C> <C>
Series A................................ 1,400,000 1,400,000 $ --
Series B................................ 1,913,424 1,661,644 909,385
Series C................................ 1,210,068 1,210,068 1,117,450
Series D................................ 1,686,200 1,488,200 1,767,851
Series E................................ 783,118 783,118 1,883,854
Series F................................ 1,840,000 1,220,000 6,464,763
--------- --------- -----------
8,832,810 7,763,030 $12,143,303
========= ========= ===========
</TABLE>

Warrants

In connection with lease financings, the Company has issued warrants for the
purchase of 27,124 and 115,786 shares of Series B and Series D Redeemable
Preferred Stock, at weighted average exercise prices of $0.365 and $1.53,
respectively.

During 1997 and 1998, the Company issued warrants to purchase 600,000 shares
of Series F Redeemable Preferred Stock to the purchases of Series F Redeemable
Preferred Stock at an exercise price of $6.00 per share in conjunction with
the issuance of the Series F Redeemable Preferred Stock.

F-13
<PAGE>

PILOT NETWORK SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

The fair value of all warrant issuances calculated using the Black-Scholes
option pricing model was not material, using the following assumptions:
dividend yield--none; expected life--contractual term; risk free interest
rate--6%; volatility--60%. Automatic termination will occur for any remaining
warrants upon the closing of the sale of the Company's common stock in a
public offering, in which the gross proceeds exceed $7,500,000 and the
offering price of the common stock exceeds $5.00 per share.

Stock Option Plan

During fiscal 1995, the Company adopted its 1994 Stock Option Plan and the
1994 Restricted Stock Purchase Plan. On April 17, 1997, the plans were merged
into a single plan and the authorized shares were increased resulting in an
aggregate 1,200,000 shares reserved for issuance. The plan, as amended, allows
the Board of Directors to issue nonqualified stock options, incentive stock
options or restricted stock to employees, officers, directors, advisors or
contractors of the Company.

The plan expires 10 years from the date of adoption. Options and restricted
stock are granted at fair market value at date of grant for incentive stock
options or no less than 85% of fair market value at the date of grant for
nonqualified options. Options and restricted stock generally vest over 4
years, with 25% vesting after one year and monthly thereafter, and expire 10
years from grant date.

As of March 31, 1998, 94,722 shares of restricted common stock held by
management were subjected to repurchase by the Company at prices ranging from
$0.035 to $0.20 per share.

The following table summarizes stock option and restricted stock activity as
if the plans had been combined at the beginning of the periods presented:

<TABLE>
<CAPTION>
WEIGHTED
AVAILABLE AVERAGE
FOR GRANT OUTSTANDING EXERCISE PRICE
---------- ----------- --------------
<S> <C> <C> <C>
Balances, March 31, 1995.. 825,054 67,416 $0.07
Granted................. (598,250) 598,250 0.09
Exercised............... -- (182,250) 0.09
Canceled................ 167,000 (167,000) 0.09
---------- --------- -----
Balances, March 31, 1996.. 393,804 316,416 0.09
Granted................. (412,000) 412,000 0.31
Exercised............... -- (96,916) 0.16
Canceled................ 169,542 (169,542) 0.22
Repurchased............. 54,834 -- 0.09
---------- --------- -----
Balances, March 31, 1997.. 206,180 461,958 0.23
Authorized.............. 830,140 -- --
Granted................. (1,020,000) 1,020,000 0.82
Exercised............... -- (72,706) 0.12
Canceled................ 283,940 (283,940) 0.57
Repurchased............. 23,892 -- 0.08
---------- --------- -----
Balances, March 31, 1998.. 324,152 1,125,312 0.68
Authorized (1).......... 1,000,000 -- --
Granted (1)............. (681,000) 681,000 3.69
Exercised (1)........... -- (222,120) 0.64
Canceled (1)............ 27,252 (27,252) 1.39
---------- --------- -----
Balances, June 30, 1998
(1)...................... 670,404 1,556,940 1.99
========== ========= =====
Exercisable as of March
31, 1998................. -- 137,806 0.22
========= =====
Exercisable as of June 30,
1998 (1)................. 217,938 0.89
========= =====
</TABLE>
- --------
(1) Unaudited.

