PILOT NETWORK SERVICES INC, DEF 14A, 1999-07-29

PILOT NETWORK SERVICES INC
DEF 14A, 1999-07-29
MISCELLANEOUS BUSINESS SERVICES

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SCHEDULE 14A
(Rule 14a-101)

INFORMATION REQUIRED IN PROXY STATEMENT

SCHEDULE 14A INFORMATION

Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of
1934
(Amendment No. )

Filed by the Registrant [X]

Filed by a Party other than the Registrant [_]

Check the appropriate box:

[_] Preliminary Proxy Statement [_]Confidential, for Use of the
Commission Only (as Permitted by
Rule 14a-6(e)(2))

[X] Definitive Proxy Statement

[_] Definitive Additional Materials

[_] Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12

Pilot Network Services, Inc.
-----------------------------------------------------
(Name of Registrant as Specified In Its Charter)

-----------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)

Payment of Filing Fee (Check the appropriate box):

[X]No fee required.

[_]Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.

(1) Title of each class of securities to which transaction applies:

(2) Aggregate number of securities to which transaction applies:

(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange ActRule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined):

(4) Proposed maximum aggregate value of transaction:

(5) Total fee paid:

[_]Fee paid previously with preliminary materials.

[_]Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.

(1) Amount Previously Paid:

(2) Form, Schedule or Registration Statement No.:

(3) Filing Party:

(4) Date Filed:
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PILOT NETWORK SERVICES, INC.

Notice of Annual Meeting of Stockholders

To Be Held September 16, 1999

The Annual Meeting of Stockholders (the "Annual Meeting") of Pilot Network
Services, Inc., a Delaware corporation (the "Company"), will be held at the
Company's offices located at 2450 Mariner's Square Loop, Alameda, California
94501 on Thursday, September 16, 1999, at 10:00 a.m., local time, for the
following purposes:

1. To elect three Class I Directors to serve until the 2001 Annual Meeting
of Stockholders or until their respective successors are elected and
qualified;

2. To approve the amendment to the Company's 1998 Stock Option Plan (the
"1998 Plan") and the reservation for issuance under the 1998 Plan of a
total of (a) 1,156,000 additional shares of the Company's Common Stock
(approximately equal to the number of shares previously reserved and
unissued under the Company's 1994 Stock Plan, and shares previously
issued and returned to the 1994 Stock Plan as a result of employee
terminations), plus (b) such number of shares as may be returned to the
1994 Stock Plan in the future as a result of employee terminations, up
to a maximum aggregate of 400,000 additional shares;

3. To ratify the appointment of KPMG, LLP as the independent auditors of
the Company for the fiscal year ending March 31, 2000; and

4. To transact such other business as may properly come before the Annual
Meeting and any adjournment or postponement thereof.

The foregoing items of business, including the nominees for directors, are
more fully described in the Proxy Statement which is attached and made a part
of this Notice.

The Board of Directors has fixed the close of business on July 22, 1999 as
the record date for determining the stockholders entitled to notice of and to
vote at the Annual Meeting and any adjournment(s) or postponement(s) thereof.

All stockholders are cordially invited to attend the Annual Meeting in
person. However, whether or not you expect to attend the Annual Meeting in
person, you are urged to mark, date, sign and return the enclosed proxy card as
promptly as possible in the postage-prepaid envelope provided to ensure your
representation and the presence of a quorum at the Annual Meeting. If you send
in your proxy card and then decide to attend the Annual Meeting to vote your
shares in person, you may still do so. Your proxy is revocable in accordance
with the procedures set forth in the Proxy Statement.

By Order of the Board of Directors,

William C. Leetham
Secretary

Alameda, California
August 3, 1999

IMPORTANT

WHETHER OR NOT YOU PLAN TO ATTEND THE MEETING, PLEASE SIGN AND RETURN THE
ENCLOSED PROXY CARD AS PROMPTLY AS POSSIBLE IN THE ENCLOSED POSTAGE-
PREPAID ENVELOPE. IF A QUORUM IS NOT REACHED, THE COMPANY WILL HAVE THE
ADDED EXPENSE OF RE-ISSUING THESE PROXY MATERIALS. IF YOU ATTEND THE
MEETING AND SO DESIRE, YOU MAY WITHDRAW YOUR PROXY AND VOTE IN PERSON.

THANK YOU FOR ACTING PROMPTLY.

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PILOT NETWORK SERVICES, INC.
1080 Marina Village Parkway
Alameda, California 94501

PROXY STATEMENT

General

This Proxy Statement is furnished in connection with the solicitation by the
Board of Directors (the "Board") of Pilot Network Services, Inc., a Delaware
corporation (the "Company"), of proxies in the enclosed form for use in voting
at the Annual Meeting of Stockholders (the "Annual Meeting") to be held at the
Company's offices located at 2450 Mariner's Square Loop, Alameda, California
94501, on Thursday, September 16, 1999, at 10:00 a.m., local time, and any
adjournment(s) or postponement(s) thereof.

This Proxy Statement, the enclosed proxy card and the Company's Annual
Report to Stockholders for the fiscal year ended March 31, 1999, including
financial statements, were first mailed to stockholders entitled to vote at the
meeting on or about August 3, 1999.

Revocability of Proxies

Any proxy given pursuant to this solicitation may be revoked by the person
giving it at any time before its use by delivering to the Company (Attention:
William C. Leetham ) a written notice of revocation or a duly executed proxy
bearing a later date, or by attending the Annual Meeting and voting in person.

Record Date; Voting Securities

The close of business on July 22, 1999 has been fixed as the record date
(the "Record Date") for determining the holders of shares of Common Stock of
the Company entitled to notice of and to vote at the Annual Meeting. At the
close of business on the Record Date, the Company had approximately 13,648,495
shares of Common Stock outstanding and held of record by approximately 100
stockholders.

Voting and Solicitation

Each outstanding share of Common Stock on the Record Date is entitled to one
vote on all matters. Shares of Common Stock may not be voted cumulatively.

Votes cast by proxy or in person at the Annual Meeting will be tabulated by
the Inspector of Elections (the "Inspector"). The Inspector will also determine
whether or not a quorum is present. The nominees for election as directors at
the Annual Meeting will be elected by a plurality of the votes of the shares of
Common Stock present in person or represented by proxy at the meeting and
entitled to vote on the election of directors. All other matters submitted to
the stockholders will require the affirmative vote of a majority of shares
present in person or represented by proxy and entitled to vote on the matter at
a duly held meeting at which a quorum is present, as required under Delaware
law for approval of proposals presented to stockholders. In general, Delaware
law also provides that a quorum consists of a majority of the shares entitled
to vote and present in person or represented by proxy. The Inspector will treat
abstentions as shares that are present and entitled to vote for purposes of
determining the presence of a quorum and as negative votes for purposes of
determining the approval of any matter submitted to the stockholders for a
vote.

Any proxy which is returned using the form of proxy enclosed and which is
not marked as to a particular item will be voted FOR the election of directors,
FOR the amendment of the Company's 1998 Stock Option Plan, FOR ratification of
the appointment of the designated independent auditors, and as the proxy
holders deem advisable on other matters that may come before the meeting, as
the case may be with respect to the item not marked. If a broker indicates on
the enclosed proxy or its substitute that it does not have discretionary

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authority as to certain shares to vote on a particular matter ("broker non-
votes"), those shares will be treated as present or represented for purposes of
determining the presence of a quorum and will be excluded from the calculation
of shares entitled to vote with respect to that matter. The Company believes
that the tabulation procedures to be followed by the Inspector are consistent
with the general requirements of Delaware law concerning voting of shares and
determination of a quorum.

