<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[ X ] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended September 30, 1999.
or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
Commission File Number: 0-24507
PILOT NETWORK SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3305774
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1080 MARINA VILLAGE PARKWAY
ALAMEDA, CA 94501
(Address of principal executive offices, including zip code)
(510) 433-7800
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- ----
At September 30, 1999, there were 13,745,796 shares of the Registrant's Common
Stock outstanding.
Page 1 of 17
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PILOT NETWORK SERVICES, INC.
QUARTERLY REPORT ON FORM 10-Q
INDEX
Page Number
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Financial Statements............................................. 3
Condensed Balance Sheets as of
March 31, 1999 and September 30, 1999............................ 3
Condensed Statements of Operations for the three months and six
months ended September 30, 1998 and 1999......................... 4
Condensed Statements of Cash Flows for the
six months ended September 30, 1998 and 1999..................... 5
Notes to Financial Statements.................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................ 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 16
PART II. OTHER INFORMATION................................................ 16
Item 2. Changes in Securities and Use of Proceeds........................ 16
Item 4. Submission of Matters to a Vote of Security Holders.............. 16
Item 6. Exhibits and Reports on Form 8-K................................. 17
SIGNATURES................................................................... 17
INDEX TO EXHIBITS............................................................ 17
</TABLE>
Page 2 of 17
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PILOT NETWORK SERVICES, INC.
CONDENSED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
<TABLE>
<CAPTION>
March 31, September 30,
1999 1999
--------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................... $ 10,660 $ 3,167
Short-term investments...................................................... 12,352 1,930
Trade receivables, less allowance for doubtful accounts of $157 and $217 as
of March 31, 1999 and September 30, 1999, respectively..................... 3,438 4,262
Prepaid and other current assets............................................ 783 735
-------- --------
Total current assets..................................................... 27,233 10,094
Property and equipment, net.................................................. 14,184 18,850
Other assets................................................................. 698 513
-------- --------
$ 42,115 $ 29,457
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................................ $ 2,334 $ 2,427
Accrued expenses............................................................ 1,675 2,341
Line of credit.............................................................. 1,439 1,311
Term loan................................................................... 3,000 -
Current portion of capital lease obligation................................. 2,175 2,471
Deferred revenue............................................................ 2,027 1,357
-------- --------
Total current liabilities................................................ 12,650 9,907
Capital lease obligations, net of current portion............................ 4,830 4,600
-------- --------
Total liabilities........................................................ 17,480 14,507
-------- --------
Stockholders' equity:
Common stock, $0.001 par value; 40,000,000 shares authorized; 13,913,024
and 14,196,732 shares issued and outstanding as of March 31, 1999 and
September 30, 1999, respectively........................................... 14 14
Additional paid-in capital.................................................. 59,563 60,067
Accumulated other comprehensive income...................................... 127 40
Deferred stock compensation................................................. (1,097) (761)
Accumulated deficit......................................................... (31,278) (41,716)
Treasury stock, 450,936 shares of common stock at cost
as of March 31, 1999 and September 30, 1999, respectively................. (2,694) (2,694)
-------- --------
Total stockholders' equity............................................... 24,635 14,950
-------- --------
$ 42,115 $ 29,457
======== ========
</TABLE>
See accompanying notes to condensed financial statements.
Page 3 of 17
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PILOT NETWORK SERVICES, INC.
CONDENSED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
September 30, September 30,
1998 1999 1998 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Service revenues................................. $ 3,770 $ 7,130 $ 7,490 $ 12,946
Cost of service revenues......................... 4,581 7,379 8,604 13,809
------- ------- ------- --------
Gross margin..................................... (811) (249) (1,114) (863)
------- ------- ------- --------
Operating costs and expenses:
Sales and marketing............................. 2,134 3,218 4,268 6,156
Engineering and development..................... 386 767 685 1,402
General and administrative...................... 728 970 1,416 1,730
------- ------- ------- --------
Operating expenses.............................. 3,248 4,955 6,369 9,288
------- ------- ------- --------
Operating loss................................... (4,059) (5,204) (7,483) (10,151)
Interest expense, net............................ (1,031) (37) (1,239) (287)
------- ------- ------- --------
Net loss......................................... (5,090) (5,241) (8,722) (10,438)
Accretion on redeemable convertible preferred
stock........................................... (151) - (488) -
------- ------- ------- --------
Net loss attributable to common stockholders..... $(5,241) $(5,241) $(9,210) $(10,438)
======= ======= ======= ========
Basic and diluted net loss per share............. $ (0.60) $ (0.38) $ (1.68) $ (0.77)
======= ======= ======= ========
Shares used in computing net loss per share...... 8,752 13,689 5,477 13,625
======= ======= ======= ========
</TABLE>
See accompanying notes to condensed financial statements.
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PILOT NETWORK SERVICES, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands, unaudited)
<TABLE>
<CAPTION>
Six months ended
September 30,
1998 1999
-------------- --------------
Cash flows from operating activities:
<S> <C> <C>
Net loss............................................................ $ (8,722) $(10,438)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization..................................... 1,790 3,371
Amortization of deferred compensation............................. 705 336
Amortization of loan fees......................................... 750 150
Changes in operating assets and liabilities:
Trade receivables............................................... (752) (824)
Prepaid and other assets........................................ (271) 83
Accounts payable................................................ (146) 93
Accrued expenses................................................ 803 666
Deferred revenue................................................ (146) (670)
-------- --------
Net cash used in operating activities......................... (5,989) (7,233)
-------- --------
Cash flows used in investing activities:
Purchases of property and equipment................................. (1,560) (6,863)
Purchases of short-term investments................................. (11,691) -
Proceeds from short-term investments................................ - 10,335
-------- --------
Net cash provided by (used in) investing activities........... (13,251) 3,472
-------- --------
Cash flows from financing activities:
Net proceeds from issuance of common stock.......................... 43,326 504
Proceeds from working capital line of credit........................ 726 -
Payments of working capital line of credit.......................... - (128)
Proceeds from term loan............................................. 6,000 -
Payments of term loan............................................... - (3,000)
Principal payments of obligations under capital leases.............. (1,038) (1,108)
-------- --------
Net cash provided by (used in) financing activities........... 49,014 (3,732)
-------- --------
Net increase (decrease) in cash and cash equivalents................. 29,774 (7,493)
Cash and cash equivalents, beginning of period....................... 1,447 10,660
-------- --------
Cash and cash equivalents, end of period............................. $ 31,221 $ 3,167
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest............................ $ 706 $ 667
======== ========
Noncash financing activities:
Assets acquired under capital lease obligations.................... $ 2,373 $ 1,174
======== ========
Accretion on preferred stock....................................... $ 488 $ -
======== ========
</TABLE>
See accompanying notes to condensed financial statements.
Page 5 of 17
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NOTES TO CONDENSED FINANCIAL STATEMENTS
1. Basis of presentation
The financial statements included herein for Pilot Network Services, Inc.
(the "Company") have been prepared by the Company, without audit, pursuant to
the rules and regulations for Form 10-Q of the Securities and Exchange
Commission. In management's opinion, the interim financial data presented
includes all adjustments (which include only normal and recurring adjustments)
necessary for a fair presentation. Certain information and footnote disclosures
normally included in the financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted pursuant
to such rules and regulations. The results of operations for the three months
ended September 30, 1999 are not necessarily indicative of the operating results
expected for the entire year. The financial statements included herein should be
read in conjunction with other documents the Company files from time to time
with the Securities and Exchange Commission, including the Company's March 31,
1999, financial statements and notes thereto included in the Company's Annual
Report on Form 10-K dated June 29, 1999 and its Quarterly Report on Form 10-Q
dated August 16, 1999.
2. Basic and diluted net loss per share
Basic and diluted loss per share is computed using the weighted average
number of common shares outstanding during the period. Inclusion of common share
equivalents would be anti-dilutive and have been excluded from per share
calculations.
