<PAGE>

                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION

                            WASHINGTON, D.C. 20549

                                   FORM 10-Q
(Mark One)

[ X ]  Quarterly report pursuant to Section 13 or 15(d) of the Securities
       Exchange Act of 1934.

       For the quarterly period ended September 30, 1999.

                                       or

[   ]  Transition report pursuant to Section 13 or 15(d) of the Securities
       Exchange Act of 1934.

                        Commission File Number: 0-24507

                          PILOT NETWORK SERVICES, INC.
             (Exact name of registrant as specified in its charter)

            DELAWARE                                94-3305774
  (State or other jurisdiction of               (I.R.S. Employer
  incorporation or organization)              Identification Number)

                          1080 MARINA VILLAGE PARKWAY
                               ALAMEDA, CA 94501
          (Address of principal executive offices, including zip code)

                                 (510) 433-7800
              (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                               Yes   X    No
                                   -----     ----

At September 30, 1999, there were 13,745,796 shares of the Registrant's Common
Stock outstanding.

                                  Page 1 of 17
<PAGE>

                         PILOT NETWORK SERVICES, INC.
                         QUARTERLY REPORT ON FORM 10-Q
                                     INDEX

                                                  Page Number

<TABLE>
<CAPTION>

PART I.     FINANCIAL INFORMATION
<S>         <C>                                                                <C>
Item 1.     Financial Statements.............................................    3

            Condensed Balance Sheets as of
            March 31, 1999 and September 30, 1999............................    3

            Condensed Statements of Operations for the three months and six
            months ended September 30, 1998 and 1999.........................    4

            Condensed Statements of Cash Flows for the
            six months ended September 30, 1998 and 1999.....................    5

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

Item 2.     Management's Discussion and Analysis of Financial Condition and
            Results of Operations............................................    7

Item 3.     Quantitative and Qualitative Disclosures About Market Risk.......   16

PART II.    OTHER INFORMATION................................................   16

Item 2.     Changes in Securities and Use of Proceeds........................   16

Item 4.     Submission of Matters to a Vote of Security Holders..............   16

Item 6.     Exhibits and Reports on Form 8-K.................................   17

SIGNATURES...................................................................   17

INDEX TO EXHIBITS............................................................   17
</TABLE>

                                  Page 2 of 17
<PAGE>

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                          PILOT NETWORK SERVICES, INC.

                            CONDENSED BALANCE SHEETS
                       (in thousands, except share data)
                                  (unaudited)
<TABLE>
<CAPTION>
                                                                                  March 31,        September 30,
                                                                                     1999               1999
                                                                                  ---------        -------------
<S>                                                                            <C>               <C>
                                    ASSETS
Current assets:
 Cash and cash equivalents...................................................         $ 10,660            $  3,167
 Short-term investments......................................................           12,352               1,930
 Trade receivables, less allowance for doubtful accounts of $157 and $217 as
  of March 31, 1999 and September 30, 1999, respectively.....................            3,438               4,262
 Prepaid and other current assets............................................              783                 735
                                                                                      --------            --------
    Total current assets.....................................................           27,233              10,094
Property and equipment, net..................................................           14,184              18,850
Other assets.................................................................              698                 513
                                                                                      --------            --------
                                                                                      $ 42,115            $ 29,457
                                                                                      ========            ========
                  LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 Accounts payable............................................................         $  2,334            $  2,427
 Accrued expenses............................................................            1,675               2,341
 Line of credit..............................................................            1,439               1,311
 Term loan...................................................................            3,000                   -
 Current portion of capital lease obligation.................................            2,175               2,471
 Deferred revenue............................................................            2,027               1,357
                                                                                      --------            --------
    Total current liabilities................................................           12,650               9,907
Capital lease obligations, net of current portion............................            4,830               4,600
                                                                                      --------            --------
    Total liabilities........................................................           17,480              14,507
                                                                                      --------            --------

Stockholders' equity:
 Common stock, $0.001 par value; 40,000,000 shares authorized; 13,913,024
  and 14,196,732 shares issued and outstanding as of March 31, 1999 and
  September 30, 1999, respectively...........................................               14                  14
 Additional paid-in capital..................................................           59,563              60,067
 Accumulated other comprehensive income......................................              127                  40
 Deferred stock compensation.................................................           (1,097)               (761)
 Accumulated deficit.........................................................          (31,278)            (41,716)
 Treasury stock, 450,936 shares of common stock at cost
   as of March 31, 1999 and September 30, 1999, respectively.................           (2,694)             (2,694)
                                                                                      --------            --------
    Total stockholders' equity...............................................           24,635              14,950
                                                                                      --------            --------
                                                                                      $ 42,115            $ 29,457
                                                                                      ========            ========
</TABLE>
           See accompanying notes to condensed financial statements.

                                  Page 3 of 17
<PAGE>

                          PILOT NETWORK SERVICES, INC.

