================================================================================

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

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

                                    FORM 10-Q

|X|  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE 
     SECURITIES EXCHANGE ACT OF 1934

     For the quarterly period ended September 30, 1998

                                       OR

|_|  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE 
     SECURITIES EXCHANGE ACT OF 1934

     For the transition period from ___________ to ___________


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

                          Commission file number 1-5486

                          COYOTE NETWORK SYSTEMS, INC.
             (Exact name of registrant as specified in its charter)

           Delaware                                       36-2448698
 -------------------------------            -----------------------------------
 (State or other jurisdiction of            (I.R.S. Employer Identification No.)
  incorporation or organization)


               4360 Park Terrace Drive, Westlake Village, CA 91361
               ---------------------------------------------------
               (Address of principal executive offices) (Zip Code)

                                 (818) 735-7600
              ----------------------------------------------------
              (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.
                                                         |X| YES         |_| NO

At November 13, 1998, the  Registrant had issued and  outstanding an aggregate 
of 10,506,148 shares of its common stock.

================================================================================
<PAGE>
                          COYOTE NETWORK SYSTEMS, INC.
                                AND SUBSIDIARIES


                                                                           Page
PART I.   FINANCIAL INFORMATION

          Item 1.    Financial Statements
                     Balance Sheets........................................   2
                     Statement of Operations...............................   3
                     Statement of Cash Flows...............................   4
                     Notes to Financial Statements.........................   5
          Item 2.    Management's Discussion and Analysis of Financial 
                       Condition and Results of Operations.................  10


PART II.  OTHER INFORMATION

          Item 1.    Legal Proceedings.....................................  12
          Item 2.    Changes in Securities and Use of Proceeds.............  12
          Item 6.    Exhibits and Reports on Form 8-K......................  12
          Signatures ......................................................  13




                                       1
<PAGE>
                         PART I - FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

                  COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
                      Condensed Consolidated Balance Sheets
                             (Dollars In Thousands)

<TABLE>
<CAPTION>
<S>                                                                       <C>                   <C>
                                                                           September 30,         March 31,
                                                                                 1998              1998
                                                                           -------------        ----------
                                        Assets                               (Unaudited)

Current assets:
     Cash and cash equivalents                                              $   16,224          $    3,746
     Marketable securities                                                        ---                   16
     Receivables                                                                 3,216                 715
     Inventories                                                                 2,515               2,122
     Notes receivable - current                                                  2,456               4,596
     Other current assets                                                        5,888               1,409
                                                                            ----------          ----------
         Total current assets                                                   30,299              12,604

Property and equipment, net                                                      5,325               2,391
Capitalized  software development                                                  763                ---
Intangible assets, net                                                           7,741               3,542
Net assets of discontinued operations                                              172                 909
Notes receivable - non-current                                                     550               1,170
Other assets                                                                     2,654               1,359
                                                                            ----------          ----------
                                                                            $   47,504          $   21,975
                                                                            ==========          ==========
                         Liabilities and Shareholders' Equity
Current liabilities:
     Accounts payable                                                       $   12,416          $    1,920
     Deferred revenue and customer deposits                                      1,871               1,900
     Accrued loss reserve                                                        3,141               2,200
     Accrued professional fees and litigation costs                                361                 805
     Other accrued liabilities                                                   4,586               1,130
     Notes payable                                                               5,098                ---
     Current portion of long-term debt                                             141                 141
                                                                            ----------          ----------
         Total current liabilities                                              27,614               8,096

Long-term debt                                                                   1,605               5,349
Other liabilities                                                                  453                 470
Commitments and contingencies (Note 4)                                             ---                ---

Shareholders' equity:
     Preferred stock - $.01 par value.
     Authorized 5,000,000 shares; 700 issued                                      ---                 ---
     Common stock - $1 par value.  Authorized 30,000,000 shares,
         issued 10,492,620 and 9,151,920 shares                                 10,493               9,152
     Additional paid-in capital                                                113,248             102,360
     Accumulated deficit                                                      (100,152)            (97,695)
     Treasury stock at cost                                                     (5,757)             (5,757)
                                                                            -----------         -----------

         Total shareholders' equity                                             17,832               8,060
                                                                            ----------          ----------

                                                                            $   47,504          $   21,975
                                                                            ==========          ==========
</TABLE>

            See notes to condensed consolidated financial statements.