As part of Pilot's initial public offering on August 10, 1998, 7,763,030
shares of common stock were issued from the conversion of the Series A, B, C, D,
E and F preferred stock. Prior to August 10, 1998, those shares were not
included in calculating diluted earnings per share because the effects would be
anti-dilutive. Also excluded from the computation of diluted earnings per share
for the three and six-month periods ending September 30, 1998, are options to
acquire 1,604,558 shares of common stock and 292,910 common share equivalents
from the assumed exercise of common stock warrants because their effects would
be anti-dilutive. Excluded from the computation of diluted earnings per share
for the three and six-month periods ending September 30, 1999, are options to
acquire 2,251,671 shares of common stock and 217,874 common share equivalents
from the assumed exercise of common stock warrants because their effects would
be anti-dilutive.
3. Recent accounting pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes standards for
accounting for derivative instruments and hedging activities. The Company is
required to adopt SFAS No. 133, as amended by SFAS No. 137, in the first quarter
of fiscal year 2002. The Company does not anticipate that SFAS No. 133 will have
a material impact on its financial statements.
4. Comprehensive Loss
Total comprehensive loss for the quarter and six months ended September 30,
1999, was $5,283,000 and $10,525,000, respectively.
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5. Subsequent event.
On November 10, 1999, the Company completed an $8.0 million credit facility
with a financial institution consisting of $5.0 million as a revolving line of
credit and $3.0 million as a term loan. The line of credit is renewable in
successive one-year terms and currently bears interest of 10.25% per annum. The
term loan expires in one year and currently bears interest of 10.25% per annum.
Additionally, the term loan must be pre-paid, without penalty, if the Company
raises more than $15 million in equity. The credit facility is secured by the
general assets of the Company. As additional consideration, the Company issued a
warrant to purchase 121,212 shares of common stock at $8.25 per share. The
Company calculated a fair value of the warrants of $1.0 million which amount
will be capitalized and amortized over the expected terms of the loans.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
In addition to historical information, this Quarterly Report contains
forward-looking statements. The forward-looking statements are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those reflected in such forward-looking statements. Factors
that might cause such a difference include, but are not limited to, those
discussed in the section entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Factors That May Affect Future
Results and Market Price of Stock." Readers are cautioned not to place undue
reliance on these forward-looking statements, which reflect management's
opinions only as of the date hereof. The Company undertakes no obligation to
revise or publicly release the results of any revision to these forward-looking
statements. Readers should carefully review the risk factors that may be
described in other documents the Company files from time to time with the
Securities and Exchange Commission, including its Annual Report on Form 10-K
filed by the Company on June 29, 1999, its Quarterly Report on Form 10-Q filed
by the Company on August 16, 1999, and any Quarterly Reports on Form 10-Q filed
by the Company in the future.
OVERVIEW
Pilot Network Services, Inc. provides a wide range of secure Internet
services that incorporate high-bandwidth connectivity and enable secure
electronic business over the Internet. The services are offered for a fixed
monthly fee on an annual subscription-basis. The Company's services include
secure hosting and Internet connectivity services that enable secure
connectivity between a corporate network and the Internet and secure virtual
private networking services that enable remote users and wide-area networks to
securely communicate enterprise-wide and over the Internet. The Company offers a
scalable solution that allows customers to quickly deploy and expand electronic
business capabilities by subscribing to Pilot's secure Internet services.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999
SERVICE REVENUES. In the three months ended September 30, 1999, service
revenues increased 89% to $7.1 million from $3.8 million in the three months
ended September 30, 1998. This growth was due primarily to increases in the
number of new customers and to additional services sold to existing customers.
To a lesser extent, annual price increases for various offered services also
contributed to this growth. Additionally, the Company was able to shorten the
implementation time for certain new services, allowing for earlier recognition
of implementation fees and billing of fees for recurring services.
Page 7 of 17
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COST OF SERVICE REVENUES. Cost of service revenues increased 61% to $7.4
million, or 103% of service revenues, in the three months ended September 30,
1999, compared to $4.6 million, or 121% of service revenues, in the three months
ended September 30, 1998. The increase in cost of service revenue was a result
of an increase in security implementation, customer service and operations
personnel from 63 at September 30, 1998, to 80 at September 30, 1999, as well as
increases in the average cost of those personnel, consulting, facilities rent,
telecommunications, equipment leases and depreciation directly related to the
Company's revenue growth. Additionally, incremental costs associated with the
opening of a new Network Security Center in Alameda, California contributed to
the increase in cost of service revenues. The Company expects the cost of
service revenues to continue to increase on an absolute basis as a result of
expected customer expansion in the Company's Network Security Centers.
SALES AND MARKETING. Sales and marketing expenses increased 51% to $3.2
million in the three months ended September 30, 1999, from $2.1 million in the
three months ended September 30, 1998, but decreased as a percentage of service
revenues to 45% for the three months ended September 30, 1999, from 57% for the
three months ended September 30, 1998. The increase in sales and marketing
expense was a result of increases in recruiting, commissions and sales promotion
directly related to the expanded sales activity. The Company expects that its
sales and marketing expenses will continue to increase in absolute dollars for
at least the next twelve months as the Company makes additional investments in
expanding its sales and marketing activities. The Company employed 40 sales and
marketing personnel at September 30, 1999.
ENGINEERING AND DEVELOPMENT. Engineering and development expenses increased
99% to $0.8 million in the three months ended September 30, 1999, from $0.4
million in the three months ended September 30, 1998, and remained relatively
flag as a percentage of service revenues at 11% for the three months ended
September 30, 1999, compared to 10% for the three months ended September 30,
1998. The increase in engineering and development expense was a result of an
increase in personnel from 9 at September 30, 1998, to 18 at September 30, 1999,
as well as an increase in consulting and other professional services. The
Company expects that its engineering and development expenses will continue to
increase in absolute dollars for at least the next twelve months as the Company
makes additional investments in developing its secure electronic commerce
services.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased 33%
to $1.0 million in the three months ended September 30, 1999 from $0.7 million
in the three months ended September 30, 1998, but decreased as a percentage of
service revenues to 14% for the three months ended September 30, 1999, from 19%
for the three months ended September 30, 1998. The increase in general and
administrative expense was a result of an increase in personnel from 13 at
September 30, 1998, to 17 at September 30, 1999, as well as increases in
professional fees and business taxes as well as other costs associated with
being a public company. The Company expects that its general and administrative
expenses will continue to increase in absolute dollars for at least the next
twelve months as the Company continues to expand its operations.
SIX MONTHS ENDED SEPTEMBER 30, 1998 AND 1999
SERVICE REVENUES. In the six months ended September 30, 1999, service
revenues increased 73% to $12.9 million from $7.5 million in the six months
ended September 30, 1998. This growth was due primarily to increases in the
number of new customers and to additional services sold to existing customers.
To a lesser extent, annual price increases for various offered services also
contributed to this growth.
COST OF SERVICE REVENUES. Cost of service revenues increased to $13.8
million, or 107% of service revenues, in the six months ended September 30,
1999, compared to $8.6 million, or 115% of service revenues, in the six months
ended September 30, 1998. The increase in cost of service revenue was a result
of an overall increase in customer service and operations personnel as well as
an increase in
Page 8 of 17
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the average cost of such personnel. Additionally, increases in consulting,
telecommunications, facilities rent, equipment leases and depreciation, all
associated with existing operations as well as the opening of a new Network
Security Center in Alameda, California contributed to the increase in cost of
service revenue.
SALES AND MARKETING. Sales and marketing expenses increased 44% to $6.2
million in the six months ended September 30, 1999 from $4.3 million in the six
months ended September 30, 1998 but decreased as a percentage of service
revenues to 44% for the six months ended September 30, 1999 from 57% for the six
months ended September 30, 1998. The increase in sales and marketing expense was
a result of additional commissions and expanding marketing programs in
connection with the Company's expansion of its operations. The Company expects
that sales and marketing expenses will continue to increase in absolute dollars
for the remainder of the fiscal year.