                       CONDENSED STATEMENTS OF OPERATIONS
                     (in thousands, except per share data)
                                  (unaudited)

<TABLE>
<CAPTION>

                                                      Three months ended               Six months ended
                                                        September 30,                   September 30,
                                                     1998            1999            1998            1999
                                                   --------        --------        --------        --------

<S>                                             <C>             <C>             <C>             <C>
Service revenues.................................     $ 3,770         $ 7,130         $ 7,490        $ 12,946
Cost of service revenues.........................       4,581           7,379           8,604          13,809
                                                      -------         -------         -------        --------
Gross margin.....................................        (811)           (249)         (1,114)           (863)
                                                      -------         -------         -------        --------
Operating costs and expenses:
 Sales and marketing.............................       2,134           3,218           4,268           6,156
 Engineering and development.....................         386             767             685           1,402
 General and administrative......................         728             970           1,416           1,730
                                                      -------         -------         -------        --------
 Operating expenses..............................       3,248           4,955           6,369           9,288
                                                      -------         -------         -------        --------
Operating loss...................................      (4,059)         (5,204)         (7,483)        (10,151)
Interest expense, net............................      (1,031)            (37)         (1,239)           (287)
                                                      -------         -------         -------        --------
Net loss.........................................      (5,090)         (5,241)         (8,722)        (10,438)

Accretion on redeemable convertible preferred
 stock...........................................        (151)              -            (488)              -
                                                      -------         -------         -------        --------

Net loss attributable to common stockholders.....     $(5,241)        $(5,241)        $(9,210)       $(10,438)
                                                      =======         =======         =======        ========

Basic and diluted net loss per share.............     $ (0.60)        $ (0.38)        $ (1.68)       $  (0.77)
                                                      =======         =======         =======        ========

Shares used in computing net loss per share......       8,752          13,689           5,477          13,625
                                                      =======         =======         =======        ========
</TABLE>


           See accompanying notes to condensed financial statements.

                                  Page 4 of 17
<PAGE>

                          PILOT NETWORK SERVICES, INC.

                       CONDENSED STATEMENTS OF CASH FLOWS
                           (in thousands, unaudited)


<TABLE>
<CAPTION>
                                                                          Six months ended
                                                                           September 30,
                                                                        1998            1999
                                                                   --------------  --------------

Cash flows from operating activities:
<S>                                                                <C>             <C>
 Net loss............................................................   $ (8,722)       $(10,438)
 Adjustments to reconcile net loss to net cash used in operating
  activities:
   Depreciation and amortization.....................................      1,790           3,371
   Amortization of deferred compensation.............................        705             336
   Amortization of loan fees.........................................        750             150
   Changes in operating assets and liabilities:
     Trade receivables...............................................       (752)           (824)
     Prepaid and other assets........................................       (271)             83
     Accounts payable................................................       (146)             93
     Accrued expenses................................................        803             666
     Deferred revenue................................................       (146)           (670)
                                                                        --------        --------
       Net cash used in operating activities.........................     (5,989)         (7,233)
                                                                        --------        --------
Cash flows used in investing activities:
 Purchases of property and equipment.................................     (1,560)         (6,863)
 Purchases of short-term investments.................................    (11,691)              -
 Proceeds from short-term investments................................          -          10,335
                                                                        --------        --------
       Net cash provided by (used in) investing activities...........    (13,251)          3,472
                                                                        --------        --------
Cash flows from financing activities:
 Net proceeds from issuance of common stock..........................     43,326             504
 Proceeds from working capital line of credit........................        726               -
 Payments of working capital line of credit..........................          -            (128)
 Proceeds from term loan.............................................      6,000               -
 Payments of term loan...............................................          -          (3,000)
 Principal payments of obligations under capital leases..............     (1,038)         (1,108)
                                                                        --------        --------
       Net cash provided by (used in) financing activities...........     49,014          (3,732)
                                                                        --------        --------

Net increase (decrease) in cash and cash equivalents.................     29,774          (7,493)

Cash and cash equivalents, beginning of period.......................      1,447          10,660
                                                                        --------        --------
Cash and cash equivalents, end of period.............................   $ 31,221        $  3,167
                                                                        ========        ========

Supplemental disclosure of cash flow information:
 Cash paid during the period for interest............................   $    706        $    667
                                                                        ========        ========
 Noncash financing activities:
  Assets acquired under capital lease obligations....................   $  2,373        $  1,174
                                                                        ========        ========
  Accretion on preferred stock.......................................   $    488        $      -
                                                                        ========        ========
</TABLE>


           See accompanying notes to condensed financial statements.

                                  Page 5 of 17
<PAGE>

NOTES TO CONDENSED FINANCIAL STATEMENTS


1.   Basis of presentation

     The financial statements included herein for Pilot Network Services, Inc.
(the "Company") have been prepared by the Company, without audit, pursuant to
the rules and regulations for Form 10-Q of the Securities and Exchange
Commission. In management's opinion, the interim financial data presented
includes all adjustments (which include only normal and recurring adjustments)
necessary for a fair presentation. Certain information and footnote disclosures
normally included in the financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted pursuant
to such rules and regulations. The results of operations for the three months
ended September 30, 1999 are not necessarily indicative of the operating results
expected for the entire year. The financial statements included herein should be
read in conjunction with other documents the Company files from time to time
with the Securities and Exchange Commission, including the Company's March 31,
1999, financial statements and notes thereto included in the Company's Annual
Report on Form 10-K dated June 29, 1999 and its Quarterly Report on Form 10-Q
dated August 16, 1999.


2.   Basic and diluted net loss per share

     Basic and diluted loss per share is computed using the weighted average
number of common shares outstanding during the period. Inclusion of common share
equivalents would be anti-dilutive and have been excluded from per share
calculations.

     As part of Pilot's initial public offering on August 10, 1998, 7,763,030
shares of common stock were issued from the conversion of the Series A, B, C, D,
E and F preferred stock. Prior to August 10, 1998, those shares were not
included in calculating diluted earnings per share because the effects would be
anti-dilutive. Also excluded from the computation of diluted earnings per share
for the three and six-month periods ending September 30, 1998, are options to
acquire 1,604,558 shares of common stock and 292,910 common share equivalents
from the assumed exercise of common stock warrants because their effects would
be anti-dilutive. Excluded from the computation of diluted earnings per share
for the three and six-month periods ending September 30, 1999, are options to
acquire 2,251,671 shares of common stock and 217,874 common share equivalents
from the assumed exercise of common stock warrants because their effects would
be anti-dilutive.