                                       2
<PAGE>
                  COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
                 Condensed Consolidated Statements of Operations
                                   (Unaudited)
                    (In Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>

                                                                     3 Months Ended                6 Months Ended
                                                                -------------------------     --------------------------
<S>                                                             <C>            <C>            <C>             <C>
                                                                Sept. 30,      Sept. 30,      Sept. 30,       Sept. 30,
                                                                   1998           1997          1998            1997
Net sales                                                       $   15,164      $     106    $   22,357       $   1,050
Cost of goods sold                                                   9,309             37        12,529             442
                                                                ----------      ---------    ----------       ---------
         Gross profit                                                5,855             69         9,828             608

Selling and administrative expenses                                  3,155          2,590         6,095           6,126
Engineering, research and development                                2,431            603         4,368           1,297
                                                                ----------      ---------    ----------       ---------

         Total operating expenses                                    5,586          3,193        10,463           7,423
                                                                ----------      ---------    ----------       ---------

Operating income (loss)                                                269         (3,124)         (635)         (6,815)

Interest expense                                                       (27)          (123)         (42)            (123)
Non-operating income                                                  ---               4          ---                4
Non-operating expense                                                 (721)        (5,522)         (880)         (5,522)
                                                                -----------      ---------   -----------      ----------
Loss from continuing operations                                       (479)        (8,765)       (1,557)        (12,456)

Loss from discontinued operations                                     (900)          ---           (900)          ---
                                                                -----------     ---------    -----------      -------
         Net loss                                               $   (1,379)     $  (8,765)   $   (2,457)      $ (12,456)
                                                                ===========     ==========   ===========      ==========

Loss per common share (basic & diluted):
         Continuing operations                                  $     (.05)     $   (1.27)   $     (.17)      $   (2.04)
         Discontinued operations                                      (.09)         ---            (.10)          ---
                                                                -----------     ---------    -----------      -------
         Net loss per common share (basic & diluted)            $     (.14)     $   (1.27)   $     (.27)      $   (2.04)
                                                                ===========     ==========   ===========      ==========

Weighted average number of common shares outstanding                 9,586          6,897         9,125           6,102
(basic &  diluted)                                               ==========      =========    ==========       =========

</TABLE>
            See notes to condensed consolidated financial statements.

                                       3
<PAGE>
                  COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
                 Condensed Consolidated Statements of Cash Flows
                                   (Unaudited)
                                 (In Thousands)

<TABLE>
<CAPTION>
                                                                                       6 MONTHS ENDED
                                                                             ----------------------------------

<S>                                                                          <C>                 <C>
                                                                             Sept. 30, 1998      Sept. 30, 1997
Operating activities:
     Net loss                                                                $   (2,457)         $  (12,456)
Adjustments to reconcile loss to net cash
  provided (used) by operating activities:
     Depreciation and amortization                                                  578                 355
     Gain on sale of land                                                           (17)               ---
     Provision for loss on discontinued operations                                  900               5,522
     Provision for common stock warrants issued                                     485                 366
     Net change in discontinued operations                                         (163)                777
     Changes in current assets and liabilities                                   10,319               2,756
                                                                             ----------          ----------

Net cash provided (used) by operating activities                             $    9,645          $   (2,680)

Investing activities:
     Capitalized software development                                              (763)               ---
     Purchases of property and equipment                                         (1,575)                (80)
     Proceeds from sales of marketable securities                                    16                 397
     Proceeds from sale of land                                                      67                ---
     Change in notes receivable                                                     270                ---
     Net change in discontinued operations                                         ---                 (411)
     Investment in affiliate                                                       (400)               ---
     Cash investment in INET                                                     (1,333)               ---
                                                                             -----------         ---------

Net cash provided (used) by investing activities                             $   (3,718)         $      (94)

Financing activities:
     Repayments of long-term debt                                            $      (71)         $      (71)
     Common stock issued                                                            306               5,347
     Preference stock issued net of expenses                                      6,345                ---
     Changes in notes payable                                                      ---                  152
     Net change in discontinued operations                                         ---                  592
     Preference stock dividends paid                                                (29)               ---
                                                                             -----------         ---------