ENGINEERING AND DEVELOPMENT. Engineering and development expenses increased
110% to $1.4 million in the six months ended September 30, 1999 from $0.7
million in the six months ended September 30, 1998 and increased as a percentage
of service revenues to 11% for the six months ended September 30, 1999 from 9%
for the six months ended September 30, 1998. The increase in engineering and
development expense was a result of increases in personnel and consulting
related expenses in connection with continuing efforts to develop new security
methodologies, integrate and enhance acquired third-party technologies to
support the Company's security and add new service offerings. The Company
expects that its engineering and development expenses will continue to increase
in absolute dollars for the remainder of the fiscal year as a result of this
increased investment activity.
GENERAL AND ADMINISTRATIVE. General and administrative expenses increased 22%
to $1.7 million in the six months ended September 30, 1999 from $1.4 million in
the six months ended September 30, 1998 but decreased as a percentage of service
revenues to 13% for the six months ended September 30, 1999 from 19% for the six
months ended September 30, 1998. The increase in general and administrative
expense was a result of increases in personnel, professional fees and business
taxes. The Company expects that its general and administrative expenses will
continue to increase in absolute dollars for the remainder of the fiscal year as
the Company continues to expand its operations.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, the Company's cash, cash equivalents and short-term
investments totaled $5.1 million compared to cash, cash equivalents and short-
term investments of $23.0 million at March 31, 1999.
As of September 30, 1999, the Company had an $8.0 million equipment line of
credit and lease facility for financing of equipment purchases at interest rates
of approximately 15%. Borrowings under the facilities are repayable in monthly
installments of principal and interest over 48 months and are secured by a lien
on the financed equipment. As of September 30, 1999, the Company had fully
utilized these lines of credit and lease facilities. The Company intends to
secure additional equipment lease lines of credit to fund growth in capital
equipment purchases.
On November 10, 1999, the Company completed an $8.0 million credit facility
with a financial institution consisting of $5.0 million as a revolving line of
credit and $3.0 million as a term loan. The line of credit is renewable in
successive one-year terms and currently bears interest of 10.25% per annum. The
term loan expires in one year and currently bears interest of 10.25% per annum.
Additionally, the term loan must be pre-paid, without penalty, if the Company
raises more than $15 million in equity. The credit facility is secured by the
general assets of the Company. As additional consideration, the Company issued a
warrant to purchase 121,212 shares of common stock at $8.25 per share. The
Company calculated a fair value of the warrants of $1.0 million which amount
was capitalized and will be amortized over the expected terms of the loans.
Page 9 of 17
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On October 19, 1998, the Company announced an open-market common stock
repurchase program under which the Company would repurchase up to 1.5 million
shares of its Common Stock. As of June 30, 1999, 450,936 shares had been
repurchased, at an aggregate cost to the Company of approximately $2.7 million.
The Company does not anticipate making any additional repurchases under this
program.
On June 30, 1998, the Company completed a borrowing arrangement with two
lenders providing $6.0 million of short term financing bearing interest at 13.5%
per annum. The loans expired in June 1999. The loans contained various pre-
payment options available after the Company's initial public offering date of
August 10, 1998. As additional consideration, the Company issued 150,000
warrants to purchase common stock at $11.20 per share. The Company calculated a
fair value of the warrants of $1.2 million which amount was capitalized and
amortized over the expected terms of the loans. One of the lenders exercised its
option for repayment of $3.0 million which was repaid in October 1998. On July
1, 1999, the Company repaid the remaining $3.0 million liability to the other
lender.
On May 11, 1998, the Company negotiated a line of credit with a financial
institution for an aggregate amount of $1.5 million. The line of credit
currently bears interest of 10.25% per annum and is secured by assets of the
Company. At September 30, 1999, $1.3 million of this debt facility was
available. This line of credit has been repaid from proceeds of the $3.0 million
term loan and terminated.
The Company's working capital and capital requirements will depend upon
numerous factors including plans to incur substantial additional capital
expenditures primarily for additions to and expansions of its Network Security
Centers, developing, acquiring or licensing new applications and technologies,
and the level of resources that the Company devotes to its sales and marketing
activities. In addition to the recently completed $8.0 million line of credit,
the Company will require additional equity financing during the quarter ending
March 31, 2000, which it is actively pursuing. In addition, the Company will
pursue additional equipment lease financing. However, there can be no
assurance that the Company will be successful in generating anticipated levels
of cash from operations or in obtaining equity or equipment lease financing.
If the Company is unable to generate sufficient cash flow from operations, or
is unable to obtain additional equity or equipment lease financing, it will 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 would have a material
adverse impact 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.
YEAR 2000 RISKS
The Company has established procedures for evaluating and managing the risks
and costs associated with the Year 2000 problem and believes that the internal
computer systems that the Company has developed are currently Year 2000
compliant. 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 order to comply with Year 2000
requirements in the foreseeable future. In the quarter ended December 31, 1998,
the Company formed a group of its technical staff on a project to upgrade and
standardize hardware, operating systems and application software versions on
most of the Company's production equipment. The Company believes that this
project is required for general consistency and operating efficiencies. However,
a by-product of this effort will be a greater level of assurance that the
Company is Year 2000 compliant. The engineering phase of the project is
currently on schedule and is estimated to be completed on or about the end of
November 1999. However, continued monitoring and a year end transition effort
will continue into January 2000.
Despite the Company's belief that its internal computer systems are currently
Year 2000 compliant, many of the Company's customers maintain their Internet
operations on commercially
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available operating systems, which may be impacted by Year 2000 complications.
In addition, the Company relies on third party vendors for certain equipment,
which may contain embedded instructions, and software included within the
Company's services, which may not be Year 2000 compliant. The Company is
conducting an audit of its third-party suppliers as to the Year 2000 compliance
of their systems. However, the failure to correct or discover a material Year
2000 problem could result in an interruption in, or a failure of, certain normal
business activities or operations. Such failures could materially and adversely
affect the Company's results of operations, liquidity and financial condition.
Due to the general uncertainty inherent in the Year 2000 problem resulting in
part from the uncertainty of the Year 2000 readiness of third-party suppliers
and customers, the Company is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the Company's
results of operations, liquidity or financial condition. The Company has
developed contingency plans for staffing and operating its Network Security
Centers in the event of any Year 2000 complications. This plan is being updated
on a continuous basis and will be in place prior to December 31, 1999. As a
precautionary measure, the Company plans to fully staff its Network Security
Centers over the New Year's Day holiday and to take other precautions during
this period. In connection with these measures, the Company expects to incur
incremental expense of at least $70,000 beyond normal holiday staffing costs.
Further, any serious or unexpected service problems that might be caused by Year
2000 complications could create the need for additional, unexpected and material
expenditures.
The dates on which the Company believes its audit of third party suppliers
and its overall Year 2000 readiness will be completed is based on the Company's
management's best estimates, which were derived utilizing numerous assumptions
of future events, including the continued availability of certain resources,
third-party cooperation and modification plans, and other factors. However,
there can be no guarantee that these estimates will be achieved, or that there
will not be a delay in, or increased costs associated with, the implementation
of Year 2000 compliant solutions. Specific factors that might cause differences
between the estimates and actual results include, but are not limited to, the
availability and cost of personnel trained in these areas, the ability to locate
and correct all relevant computer code, timely responses to and corrections by
third-parties and suppliers, the ability to implement interfaces between the new
systems and the systems not being replaced, and similar uncertainties. Due to
the general uncertainty inherent in the Year 2000 problem, resulting in part
from the uncertainty of the Year 2000 readiness of third-parties and the
interconnection of global businesses, the Company cannot ensure its ability to
timely and cost-effectively resolve problems associated with the Year 2000 issue
and is unable to determine at this time whether the consequences of Year 2000
failures will have a material impact on the Company's results of operations,
liquidity or financial condition. The Company operates a number of servers on
behalf of its customers. The Company has limited control over most of the
software and applications that are running on such servers and believes that it
bears no responsibility for the Year 2000 compliance of such servers. The
Company is unable to determine what costs, if any, it may have to incur to the
extent that such customers are unable to complete their own Year 2000 compliance
on such servers. Although the Company believes that it is not obligated to make
such upgrades and believes that any costs incurred should be billable to its
customers, Year 2000 problems on such customer servers may force the Company to
make significant, unplanned allocations of limited technical and financial
resources. Any significant unplanned allocations could have a material and
adverse impact on the Company's results of operations, liquidity and financial
condition.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
The Company operates in a rapidly changing environment that involves numerous
risks, some of which are beyond the Company's control. The following discussion
highlights some of these risks.