3.   Recent accounting pronouncements

     In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes standards for
accounting for derivative instruments and hedging activities. The Company is
required to adopt SFAS No. 133, as amended by SFAS No. 137, in the first quarter
of fiscal year 2002. The Company does not anticipate that SFAS No. 133 will have
a material impact on its financial statements.

4.   Comprehensive Loss

     Total comprehensive loss for the quarter and six months ended September 30,
1999, was $5,283,000 and $10,525,000, respectively.

                                  Page 6 of 17
<PAGE>

5.  Subsequent event.

     On November 10, 1999, the Company completed an $8.0 million credit facility
with a financial institution consisting of $5.0 million as a revolving line of
credit and $3.0 million as a term loan. The line of credit is renewable in
successive one-year terms and currently bears interest of 10.25% per annum. The
term loan expires in one year and currently bears interest of 10.25% per annum.
Additionally, the term loan must be pre-paid, without penalty, if the Company
raises more than $15 million in equity. The credit facility is secured by the
general assets of the Company. As additional consideration, the Company issued a
warrant to purchase 121,212 shares of common stock at $8.25 per share. The
Company calculated a fair value of the warrants of $1.0 million which amount
will be capitalized and amortized over the expected terms of the loans.


ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
           AND RESULTS OF OPERATIONS


   In addition to historical information, this Quarterly Report contains
forward-looking statements.  The forward-looking statements are subject to
certain risks and uncertainties that could cause actual results to differ
materially from those reflected in such forward-looking statements.  Factors
that might cause such a difference include, but are not limited to, those
discussed in the section entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Factors That May Affect Future
Results and Market Price of Stock."  Readers are cautioned not to place undue
reliance on these forward-looking statements, which reflect management's
opinions only as of the date hereof. The Company undertakes no obligation to
revise or publicly release the results of any revision to these forward-looking
statements. Readers should carefully review the risk factors that may be
described in other documents the Company files from time to time with the
Securities and Exchange Commission, including its Annual Report on Form 10-K
filed by the Company on June 29, 1999, its Quarterly Report on Form 10-Q filed
by the Company on August 16, 1999, and any Quarterly Reports on Form 10-Q filed
by the Company in the future.

OVERVIEW

   Pilot Network Services, Inc. provides a wide range of secure Internet
services that incorporate high-bandwidth connectivity and enable secure
electronic business over the Internet. The services are offered for a fixed
monthly fee on an annual subscription-basis. The Company's services include
secure hosting and Internet connectivity services that enable secure
connectivity between a corporate network and the Internet and secure virtual
private networking services that enable remote users and wide-area networks to
securely communicate enterprise-wide and over the Internet. The Company offers a
scalable solution that allows customers to quickly deploy and expand electronic
business capabilities by subscribing to Pilot's secure Internet services.

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999

   SERVICE REVENUES. In the three months ended September 30, 1999, service
revenues increased 89% to $7.1 million from $3.8 million in the three months
ended September 30, 1998. This growth was due primarily to increases in the
number of new customers and to additional services sold to existing customers.
To a lesser extent, annual price increases for various offered services also
contributed to this growth. Additionally, the Company was able to shorten the
implementation time for certain new services, allowing for earlier recognition
of implementation fees and billing of fees for recurring services.

                                  Page 7 of 17
<PAGE>

   COST OF SERVICE REVENUES. Cost of service revenues increased 61% to $7.4
million, or 103% of service revenues, in the three months ended September 30,
1999, compared to $4.6 million, or 121% of service revenues, in the three months
ended September 30, 1998. The increase in cost of service revenue was a result
of an increase in security implementation, customer service and operations
personnel from 63 at September 30, 1998, to 80 at September 30, 1999, as well as
increases in the average cost of those personnel, consulting, facilities rent,
telecommunications, equipment leases and depreciation directly related to the
Company's revenue growth. Additionally, incremental costs associated with the
opening of a new Network Security Center in Alameda, California contributed to
the increase in cost of service revenues. The Company expects the cost of
service revenues to continue to increase on an absolute basis as a result of
expected customer expansion in the Company's Network Security Centers.

   SALES AND MARKETING. Sales and marketing expenses increased 51% to $3.2
million in the three months ended September 30, 1999, from $2.1 million in the
three months ended September 30, 1998, but decreased as a percentage of service
revenues to 45% for the three months ended September 30, 1999, from 57% for the
three months ended September 30, 1998.  The increase in sales and marketing
expense was a result of increases in recruiting, commissions and sales promotion
directly related to the expanded sales activity. The Company expects that its
sales and marketing expenses will continue to increase in absolute dollars for
at least the next twelve months as the Company makes additional investments in
expanding its sales and marketing activities. The Company employed 40 sales and
marketing personnel at September 30, 1999.

   ENGINEERING AND DEVELOPMENT. Engineering and development expenses increased
99% to $0.8 million in the three months ended September 30, 1999, from $0.4
million in the three months ended September 30, 1998, and remained relatively
flag as a percentage of service revenues at 11% for the three months ended
September 30, 1999, compared to 10% for the three months ended September 30,
1998.  The increase in engineering and development expense was a result of an
increase in personnel from 9 at September 30, 1998, to 18 at September 30, 1999,
as well as an increase in consulting and other professional services. The
Company expects that its engineering and development expenses will continue to
increase in absolute dollars for at least the next twelve months as the Company
makes additional investments in developing its secure electronic commerce
services.