Net cash provided by financing activities                                    $    6,551          $    6,020
                                                                             ----------          ----------

Increase (decrease) in cash and cash equivalents                                 12,478               3,246

Cash and cash equivalents:
     At beginning of the period                                                   3,746                  81
                                                                             ----------          ----------
     At end of the period                                                    $   16,224          $    3,327
                                                                             ==========          ==========

Non-cash transactions:
     Issuance of common stock warrants to investment banker                                     
       and placement agent                                                          485                 366
     Note payable to related party                                                 ---                   98
     Change in convertibility of Class A/B Units                                   ---                5,522
     Conversion of note payable to common stock                                    ---                  250
     Conversion of convertible notes and interest into common stock               3,407                 825
     Discount granted for investment in affiliate                                   900                ---
     Issuance of common stock for INET acquisition                                1,686                ---
</TABLE>

            See notes to condensed consolidated financial statements

                                       4
<PAGE>
                  COYOTE NETWORK SYSTEMS, INC. AND SUBSIDIARIES
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                   (Unaudited)


NOTE 1   BASIS OF PRESENTATION 

         The accompanying  unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted  accounting  principles
for interim  financial  information  and with the  instructions to Form 10-Q and
Article  10 of  Regulation  S-X.  Accordingly,  they do not  include  all of the
information and footnotes required by generally accepted  accounting  principles
for complete financial statements. In the opinion of management, all adjustments
(consisting  of  normal  recurring  accruals)  considered  necessary  for a fair
presentation  have been included.  Operating  results for the three months ended
September 30, 1998,  are not  necessarily  indicative of the results that may be
expected  for the fiscal year ending March 31,  1999.  For further  information,
refer to the consolidated financial statements and footnotes thereto included in
the  Company's  annual  report on Form 10-K for the fiscal  year ended March 31,
1998.

         The  computation  of loss per common share is  determined  by using the
weighted  average  number  of shares of common  stock  outstanding  during  each
period.


NOTE 2   DISCONTINUED OPERATIONS

         On November 20, 1996, the Board of Directors of Coyote Network Systems,
Inc. (the "Company")  approved a  restructuring  plan (the  "Restructuring")  to
separate its telecom switching equipment business (the "CTL Business") performed
through its  operating  subsidiary  Coyote  Technologies,  LLC ("CTL")  from the
following businesses:

                             Segment                            Company
           Telecommunications equipment distribution            C&L
           Wire installation and service                        Valley
           Wholesale distribution of meat and seafood           Entree/APC

         The  Restructuring  provided for a spin-off of the non-CTL  businesses,
through a special  dividend to the  Company's  shareholders.  Consequently,  the
Company reported the results of operations of the  telecommunications  equipment
distribution  segment,  the voice and data network wire installation and service
segment and the wholesale distribution of meat and seafood segment separately as
discontinued operations. Subsequently, the Company received a purchase offer for
a majority of the assets of APC. On February 3, 1997,  the Board of Directors of
the  Company  approved  the sale of a majority  of the assets of APC to Colorado
Boxed Beef Company ("Colorado"). The sale closed on February 3, 1997.

         As a  result  of the  sale of  APC's  assets,  the  Company's  Board of
Directors  terminated  the  original  Restructuring  plan for a spin-off  of the
non-CTL businesses. The Company adopted a revised Restructuring plan to sell C&L
and  Valley.  The  revised  Restructuring  plan  was  approved  by the  Board of
Directors in February 1997. On November 20, 1997, the Company completed the sale
of its telecommunications  equipment distributor subsidiary, C&L Communications,
Inc. ("C&L"), to the management of C&L.

         In March 1998,  the Company  reached  agreement  on the sale of its 80%
owned wire  installation  and service  subsidiary,  Valley  Communications  Inc.
("Valley") to Technology Services  Corporation  ("TSC").  Under the terms of the
agreement, the Company received $2,300,000, which was paid in cash in June 1998,
and $811,000 paid by the  assumption by TSC of the  Company's  entire  liability
under certain  promissory notes to and among the Company and other  shareholders
of Valley dated August 1995.