FUTURE CAPITAL NEEDS. The Company's working capital and capital requirements
will depend upon numerous factors including plans to incur substantial
additional capital expenditures primarily for additions to and expansions of its
Network Security Centers, developing, acquiring or licensing new applications
and technologies, and the level of resources that the Company devotes to its
Page 11 of 17
<PAGE>
sales and marketing activities. In addition to the recently completed $8.0
million line of credit, the Company will require additional equity financing
during the quarter ending March 31, 2000, which it is actively pursuing. In
addition, the Company will pursue additional equipment lease financing.
However, there can be no assurance that the Company will be successful in
generating anticipated levels of cash from operations or in obtaining equity
or equipment lease financing. If the Company is unable to generate sufficient
cash flow from operations, or is unable to obtain additional equity or
equipment lease financing, it will 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 would have a material adverse impact 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.
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 September 30, 1999, the
Company had an accumulated deficit of approximately $41.7 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 security technologies, 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 1998 and fiscal 1999 and expects to continue
experiencing significant net losses on a quarterly and annual basis for the
foreseeable future, including a negative gross margin at least for the next six
months. 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. 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.
POTENTIAL FLUCTUATIONS IN RESULTS OF OPERATIONS. The Company derives revenue
from its customers primarily through initial setup 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 continued growth in its customer base
and the retention of its customers for sufficient periods to provide returns on
the Company's investment. 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.
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.
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 Heuristic Defense
Infrastrucure delivered through its Network Security Centers is designed to
prevent unauthorized access to customers' networks from the Internet. Any
failure
Page 12 of 17
<PAGE>
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. 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.
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'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.
In addition, the Company will be required to expend substantial resources for
leases and improvements of 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.
The Company has recently hired large numbers of new employees. This growth
has placed and may continue to place a significant strain on the Company's
financial, management, operational and other resources. If the Company's
executives were unable to manage growth effectively, the Company's business,
results of operations and financial condition would be materially adversely
affected.
COMPETITION. The market served by the Company is new, rapidly evolving,
highly competitive and largely undefined. There are few general barriers to
entry, and the Company expects that it will face additional competition from
existing competitors and new market entrants in the future. 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. 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, 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.
Page 13 of 17
<PAGE>
RISK OF SYSTEM FAILURE. The Company's success depends on the excellence of
security protection and uninterrupted operation of its network infrastructure.
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. 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.
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, any of which could adversely
affect the Company's international operations.
DEPENDENCE UPON SCALABILITY OF THE COMPANY'S NETWORK. The Company must
continue to expand and adapt its network infrastructure as the number of
customers 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. 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. 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.
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.
DEPENDENCE UPON THIRD PARTY NETWORK INFRASTRUCTURE PROVIDERS. The Company's
success will depend upon third party network infrastructure providers. 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
or to refuse to offer services to the Company 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. 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.
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. 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
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.
Page 14 of 17
<PAGE>
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 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. 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. 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.
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. Any officer or employee of the Company can terminate
his or her relationship with the Company at any time. 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.
RISKS ASSOCIATED WITH INFORMATION DISSEMINATED THROUGH THE COMPANY'S NETWORK.
The law relating to the liability of on-line 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 on-line 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. 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.
PROTECTION AND ENFORCEMENT OF INTELLECTUAL PROPERTY RIGHTS. The Company
relies on a combination of copyright, trademark, patent, service mark and trade
secret laws and contractual restrictions to establish and protect certain
proprietary rights in technology underlying its services. There can be no
assurance that patents or trademarks will be issued or granted from currently
pending or any future applications, or that any patents or trademarks that may
be issued or granted will be sufficient in scope or strength to provide
meaningful protection or any commercial advantage to the Company. 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.
There can be no assurance that 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.
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. Any such claim, whether meritorious
or not, could be time-consuming, result in costly litigation, cause product
installation delays,
Page 15 of 17
<PAGE>
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. As a result, any such claim could have a material adverse
effect upon the Company's business, results of operations and financial
condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company has limited exposure to financial market risks, including changes
in interest rates. The fair value of Pilot's investment portfolio or related
income would not be significantly impacted by a 100 basis point increase or
decrease in interest rates due mainly to the short-term nature of the major
portion of our investment portfolio. An increase or decrease in interest rates
would not significantly increase or decrease interest expense on debt
obligations due to the fixed nature of the Company's debt obligations. Pilot's
foreign operations are limited in scope and thus the Company is not materially
exposed to foreign currency fluctuations.
PART II. OTHER INFORMATION.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
The Company filed a registration statement on Form S-1, File No. 333-57453,
for an initial public offering of Common Stock which was declared effective by
the Securities and Exchange Commission on August 10, 1998. In that offering, the
Company sold an aggregate of 3,110,000 shares of its Common Stock with net
offering proceeds of $39.4 million. As of September 30, 1999, the Company had
used approximately $37.8 million of those proceeds as follows:
Construction of plant, building and facilities: $4.3 million
Purchase and installation of machinery and equipment: $9.4 million
Purchases of real estate: None
Acquisition of other businesses: None
Repayment of indebtedness: $9.0 million
Working capital: None
Repurchase of Common Stock: $2.7 million
Cash loss from operations: $12.4 million
The foregoing amounts represent the Company's best estimate of its use of
proceeds for the period indicated. No payments were made to directors or
officers of the Company or their associates, holders of 10% or more of any class
of equity securities of the Company or to affiliates of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On September 16, 1999, the Company held its Annual Meeting of Stockholders.
At the meeting, the stockholders elected as Class I directors M. Marketta
Silvera (with 10,571,957 affirmative votes and 298,004 votes withheld), Shanda
Bahles (with 10,720,122 affirmative votes and 149,839 votes withheld), and
Thomas B. Kelly (with 10,818,074 affirmative votes and 51,887 votes withheld).
In addition, the stockholders approved the amendment of the Company's 1998
Stock Option Plan (with 5,022,717 affirmative votes, 806,667 negative votes,
5,017,744 broker non-votes and 22,833 abstentions).
The stockholders also ratified the appointment of KPMG, LLP, as the Company's
independent public accountants for fiscal year ending March 31, 2000, (with
10,834,785 affirmative votes, 18,630 negative votes, and 16,546 abstentions).
Page 16 of 17
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
Exhibit Number Description of Exhibit
10.1 1998 Stock Option Plan, as amended on April 23, 1999
27.1 Financial Data Schedule
B. Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
November 15, 1999 /s/ William C. Leetham
- ----------------- ----------------------
William C. Leetham
Senior Vice President, Finance and Administration
Chief Financial Officer, Treasurer and Secretary
(Principal Financial and Accounting Officer)
EXHIBIT INDEX
Exhibit Number Description of Exhibit
10.1 1998 Stock Option Plan, as amended on April 23, 1999
27.1 Financial Data Schedule
Page 17 of 17
<PAGE>
Exhibit 10.1
PILOT NETWORK SERVICES, INC.
1998 STOCK OPTION PLAN
----------------------
(As Amended April 23, 1999)
1. Purposes of the Plan. The purposes of this Stock Option Plan are to
--------------------
attract and retain the best available personnel for positions of substantial
responsibility, to provide additional incentive to the Employees and Consultants
of the Company and to promote the success of the Company's business.
Options granted hereunder may be either Incentive Stock Options (as
defined under Section 422 of the Code) or Nonstatutory Stock Options, at the
discretion of the Board and as reflected in the terms of the written option
agreement.