The solicitation of proxies will be conducted by mail and the Company will
bear all attendant costs. These costs will include the expense of preparing and
mailing proxy solicitation materials for the Annual Meeting and reimbursements
paid to brokerage firms and others for their expenses incurred in forwarding
solicitation materials regarding the Annual Meeting to beneficial owners of the
Company's Common Stock. The Company may conduct further solicitation
personally, telephonically or by facsimile through its officers, directors and
employees, none of whom will receive additional compensation for assisting with
the solicitation. Skinner & Co., Inc. may be hired as the Company's proxy
solicitor and shall charge the Company fees of approximately $5,000.

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PROPOSAL NO. 1

ELECTION OF DIRECTORS

Nominees

The Company's Certificate of Incorporation provides for a classified Board
of Directors. The Board of Directors is divided into two classes, designated
Class I and Class II, respectively. Each class of directors consists of three
directors, and each class of directors serves for a staggered two year term or
until a successor is elected and qualified. The Class I directors are M.
Marketta Silvera, Thomas B. Kelly and Shanda Bahles, whose current terms will
end at this Annual Meeting. The Class II directors are Thomas O'Rourke and
K. Flynn McDonald, with one Class II director vacancy, whose current terms will
end at the Annual Meeting of Stockholders in 2000.

At the Annual Meeting, all three members of Class I are standing for re-
election to serve until the 2001 Annual Meeting of Stockholders or until their
respective successors are elected and qualified.

In the event any nominee is unable or unwilling to serve as a director at
the time of the Annual Meeting, the proxies may be voted for the balance of
those nominees named and for any substitute nominee designated by the present
Board or the proxy holders to fill such vacancy, or for the balance of the
nominees named without nomination of a substitute, or the size of the Board may
be reduced in accordance with the Bylaws of the Company. The Board has no
reason to believe that any of the persons named below will be unable or
unwilling to serve as a nominee or as a director if elected.

Assuming a quorum is present, the three nominees receiving the highest
number of affirmative votes of shares entitled to be voted for them will be
elected as Class I directors of the Company with a term expiring at the 2001
Annual Meeting of Stockholders. Unless marked otherwise, proxies received will
be voted FOR the election of each of the three nominees named below. In the
event that additional persons are nominated for election as directors, the
proxy holders intend to vote all proxies received by them in such a manner as
will ensure the election of as many of the nominees listed below as possible,
and, in such event, the specific nominees to be voted for will be determined by
the proxy holders.

The names of the directors, their ages as of July 1, 1999 and certain other
information about them are set forth below:

<TABLE>
<CAPTION>
Name Age Position with the Company Class Director Since
- ---- --- ------------------------- ----- --------------
<S> <C> <C> <C> <C>
M. Marketta Silvera..... 56 Chairman of the Board of Directors, President I 1993
and Chief Executive Officer
Shanda Bahles (1)(2).... 43 Director I 1994
K. Flynn McDonald....... 46 Director II 1995
Thomas O'Rourke (1)(2).. 75 Director II 1995
Thomas B. Kelly (1)..... 56 Director I 1999
</TABLE>
- --------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee

There are no family relationships among any of the directors or executive
officers of the Company.

Nominees for Election as Class I Directors through 2001

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company. Ms. Silvera served as Vice President of Sales and Marketing at Granite
Systems, a voice technology systems developer, and Votan from 1986 to 1989. Ms.
Silvera is also a director of AVIOS, a voice and data technology organization,
and has previously served as its President.

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

Thomas B. Kelly has served as a director of the Company since March 1999.
Mr. Kelly was a Managing Partner of Arthur Andersen, LLP, from 1984 to 1999.
From 1976 to 1984 Mr. Kelly was a Partner of Arthur Andersen, LLP, and has
worked in various other positions within Arthur Andersen since 1967.

Class II Directors Whose Terms Expire 2000

K. Flynn McDonald has served as a director of the Company since March 1995.
Ms. McDonald has been a Managing Director of Vector Fund Management II, L.P.,
the General Partner of Vector Later-Stage Equity Fund II, L.P., since November
1995. From December 1993 to October 1995, Ms. McDonald served as Vice President
of Investments at Technology Funding, Inc., a venture capital firm focused on
technology and health care companies. From 1986 to 1993, she held various
positions at Raychem Corporation, a material sciences company, including Vice
President of Raychem Ventures, Inc. Ms. McDonald is a also Director of
LifeCell Corporation, a company focusing on solid-state, semiconductor gamma
detector technology; Decibel Instruments, Inc., a hearing device company; and
Spinal Concepts, Inc., a spinal fixation device company.

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

Meetings and Committees of the Board of Directors

During the fiscal year ended March 31, 1999 (the "last fiscal year"), the
Board met five times and acted by unanimous written consent five times. No
director attended fewer than 75% of the aggregate number of meetings of the
Board and meetings of the committees of the Board on which he or she serves.
The Board has an Audit Committee and a Compensation Committee. The Board does
not have a nominating committee or a committee performing the functions of a
nominating committee. A nomination for a director made by a stockholder must be
submitted to William C. Leetham at the address of the Company's executive
offices set forth above on or before August 27, 1999.

Nominations that are intended to be included in the Company's proxy
statement for the 2000 Annual Meeting must be submitted no later than April 5,
2000. See "Deadline for Receipt of Stockholder Proposals for 2000 Annual
Meeting."

The Audit Committee consists of directors Shanda Bahles, Thomas O'Rourke and
Thomas B. Kelly, three of the Company's non-employee directors, and held two
meetings during the last fiscal year. Mr. Kelly was not a member of the Audit
Committee at the time of either meeting. The Audit Committee recommends the
engagement of the firm of certified public accountants to audit the financial
statements of the Company and monitors the effectiveness of the audit effort,
the Company's financial and accounting organization and its system of internal
accounting controls.

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The Compensation Committee consists of directors Shanda Bahles and Thomas
O'Rourke, and met one time and acted by unanimous written consent four times
during the last fiscal year. Its functions are to establish and administer the
Company's policies regarding annual executive salaries and cash incentives and
long-term equity incentives. The Compensation Committee administers the
Company's 1998 Stock Option Plan, 1994 Stock Plan, 1998 Directors' Stock Option
Plan and 1998 Employee Stock Purchase Plan.

Compensation of Directors

Directors currently receive no cash fees for services provided in that
capacity but are reimbursed for out-of-pocket expenses incurred in connection
with attendance at meetings of the Board. The Company's 1998 Directors' Stock
Option Plan (the "Directors' Plan") provided that each nonemployee director as
of the date of the Company's initial public offering received an option to
purchase 5,000 shares of Common Stock as of such date. In addition, the
Directors' Plan provides that each person who becomes a nonemployee director of
the Company following the date of the Company's initial public offering will be
granted a nonstatutory stock option to purchase 25,000 shares of Common Stock
on the date on which he or she is first appointed or elected to the Board.
Thereafter, on the date of each annual meeting of the Company's stockholders
immediately following which a nonemployee director is serving on the Board of
Directors, he or she shall be granted an additional option to purchase 5,000
shares of Common Stock if, on the meeting date, he or she has served on the
Company's Board of Directors for at least six months. Each of the nonemployee
directors, including the director nominees, will have served for more than six
months at the time of the Annual Meeting, and so will receive options to
purchase 5,000 shares of the Company's Common Stock under the Directors' Plan,
provided that all nominee directors are reelected to the Board at the Annual
Meeting. Thomas Kelly received an option to purchase 25,000 shares under the
Directors' Plan on March 15, 1999, the day he was appointed to the Board. All
options granted under the Directors' Plan have an exercise price equal to the
fair market value of the Company's Common Stock based upon the closing price of
the stock on the Nasdaq National Market as of the date of grant, except that
the options granted to nonemployee directors of the Company as of the date of
the Company's initial public offering had an exercise price equal to the price
at which the Company's stock was first sold to the public by the underwriters
of the offering. Options granted at the time a nonemployee director is first
appointed or elected to the Board vest as to 25% per year over four years.
Options granted on the date of an annual meeting of stockholders vest in full
on the first anniversary of the date of grant.