                                       5
<PAGE>
      
     As of November 4, 1998,  the Company had  collected all cash related to the
sale of  discontinued  operations  except $530,000 due under a note and the only
asset  of  discontinued  operations  was  real  estate  related  to the land and
buildings of the discontinued APC operation. The real estate is listed for sale.
Based upon an estimate  of the  current  market  value of the real  estate,  the
Company has taken an additional  charge of $900,000 in the second  quarter ended
September  30, 1998,  reducing the asset book value to $170,000 net of mortgages
applicable to the property.


NOTE 3   ACQUISITIONS

         On September 30, 1998,  the Company  completed the  acquisition of INET
Interactive  Network  System,  Inc.  ("INET")  through the merger of INET into a
wholly  owned   subsidiary  of  the  Company.   Headquartered  in  Los  Angeles,
California,  INET is a provider of international  long distance services to more
than 17,000 customers, primarily to French and Japanese affinity groups.

         Under the terms of the merger  agreement,  the Company  made total cash
payments of  $1,000,000  and issued a total of 198,300  shares of the  Company's
common stock as consideration for the outstanding  shares of INET capital stock,
the  cancellation  of certain  warrants to purchase shares of INET common stock,
the transfer of certain lines of credit and certain  contractual  releases.  The
Company  also agreed to forgive  and  extinguish  all loans and  advances in the
amount of $433,000  which had been made to INET prior to the merger.  As further
consideration, the Company will issue earnout shares of the Company common stock
to the former INET shareholders in five installments  based upon certain earning
targets being achieved during the period from October 1, 1998 to March 31, 2001.
The maximum amount payable under the earnout agreement is $2,000,000  payable in
Company common stock to be valued at certain  average trading prices at the time
any earnout is payable.

         In September  1998,  the Company  acquired a 19.9%  equity  position in
Crescent  Communications,   Inc.  ("Crescent").  Crescent  is  headquartered  in
California  and was  formed to  provide  primarily  wholesale  telecommunication
services to select  international  markets.  The Company  acquired this minority
interest for the sum of $1,300,000  represented by a cash payment of $400,000 to
Crescent  and $900,000 in the form of a discount  granted on  equipment  sold to
Crescent in September 1998.


         In October 1998, the Company announced that it intends to acquire a 19%
equity position in DTA Communications  Network, Inc. ("DTA"), a facilities based
provider of  wholesale  international  long  distance  telephone  services.  The
acquisition is expected to be completed in the third quarter of fiscal 1999.


NOTE 4   COMMITMENTS AND CONTINGENCIES

         Coyote  Network  Systems,  Inc.  (The  Diana  Corporation)   Securities
Litigation (Civ. No.  97-3186).  This is a consolidation of what were originally
nine  separate  actions  brought in the  United  States  District  Court for the
Central  District of California on behalf of purchasers of the Company's  common
stock during a class period that  extended  from December 6, 1994 through May 2,
1997. On July 23, 1997, the Court entered a stipulation and order  consolidating
the nine actions for all  purposes.  On September  9, 1997,  plaintiffs  filed a
consolidated amended complaint (the "Consolidated  Complaint")  asserting claims
against the Company,  certain of its present and former  directors and officers,
and others under  Section  10(b) of the  Securities  Exchange  Act of 1934.  The
Consolidated Complaint alleges essentially that the Company and other defendants
were  engaged in a scheme to inflate  the price of the  Company's  common  stock
during the class period through false and misleading statements and manipulative
transactions.   The  Consolidated   Complaint  seeks  unspecified  damages,  but
identifies  the  significant  movement in the  Company's  stock price during the
putative  class  period (a swing of more than $115 per  share) to imply that the
damages that will be claimed will exceed the Company's assets.