2. Definitions. As used herein, the following definitions shall apply:
-----------
(a) "Administrator" shall mean the Board or any of its Committees
-------------
appointed pursuant to Section 4 of the Plan.
(b) "Affiliate" shall mean an entity other than a Subsidiary (as
---------
defined below) in which the Company owns an equity interest.
(c) "Applicable Laws" shall have the meaning set forth in Section 4(a)
---------------
below.
(d) "Board" shall mean the Board of Directors of the Company.
-----
(e) "Code" shall mean the Internal Revenue Code of 1986, as amended.
----
(f) "Committee" shall mean the Committee appointed by the Board of
---------
Directors in accordance with Section 4(a) of the Plan, if one is appointed.
(g) "Common Stock" shall mean the Common Stock of the Company.
------------
(h) "Company" shall mean Pilot Network Services, Inc., a California
-------
corporation.
(i) "Consultant" means any person, including an advisor, who is
----------
engaged by the Company or any Parent or Subsidiary to render services and is
compensated for such services, and any director of the Company whether
compensated for such services or not.
(j) "Continuous Status as an Employee or Consultant" shall mean the
----------------------------------------------
absence of any interruption or termination of service as an Employee or
Consultant. Continuous Status as an Employee or Consultant shall not be
considered interrupted in the case of sick leave, military leave, or any other
leave of absence approved by the Administrator; provided that such leave is
--------
<PAGE>
for a period of not more than 90 days or reemployment upon the expiration of
such leave is guaranteed by contract or statute. For purposes of this Plan, a
change in status from an Employee to a Consultant or from a Consultant to an
Employee will not constitute a termination of employment.
(k) "Director" shall mean a member of the Board.
--------
(l) "Employee" shall mean any person (including any Named Executive,
--------
Officer or Director) employed by the Company or any Parent, Subsidiary or
Affiliate of the Company. The payment by the Company of a director's fee to a
Director shall not be sufficient to constitute "employment" of such Director by
the Company.
(m) "Exchange Act" shall mean the Securities Exchange Act of 1934, as
------------
amended.
(n) "Fair Market Value" means, as of any date, the value of Common
-----------------
Stock determined as follows:
(i) If the Common Stock is listed on any established stock
exchange or a national market system including without limitation the National
Market of the National Association of Securities Dealers, Inc. Automated
Quotation ("Nasdaq") System, its Fair Market Value shall be the closing sales
price for such stock as quoted on such system on the date of determination (if
for a given day no sales were reported, the closing bid on that day shall be
used), as such price is reported in The Wall Street Journal or such other source
as the Administrator deems reliable;
(ii) If the Common Stock is quoted on the Nasdaq System (but not
on the National Market thereof) or regularly quoted by a recognized securities
dealer but selling prices are not reported, its Fair Market Value shall be the
mean between the bid and asked prices for the Common Stock or;
(iii) In the absence of an established market for the Common
Stock, the Fair Market Value thereof shall be determined in good faith by the
Administrator.
(o) "Incentive Stock Option" shall mean an Option intended to qualify
----------------------
as an incentive stock option within the meaning of Section 422 of the Code, as
designated in the applicable written option agreement.
(p) "Named Executive" shall mean any individual who, on the last day
---------------
of the Company's fiscal year, is the chief executive officer of the Company (or
is acting in such capacity) or among the four highest compensated officers of
the Company (other than the chief executive officer). Such officer status shall
be determined pursuant to the executive compensation disclosure rules under the
Exchange Act.
(q) "Nonstatutory Stock Option" shall mean an Option not intended to
-------------------------
qualify as an Incentive Stock Option, as designated in the applicable written
option agreement.
-2-
<PAGE>
(r) "Officer" shall mean a person who is an officer of the Company
-------
within the meaning of Section 16 of the Exchange Act and the rules and
regulations promulgated thereunder.
(s) "Option" shall mean a stock option granted pursuant to the Plan.
------
(t) "Optioned Stock" shall mean the Common Stock subject to an Option.
--------------
(u) "Optionee" shall mean an Employee or Consultant who receives an
--------
Option.
(v) "Parent" shall mean a "parent corporation," whether now or
------
hereafter existing, as defined in Section 424(e) of the Code.
(w) "Plan" shall mean this 1998 Stock Option Plan.
----
(x) "Rule 16b-3" shall mean Rule 16b-3 promulgated under the Exchange
----------
Act as the same may be amended from time to time, or any successor provision.
(y) "Share" shall mean a share of the Common Stock, as adjusted in
-----
accordance with Section 14 of the Plan.
(z) "Subsidiary" shall mean a "subsidiary corporation," whether now or
----------
hereafter existing, as defined in Section 424(f) of the Code.
3. Stock Subject to the Plan. Subject to the provisions of Section 14 of
-------------------------
the Plan, the maximum aggregate number of Shares that may be optioned and sold
under the Plan is 2,156,000 Shares of Common Stock, plus such number of Shares
as may be returned to the Company's 1994 Stock Plan on or after September 16,
1999 upon termination of an optionee's employment or consulting relationship
with the Company up to a maximum of 400,000 Shares, plus an 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 (i) 500,000 Shares, (ii) three percent (3%) of
the Shares outstanding on the last day of the immediately preceding fiscal year,
or (iii) such lesser number of Shares as the Board shall determine. The Shares
may be authorized, but unissued, or reacquired Common Stock.
If an Option should expire or become unexercisable for any reason without
having been exercised in full, the unpurchased Shares that were subject thereto
shall, unless the Plan shall have been terminated, become available for future
grant under the Plan. Notwithstanding any other provision of the Plan, shares
issued under the Plan and later repurchased by the Company shall not become
available for future grant under the Plan.
4. Administration of the Plan.
--------------------------
(a) Composition of Administrator.
----------------------------
-3-
<PAGE>
(i) Multiple Administrative Bodies. If permitted by Rule 16b-3,
-------------------------------
and by the legal requirements relating to the administration of incentive stock
option plans, if any, of applicable securities laws and the Code (collectively,
the "Applicable Laws"), grants under the Plan may (but need not) be made by
---------------
different administrative bodies with respect to Directors, Officers who are not
directors and Employees who are neither Directors nor Officers.
(ii) Administration with respect to Directors and Officers. With
-----------------------------------------------------
respect to grants of Options to Employees or Consultants who are also Officers
or Directors of the Company, grants under the Plan shall be made by (A) the
Board, if the Board may make grants under the Plan in compliance with Rule 16b-3
and Section 162(m) of the Code as it applies so as to qualify grants of Options
to Named Executives as performance-based compensation, or (B) a Committee
designated by the Board to make grants under the Plan, which Committee shall be
constituted in such a manner as to permit grants under the Plan to comply with
Rule 16b-3, to qualify grants of Options to Named Executives as performance-
based compensation under Section 162(m) of the Code and otherwise so as to
satisfy the Applicable Laws.
(iii) Administration with respect to Other Persons. With respect
--------------------------------------------
to grants of Options to Employees or Consultants who are neither Directors nor
Officers of the Company, the Plan shall be administered by (A) the Board or (B)
a Committee designated by the Board, which Committee shall be constituted in
such a manner as to satisfy the Applicable Laws.
(iv) General. If a Committee has been appointed pursuant to
-------
subsection (ii) or (iii) of this Section 4(a), such Committee shall continue to
serve in its designated capacity until otherwise directed by the Board. From
time to time the Board may increase the size of any Committee and appoint
additional members thereof, remove members (with or without cause) and appoint
new members in substitution therefor, fill vacancies (however caused) and remove
all members of a Committee and thereafter directly administer the Plan, all to
the extent permitted by the Applicable Laws and, in the case of a Committee
appointed under subsection (ii), to the extent permitted by Rule 16b-3 and to
the extent required under Section 162(m) of the Code to qualify grants of
Options to Named Executives as performance-based compensation.