In addition, K. Flynn McDonald received a fully-vested stock option to
purchase 20,000 shares of Common Stock under the Company's 1998 Stock Option
Plan in June 1998, with an exercise price of $13.00.

Recommendation of the Board:

THE BOARD RECOMMENDS A VOTE FOR
THE ELECTION OF ALL NOMINEES NAMED ABOVE.

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PROPOSAL NO. 2

AMENDMENT OF THE 1998 STOCK OPTION PLAN

At the Annual Meeting, the Company's stockholders are being asked to approve
certain amendments of the Company's 1998 Stock Option Plan (the "1998 Plan").
The following is a summary of principal features of the 1998 Plan, as well as a
description of the amendments for which the Company is now seeking stockholder
approval. This summary does not purport to be a complete description of all the
provisions of the 1998 Plan. Any stockholder of the Company who wishes to
obtain a copy of the actual plan document may do so upon written request to the
William C. Leetham at the Company's principal offices at 1080 Marina Village
Parkway, Alameda, California 94501.

The Board of Directors in April 1999 approved amendments to the 1998 Plan
that increase the number of shares of Common Stock available for issuance under
the plan by up to 1,556,000 shares. At the time of the Company's initial public
offering, the Company discontinued issuances under its 1994 Stock Plan. At that
time, a certain number of shares remained available for grant under the 1994
Stock Plan and since then additional shares have and are expected to be
returned to this plan as a result of terminations of optionees' employment and
consulting relationships with Pilot. The 1,556,000 share increase in the number
of shares available under the 1998 Plan for which stockholder approval is now
being sought is approximately equal to the 1,156,000 shares previously reserved
for issuance under the 1994 Stock Plan that were never issued or which have
already returned to the 1994 Stock Plan as a result of employee and consultant
terminations, plus up to an additional 400,000 shares that may be returned to
such plan as a result of future terminations. Accordingly, at the Annual
Meeting, the stockholders are being asked to approve these amendments to the
1998 Plan which will result in an increase of 1,556,000 in the maximum
aggregate number of shares of Common Stock available for issuance under this
plan.

General

The 1998 Plan was adopted by the Company's Board of Directors and
stockholders in June 1998 and July 1998, respectively. Initially, 1,000,000
shares of Common Stock were reserved for issuance under the 1998 Plan, plus an
automatic annual increase on the first day of each of the Company's fiscal
years in 1999, 2000, 2001, 2002 and 2003 equal to the lesser of 500,000 shares,
3% of the Company's outstanding shares of Common Stock on the last day of the
immediately preceding fiscal year or a lesser number of shares as determined by
the Board of Directors. An additional 404,082 shares of Common Stock were made
available for issuance under the 1998 Plan as of April 1, 1999 under the above
formula evergreen provision. Shares not purchased under an option prior to its
expiration will be available for future option grants under the 1998 Plan.

The 1998 Plan provides for the granting to employees of incentive stock
options within the meaning of Section 422 of the Internal Revenue Code of 1986,
as amended (the "Code"), and for the granting of nonstatutory stock options to
employees and consultants (including non-employee directors). See
"United States Federal Income Tax Information" below for information concerning
the tax treatment of both incentive stock options and nonstatutory stock
options.

As of July 1, 1999, no shares had been issued upon exercise of options
granted under the 1998 Plan, and all remaining shares available under the plan
are subject to outstanding options (without taking into account the amendments
for which stockholder approval is now being sought). The closing price of the
Company's Common Stock, as reported on the Nasdaq National Market on July 1,
1999, was $9.50. The actual benefits, if any, to the holders of stock options
issued under the 1998 Plan are not determinable prior to exercise as the value,
if any, of such stock options to their holders is represented by the difference
between the market price of a share of the Company's Common Stock on the date
of exercise and the exercise price of a holder's stock option. As of July 1,
1999, the following current executive officers of the Company and directors of
the Company have received grants under the 1998 Plan: M. Marketta Silvera
(30,000 shares), William C. Leetham (20,000 shares), Robert G. Carrade (10,000
shares), Thomas A. Wadlow (20,000 shares), Martin W. Wegenstein (150,000
shares), Dana R. Nelson (150,000 shares) and K. Flynn McDonald (20,000 shares).
In

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addition, as of July 1, 1999, options to purchase approximately 1,006,650
shares of Common Stock granted under the 1998 Plan are held by all current
employees (excluding options held by executive officers) as a group, options to
purchase 380,000 shares are held by all current executive officers as a group
and options to purchase 20,000 shares are held by all directors who are not
executive officers as a group.

The 1998 Plan is not a qualified deferred compensation plan under Section
401(a) of the Code, and is not subject to the provisions of the Employee
Retirement Income Security Act of 1974, as amended.

Purpose

The purposes of the 1998 Plan are to attract and retain the best available
personnel for the Company, to provide additional incentive to the employees,
officers and consultants of the Company, and to promote the success of the
Company's business.

Administration

The 1998 Plan is administered by the Board of Directors or one or more
committees of the Board (in either case, referred to as the "Administrator").
All questions of interpretation or application of the 1998 Plan are determined
in the sole discretion of the Administrator. Grants of options to employees or
consultants who are also officers or directors of the Company shall be made by
the Administrator in a manner designed to cause such grants to be exempt from
the application of Rule 16(b) of the Exchange Act and to qualify such grants to
the Company's officers listed in the Summary Compensation Table below as
"performance-based compensation" under Section 162(m) of the Internal Revenue
Code. Members of the Board of Directors receive no additional compensation for
their services in connection with administration of the plan.

Eligibility

The 1998 Plan provides that options may be granted to employees (including
officers and directors who are also employees) and consultants (including non-
employee directors) of the Company. Incentive stock options may be granted only
to employees. The Administrator selects the optionees and determines the number
of shares and the exercise price to be associated with each option. In making
such determination, the Administrator takes into account the duties and
responsibilities of the optionee, the value of the optionee's services, the
optionee's present and potential contribution to the success of the Company,
and other relevant factors. As of July 1, 1999, there are approximately 154
employees, officers and consultants eligible to participate in the 1998 Plan.

Limitations on Amount of Awards

The 1998 Plan provides that the maximum number of shares of Common Stock
which may be granted under options to any one employee during any fiscal year
is 1,000,000, subject to adjustment as provided in the plan. There is also a
limit on the aggregate market value of shares subject to all incentive stock
options that may be granted to an employee during any calendar year.

Terms of Options

The terms of options granted under the 1998 Plan are determined by the
Administrator. Each option is evidenced by a stock option agreement between the
Company and the optionee and is subject to the following additional terms and
conditions:

(a) Exercise Price. The exercise price of a stock option granted under
the 1998 Plan is determined by the Administrator subject to the following
restrictions. The exercise price of incentive stock options and of
nonstatutory stock options granted to the Company's officers listed in the
Summary Compensation Table below must be at least equal to the fair market
value of the shares on the date of grant. The exercise

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price of nonstatutory stock options granted to other persons must be equal
to at least 85% of the fair market value of the shares on the date of
grant. Incentive stock options granted to stockholders owning more than 10%
of the total combined voting power of all classes of the Company's stock
(such holders are referred to as "10% Stockholders") are subject to the
additional restriction that the exercise price of such options must be
equal to at least 110% of the fair market value on the date of the grant.
The fair market value of the shares subject to an option is based upon the
closing price of the Company's Common Stock as reported on the Nasdaq
National Market as of the relevant date.