                                       6
<PAGE>
         On July 9, 1998, the respective  counsel for the Plaintiffs and for the
Company executed a letter agreeing in principle,  subject to various  conditions
and contingencies, to settle the claims against the Company and its subsidiaries
in The Diana Securities Litigation. If consummated,  the settlement will require
the  Company to issue  warrants  to acquire  2,500,000  shares of the  Company's
common stock.  The warrants will be exercisable for three years from the date of
issuance and will have an exercise  price of $9 per share in the first year, $10
per share in the  second  year and $11 per share in the third  year,  subject to
adjustment in certain  events.  On November 5, 1998, the Company's  common stock
was listed on Nasdaq.  The  Company  will use its best  efforts to arrange for a
listing of the warrants on Nasdaq.  Among the  conditions to the  settlement are
that the Plaintiffs  also reach a settlement  with the individual  defendants in
the  litigation  and their D&O  insurance  carriers  and that,  ultimately,  the
settlement  receives  court  approval.  The Company  regards  this  agreement in
principle as a step toward the resolution of this litigation, but cautions that,
in view of the conditions and  contingencies  associated  with this  preliminary
agreement,  the Company is unable to predict with certainty the nature or timing
of an actual  settlement.  The Company  recorded  the fair  market  value of the
warrants of $8,000,000 in the financial statements for fiscal 1998.

         After the Company and the  Plaintiffs  entered into their  agreement in
principle, Plaintiffs and the individual defendants and their D&O carriers, also
entered into an  agreement  in  principle to settle the action.  The parties are
presently in the process of negotiating a formal settlement  agreement that will
be presented to the Court for approval.

         Performed Line Products v. Coyote  Technologies,  LLC, Case No. 3:98 CV
1871-T,  in the Federal  District Court for the Northern  District of Texas. The
Company's subsidiary, Coyote Technologies, LLC, is the defendant in this action.
PLP alleges that Coyote is infringing  upon the "Coyote"  trademark that PLP has
registered in connection  with its cable and  enclosure  product line.  PLP also
asserts  claims  under  the  Texas  Deceptive  Trade  Practices  Act.  PLP seeks
permanent  injunctive relief preventing Coyote  Technologies' use of any form of
the name "Coyote," and unspecified  damages for past alleged  infringement.  The
Company  defends on the basis that its DSS 10000  product does not infringe upon
the use of the  Coyote  name for PLP's very  dissimilar  products.  The  Company
intends to vigorously defend the action.

         Superior  Street,  LLC v. Coyote Network  Systems,  Inc., Case No. 98 L
11488,  in the  Circuit  Court for Cook  County,  Illinois.  The  Company is the
defendant in this case in which Superior Street alleges that Coyote has breached
a  consulting  contract.  An Answer  to the  Complaint  has not yet been  filed.
However, the Company intends to defend this action vigorously.

         The  Company is also  involved  with other  proceedings  or  threatened
actions incident to the operation of its businesses.  It is management's opinion
that none of these matters will have a material  adverse effect on the Company's
financial position, results of operations or cash flows.


NOTE 5   SHAREHOLDERS' EQUITY

Convertible Preferred Stock and Warrants
----------------------------------------
         In  September  1998,  the  Company  entered  into a  private  placement
agreement and issued 700 shares of 5% Series A Convertible  Preferred Stock, par
value $.01 and a stated value of $10,000 per share.  The total cash  received by
the Company was  $6,345,000  after  payment of  $655,000  for fees and  expenses
associated  with the  issue.  The  preferred  stock has no voting  rights and is
convertible,  subject to certain  limitations and  restrictions,  into shares of
common stock, after a minimum holding period of 120 days, based upon a per share
common  stock price that will be the lesser of the initial  conversion  price as
defined in the  contract  or 87% of the  average  of the three  lowest per share
market  values  during  the  ten  trading  day  period  prior  to an  applicable
conversion   date.   Details  of  voting   powers,   preferences   and  relative
participation, optional or other special rights and qualifications,  limitations
or restrictions  of the 5% Series A Convertible  Preferred Stock are included in
Exhibit 10.03 attached herewith.

                                       7
<PAGE>
         In conjunction  with this agreement,  the Company issued warrant rights
to the investment  participant  to purchase  225,000 shares of common stock at a
warrant exercise price of $8.43 per share. The term of the warrants is 3 years.

Common Stock Dividend
---------------------
         In October 1998, the Board of Directors  approved the  declaration of a
5% common stock dividend.  Based upon an established  record date of October 21,
1998,  the Company  issued  497,623  shares of common stock on November 4, 1998.
Certain contractual  anti-dilution provisions will reduce conversion and warrant
exercise prices by a minor amount.