F-14
<PAGE>

PILOT NETWORK SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

The following table summarizes information about fixed stock options
outstanding at March 31, 1998:

<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
REMAINING NUMBER OF
EXERCISE NUMBER OF CONTRACTUAL SHARES
PRICES SHARES LIFE EXERCISABLE
-------- --------- ----------- -----------
<S> <C> <C> <C>
$0.035................................... 27,416 6.5 23,990
0.09.................................... 93,542 7.4 58,294
0.20.................................... 58,354 8.2 21,104
0.40.................................... 43,000 8.6 15,980
0.75.................................... 830,000 9.5 18,438
1.50.................................... 73,000 9.8 --
--------- -------
0.035-1.50.............................. 1,125,312 137,806
========= =======
</TABLE>

The Company accounts for the plan using the intrinsic value method. As such,
compensation expense is recorded if on the date of grant the current fair
value per share of the underlying stock exceeds the exercise price per share.
With respect to certain options granted during fiscal 1998 and the first
quarter of fiscal 1999 ended June 30, 1998, the Company has recorded deferred
compensation of $1,055,280 and $2,175,000, respectively for the difference at
the grant date between the exercise price per share and the fair value per
share, based upon management's estimate of the fair value of the Company's
stock on the various grant dates of the common stock underlying the options.

Had compensation cost for the Company's stock-based compensation plan been
determined consistent with SFAS No. 123, the Company's net loss would have
increased to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Net loss attributable to common
stockholders:
As reported........................ $(2,012,902) $(3,129,970) $(6,703,784)
Pro forma.......................... (2,105,200) (3,132,204) (6,727,281)
Net loss per share:
As reported basic and diluted net
loss per share.................... $ (1.07) $ (1.58) $ (3.31)
Pro forma basic and diluted net
loss per share.................... $ (1.07) $ (1.58) $ (3.32)
Shares used in computing reported
and pro forma basic and diluted
net loss per share................ 1,889,048 1,982,422 2,025,470
</TABLE>

Under SFAS 123 the fair value of each option grant is estimated on the date
of grant using the minimum value method with the following weighted average
assumptions; no dividend yield; risk free interest rate of 6.5%; and expected
life for the options of five years.

The effect of applying SFAS No. 123 for disclosing compensation costs may
not be representative of the effects on pro forma net loss for future years
because pro forma net loss reflects compensation costs only for stock options
granted in fiscal 1996, 1997 and 1998 and does not consider compensation costs
for stock options granted prior to April 1, 1995.

F-15
<PAGE>

PILOT NETWORK SERVICES, INC.

NOTES TO FINANCIAL STATEMENTS--(CONCLUDED)

(6) SUBSEQUENT EVENTS

Equipment Financing

On April 1, 1998, the Company increased its equipment financing commitment
with a financial institution for financing of equipment purchases up to
$5,000,000 at interest rates of approximately 15%. The Company's ability to
draw more than $2,000,000 of this line is subject to receiving $3,000,000 of
new equity investment. Borrowing under the financing is repayable in monthly
installments of principal and interest over 48 months and is secured by a lien
on the leased equipment.

Debt Financing

On May 11, 1998, the Company negotiated a line of credit with a financial
institution for an aggregate amount of $1,500,000. The line of credit bears
interest at a minimum of 11% per annum and is secured by assets of the
Company.

On June 30, 1998 the Company completed a borrowing agreement with two
lenders providing $6.0 million of short term financing. The loan expires in
June 1999 and bears interest at 13.5% per year. The loan may be pre-paid at
the Company's option after 6 months and at the option of the lenders at any
time after the Company's initial public offering. As additional consideration,
the Company issued 150,000 warrants to purchase Common Stock at any exercise
price of 80% of the initial public offering price. The Company has determined
that the warrants have a fair value of $1.2 million. The Company has
capitalized the cost of the warrants and expects to write off such amount over
the one-year term of the loan.