(b) Exercise of the Option. The Administrator determines when options
are exercisable. Generally, an optionee must earn the right to exercise (or
"vest" in) the option by continuing to work for the Company. An option is
exercised by giving written notice of exercise to the Company specifying
the number of full shares of Common Stock being purchased, and by tendering
payment of the purchase price to the Company. The method of payment of the
exercise price of the shares purchased upon exercise of an option is
determined by the Administrator. The 1998 Plan generally allows for payment
of the exercise price in cash, with a promissory note, by surrender of
shares of Common Stock owned by the optionee, by the Company's retention of
a number of shares underlying the option equal to the exercise price or by
delivery to the Company by the broker selling the shares issued upon
exercise of the option the amount of sale or loan proceeds required to pay
the exercise price.

(c) Termination of Employment. If an optionee's employment or consulting
relationship with the Company is terminated for any reason other than death
or total and permanent disability, options under the 1998 Plan generally
must be exercised within 90 days after the date of termination to the
extent the option was exercisable as of such date.

(d) Disability. If an optionee is unable to continue his or her
employment or consulting relationship with the Company as a result of or
her total and permanent disability, options generally must be exercised
within six months after the date of termination and may be exercised only
to the extent the option was exercisable on the date of termination.

(e) Death. If an optionee should die while employed or retained by the
Company, and such optionee has been continuously employed or retained by
the Company since the date of grant of the option, the option must
generally be exercised within six months after the date of death by the
optionee's estate or by a person who acquired the right to exercise the
option by bequest or inheritance to the extent the optionee would have been
entitled to exercise the option had the optionee continued living and
remained employed or retained by the Company for three months after the
date of death.

If an optionee should die within 30 days after the he or she ceased to be
continuously employed or retained by the Company, the option must generally be
exercised within six months after the date of death by the optionee's estate or
by a person who acquired the right to exercise the option by bequest or
inheritance to the extent that the optionee was entitled to exercise the option
at the date of termination.

(f) Option Termination Date. Generally, options granted under the 1998
Plan expire ten years from the date of grant unless a shorter period is
specified in the option agreement. Incentive stock options granted to 10%
Stockholders may not have a term of more than five years. Under no
circumstances may an option be exercised by any person after expiration of
its term.

(g) Nontransferability of Options. Incentive stock options are not
transferable by the optionee, other than by will or the laws of descent and
distribution, and are exercisable only by the optionee during his or her
lifetime or, in the event of death, by a person who acquires the right to
exercise the option by bequest or inheritance or by reason of the death of
the optionee. The Administrator may in its discretion grant nonstatutory
stock options with limited transferability rights.

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(h) Change of Control of the Company. In the event of a merger of the
Company with or into another corporation or sale of all or substantially
all of the Company's assets, outstanding options shall be assumed or
substituted by the Company's acquiror. The Administrator retains the
discretion to provide that, instead of such assumption or substitution, the
vesting of outstanding options shall accelerate in full or in part in
connection with an acquisition of the Company. Should the Administrator
accelerate the vesting of outstanding options, it will provide notice to
optionees that options remain exercisable for 15 days from the date of such
notice, after which they terminate.

(i) Other Provisions. The option agreement may contain such other terms,
provisions and conditions not inconsistent with the 1998 Plan as may be
determined by the Administrator.

Adjustments Upon Changes in Capitalization

In the event any change, such as a stock split, reverse stock split, stock
dividend, combination or reclassification, is made in the Company's
capitalization that results in an increase or decrease in the number of
outstanding shares of Common Stock without receipt of consideration by the
Company, appropriate adjustment shall be made in the exercise price of each
outstanding option, the number of shares subject to each option, and the annual
limitation on grants to employees, as well as the number of shares available
for issuance under the 1998 Plan. In the event of the proposed dissolution or
liquidation of the Company, each option will terminate unless otherwise
provided by the Administrator.

Amendment and Termination

The Board of Directors may amend the 1998 Plan at any time or from time to
time or may terminate it without approval of the stockholders, except that
stockholder approval is required for any amendment to the 1998 Plan that

. increases the number of shares that may be issued under the 1998 Plan,

. modifies the standards of eligibility,

. modifies the 1,000,000-share annual limitation on grants to employees,
or

. results in other changes that would require stockholder approval to
qualify options granted to the Company's executive officers under the
1998 Plan as performance-based compensation under Section 162(m) of the
Code.

No action by the Board of Directors or the stockholders may alter or impair any
option previously granted under the 1998 Plan, unless mutually agreed to by
both the optionee and the Company.

The 1998 Plan shall terminate in June 2008. Any options outstanding under
the plan at that time shall remain outstanding until they expire by their
terms.

United States Federal Income Tax Information

The following is a brief summary of the U.S. federal income tax consequences
of transactions under the 1998 Plan based on federal income tax laws in effect
on the date of this Proxy Statement. This summary does not address all matters
that may be relevant to a particular optionee based on his or her specific
circumstances. It addresses only current U.S. federal income tax law and does
not discuss the income tax laws of any state, municipality, or non-U.S. taxing
jurisdiction, or gift, estate or other tax laws other than federal income tax
law. Each optionee should consult his or her own tax advisor concerning the tax
implications of option grants and exercises, and the disposition of stock
acquired upon such exercises, under the 1998 Plan.

Options granted under the 1998 Plan may be either incentive stock options,
which are intended to qualify for the special tax treatment provided by Section
422 of the Code, or nonstatutory stock options, which will not qualify for such
treatment.

9
<PAGE>

Treatment of Incentive Stock Options. If an option granted under the 1998
Plan is an incentive stock option, the optionee will recognize no taxable
income upon grant of the option and will incur no federal income tax liability
due to its exercise, except to the extent that such exercise causes the
optionee to incur alternative minimum tax (see discussion below.) The Company
will not be allowed a deduction for federal income tax purposes as a result of
the exercise of an incentive stock option regardless of the applicability of
the alternative minimum tax to the optionee. Upon the sale or exchange of the
shares more than two years after grant of the option and one year after
exercise of the option by the optionee, any gain will be treated as a long-term
capital gain. If both of these holding periods are not satisfied, the optionee
will recognize ordinary income equal to the difference between the exercise
price and the lower of the fair market value of the Common Stock on the date of
the option exercise or the sale price of the Common Stock. The Company will be
entitled to a deduction in the same amount as the ordinary income recognized by
the optionee. Any gain or loss recognized on a disposition of the shares prior
to completion of both of the above holding periods in excess of the amount
treated as ordinary income will be characterized as long-term capital gain if
the sale occurs more than one year after exercise of the option or as short-
term capital gain if the sale is made earlier. The maximum capital gains rate
in effect as of the date of this Proxy Statement is 20%.

Treatment of Nonstatutory Stock Options. An optionee will not recognize any
taxable income at the time he or she is granted a nonstatutory stock option.
However, upon its exercise, the optionee will recognize ordinary income for tax
purposes measured by the excess of the fair market value of the shares over the
exercise price. The income recognized by an optionee who is also an employee of
the Company will be subject to income and employment tax withholding by the
Company by payment in cash by the optionee or out of the optionee's current
earnings. The Company will be entitled to a deduction equal to the amount of
ordinary income recognized by the optionee upon exercise of a nonstatutory
stock option. Upon the sale of such shares by the optionee, any difference
between the sale price and the fair market value of the shares as of the date
of exercise of the option will be treated as capital gain or loss, and will
qualify for long-term capital gain or loss treatment if the shares have been
held for more than one year from date of exercise.