Common Stock Options and Warrants
---------------------------------
         Since June 30, 1998,  the  Company's  Board of Directors has granted to
certain executives,  employees and non-employee  directors options to purchase a
total of 192,242  shares of Company  common  stock.  During  the  quarter  ended
September  30,  1998,  the  Company  issued  warrants  with  three year terms to
purchase a total of 145,000 shares of Company common stock to non-employees. The
fair market value of the warrants was determined  using the Black Scholes Method
and a total amount of $485,000 was charged against earnings during the quarter.


NOTE 6   RELATED PARTY TRANSACTIONS

         In January  1998,  the Board of  Directors  of the Company  approved an
interest-free  loan to Daniel W.  Latham for a maximum  amount of $500,000 to be
used solely for the purpose of  providing a partial down payment on his purchase
of a residence in  California.  The funding is to be secured by the  residential
property and is for a five-year term unless  specifically  extended by the Board
of  Directors.  Earlier  repayment  of the loan will be demanded in the event of
either (1) sale or refinancing of the property;  (2) termination of Mr. Latham's
employment either voluntarily or for cause; or (3) sale by Mr. Latham of all, or
substantially all, of his stock in Coyote Network Systems,  Inc. As of September
30, 1998, $421,000 was funded under this agreement.

         In July 1998, the Company authorized an interest-free loan to Edward A.
Beeman in the amount of $75,000 to be used solely for the purpose of providing a
partial down payment on his purchase of a residence in  California.  The funding
is for a five year term unless  specifically  extended by the  Company.  Earlier
repayment  of the loan  will be  demanded  in the  event of  termination  of Mr.
Beeman's  employment  either  voluntarily or for cause.  This loan was funded in
July 1998.

         In October 1998,  the Company  amended the terms of the above loans and
in agreement with Messrs.  Latham and Beeman established an annual interest rate
of 6.5% to be applied to the loans and payable at the completion of the term.

         In  September  1998,  the Company  sold  approximately  $13,000,000  of
equipment to Crescent  Communications,  Inc.  ("Crescent") through a third party
leasing arrangement.  In addition to the cash proceeds,  the Company received an
approximately 20 percent ownership  interest in Crescent and the Company entered
into a maintenance and service agreement with Crescent. The Company has deferred
recognition  of  approximately  $2.5  million of this sale related to its equity
interest in the buyer and amounts reserved for service contingencies. The entire
cash proceeds related to the sale were collected prior to September 30, 1998.



                                       8
<PAGE>
NOTE 7   LINE OF CREDIT

         As  of  September  30,  1998,  Coyote  Gateway,   LLC  ("CGL")  has  an
established  a line of credit of $8,100,000  secured by CGL's trade  receivables
and by 708,692  treasury  shares of the Company's  common stock. As of September
30, 1998, $5,062,000 had been drawn against this line of credit.


NOTE 8   YEAR 2000 COMPLIANCE

                 The Company believes that its CTL switching  product  operating
systems and its internal  computer  systems are Year 2000 compliant and does not
anticipate  that it will  incur  significant  expenditures  to ensure  that such
systems  will  function  properly  with  respect  to dates in the Year  2000 and
beyond.  The Company  has  designed  and tested the current  versions of its DSS
Switches, AMT and CMS products,  which comprise the principle products sensitive
to the Year 2000  issues.  There were no problems  found with the date  rollover
issue nor were any problems  encountered with the Year 2000 leap year issue. The
products continued processing calls without interruption during the test cycles.
Testing of all  products  and  components  will  continue as other  adjuncts are
integrated  and tested.  The Company is  conducting a review of its  significant
suppliers and other third parties to ensure that those parties have  appropriate
plans to  remedy  Year  2000  issues  where  their  systems  interface  with the
Company's systems or otherwise impact its operations.  The Company is continuing
to request and receive Year 2000  certification  documents  from its third party
software  suppliers.  Third party software used in the development and operation
of DSS, AMT & CMS products was verified to be Year 2000 compliant  during system
testing.