Stock Based Compensation Plans

On June 12, 1998, the Board of Directors approved the Company's 1998 Stock
Option Plan (the 1998 Plan). The 1998 plan reserves 1,000,000 shares plus
annual increases limited to the lesser of 500,000 shares, 3% of the Company's
outstanding common stock, or the number determined by the Board of Directors.
Also on June 12, 1998, the Board of Directors approved the 1998 Directors
Stock Option Plan which reserves 200,000 shares of Common Stock and a 1998
Employee Stock Purchase Plan which reserves 200,000 shares of Common Stock.
The 1998 Employee Stock Purchase Plan provides for automatic annual increases
of the lesser of 100,000 shares, 1/2% of the Company's outstanding Common
Stock or an amount determined by the Board of Directors.

Reincorporation

On June 12, 1998, the Board of Directors approved the Company's
reincorporation in the state of Delaware and a 2 for 1 split of common and
preferred stock, both of which were consummated on August 4, 1998. The
Certificate of Incorporation of the Delaware successor corporation authorizes
40,000,000 shares of common stock, $.001 par value per share, and 9,432,810
shares of preferred stock, $.001 par value per share. The accompanying
financial statements have been retroactively restated to give effect to the
reincorporation and stock split.

Initial Public Offering

In June 1998, the Board of Directors authorized the filing of a registration
statement with the Securities and Exchange Commission that would permit the
Company and certain stockholders of the Company to sell shares of the
Company's common stock in connection with a proposed initial public offering
("IPO"). If the offering is consummated under the terms presently anticipated,
all the then outstanding shares of the Company's redeemable convertible
preferred stock will automatically convert into shares of common stock on a
one-for-one basis upon the closing of the proposed IPO.

F-16
<PAGE>

PILOT'S GLOBAL EXPANSION

[Chart shows current Network Security Centers in San Francisco, Los Angeles,
Chicago and New York and New Centers in Boston, Minneapolis, Washington, D.C.
and London commencing operations in 1998 and identified on a globe. Chart
indicates:

Arrows pointing to Europe and Asia to indicate anticipated
international expansion. Legend indicates the following types of
operations:]

-- Pilot Network Security Centers
-- New Centers in 1998
-- Anticipated International Expansion

The Company currently has Network Security Centers in the San Francisco, Los
Angeles, New York and Chicago, and is commencing operations in the Boston,
Washington D.C., Minneapolis and London metropolitan areas during 1998. The
Company intends to establish additional Network Security Centers in the United
States, Europe and Asia, although the Company has not identified specific
locations for expansion. In addition, there can be no assurance with respect
to the timing or extent of such expansion or that the Company will be
successful in expanding its operations. See "Risk Factors--Risks of Business
Expansion and Management Growth."
<PAGE>

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

NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFOR-
MATION OR MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS AND, IF
GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY, ANY SELLING STOCKHOLDER OR ANY UNDER-
WRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION
OF ANY OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO
ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER IN SUCH JURISDICTION. NEI-
THER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER
ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THE INFORMATION HEREIN IS CORRECT
AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF OR THAT THERE HAS BEEN NO CHANGE
IN THE AFFAIRS OF THE COMPANY SINCE SUCH DATE.

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TABLE OF CONTENTS

<TABLE>
<CAPTION>
Page
----
<S> <C>
Prospectus Summary....................................................... 3
Risk Factors............................................................. 5
Use of Proceeds.......................................................... 18
Dividend Policy.......................................................... 18
Capitalization........................................................... 19
Dilution................................................................. 20
Selected Financial Data.................................................. 21
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 22
Business................................................................. 30
Management............................................................... 43
Certain Relationships and Related Transactions........................... 54
Principal and Selling Stockholders....................................... 57
Description of Capital Stock............................................. 59
Shares Eligible for Future Sale.......................................... 62
Underwriting............................................................. 64
Notice to Canadian Residents............................................. 66
Legal Matters............................................................ 67
Experts.................................................................. 67
Additional Information................................................... 67
Index to Financial Statements............................................ F-1
</TABLE>

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UNTIL SEPTEMBER 4, 1998, (25 DAYS AFTER THE COMMENCEMENT OF THE OFFERING), ALL
DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.

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[LOGO OF PILOT NETWORK SERVICES, INC.]

3,250,000 Shares
Common Stock
($0.001 par value)

PROSPECTUS

CREDIT SUISSE FIRST BOSTON

BANCAMERICA ROBERTSON STEPHENS

HAMBRECHT & QUIST

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