   GENERAL AND ADMINISTRATIVE. General and administrative expenses increased 33%
to $1.0 million in the three months ended September 30, 1999 from $0.7 million
in the three months ended September 30, 1998, but decreased as a percentage of
service revenues to 14% for the three months ended September 30, 1999, from 19%
for the three months ended September 30, 1998. The increase in general and
administrative expense was a result of an increase in personnel from 13 at
September 30, 1998, to 17 at September 30, 1999, as well as increases in
professional fees and business taxes as well as other costs associated with
being a public company. The Company expects that its general and administrative
expenses will continue to increase in absolute dollars for at least the next
twelve months as the Company continues to expand its operations.


SIX MONTHS ENDED SEPTEMBER 30, 1998 AND 1999

   SERVICE REVENUES. In the six months ended September 30, 1999, service
revenues increased 73% to $12.9 million from $7.5 million in the six months
ended September 30, 1998. This growth was due primarily to increases in the
number of new customers and to additional services sold to existing customers.
To a lesser extent, annual price increases for various offered services also
contributed to this growth.

   COST OF SERVICE REVENUES. Cost of service revenues increased to $13.8
million, or 107% of service revenues, in the six months ended September 30,
1999, compared to $8.6 million, or 115% of service revenues, in the six months
ended September 30, 1998. The increase in cost of service revenue was a result
of an overall increase in customer service and operations personnel as well as
an increase in

                                  Page 8 of 17
<PAGE>

the average cost of such personnel. Additionally, increases in consulting,
telecommunications, facilities rent, equipment leases and depreciation, all
associated with existing operations as well as the opening of a new Network
Security Center in Alameda, California contributed to the increase in cost of
service revenue.

   SALES AND MARKETING. Sales and marketing expenses increased 44% to $6.2
million in the six months ended September 30, 1999 from $4.3 million in the six
months ended September 30, 1998 but decreased as a percentage of service
revenues to 44% for the six months ended September 30, 1999 from 57% for the six
months ended September 30, 1998. The increase in sales and marketing expense was
a result of additional commissions and expanding marketing programs in
connection with the Company's expansion of its operations. The Company expects
that sales and marketing expenses will continue to increase in absolute dollars
for the remainder of the fiscal year.

   ENGINEERING AND DEVELOPMENT. Engineering and development expenses increased
110% to $1.4 million in the six months ended September 30, 1999 from $0.7
million in the six months ended September 30, 1998 and increased as a percentage
of service revenues to 11% for the six months ended September 30, 1999 from 9%
for the six months ended September 30, 1998. The increase in engineering and
development expense was a result of increases in personnel and consulting
related expenses in connection with continuing efforts to develop new security
methodologies, integrate and enhance acquired third-party technologies to
support the Company's security and add new service offerings. The Company
expects that its engineering and development expenses will continue to increase
in absolute dollars for the remainder of the fiscal year as a result of this
increased investment activity.

   GENERAL AND ADMINISTRATIVE. General and administrative expenses increased 22%
to $1.7 million in the six months ended September 30, 1999 from $1.4 million in
the six months ended September 30, 1998 but decreased as a percentage of service
revenues to 13% for the six months ended September 30, 1999 from 19% for the six
months ended September 30, 1998. The increase in general and administrative
expense was a result of increases in personnel, professional fees and business
taxes. The Company expects that its general and administrative expenses will
continue to increase in absolute dollars for the remainder of the fiscal year as
the Company continues to expand its operations.


LIQUIDITY AND CAPITAL RESOURCES

   At September 30, 1999, the Company's cash, cash equivalents and short-term
investments totaled $5.1 million compared to cash, cash equivalents and short-
term investments of $23.0 million at March 31, 1999.

   As of  September 30, 1999, the Company had an $8.0 million equipment line of
credit and lease facility for financing of equipment purchases at interest rates
of approximately 15%. Borrowings under the facilities are repayable in monthly
installments of principal and interest over 48 months and are secured by a lien
on the financed equipment. As of September 30, 1999, the Company had fully
utilized these lines of credit and lease facilities. The Company intends to
secure additional equipment lease lines of credit to fund growth in capital
equipment purchases.

     On November 10, 1999, the Company completed an $8.0 million credit facility
with a financial institution consisting of $5.0 million as a revolving line of
credit and $3.0 million as a term loan. The line of credit is renewable in
successive one-year terms and currently bears interest of 10.25% per annum. The
term loan expires in one year and currently bears interest of 10.25% per annum.
Additionally, the term loan must be pre-paid, without penalty, if the Company
raises more than $15 million in equity. The credit facility is secured by the
general assets of the Company. As additional consideration, the Company issued a
warrant to purchase 121,212 shares of common stock at $8.25 per share. The
Company calculated a fair value of the warrants of $1.0 million which amount
was capitalized and will be amortized over the expected terms of the loans.

                                  Page 9 of 17
<PAGE>

   On October 19, 1998, the Company announced an open-market common stock
repurchase program under which the Company would repurchase up to 1.5 million
shares of its Common Stock.  As of June 30, 1999, 450,936 shares had been
repurchased, at an aggregate cost to the Company of approximately $2.7 million.
The Company does not anticipate making any additional repurchases under this
program.