Alternative Minimum Tax

The exercise of an incentive stock option may subject an optionee to the
alternative minimum tax under Section 55 of the Code. The alternative minimum
tax is calculated by applying a tax rate of 26% to alternative minimum taxable
income of joint filers up to $175,000 ($87,500 for married taxpayers filing
separately) and 28% to alternative minimum taxable income above that amount.
Alternative minimum taxable income is equal to (i) taxable income adjusted for
certain items, plus (ii) items of tax preference less (iii) an exemption amount
of $45,000 for joint returns, $33,750 for unmarried individual returns and
$22,500 in the case of married taxpayers filing separately (which exemption
amounts are phased out for taxpayers in higher income tax brackets).
Alternative minimum tax will be due if the tax determined under the foregoing
formula exceeds the regular tax of the taxpayer for the year.

In computing alternative minimum taxable income, shares purchased upon
exercise of an incentive stock option are treated as if they had been acquired
by the optionee pursuant to exercise of a nonstatutory stock option. As a
result, the optionee recognizes alternative minimum taxable income equal to the
excess of the fair market value of the Common Stock on the date of exercise
over the option exercise price. Because the alternative minimum tax calculation
may be complex, optionees should consult their own tax advisors prior to
exercising incentive stock options.

If an optionee pays alternative minimum tax, the amount of such tax may be
carried forward as a credit against any subsequent year's regular tax in excess
of the alternative minimum tax for such year.

Required Vote

The approval of the amendments of the 1998 Plan as described above requires
the affirmative vote of the holders of a majority of the shares of the
Company's Common Stock present at the Annual Meeting in person or by proxy and
entitled to vote.

10
<PAGE>

Recommendation of the Board of Directors

THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR
APPROVAL OF THE AMENDMENTS OF THE 1998 PLAN.

11
<PAGE>

PROPOSAL NO. 3

RATIFICATION OF APPOINTMENT OF INDEPENDENT AUDITORS

KPMG, LLP has served as the Company's independent auditors since 1994 and
has been appointed by the Board to continue as the Company's independent
auditors for the fiscal year ending March 31, 2000. In the event that
ratification of this selection of auditors is not approved by a majority of the
shares of Common Stock present in person or represented by proxy and entitled
to vote on this matter at the Annual Meeting, the Board will reconsider its
selection of auditors.

A representative of KPMG, LLP is expected to be present at the Annual
Meeting. This representative will have an opportunity to make a statement and
will be available to respond to appropriate questions.

Recommendation of the Board:

THE BOARD RECOMMENDS A VOTE FOR RATIFICATION OF THE
APPOINTMENT OF KPMG, LLP AS THE COMPANY'S INDEPENDENT
AUDITORS FOR THE FISCAL YEAR ENDING MARCH 31, 2000

12
<PAGE>

EXECUTIVE OFFICERS

The following table sets forth certain information regarding the executive
officers of the Company as of July 1, 1999.

<TABLE>
<CAPTION>
Name Age Office(s)
---- --- ---------
<C> <C> <S>
M. Marketta Silvera... 56 Chairman of the Board of Directors, President and
Chief Executive Officer
William C. Leetham.... 46 Senior Vice President, Finance and Administration,
Chief Financial Officer, Treasurer and Secretary
Dana R. Nelson........ 50 Senior Vice President, Sales and Marketing
Martin W. Wegenstein.. 49 Senior Vice President, Operations
Thomas A. Wadlow...... 42 Vice President, Engineering and Development
Robert G. Carrade..... 37 Vice President, Finance and Administration
</TABLE>

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

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

Dana R. Nelson has served as Senior Vice President, Sales, since January
1999. From 1997 to 1999, Mr. Nelson served as the Senior Vice President of
Sales of NetVantage, a networking company that was sold to Cabletron Systems in
1998. From 1995 to 1997, Mr. Nelson was the Vice President, Worldside Sales and
Marketing for Digi International , a data communications hardware and software
provider. From 1983 to 1995, Mr. Nelson held various positions with Ascom
Timeplex, a supplier of networking equipment, most recently serving as Vice
President, Worldwide Sales.

Martin W. Wegenstein has served as Senior Vice President, Operations, since
April 1999. From 1998 through April, 1999, Mr. Wegenstein was the owner of The
Wegenstein Group, an information and knowledge management consulting firm. From
1995 through 1998, Mr. Wegenstein served as Vice President and CIO of Applied
Materials, a silicon wafer fabrication company. From 1992 to 1995, Mr.
Wegenstein served as Vice President of Information Technology and CIO of Rachem
Corporation, a material science company. From 1985 Mr. Wegenstein served as
Director of Corporate Information Systems at Emerson Electric Co., an
electrical manufacturing company.

Thomas A. Wadlow has served as Vice President, Engineering and Development
of the Company since January 1996, and Director of Engineering from September
1993 to January 1996. From 1989 to September 1993, he served as Research
Network Architect at Sun Microsystems Laboratories, Inc., a workstation
manufacturer. From 1988 to 1989, Mr. Wadlow served as Systems and Network
Manager of ParcPlace Systems, an object oriented software developer. From 1987
to 1988, Mr. Wadlow served as an engineer of the Smalltalk Group of Xerox Palo
Alto Research Center, a computer science research laboratory. Prior to 1988

13
<PAGE>

Mr. Wadlow served in various senior technical staff positions at Schlumberger
Limited, a petroleum exploration and research company, and Lawrence Livermore
National Laboratories, a national defense contractor.

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

COMMON STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth information that has been provided to the
Company with respect to beneficial ownership of shares of the Company's Common
Stock as of July 1, 1999 for (i) each person who is known by the Company to own
beneficially more than five percent of the outstanding shares of Common Stock,
(ii) each director of the Company, (iii) each of the executive officers named
in the Summary Compensation Table of this proxy statement (the "Named Executive
Officers"), and (iv) all directors and executive officers of the Company as a
group.

<TABLE>
<CAPTION>
Amount and
Nature of Percent of
Beneficial Common
Name and Address Ownership(1) Stock(1)(2)
- ---------------- ------------ -----------
<S> <C> <C>
Entities affiliated with
El Dorado Ventures(3)................................. 1,648,661 12.1%
2400 Sand Hill Road
Menlo Park, CA 94025
M. Marketta Silvera(4)................................. 1,275,000 9.3
GE Electric Capital Corporation(5)..................... 750,000 5.5
120 Long Ridge Road
Stamford, CT 06927
Shanda Bahles(6)....................................... 1,653,661 12.1
Thomas O'Rourke(7)..................................... 399,580 2.9
Thomas A. Wadlow(8).................................... 238,956 1.7
Robert G. Carrade(9)................................... 149,125 1.1
K. Flynn McDonald(10).................................. 52,400 *
William C. Leetham(11)................................. 38,895 *
Michael Millikin(12)................................... 29,166 *
Peter Liebowitz(13).................................... 5,000 *
All directors and executive officers as
a group (12 persons)(14).............................. 3,841,783 27.8%
</TABLE>
- --------
* Represents beneficial ownership of less than 1% of the Company's Common
Stock.

(1) Except pursuant to applicable community property laws or as indicated in
the footnotes of this table, to the Company's knowledge, each stockholder
identified in the table possesses sole voting and investment power with
respect to all shares of Common Stock shown as beneficially owned by such
stockholder.