(b) Powers of the Administrator. Subject to the provisions of the
---------------------------
Plan and in the case of a Committee, the specific duties delegated by the Board
to such Committee, the Administrator shall have the authority, in its
discretion:
(i) to determine the Fair Market Value of the Common Stock, in
accordance with Section 2(m) of the Plan;
(ii) to select the Employees and Consultants to whom Options may
from time to time be granted hereunder;
(iii) to determine whether and to what extent Options are
granted hereunder;
-4-
<PAGE>
(iv) to determine the number of shares of Common Stock to be
covered by each such award granted hereunder;
(v) to approve forms of agreement for use under the Plan;
(vi) to determine the terms and conditions, not inconsistent
with the terms of the Plan, of any award granted hereunder (including, but not
limited to, the share price and any restriction or limitation, or any vesting
acceleration or waiver of forfeiture restrictions regarding any Option and/or
the shares of Common Stock relating thereto, based in each case on such factors
as the Administrator shall determine, in its sole discretion);
(vii) to reduce the exercise price of any Option to the then
current Fair Market Value if the Fair Market Value of the Common Stock covered
by such Option shall have declined since the date the Option was granted.
(c) Effect of Administrator's Decision. All decisions, determinations
----------------------------------
and interpretations of the Administrator shall be final and binding on all
Optionees and any other holders of any Options.
5. Eligibility.
-----------
(a) Recipients of Grants. Nonstatutory Stock Options may be granted
--------------------
to Employees and Consultants. Incentive Stock Options may be granted only to
Employees, provided, however, that Employees of an Affiliate shall not be
-------- -------
eligible to receive Incentive Stock Options. An Employee or Consultant who has
been granted an Option may, if he or she is otherwise eligible, be granted an
additional Option or Options.
(b) Type of Option. Each Option shall be designated in the written
--------------
option agreement as either an Incentive Stock Option or a Nonstatutory Stock
Option. However, notwithstanding such designations, to the extent that the
aggregate Fair Market Value of Shares with respect to which Incentive Stock
Options are exercisable for the first time by an Optionee during any calendar
year (under all plans of the Company or any Parent or Subsidiary) exceeds
$100,000, such excess Options shall be treated as Nonstatutory Stock Options.
For purposes of this Section 5(b), Incentive Stock Options shall be taken into
account in the order in which they were granted, and the Fair Market Value of
the Shares shall be determined as of the time the Option with respect to such
Shares is granted.
(c) No Employment Rights. The Plan shall not confer upon any Optionee
--------------------
any right with respect to continuation of employment or consulting relationship
with the Company, nor shall it interfere in any way with his or her right or the
Company's right to terminate his or her employment or consulting relationship at
any time, with or without cause.
6. Term of Plan. The Plan shall become effective upon the earlier to
------------
occur of its adoption by the Board or its approval by the shareholders of the
Company as described in Section 20 of the Plan. It shall continue in effect for
a term of ten (10) years unless sooner terminated under Section 16 of the Plan.
-5-
<PAGE>
7. Term of Option. The term of each Option shall be the term stated in
--------------
the Option Agreement; provided, however, that the term shall be no more than ten
-------- -------
(10) years from the date of grant thereof or such shorter term as may be
provided in the Option Agreement. However, in the case of an Incentive Stock
Option granted to an Optionee who, at the time the Incentive Stock Option is
granted, owns stock representing more than ten percent (10%) of the voting power
of all classes of stock of the Company or any Parent or Subsidiary, the term of
the Incentive Stock Option shall be five (5) years from the date of grant
thereof or such shorter term as may be provided in the Option Agreement.
8. Limitation on Grants to Employees. Subject to adjustment as provided
---------------------------------
in this Plan, the maximum number of Shares which may be subject to options
granted to any one Employee under this Plan for any fiscal year of the Company
shall be 1,000,000.
9. Option Exercise Price and Consideration.
---------------------------------------
(a) Exercise Price. The per Share exercise price for the Shares to be
--------------
issued pursuant to exercise of an Option shall be such price as is determined by
the Administrator, but shall be subject to the following:
(i) In the case of an Incentive Stock Option
(A) granted to an Employee who, at the time of the grant of
such Incentive Stock Option, owns stock representing more than ten percent (10%)
of the voting power of all classes of stock of the Company or any Parent or
Subsidiary (a "10% Shareholder"), the per Share exercise price shall be no less
---------------
than 110% of the Fair Market Value per Share on the date of grant; or
(B) granted to any other Employee, the per Share exercise
price shall be no less than 100% of the Fair Market Value per Share on the date
of grant.
(ii) In the case of a Nonstatutory Stock Option
(A) granted to a 10% Shareholder prior to the date, if any,
upon which any security of the Company is listed or approved for listing on a
national securities exchange or designated or approved for designation as a
national market system security on an interdealer quotation system by the
National Association of Securities Dealers, Inc., the per Share exercise price
shall be no less than 110% of the Fair Market Value per Share on the date of
grant;
(B) granted to a person who, at the time of the grant of such
Option, is a Named Executive of the Company, the per share Exercise Price shall
be no less than 100% of the Fair Market Value on the date of grant; or
(C) granted to any person other than a Named Executive, the
per Share exercise price shall be no less than 85% of the Fair Market Value per
Share on the date of grant.
-6-
<PAGE>
(b) Permissible Consideration. The consideration to be paid for the
-------------------------
Shares to be issued upon exercise of an Option, including the method of payment,
shall be determined by the Administrator (and, in the case of an Incentive Stock
Option, shall be determined at the time of grant) and may consist entirely of
(1) cash, (2) check, (3) promissory note, (4) other Shares that (x) in the case
of Shares acquired upon exercise of an Option either have been owned by the
Optionee for more than six months on the date of surrender or were not acquired,
directly or indirectly, from the Company, and (y) have a Fair Market Value on
the date of surrender equal to the aggregate exercise price of the Shares as to
which said Option shall be exercised, (5) authorization from the Company to
retain from the total number of Shares as to which the Option is exercised that
number of Shares having a Fair Market Value on the date of exercise equal to the
exercise price for the total number of Shares as to which the Option is
exercised, (6) delivery of a properly executed exercise notice together with
irrevocable instructions to a broker to deliver promptly to the Company the
amount of sale or loan proceeds required to pay the exercise price, (7) any
combination of the foregoing methods of payment, or (8) such other consideration
and method of payment for the issuance of Shares to the extent permitted under
Applicable Laws. In making its determination as to the type of consideration to
accept, the Administrator shall consider if acceptance of such consideration may
be reasonably expected to benefit the Company.
10. Exercise of Option.
------------------
(a) Procedure for Exercise; Rights as a Shareholder. Any Option
-----------------------------------------------
granted hereunder shall be exercisable at such times and under such conditions
as determined by the Administrator, including performance criteria with respect
to the Company and/or the Optionee, and as shall be permissible under the terms
of the Plan; provided however that any Option granted hereunder prior to the
date, if any, upon which any security of the Company is listed or approved for
listing on a national securities exchange or designated or approved for
designation as a national market system security on an interdealer quotation
system by the National Association of Securities Dealers, Inc. to a person who
is not either an Officer, a Director or a Consultant of the Company shall become
exercisable at a rate of at least 20% per year over five years from the date of
grant.
An Option may not be exercised for a fraction of a Share.
An Option shall be deemed to be exercised when written notice of such
exercise has been given to the Company in accordance with the terms of the
Option by the person entitled to exercise the Option and full payment for the
Shares with respect to which the Option is exercised has been received by the
Company. Full payment may, as authorized by the Administrator, consist of any
consideration and method of payment allowable under Section 9(b) of the Plan.
Until the issuance (as evidenced by the appropriate entry on the books of the
Company or of a duly authorized transfer agent of the Company) of the stock
certificate evidencing such Shares, no right to vote or receive dividends or any
other rights as a shareholder shall exist with respect to the Optioned Stock,
notwithstanding the exercise of the Option. The Company shall issue (or cause
to be issued) such stock certificate promptly upon exercise of the
-7-
<PAGE>
Option. No adjustment will be made for a dividend or other right for which the
record date is prior to the date the stock certificate is issued, except as
provided in Section 14 of the Plan.