   On June 30, 1998, the Company completed a borrowing arrangement with two
lenders providing $6.0 million of short term financing bearing interest at 13.5%
per annum. The loans expired in June 1999. The loans contained various pre-
payment options available after the Company's initial public offering date of
August 10, 1998. As additional consideration, the Company issued 150,000
warrants to purchase common stock at $11.20 per share. The Company calculated a
fair value of the warrants of $1.2 million which amount was capitalized and
amortized over the expected terms of the loans. One of the lenders exercised its
option for repayment of $3.0 million which was repaid in October 1998. On July
1, 1999, the Company repaid the remaining $3.0 million liability to the other
lender.

   On May 11, 1998, the Company negotiated a line of credit with a financial
institution for an aggregate amount of $1.5 million. The line of credit
currently bears interest of 10.25% per annum and is secured by assets of the
Company. At September 30, 1999, $1.3 million of this debt facility was
available. This line of credit has been repaid from proceeds of the $3.0 million
term loan and terminated.

   The Company's working capital and capital requirements will depend upon
numerous factors including plans to incur substantial additional capital
expenditures primarily for additions to and expansions of its Network Security
Centers, developing, acquiring or licensing new applications and technologies,
and the level of resources that the Company devotes to its sales and marketing
activities. In addition to the recently completed $8.0 million line of credit,
the Company will require additional equity financing during the quarter ending
March 31, 2000, which it is actively pursuing. In addition, the Company will
pursue additional equipment lease financing. However, there can be no
assurance that the Company will be successful in generating anticipated levels
of cash from operations or in obtaining equity or equipment lease financing.
If the Company is unable to generate sufficient cash flow from operations, or
is unable to obtain additional equity or equipment lease financing, it will be
required to sell assets, scale down its operations and expansion plans,
refinance all or a portion of its existing indebtedness or obtain other
sources of financing earlier than planned, any of which would have a material
adverse impact on the Company's business, results of operations and financial
condition. There can be no assurance that any such refinancing would be
available on commercially reasonable terms, or at all, or that any other
financing could be obtained.

YEAR 2000 RISKS

   The Company has established procedures for evaluating and managing the risks
and costs associated with the Year 2000 problem and believes that the internal
computer systems that the Company has developed are currently Year 2000
compliant. To date, the Company has not incurred significant incremental costs
in order to comply with Year 2000 requirements and does not believe it will
incur significant incremental costs in order to comply with Year 2000
requirements in the foreseeable future. In the quarter ended December 31, 1998,
the Company formed a group of its technical staff on a project to upgrade and
standardize hardware, operating systems and application software versions on
most of the Company's production equipment. The Company believes that this
project is required for general consistency and operating efficiencies. However,
a by-product of this effort will be a greater level of assurance that the
Company is Year 2000 compliant. The engineering phase of the project is
currently on schedule and is estimated to be completed on or about the end of
November 1999.  However, continued monitoring and a year end transition effort
will continue into January 2000.

   Despite the Company's belief that its internal computer systems are currently
Year 2000 compliant, many of the Company's customers maintain their Internet
operations on commercially

                                 Page 10 of 17
<PAGE>

available operating systems, which may be impacted by Year 2000 complications.
In addition, the Company relies on third party vendors for certain equipment,
which may contain embedded instructions, and software included within the
Company's services, which may not be Year 2000 compliant. The Company is
conducting an audit of its third-party suppliers as to the Year 2000 compliance
of their systems. However, the failure to correct or discover a material Year
2000 problem could result in an interruption in, or a failure of, certain normal
business activities or operations. Such failures could materially and adversely
affect the Company's results of operations, liquidity and financial condition.
Due to the general uncertainty inherent in the Year 2000 problem resulting in
part from the uncertainty of the Year 2000 readiness of third-party suppliers
and customers, the Company is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the Company's
results of operations, liquidity or financial condition. The Company has
developed contingency plans for staffing and operating its Network Security
Centers in the event of any Year 2000 complications. This plan is being updated
on a continuous basis and will be in place prior to December 31, 1999. As a
precautionary measure, the Company plans to fully staff its Network Security
Centers over the New Year's Day holiday and to take other precautions during
this period. In connection with these measures, the Company expects to incur
incremental expense of at least $70,000 beyond normal holiday staffing costs.
Further, any serious or unexpected service problems that might be caused by Year
2000 complications could create the need for additional, unexpected and material
expenditures.

   The dates on which the Company believes its audit of third party suppliers
and its overall Year 2000 readiness will be completed is based on the Company's
management's best estimates, which were derived utilizing numerous assumptions
of future events, including the continued availability of certain resources,
third-party cooperation and modification plans, and other factors. However,
there can be no guarantee that these estimates will be achieved, or that there
will not be a delay in, or increased costs associated with, the implementation
of Year 2000 compliant solutions. Specific factors that might cause differences
between the estimates and actual results include, but are not limited to, the
availability and cost of personnel trained in these areas, the ability to locate
and correct all relevant computer code, timely responses to and corrections by
third-parties and suppliers, the ability to implement interfaces between the new
systems and the systems not being replaced, and similar uncertainties. Due to
the general uncertainty inherent in the Year 2000 problem, resulting in part
from the uncertainty of the Year 2000 readiness of third-parties and the
interconnection of global businesses, the Company cannot ensure its ability to
timely and cost-effectively resolve problems associated with the Year 2000 issue
and is unable to determine at this time whether the consequences of Year 2000
failures will have a material impact on the Company's results of operations,
liquidity or financial condition. The Company operates a number of servers on
behalf of its customers. The Company has limited control over most of the
software and applications that are running on such servers and believes that it
bears no responsibility for the Year 2000 compliance of such servers. The
Company is unable to determine what costs, if any, it may have to incur to the
extent that such customers are unable to complete their own Year 2000 compliance
on such servers. Although the Company believes that it is not obligated to make
such upgrades and believes that any costs incurred should be billable to its
customers, Year 2000 problems on such customer servers may force the Company to
make significant, unplanned allocations of limited technical and financial
resources. Any significant unplanned allocations could have a material and
adverse impact on the Company's results of operations, liquidity and financial
condition.


FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK

   The Company operates in a rapidly changing environment that involves numerous
risks, some of which are beyond the Company's control. The following discussion
highlights some of these risks.

   FUTURE CAPITAL NEEDS. The Company's working capital and capital requirements
will depend upon numerous factors including plans to incur substantial
additional capital expenditures primarily for additions to and expansions of its
Network Security Centers, developing, acquiring or licensing new applications
and technologies, and the level of resources that the Company devotes to its

                                 Page 11 of 17
<PAGE>

sales and marketing activities. In addition to the recently completed $8.0
million line of credit, the Company will require additional equity financing
during the quarter ending March 31, 2000, which it is actively pursuing. In
addition, the Company will pursue additional equipment lease financing.
However, there can be no assurance that the Company will be successful in
generating anticipated levels of cash from operations or in obtaining equity
or equipment lease financing. If the Company is unable to generate sufficient
cash flow from operations, or is unable to obtain additional equity or
equipment lease financing, it will be required to sell assets, scale down its
operations and expansion plans, refinance all or a portion of its existing
indebtedness or obtain other sources of financing earlier than planned, any of
which would have a material adverse impact on the Company's business, results
of operations and financial condition. There can be no assurance that any such
refinancing would be available on commercially reasonable terms, or at all, or
that any other financing could be obtained.

   LIMITED OPERATING HISTORY; HISTORY OF LOSSES. The Company began operations in
1993, and has experienced operating losses and negative cash flows from
operations in each quarterly and annual period. As of September 30, 1999, the
Company had an accumulated deficit of approximately $41.7 million. The revenue
and income potential of the Company's business and market is unproven, and the
Company's limited operating history makes an evaluation of the Company and its
prospects difficult. The Company has recently made and expects to continue
making significant investments in security technologies, new and existing
Network Security Centers, sales and marketing activities, and the development of
new services. As a result, the Company experienced a decline in gross margin and
an increase in net loss in fiscal 1998 and fiscal 1999 and expects to continue
experiencing significant net losses on a quarterly and annual basis for the
foreseeable future, including a negative gross margin at least for the next six
months. Failure of the Company's services to achieve market acceptance would
have a material adverse effect on the Company's business, results of operations
and financial condition. There can be no assurance that the Company will ever
achieve profitability on a quarterly or an annual basis or will sustain
profitability if achieved.

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

   For these and other reasons, in some future quarters, the Company's results
of operations may fall below the expectations of securities analysts or
investors, which could have a material adverse effect on the market price of the
Company's Common Stock.

   RISKS ASSOCIATED WITH SECURITY BREACHES. The Company's success is
substantially dependent on the continued confidence of its current and future
customers that the Company provides superior network security protection.
Despite the Company's focus on Internet security, there can be no assurance that
the Company will be able to stop unauthorized attempts, whether made
unintentionally or by computer "attackers," to gain access to or disrupt the
network operations of the Company's customers. The Company's Heuristic Defense
Infrastrucure delivered through its Network Security Centers is designed to
prevent unauthorized access to customers' networks from the Internet. Any
failure

                                 Page 12 of 17
<PAGE>

by the Company to stop unauthorized access from the Internet or disruptions to
related Internet operations of its customers could materially adversely affect
such customers and the Company. Although the Company generally limits warranties
and liabilities relating to security in its customer contracts, the Company's
customers may seek to hold the Company responsible for any losses suffered by
the customer as a result of unauthorized access to customers' network systems
from the Internet. This could result in liability to the Company, which could
have a material adverse effect upon its business, operating results and
financial condition. Moreover, computer attackers from the Internet could
infiltrate the Company's network and seek to sabotage its network or services by
creating bugs or viruses or through other means. In addition, any adverse
publicity resulting from any such unauthorized access could deter future
customers from using the Company's services and could cause current customers to
cease using the Company's services, which could have a material adverse effect
upon the Company's business, operating results and financial condition.

   RISKS ASSOCIATED WITH THE EMERGING MARKET FOR OUTSOURCED NETWORK SECURITY
SERVICES. The market for Internet security monitoring, detection and defense
services in general is new and rapidly evolving. If the market for such services
fails to grow or grows more slowly than the Company currently anticipates, the
Company's business, operating results and financial condition would be
materially and adversely affected.

   RISKS OF BUSINESS EXPANSION AND MANAGEMENT OF GROWTH. The Company intends to
expand domestically and internationally by adding Network Security Centers in
new locations and expanding Network Security Centers in existing locations. The
Company's inability to manage effectively its expansion, including any
disruption of service to current customers, would have a material adverse effect
upon the Company's business, results of operations and financial condition.

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

   The Company has recently hired large numbers of new employees. This growth
has placed and may continue to place a significant strain on the Company's
financial, management, operational and other resources. If the Company's
executives were unable to manage growth effectively, the Company's business,
results of operations and financial condition would be materially adversely
affected.

   COMPETITION. The market served by the Company is new, rapidly evolving,
highly competitive and largely undefined. There are few general barriers to
entry, and the Company expects that it will face additional competition from
existing competitors and new market entrants in the future. There can be no
assurance that the Company will have the resources or expertise to compete
successfully in the future.