(2) Applicable percentage of ownership for each stockholder is based on
13,638,786 shares of Common Stock outstanding as of July 1, 1999, together
with applicable options and warrants for such stockholders. Beneficial
ownership is determined in accordance with the rules of the Securities and
Exchange Commission. The number of shares beneficially owned by a person
includes shares of Common Stock subject to options held by that person
that are currently exercisable within 60 days of July 1, 1999. Such shares
issuable pursuant to such options are deemed outstanding for computing the
percentage ownership

14
<PAGE>

of the person holding such options but are not deemed outstanding for the
purposes of computing the percentage ownership of each other person.
Unless otherwise indicated, the address of each of the individuals named
above is: c/o Pilot Network Services, Inc., 1080 Marina Village Parkway,
Alameda, CA 94501.

(3) Consists of 29,418 shares held by El Dorado C&L Fund, L.P., 55,704 shares
held by El Dorado Technology IV, L.P., and 1,563,540 shares held by El
Dorado Ventures III, L.P. (collectively, the "El Dorado Entities").

(4) Includes 55,000 shares issuable upon exercise of stock options that are
exercisable within 60 days of July 1, 1999.

(5) Includes 50,000 shares issuable upon exercise of stock options that are
exercisable within 60 days of July 1, 1999 held by AmeriData, which was
acquired in June 1996 by GE Capital Corp., a subsidiary of General
Electric Company, and is now GE Capital Information Technologies
Solutions, Inc.

(6) Includes 1,648,662 shares held by the El Dorado Entities. Ms. Bahles, a
Director of the Company and a General Partner to each of the El Dorado
Entities, disclaims beneficial ownership of the shares held by the El
Dorado Entities, except for her proportional pecuniary interest therein,
if any. Also includes 5,000 shares issuable upon exercise of stock
options that are exercisable within 60 days of July 1, 1999.

(7) Includes 394,580 shares held by O'Rourke Investment Corporation ("OIC").
Mr. O'Rourke, a Director of the Company and Chairman and CEO of OIC, owns
a majority of the outstanding voting shares of OIC and is a director of
OIC. Also includes 5,000 shares issuable upon exercise of stock options
that are exercisable within 60 days of July 1, 1999.

(8) Includes 29,374 shares issuable upon exercise of stock options that are
exercisable within 60 days of July 1, 1999.

(9) Includes 15,132 shares issuable upon exercise of stock options that are
exercisable within 60 days of July 1, 1999.

(10) Includes 25,000 shares issuable upon exercise of stock options that are
exercisable within 60 days of July 1, 1999.

(11) Includes 36,875 shares issuable upon exercise of stock options that are
exercisable within 60 days of July 1, 1999.

(12) Beneficial ownership calculation is based solely on a review of
stockholder records by the Company as of March 31, 1999.

(13) Beneficial ownership calculation is based solely on a review of the most
recent Section 16 filings known by the Company to have been made by the
holder with the Securities and Exchange Commission.

(14) Includes 171,381 shares issuable upon exercise of stock options that are
exercisable within 60 days of July 1, 1999.

15
<PAGE>

COMPENSATION OF EXECUTIVE OFFICERS

The following table shows the compensation earned by (a) the individual who
served as the Company's Chief Executive Officer during the fiscal year ended
March 31, 1999; and, (b) the three other most highly compensated individuals
who were serving as executive officers of the Company at the end of fiscal year
ended March 31, 1999 and two additional individuals who were not serving as
executive officers at the end of fiscal year ended March 31, 1999; and (c) the
compensation received by each such individual for the Company's two preceding
fiscal years.

Summary Compensation Table

<TABLE>
<CAPTION>
Long-Term
Compensation
------------
Awards
------------
Annual Compensation
--------------------------------------------------- Securities All Other
Other Annual Underlying Compensation ($)
Name and Principal Position(1) Fiscal Year Salary ($)(2) Bonus ($)(3) Compensation Options (#) (4)
- ------------------------------ ----------- ------------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
M. Marketta Silvera........... 1999 $225,000 $10,200 -- 60,000 $261
President and Chief Executive 1998 205,000 43,650 -- 60,000 237
Officer

William C. Leetham(5)......... 1999 129,563 6,800 -- 150,000 223
Senior Vice President, Finance
and Administration, Chief
Financial Officer, Treasurer
and Secretary

Robert G. Carrade ............ 1999 125,000 4,080 -- 35,000 261
Vice President, Finance and 1998 115,000 18,188 -- 30,000 230
Administration

Thomas A. Wadlow ............. 1999 125,000 4,080 -- 35,000 261
Vice President, Engineering 1998 110,000 18,188 -- 30,000 178
and Development

Peter Liebowitz(6)............ 1999 129,616 16,735 -- -- 171
Senior Vice President, Sales 1998 37,500 25,000 -- 150,000 90
and Marketing

Michael Millikin(7)........... 1999 150,150 13,600 -- 50,000 261
Vice President, Operations and 1998 37,500 25,000 -- 100,000 90
Business Development
</TABLE>
- --------
(1) In January 1999, the Company hired Dana R. Nelson as its Senior Vice
President of Sales and Marketing at an annualized salary of $175,000 and in
April 1999, the Company hired Martin W. Wegenstein as its Senior Vice
President of Operations at an annualized salary of $175,000.
(2) Includes amounts deferred under the Company's 401(k) plan.
(3) Include bonuses earned in the indicated year and paid in the subsequent
year. Excludes bonuses paid in the indicated year but earned in the
preceding year.
(4) Amounts listed represent term life insurance premiums paid on behalf of the
listed individual.
(5) Mr. Leetham joined the Company in May 1998 at an annualized salary of
$150,000.
(6) Mr. Liebowitz joined the Company in January 1998 and left the Company in
January 1999.
(7) Mr. Millikin joined the Company in January 1998 and left the Company in
March 1999.

16
<PAGE>

OPTION GRANTS IN LAST FISCAL YEAR

The following table provides certain information with respect to stock
options granted to the persons listed in the Summary Compensation Table in the
last fiscal year. In addition, as required by Securities and Exchange
Commission rules, the table sets forth the hypothetical gains that would exist
for the options based on assumed rates of annual compound stock price
appreciation during the option term.
<TABLE>
<CAPTION>
Individual Grants(1)
------------------------------------------------ Potential Realizable
Percent Value at Assumed
Number of of Total Options Annual Rates of Stock
Securities Granted Price Appreciation
Underlying to Employees Exercise For Option Term(3)
Options in Fiscal Price Expiration ---------------------
Name Granted (#) Year(%)(2) ($/sh) Date 5% ($) 10% ($)
---- ---------- ---------------- -------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
M. Marketta Silvera..... 60,000 3.9% $3.30 4/24/03 $ 874,077 $1,154,828
William C. Leetham(4)... 150,000 9.8 6.00 5/20/08 2,520,679 4,546,859
Robert G. Carrade....... 35,000 2.3 3.00 4/24/08 693,158 1,165,934
Thomas A. Wadlow........ 35,000 2.3 3.00 4/24/08 693,158 1,165,934
Michael Millikin........ 50,000 3.3 5.875 10/23/08 184,738 468,162
Peter Liebowitz......... -- -- -- -- -- --
</TABLE>
- --------
(1) No stock appreciation rights were granted to the above officers in the last
fiscal year. Options vest 25% upon the first anniversary of the vesting
commencement date, with the remaining shares vesting in equal monthly
installments over the following three years.
(2) Based on an aggregate of 1,536,400 options granted to employees during the
fiscal year ended March 31, 1999.
(3) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by the Securities and Exchange Commission. There is no
assurance provided to any executive officer or any other holder of the
Company's securities that the actual stock price appreciation over the 10-
year option term will be at the assumed 5% and 10% levels or at any other
defined level. Unless the market price of the Common Stock appreciates over
the option term, no value will be realized from the option grants made to
the executive officers. For options granted prior to the closing of the
Company's initial public offering, the potential realizable value is
calculated by assuming that the initial public offering price of $14.00 per
share appreciates at the indicated rate for the entire term of the option.
(4) In the event the Company is acquired and such officer's employment is
terminated without cause within 12 months after such acquisition, then 50%
of the unvested portion of such officer's options shall immediately become
fully vested at the time of such termination.