Exercise of an Option in any manner shall result in a decrease in the
number of Shares which thereafter may be available, both for purposes of the
Plan and for sale under the Option, by the number of Shares as to which the
Option is exercised.
(b) Termination of Status as an Employee or Consultant. In the event
--------------------------------------------------
of termination of an Optionee's Continuous Status as an Employee or Consultant,
such Optionee may, but only within thirty (30) days (or such other period of
time, not exceeding three (3) months in the case of an Incentive Stock Option or
six (6) months in the case of a Nonstatutory Stock Option, as is determined by
the Administrator, with such determination in the case of an Incentive Stock
Option being made at the time of grant of the Option) after the date of such
termination (but in no event later than the date of expiration of the term of
such Option as set forth in the Option Agreement), exercise his or her Option to
the extent that he or she was entitled to exercise it at the date of such
termination. To the extent that the Optionee was not entitled to exercise the
Option at the date of such termination, or if the optionee does not exercise
such Option (which he or she was entitled to exercise) within the time specified
herein, the Option shall terminate.
(c) Disability of Optionee. Notwithstanding Section 10(b) above, in
----------------------
the event of termination of an Optionee's Continuous Status as an Employee or
Consultant as a result of his or her total and permanent disability (as defined
in Section 22(e)(3) of the Code), he or she may, but only within six (6) months
(or such other period of time not exceeding twelve (12) months as is determined
by the Administrator, with such determination in the case of an Incentive Stock
Option being made at the time of grant of the Option) from the date of such
termination (but in no event later than the date of expiration of the term of
such Option as set forth in the Option Agreement), exercise his or her Option to
the extent 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 the
Option at the date of termination, or if he does not exercise such Option (which
he was entitled to exercise) within the time specified herein, the Option shall
terminate.
(d) Death of Optionee. In the event of the death of an Optionee:
-----------------
(i) during the term of the Option who is at the time of his death
an Employee or Consultant of the Company and who shall have been in Continuous
Status as an Employee or Consultant since the date of grant of the Option, the
Option may be exercised, at any time within six (6) months (or such other period
of time, not exceeding twelve (12) months, as is determined by the
Administrator, with such determination in the case of an Incentive Stock Option
being made at the time of grant of the Option) following the date of death (but
in no event later than the date of expiration of the term of such Option as set
forth in the Option Agreement), by the Optionee's estate or by a person who
acquired the right to exercise the Option by bequest or inheritance but only to
the extent of the right to exercise that would have accrued had the Optionee
continued living and remained in Continuous Status as an Employee or Consultant
-8-
<PAGE>
three (3) months (or such other period of time as is determined by the
Administrator as provided above) after the date of death, subject to the
limitation set forth in Section 5(b); or
(ii) within thirty (30) days (or such other period of time not
exceeding three (3) months as is determined by the Administrator, with such
determination in the case of an Incentive Stock Option being made at the time of
grant of the Option) after the termination of Continuous Status as an Employee
or Consultant, the Option may be exercised, at any time within six (6) months
following the date of death (but in no event later than the date of expiration
of the term of such Option as set forth in the Option Agreement), by the
Optionee's estate or by a person who acquired the right to exercise the Option
by bequest or inheritance, but only to the extent of the right to exercise that
had accrued at the date of termination.
(e) Rule 16b-3. Options granted to persons subject to Section 16(b)
----------
of the Exchange Act must comply with Rule 16b-3 and shall contain such
additional conditions or restrictions as may be required thereunder to qualify
for the maximum exemption from Section 16 of the Exchange Act with respect to
Plan transactions.
11. Withholding Taxes. As a condition to the exercise of Options granted
-----------------
hereunder, the Optionee shall make such arrangements as the Administrator may
require for the satisfaction of any federal, state, local or foreign withholding
tax obligations that may arise in connection with the exercise, receipt or
vesting of such Option. The Company shall not be required to issue any Shares
under the Plan until such obligations are satisfied.
12. Stock Withholding to Satisfy Withholding Tax Obligations. At the
--------------------------------------------------------
discretion of the Administrator, Optionees may satisfy withholding obligations
as provided in this paragraph. When an Optionee incurs tax liability in
connection with an Option which tax liability is subject to tax withholding
under applicable tax laws, and the Optionee is obligated to pay the Company an
amount required to be withheld under applicable tax laws, the Optionee may
satisfy the withholding tax obligation by one or some combination of the
following methods: (a) by cash payment, or (b) out of Optionee's current
compensation, or (c) if permitted by the Administrator, in its discretion, by
surrendering to the Company Shares that (i) in the case of Shares previously
acquired from the Company, have been owned by the Optionee for more than six
months on the date of surrender, and (ii) have a fair market value on the date
of surrender equal to or less than the applicable taxes, or (d) by electing to
have the Company withhold from the Shares to be issued upon exercise of the
Option that number of Shares having a fair market value equal to the amount
required to be withheld. For this purpose, the fair market value of the Shares
to be withheld shall be determined on the date that the amount of tax to be
withheld is to be determined (the "Tax Date").
--------
Any surrender by an Officer or Director of previously owned Shares to
satisfy tax withholding obligations arising upon exercise of this Option must
comply with the applicable provisions of Rule 16b-3.
All elections by an Optionee to have Shares withheld to satisfy tax
withholding obligations shall be made in writing in a form acceptable to the
Administrator and shall be subject to the following restrictions:
-9-
<PAGE>
(a) the election must be made on or prior to the applicable Tax Date;
(b) once made, the election shall be irrevocable as to the particular
Shares of the Option as to which the election is made; and
(c) all elections shall be subject to the consent or disapproval of
the Administrator.
In the event the election to have Shares withheld is made by an
Optionee and the Tax Date is deferred under Section 83 of the Code because no
election is filed under Section 83(b) of the Code, the Optionee shall receive
the full number of Shares with respect to which the Option is exercised but such
Optionee shall be unconditionally obligated to tender back to the Company the
proper number of Shares on the Tax Date.
13. Non-Transferability of Options. The Option may not be sold, pledged,
------------------------------
assigned, hypothecated, transferred, or disposed of in any manner other than by
will or by the laws of descent or distribution; provided that, after the date,
if any, upon which any security of the Company is listed or approved for listing
on a national securities exchange or designated or approved for designation as a
national market system security on an interdealer quotation system by the
National Association of Securities Dealers, Inc., the Administrator may in its
discretion grant transferable Nonstatutory Stock Options pursuant to option
agreements specifying (i) the manner in which such Nonstatutory Stock Options
are transferable and (ii) that any such transfer shall be subject to the
Applicable Laws. The designation of a beneficiary by an Optionee will not
constitute a transfer. An Option may be exercised, during the lifetime of the
Optionee, only by the Optionee or a transferee permitted by this Section 13.
14. Adjustments Upon Changes in Capitalization; Corporate Transactions.
------------------------------------------------------------------
(a) Adjustment. Subject to any required action by the shareholders of
----------
the Company, the number of shares of Common Stock covered by each outstanding
Option, the number of shares of Common Stock that have been authorized for
issuance under the Plan but as to which no Options have yet been granted or
which have been returned to the Plan upon cancellation or expiration of an
Option, the maximum number of shares of Common Stock for which Options may be
granted to any employee under Section 8 of the Plan, the number of shares of
Common Stock set forth in Section 3(i) above, and the price per share of Common
Stock covered by each such outstanding Option, shall be proportionately adjusted
for any increase or decrease in the number of issued shares of Common Stock
resulting from a stock split, reverse stock split, stock dividend, combination
or reclassification of the Common Stock (including any such change in the number
of shares of Common Stock effected in connection with a change in domicile of
the Company), or any other increase or decrease in the number of issued shares
of Common Stock effected without receipt of consideration by the Company;
provided, however, that conversion of any convertible securities of the Company
shall not be deemed to have been "effected without receipt of consideration."