   The Company competes with a broad range of products and services. Many of the
Company's competitors have substantially greater financial, technical and
marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships in the industry than the
Company. As a result, certain of these competitors may be able to develop and
expand their network infrastructures and service offerings more quickly, adapt
to new or emerging technologies and changes in customer requirements more
quickly, take advantage of acquisition and other opportunities more readily,
devote greater resources to the marketing and sale of their products and adopt
more aggressive pricing policies than the Company. In addition, the Company
believes that the businesses in which the Company competes are likely to
encounter consolidation in the near future, which could result in increased
price and other competition that could have a material adverse effect on the
Company's business, results of operations and financial condition.

                                 Page 13 of 17
<PAGE>

   RISK OF SYSTEM FAILURE. The Company's success depends on the excellence of
security protection and uninterrupted operation of its network infrastructure.
Despite existing and planned precautions by the Company, the occurrence of a
natural disaster or other unanticipated problems at one or more of the Company's
Network Security Centers could result in interruptions in the services provided
by the Company. Any damage to or failure of the Company's systems or those of
its service providers could result in reductions in, or terminations of,
services supplied to the Company's customers. Such reductions or terminations in
service could materially and adversely impact the Company's customers, which
could have a material adverse effect on the Company's business, results of
operations and financial condition.

   RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. A key component of the
Company's long-term strategy is to expand into international markets. If revenue
generated by any international Network Security Center is not adequate to offset
the expense of establishing and maintaining any such international operation,
the Company's business, results of operations and financial condition could be
materially adversely affected. In addition, the Company faces certain risks
inherent in conducting business internationally, any of which could adversely
affect the Company's international operations.

   DEPENDENCE UPON SCALABILITY OF THE COMPANY'S NETWORK. The Company must
continue to expand and adapt its network infrastructure as the number of
customers and the amount of information they wish to transmit increases, and as
customer requirements change. The expansion and adaptation of the Company's
telecommunications infrastructure will require substantial financial,
operational and management resources. Due to the limited deployment of the
Company's services to date, the ability of the Company's network to connect and
manage a substantially larger number of customers at high transmission speeds is
as yet unknown, and the Company faces risks related to the network's ability to
operate with higher customer levels while maintaining superior performance. The
Company's failure to achieve or maintain high capacity data transmission could
significantly reduce customer demand for its services and have a material
adverse effect on its business, results of operations and financial condition.
There can be no assurance that the Company will be able to expand or adapt its
telecommunications infrastructure to meet additional demand or its customers'
changing requirements.

   DEPENDENCE UPON THIRD PARTY NETWORK INFRASTRUCTURE PROVIDERS. The Company's
success will depend upon third party network infrastructure providers. In
addition, the Company relies on a number of public and private peering
interconnections (i.e., arrangements among access providers to carry traffic of
each other) to deliver its services. If the carriers that operate the Internet
exchange points ("IXPs") were to discontinue their support of the peering points
or to refuse to offer services to the Company and no alternative providers were
to emerge, or such alternative providers were to increase the cost of utilizing
the IXPs, the transmission of network traffic by the Company would be
significantly constrained. If the Company were unable to access on a cost-
effective basis alternative networks to distribute its customers' content or
pass through any additional costs of utilizing these networks to its customers,
the Company's business, results of operations and financial condition could be
materially adversely affected.

   DEPENDENCE ON OTHER THIRD-PARTY RELATIONSHIPS. The Company is dependent on
other companies to supply certain key components of its telecommunications
infrastructure and system and network management solutions that, in the
quantities and quality demanded by the Company, are available only from sole or
limited sources. Any failure to obtain required components or software on a
timely basis and at an acceptable cost would have a material adverse effect on
the Company's business, results of operations and financial condition. The
Company also intends to develop alternative distribution and lead generation
channel partners for the Company's services, such as systems integration firms
and bandwidth providers. Any failure by the Company to develop these channel
partners could materially and adversely impact the ability of the Company to
generate increased revenues, which could have a material adverse effect on the
Company's business, results of operations and financial condition.

                                 Page 14 of 17
<PAGE>

   RAPID TECHNOLOGICAL CHANGE; EVOLVING INDUSTRY STANDARDS. The Company's future
success will depend, in part, on its ability to offer services that incorporate
leading technology, address the increasingly sophisticated and varied needs of
its current and prospective customers and respond to technological advances and
emerging industry standards and practices on a timely and cost-effective basis.
The market for the Company's services is characterized by rapidly changing and
unproven technology, evolving industry standards, changes in customer needs,
emerging competition and frequent new service introductions. There can be no
assurance that future advances in technology will be beneficial to, or
compatible with, the Company's business or that the Company will be able to
incorporate such advances on a cost-effective and timely basis into its
business. The Company believes that its ability to compete successfully is also
dependent upon the continued compatibility and interoperability of its services
with products, services and architectures offered by various vendors as part of
the Company's services. There can be no assurance that such products will be
compatible with the Company's infrastructure or that such products will
adequately address changing customer needs. In addition, there can be no
assurance that products, services or technologies developed by others will not
render the Company's services uncompetitive or obsolete.

   DEPENDENCE ON KEY PERSONNEL. The Company's success depends in significant
part upon the continued services of its key technical, sales and senior
management personnel, including the Company's President and Chief Executive
Officer, Marketta Silvera, and the Company's Vice President, Engineering and
Development, Thomas Wadlow. Any officer or employee of the Company can terminate
his or her relationship with the Company at any time. The loss of the services
of one or more of the Company's key employees or the Company's failure to
attract additional qualified personnel could have a material adverse effect on
the Company's business, results of operations and financial condition.