17
<PAGE>

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION VALUES

The following table sets forth certain information with respect to stock
options exercised by the persons listed in the Summary Compensation Table
during the fiscal year ended March 31, 1999. In addition, the table sets forth
the number of shares covered by stock options as of the fiscal year ended March
31, 1999, and the value of "in-the-money" stock options, which represents the
positive spread between the exercise price of a stock option and the market
price of the shares subject to such option at the end of the fiscal year ended
March 31, 1999.

<TABLE>
<CAPTION>
Number of Value of
Unexercised Unexercised
Shares Options at In-the-Money
Acquired Fiscal Year End Options at
on Exercise Value (#) Exercisable/ Fiscal Year End ($)
Name (#) Realized ($)(3) Unexercisable(1) Exercisable/Unexercisable(2)
---- ----------- --------------- ---------------- ----------------------------
<S> <C> <C> <C> <C>
M. Marketta Silvera..... -- $ -- 28,750/91,250 $407,905/$792,515
William C. Leetham...... -- -- 17,000/133,000 151,946/1,188,754
Robert G. Carrade....... 19,062 91,746 -- /51,980 -- /659,487
Thomas A. Wadlow........ -- -- 28,020/51,980 406,153/659,487
Michael Millikin(4)..... 64,583 309,371 -- /-- -- /--
Peter Liebowitz(5)...... 93,750 332,813 -- /-- -- /--
</TABLE>
- --------
(1) No stock appreciation rights (SARs) were outstanding during fiscal 1999.
(2) Based on the $14.938 per share closing price of the Company's Common Stock
on The Nasdaq Stock Market on March 31, 1999, less the exercise price of
the options.
(3) Value realized is calculated based on the closing price of the Company's
Common Stock as reported on the Nasdaq Stock Market on the date of exercise
minus the exercise price of the option and does not necessarily indicate
that the optionee sold such stock.
(4) The Company repurchased 35,417 shares of Mr. Millikin's stock in March 1999
at the original purchase price of such shares.
(5) The Company repurchased 56,250 shares of Mr. Liebowitz's stock in January
1999 at the original purchase price of such shares.

18
<PAGE>

Notwithstanding anything to the contrary set forth in any of the Company's
filings under the Securities Act of 1933 or the Securities Exchange Act of 1934
that might incorporate future filings, including this Proxy Statement, in whole
or in part, the following report and the Stock Performance Graph which follows
shall not be deemed to be incorporated by reference into any such filings.

COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION

The following is a report of the Compensation Committee of the Board of
Directors (the "Committee") describing the compensation policies applicable to
the Company's executive officers during the fiscal year ended March 31, 1999.
The Committee is responsible for establishing and monitoring the general
compensation policies and compensation plans of the Company, as well as the
specific compensation levels for executive officers, including administration
of the Company's stock plans and approving stock option grants. Executive
officers who are also directors have not participated in deliberations or
decisions involving their own compensation.

General Compensation Policy

Under the supervision of the Board of Directors, the Company's compensation
policy is designed to attract and retain qualified key executives critical to
the Company's growth and long-term success. It is the objective of the Board of
Directors to have a portion of each executive's compensation contingent upon
the Company's performance as well as upon the individual's personal
performance. Accordingly, each executive officer's compensation package is
comprised of three elements: (i) base salary which reflects individual
performance and expertise, (ii) variable bonus awards payable in cash and tied
to the achievement of certain performance goals that the Board of Directors
establishes from time to time for the Company and (iii) long-term stock-based
incentive awards which are designed to strengthen the mutuality of interests
between the executive officers and the Company's stockholders.

The summary below describes in more detail the factors which the Board of
Directors considers in establishing each of the three primary components of the
compensation package provided to the executive officers.

Base Salary

The level of base salary is established primarily on the basis of the
individual's qualifications and relevant experience, the strategic goals for
which he or she has responsibility, the compensation levels at companies which
compete with the Company for business and executive talent, and the incentives
necessary to attract and retain qualified management. Base salary is adjusted
each year to take into account the individual's performance and to maintain a
competitive salary structure. Company performance does not play a significant
role in the determination of base salary.

Cash-Based Incentive Compensation

Cash bonuses are awarded on a discretionary basis to executive officers on
the basis of their success in achieving designated individual goals and the
Company's success in achieving specific company-wide goals, such as customer
satisfaction, revenue growth and earnings growth.

Long-Term Incentive Compensation

The Company has utilized its stock option plans to provide executives and
other key employees with incentives to maximize long-term stockholder values.
Awards under this plan by the Board of Directors take the form of stock options
designed to give the recipient a significant equity stake in the Company and
thereby closely align his or her interests with those of the Company's
stockholders. Factors considered in making such

19
<PAGE>

awards include the individual's position in the Company, his or her performance
and responsibilities, and internal comparability considerations.

Each option grant allows the executive officer to acquire shares of Common
Stock at a fixed price per share (the fair market value on the date of grant)
over a specified period of time (up to 10 years). The options typically vest in
periodic installments over a four-year period, contingent upon the executive
officer's continued employment with the Company. Accordingly, the option will
provide a return to the executive officer only if he or she remains in the
Company's service, and then only if the market price of the Common Stock
appreciates over the option term.

Compensation of the Chief Executive Officer

M. Marketta Silvera has served as the Company's President and Chief
Executive Officer since June 1993. Her base salary and cash bonus for fiscal
1999 was $225,000 and $10,200, respectively.

The factors discussed above in "Base Salary," "Cash-Based Incentive
Compensation," and "Long-Term Incentive Compensation" were also applied in
establishing the amount of Ms. Silvera's salary and stock option grant for
fiscal 1999. Significant factors in establishing Ms. Silvera's compensation
were Ms. Silvera's personal performance during the fiscal year as well as her
role in attaining the Company's overall objectives in revenue attainment and
operating results.

Deductibility of Executive Compensation

The Committee has considered the impact of Section 162(m) of the Internal
Revenue Code adopted under the Omnibus Budget Reconciliation Act of 1993, which
section disallows a deduction for any publicly held corporation for individual
compensation exceeding $1 million in any taxable year for the CEO and four
other most highly compensated executive officers, respectively, unless such
compensation meets the requirements for the "performance-based" exception to
Section 162(m). As the cash compensation paid by the Company to each of its
executive officers is expected to be below $1 million and the Committee
believes that options granted under the Company's 1998 Stock Plan or its 1994
Stock Plan to such officers will meet the requirements for qualifying as
performance-based, the Committee believes that Section 162(m) will not affect
the tax deductions available to the Company with respect to the compensation of
its executive officers. It is the Committee's policy to qualify, to the extent
reasonable, its executive officers' compensation for deductibility under
applicable tax law. However, the Company may from time to time pay compensation
to its executive officers that may not be deductible.

Shanda Bahles
Thomas O'Rourke

Compensation Committee Interlocks and Insider Participation

The Compensation Committee of the Board of Directors currently consists of
Shanda Bahles and Thomas O'Rourke. No member of the Compensation Committee or
executive officer of the Company has a relationship that would constitute an
interlocking relationship with executive officers or directors of another
entity.