Such adjustment shall be made by the Administrator, whose determination in that
respect shall be final, binding and conclusive. Except as expressly provided
herein, no issuance by the Company of shares of stock of any class, or
securities convertible into shares of stock of any class, shall affect, and no
adjustment by
-10-
<PAGE>
reason thereof shall be made with respect to, the number or price of shares of
Common Stock subject to an Option.
(b) Corporate Transactions. In the event of the proposed dissolution
----------------------
or liquidation of the Company, the Option will terminate immediately prior to
the consummation of such proposed action, unless otherwise provided by the
Administrator. The Administrator may, in the exercise of its sole discretion in
such instances, declare that any Option shall terminate as of a date fixed by
the Administrator and give each Optionee the right to exercise his or her Option
as to all or any part of the Optioned Stock, including Shares as to which the
Option would not otherwise be exercisable. In the event of a (i) proposed sale
of all or substantially all of the assets of the Company, or (ii) a merger,
consolidation or other capital reorganization of the Company (other than one in
which the holders of more than fifty percent (50%) of the shares of capital
stock of the Company outstanding immediately prior to such transaction continue
to hold (either by the voting securities remaining outstanding or by being
converted into voting securities of the surviving entity) more than fifty
percent (50%) of the total voting power represented by the voting securities of
the Company, or such surviving entity, outstanding immediately after such merger
or consolidation), the Option shall be assumed or an equivalent option shall be
substituted by such successor corporation or a parent or subsidiary of such
successor corporation, unless the Administrator determines, in the exercise of
its sole discretion and in lieu of such assumption or substitution, that the
Optionee shall have the right to exercise the Option as to some or all of the
Optioned Stock, including Shares as to which the Option would not otherwise be
exercisable. If the Administrator makes an Option exercisable in lieu of
assumption or substitution in the event of a merger or sale of assets, the
Administrator shall notify the Optionee that the Option shall be exercisable for
a period of fifteen (15) days from the date of such notice, and the Option will
terminate upon the expiration of such period. For purposes of this Section
14(b), an Option shall be considered assumed, without limitation, if, at the
time of issuance of the stock or other consideration upon such merger or sale of
assets, each Optionee would be entitled to receive upon exercise of an Option
the same number and kind of shares of stock or the same amount of property, cash
or securities as the Optionee would have been entitled to receive upon the
occurrence of such transaction if the Optionee had been, immediately prior to
such transaction, the holder of the number of Shares of Common Stock covered by
the Option at such time (after giving effect to any adjustments in the number of
Shares covered by the Option as provided for in this Section 14).
15. Time of Granting Options. The date of grant of an Option shall, for
------------------------
all purposes, be the date on which the Administrator makes the determination
granting such Option or such other date as is determined by the Administrator;
provided however that in the case of any Incentive Stock Option, the grant date
- -------- -------
shall be the later of the date on which the Administrator makes the
determination granting such Incentive Stock Option or the date of commencement
of the Optionee's employment relationship with the Company. Notice of the
determination shall be given to each Employee or Consultant to whom an Option is
so granted within a reasonable time after the date of such grant.
-11-
<PAGE>
16. Amendment and Termination of the Plan.
-------------------------------------
(a) Amendment and Termination. The Board may amend or terminate the
-------------------------
Plan from time to time in such respects as the Board may deem advisable;
provided that, the following revisions or amendments shall require approval of
the shareholders of the Company in the manner described in Section 20 of the
Plan:
(i) any increase in the number of Shares subject to the Plan,
other than an adjustment under Section 14 of the Plan;
(ii) any change in the designation of the class of persons
eligible to be granted Options; or
(iii) any change in the limitation on grants to employees as
described in Section 8 of the Plan or other changes which would require
shareholder approval to qualify options granted hereunder as performance-based
compensation under Section 162(m) of the Code.
(b) Shareholder Approval. If any amendment requiring shareholder
--------------------
approval under Section 16(a) of the Plan is made subsequent to the first
registration of any class of equity securities by the Company under Section 12
of the Exchange Act, such shareholder approval shall be solicited as described
in Section 20 of the Plan.
(c) Effect of Amendment or Termination. Any such amendment or
----------------------------------
termination of the Plan shall not affect Options already granted and such
Options shall remain in full force and effect as if this Plan had not been
amended or terminated, unless mutually agreed otherwise between the Optionee and
the Board, which agreement must be in writing and signed by the Optionee and the
Company.
17. Conditions Upon Issuance of Shares. Shares shall not be issued
----------------------------------
pursuant to the exercise of an Option unless the exercise of such Option and the
issuance and delivery of such Shares pursuant thereto shall comply with all
relevant provisions of law, including, without limitation, the Securities Act of
1933, as amended, the Exchange Act, the rules and regulations promulgated
thereunder, and the requirements of any stock exchange upon which the Shares may
then be listed, and shall be further subject to the approval of counsel for the
Company with respect to such compliance.
As a condition to the exercise of an Option, the Company may require the
person exercising such Option to represent and warrant at the time of any such
exercise that the Shares are being purchased only for investment and without any
present intention to sell or distribute such Shares if, in the opinion of
counsel for the Company, such a representation is required by any of the
aforementioned relevant provisions of law.
18. Reservation of Shares. The Company, during the term of this Plan,
---------------------
will at all times reserve and keep available such number of Shares as shall be
sufficient to satisfy the requirements of the Plan. The inability of the
Company to obtain authority from any regulatory
-12-
<PAGE>
body having jurisdiction, which authority is deemed by the Company's counsel to
be necessary to the lawful issuance and sale of any Shares hereunder, shall
relieve the Company of any liability in respect of the failure to issue or sell
such Shares as to which such requisite authority shall not have been obtained.
19. Option Agreement. Options shall be evidenced by written option
----------------
agreements in such form as the Board shall approve.
20. Shareholder Approval.
--------------------
(a) Continuance of the Plan shall be subject to approval by the
shareholders of the Company within twelve (12) months before or after the date
the Plan is adopted. Such shareholder approval shall be obtained in the manner
and to the degree required under applicable federal and state law and the rules
of any stock exchange upon which the Shares are listed.
(b) In the event that the Company registers any class of equity
securities pursuant to Section 12 of the Exchange Act, any required approval of
the shareholders of the Company obtained after such registration shall be
solicited substantially in accordance with Section 14(a) of the Exchange Act and
the rules and regulations promulgated thereunder.
(c) If any required approval by the shareholders of the Plan itself or
of any amendment thereto is solicited at any time otherwise than in the manner
described in Section 20(b) hereof, then the Company shall, at or prior to the
first annual meeting of shareholders held subsequent to the later of (1) the
first registration of any class of equity securities of the Company under
Section 12 of the Exchange Act or (2) the granting of an Option hereunder to an
officer or director after such registration, do the following:
(i) furnish in writing to the holders entitled to vote for the
Plan substantially the same information that would be required (if proxies to be
voted with respect to approval or disapproval of the Plan or amendment were then
being solicited) by the rules and regulations in effect under Section 14(a) of
the Exchange Act at the time such information is furnished; and
(ii) file with, or mail for filing to, the Securities and Exchange
Commission four copies of the written information referred to in subsection (i)
hereof not later than the date on which such information is first sent or given
to shareholders.
-13-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE PILOT
NETWORK SERVICES, INC. FORM 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 3,167
<SECURITIES> 1,930
<RECEIVABLES> 4,479
<ALLOWANCES> 217
<INVENTORY> 0
<CURRENT-ASSETS> 10,094
<PP&E> 30,335
<DEPRECIATION> 11,485
<TOTAL-ASSETS> 29,457
<CURRENT-LIABILITIES> 9,907
<BONDS> 4,600
0
0
<COMMON> 14
<OTHER-SE> 14,936
<TOTAL-LIABILITY-AND-EQUITY> 29,457
<SALES> 7,130
<TOTAL-REVENUES> 7,130
<CGS> 7,379
<TOTAL-COSTS> 7,379
<OTHER-EXPENSES> 4,955
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (37)
<INCOME-PRETAX> (5,241)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,241)
<EPS-BASIC> (0.38)
<EPS-DILUTED> (0.38)
</TABLE>