   RISKS ASSOCIATED WITH INFORMATION DISSEMINATED THROUGH THE COMPANY'S NETWORK.
The law relating to the liability of on-line services companies and Internet
access providers for information carried on or disseminated through their
networks is currently unsettled. It is possible that claims could be made
against on-line services companies and Internet access providers under both
United States and foreign law for defamation, negligence, copyright or trademark
infringement, or other theories based on the nature and content of the materials
disseminated through their networks. The imposition upon the Company and other
Internet network providers of potential liability for information carried on or
disseminated through their systems could require the Company to implement
measures to reduce its exposure to such liability, which may require the
expenditure of substantial resources, or to discontinue certain service or
product offerings.

   PROTECTION AND ENFORCEMENT OF INTELLECTUAL PROPERTY RIGHTS. The Company
relies on a combination of copyright, trademark, patent, service mark and trade
secret laws and contractual restrictions to establish and protect certain
proprietary rights in technology underlying its services. There can be no
assurance that patents or trademarks will be issued or granted from currently
pending or any future applications, or that any patents or trademarks that may
be issued or granted will be sufficient in scope or strength to provide
meaningful protection or any commercial advantage to the Company. The laws of
certain foreign countries may not protect the Company's products, services or
intellectual property rights to the same extent as do the laws of the United
States.

   There can be no assurance that contractual arrangements or other steps taken
by the Company to protect its intellectual property will prove sufficient to
prevent infringement of or misappropriation of the Company's technology or to
deter independent third-party development of similar technologies. Any such
infringement or misappropriation, should it occur, could have a material adverse
effect on the Company's business, results of operation and financial condition.

   To date, the Company has not been notified that the Company's products
infringe the proprietary rights of third parties, but there can be no assurance
that third parties will not claim infringement or indemnification by the Company
with respect to current or future products. Any such claim, whether meritorious
or not, could be time-consuming, result in costly litigation, cause product
installation delays,

                                 Page 15 of 17
<PAGE>

prevent the Company from using important technologies or methods, subject the
Company to substantial damages, or require the Company to enter into royalty or
licensing agreements. As a result, any such claim could have a material adverse
effect upon the Company's business, results of operations and financial
condition.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

   The Company has limited exposure to financial market risks, including changes
in interest rates.  The fair value of Pilot's investment portfolio or related
income would not be significantly impacted by a 100 basis point increase or
decrease in interest rates due mainly to the short-term nature of the major
portion of our investment portfolio.  An increase or decrease in interest rates
would not significantly increase or decrease interest expense on debt
obligations due to the fixed nature of the Company's debt obligations.  Pilot's
foreign operations are limited in scope and thus the Company is not materially
exposed to foreign currency fluctuations.


PART II.  OTHER INFORMATION.

ITEM 2.    CHANGES IN SECURITIES AND USE OF PROCEEDS.

   The Company filed a registration statement on Form S-1, File No. 333-57453,
for an initial public offering of Common Stock which was declared effective by
the Securities and Exchange Commission on August 10, 1998. In that offering, the
Company sold an aggregate of 3,110,000 shares of its Common Stock with net
offering proceeds of $39.4 million. As of September 30, 1999, the Company had
used approximately $37.8 million of those proceeds as follows:

 Construction of plant, building and facilities:          $4.3 million
 Purchase and installation of machinery and equipment:    $9.4 million
 Purchases of real estate:                              None
 Acquisition of other businesses:                       None
 Repayment of indebtedness:                               $9.0 million
 Working capital:                                       None
 Repurchase of Common Stock:                              $2.7 million
 Cash loss from operations:                              $12.4 million

   The foregoing amounts represent the Company's best estimate of its use of
proceeds for the period indicated. No payments were made to directors or
officers of the Company or their associates, holders of 10% or more of any class
of equity securities of the Company or to affiliates of the Company.


ITEM 4.    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

   On September 16, 1999, the Company held its Annual Meeting of Stockholders.
At the meeting, the stockholders elected as Class I directors M. Marketta
Silvera (with 10,571,957 affirmative votes and  298,004 votes withheld), Shanda
Bahles (with 10,720,122 affirmative votes and  149,839 votes withheld), and
Thomas B. Kelly (with 10,818,074 affirmative votes and  51,887 votes withheld).

   In addition, the stockholders approved the amendment of the Company's 1998
Stock Option Plan (with 5,022,717 affirmative votes, 806,667 negative votes,
5,017,744 broker non-votes and 22,833 abstentions).

   The stockholders also ratified the appointment of KPMG, LLP, as the Company's
independent public accountants for fiscal year ending March 31, 2000, (with
10,834,785 affirmative votes, 18,630 negative votes, and 16,546 abstentions).

                                 Page 16 of 17
<PAGE>

ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K


A. Exhibits

Exhibit Number  Description of Exhibit

10.1            1998 Stock Option Plan, as amended on April 23, 1999
27.1            Financial Data Schedule


B. Reports on Form 8-K

None



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


November 15, 1999       /s/ William C. Leetham
-----------------       ----------------------
                        William C. Leetham
                        Senior Vice President, Finance and Administration
                        Chief Financial Officer, Treasurer and Secretary
                        (Principal Financial and Accounting Officer)



EXHIBIT INDEX


Exhibit Number  Description of Exhibit

10.1            1998 Stock Option Plan, as amended on April 23, 1999
27.1            Financial Data Schedule

                                 Page 17 of 17