20
<PAGE>

CERTAIN RELATIONSHIPS AND TRANSACTIONS

The Company has entered into service agreements with entities affiliated
with General Electric Company containing standard terms and conditions
resulting from third party arm's length negotiations between the Company and
each such entity. Such entities may be affiliated with GE Electric Capital
Corporation, a principal stockholder of the Company's Common Stock. The Company
also entered into an agreement with AmeriData Technologies Inc. ("AmeriData")
on June 18, 1996 whereby the Company granted AmeriData options to purchase
200,000 shares of the Company's Common Stock at $2.00 per share and Ameridata
agreed to sell the Company's Internet security service to AmeriData customers
in exchange for a commission on the first two years of revenue from those
customers. The Company and AmeriData also agreed to cooperate in areas such as
training and marketing. In June 1996, Ameridata was acquired by GE Capital
Corp., a subsidiary of General Electric Company, and is now GE Capital
Information Technologies Solutions, Inc.

21
<PAGE>

STOCK PERFORMANCE GRAPH

The following graph compares the cumulative total stockholder return data
for the Company's stock since August 10, 1998 (the date on which the Company's
stock was first registered under Section 12 of the Securities Exchange Act of
1934, as amended) to the cumulative return over such period of (i) The Nasdaq
National Market Composite Index, and (ii) the Credit Suisse First Boston EC
Index. The graph assumes that $100 was invested on August 11, 1998, the date on
which the Company completed the initial public offering of its Common Stock, in
the Common Stock of the Company and in each of the comparative indices. The
graph further assumes that such amount was initially invested in the Common
Stock of the Company at a per share price of $14.00, the price to which such
stock was first offered to the public by the Company on the date of its initial
public offering, and reinvestment of any dividends. The stock price performance
on the following graph is not necessarily indicative of future stock price
performance.

COMPARISON OF 1 YEAR CUMULATIVE TOTAL RETURN *
AMONG PILOT NETWORK SERVICES, INC., THE NASDAQ NATIONAL
MARKET COMPOSITE INDEX AND CREDIT SUISSE FIRST BOSTON EC INDEX

[GRAPH]
- --------
* Assumes $100 invested on August 11, 1998 in stock or index, including
reinvestment of dividends. Fiscal year ending March 31, 1999.

<TABLE>
<CAPTION>
8/11/98 9/30/98 12/31/98 3/31/99
------- ------- -------- -------
<S> <C> <C> <C> <C>
Pilot Network Services, Inc................... 100.0 47.3 63.8 106.7
The Nasdaq National Market Composite Index.... 100.0 94.5 122.3 137.3
Credit Suisse First Boston EC Index........... 100.0 85.5 137.0 212.5
</TABLE>

22
<PAGE>

DEADLINE FOR RECEIPT OF STOCKHOLDER PROPOSALS FOR 2000 ANNUAL MEETING

Proposals of stockholders intended to be included in the Company's proxy
statement for the 2000 Annual Meeting of Stockholders must be received by
William C. Leetham, 1080 Marine Village Parkway, Alameda, California 94501, no
later than April 5, 2000. If the Company is not notified of a stockholder
proposal by June 19, 2000, then the proxies held by management of the Company
provide discretionary authority to vote against such stockholder proposal, even
though such proposal is not discussed in the Proxy Statement.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Exchange Act requires the Company's directors,
executive officers and persons who own more than 10% of the Company's Common
Stock (collectively, "Reporting Persons") to file with the Securities and
Exchange Commission ("SEC") initial reports of ownership and changes in
ownership of the Company's Common Stock. Reporting Persons are required by SEC
regulations to furnish the Company with copies of all Section 16(a) reports
they file. To the Company's knowledge, based solely on its review of the copies
of such reports received or written representations from certain Reporting
Persons that no other reports were required, the Company believes that during
its fiscal year ended March 31, 1999, all Reporting Persons complied with all
applicable filing requirements except for the following Reporting Persons: (i)
Peter Liebowitz filed a late Form 4 reporting seven transactions and five
transactions that should have been reported on a Form 4 are reported on his
Form 5; and (ii) Thomas Kelly filed a late Form 3.

OTHER MATTERS

The Board of Directors knows of no other business that will be presented to
the Annual Meeting. If any other business is properly brought before the Annual
Meeting, proxies in the enclosed form will be voted in respect thereof as the
proxy holders deem advisable.

It is important that the proxies be returned promptly and that your shares
be represented. Stockholders are urged to mark, date, execute and promptly
return the accompanying proxy card in the enclosed envelope.

By Order of the Board of Directors,

William C. Leetham
Secretary

August 3, 1999
Alameda, California

23
<PAGE>

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.

(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 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

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<PAGE>

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.

(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 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

A-2
<PAGE>

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.

(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;

(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

A-3
<PAGE>

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.

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-4
<PAGE>

(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.

(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.

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<PAGE>

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
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 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

A-6
<PAGE>

(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:

(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

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

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<PAGE>

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 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

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<PAGE>

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.

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.

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<PAGE>

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 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.

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<PAGE>

THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF PILOT NETWORK
SERVICES, INC. FOR THE ANNUAL MEETING OF STOCKHOLDERS TO BE HELD SEPTEMBER 16,
1999
The undersigned stockholder of Pilot Network Services, Inc., a Delaware
corporation, (the"Company") hereby acknowledges receipt of the Notice of Annual
Meeting of Stockholders and Proxy Statement, each dated August 3, 1999, and
hereby appoints M. Marketta Silvera and William C. Leetham or either of them,
proxies and attorneys-in-fact, with full power to each of substitution, on
behalf and in the name of the undersigned, to represent the undersigned at the
Annual Meeting of Stockholders of Pilot Network Services, Inc. to be held on
Thursday, September 16, 1999 at 10:00 a.m., local time, at the Company's
offices at 2450 Mariner's Square Loop, Alameda, CA 94501 and at any adjournment
or postponement thereof, and to vote all shares of Common Stock which the
undersigned would be entitled to vote if then and there personally present, on
the matters set forth below:
1. ELECTION OF CLASS I DIRECTORS
[_] FOR all nominees listed below (except as indicated)
[_] WITHHOLD authority to vote for all nominees listed below
If you wish to withhold authority to vote for any individual nominee,
strike a line through that nominee's name in the list below:
M. Marketta Silvera Thomas B. Kelly Shanda Bahles
2. PROPOSAL TO AMEND THE 1998 STOCK OPTION PLAN:

[_] FOR[_] AGAINST[_] ABSTAIN

3. PROPOSAL TO RATIFY THE APPOINTMENT OF KPMG, LLP AS THE INDEPENDENT
AUDITORS OF THE COMPANY FOR THE FISCAL YEAR ENDING MARCH 31, 2000:

[_] FOR[_] AGAINST[_] ABSTAIN

and. in their discretion, upon such other matter or matters that may properly
come before the meeting and any postponement(s) or adjournment(s) thereof.

PLEASE SIGN ON REVERSE SIDE AND RETURN IMMEDIATELY

THIS PROXY WILL BE VOTED AS DIRECTED OR, IF NO CONTRARY DIRECTION IS INDICATED,
WILL BE VOTED AS FOLLOWS: (1) FOR THE ELECTION OF CLASS I DIRECTORS; (2) FOR
THE AMENDMENT OF THE 1998 STOCK OPTION PLAN; (3) FOR RATIFICATION OF THE
APPOINTMENT OF KPMG, LLP AS THE INDEPENDENT AUDITORS OF THE COMPANY FOR THE
FISCAL YEAR ENDING MARCH 31, 2000; AND AS SAID PROXIES DEEM ADVISABLE ON SUCH
OTHER MATTERS AS MAY COME BEFORE THE MEETING.

Dated: _______________________,
_______________________________
Signature
Dated: ________________________
_______________________________
Signature

(This Proxy should be marked, dated, signed by the stockholder(s) exactly as
his or her name appears hereon, and returned promptly in the enclosed envelope.
Persons signing in a fiduciary capacity should so indicate. If shares are held
by joint tenants or as community property, both should sign.)