         The costs  incurred by the Company to date on the Year 2000 issues have
not been  material to the  Company's  financial  condition  or  operations.  The
Company  presently does not have a documented Year 2000 contingency plan to cope
with a worst case scenario.  The Company intends to complete  documentation of a
contingency  plan by December 31, 1998. There can be no assurance that a failure
of the CTL  switching  product  operating  systems or that the  systems of third
parties  on which the  Company's  systems  and  operations  rely to be Year 2000
compliant  will not have a material  adverse  affect on the Company's  business,
financial condition or operating results.


                                       9
<PAGE>
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANICAL CONDITION AND RESULTS
         OF OPERATIONS


Results of Operations
---------------------
         For the second  quarter of fiscal 1999 ended  September  30, 1998,  the
Company's revenues were $15,164,000, primarily from the sale of DSS Switches and
associated OEM equipment,  compared to revenues of $106,000 in the corresponding
quarter of fiscal 1998. The increase is primarily attributable to shipments made
to Crescent  through a third party leasing  company under a major contract which
accounted for 82% of the revenue for the quarter.

         The second quarter  revenue  generated  $5,855,000 of gross profit,  an
increase of $5,786,000 in gross profit compared to the corresponding  quarter of
the prior fiscal year.  The gross profit margin for the second quarter of fiscal
1999 is lower than prior  quarters  due to the  deferral  of a portion of a sale
contract as described in Note 6 of the Financial Statements.

         Selling  and  general  administration   expenses  for  the  quarter  of
$3,155,000  were  $565,000  higher than the  corresponding  quarter of the prior
fiscal  year,  primarily  due to the  increased  level of selling and  marketing
support expenses  associated with the significant  increase in the sales revenue
and marketing activity.

         Engineering,  research  and  development  expenses  for the  quarter of
$2,431,000 were $1,828,000 above the corresponding  period expense for the prior
year as the  Company  continued  to enhance  product  offerings.  The Company is
accelerating  development  of its  client/server  architecture  as  well  as the
Company's  roll out of voice  over  Internet  Protocol  (IP)  and  IP/ATM  as an
enhancement to the current product line.

         Operating  income for the  quarter was  $269,000  compared to a loss of
$3,124,000 in the corresponding  quarter of fiscal 1998. This improvement is due
to the  increase  in gross  profit  generated  by the higher  level of  revenues
achieved in the quarter.

         Non-operating  expense for the quarter was  $721,000,  primarily due to
investment  banking  consulting  expenses.  In the corresponding  quarter of the
prior fiscal year, the Company incurred a one-time  non-operating expense charge
of $5,522,000  related to the  convertibility  of certain  ownership  units into
Company common stock.

         The loss from discontinued operations in the quarter of $900,000 is due
to a  management  estimate of the  reduction  in  potential  market value of the
discontinued APC operation real estate which is currently listed for sale.

         The net loss for the quarter was  $1,379,000  compared to a net loss of
$8,765,000 in the corresponding quarter of the prior year. This reduction in the
net loss was  primarily  due to the  improvement  in operating  performance  and
operating income and the reduction in non-operating expense.


                                       10
<PAGE>
Liquidity and Capital Resources
-------------------------------
         The Company  generated  an increase in cash of  $12,478,000  during the
first two quarters of fiscal 1999, and closed the second quarter ended September
30, 1998, with a cash and cash equivalents balance of $16,224,000.

         Net cash provided by operating  activities in the first two quarters of
fiscal 1998 was  $9,645,000  compared to a net cash usage of  $2,680,000  in the
corresponding  six months of the prior  fiscal  year.  The increase in operating
revenues  and  operating  profit  together  with prompt  collection  of customer
receivables  were the main  contributors  to the increase in cash  provided from
operations.

         Net cash used in investing  activities during the first two quarters of
fiscal 1999 of  $3,718,000  consisted  primarily  of (1) the cash portion of the
acquisition  of INET ($1.3M),  (2) the cash portion of a minority  investment in
Crescent ($0.4M),  (3) the purchase of manufacturing and test equipment ($1.5M),
and (4) investment in engineering software development ($0.7M).

         Financing  activities provided $6,551,000 during the first two quarters
of fiscal 1999 which consisted primarily of the net receipts from the sale of 5%
Series A Convertible Preferred Stock of the Company in September 1998.

         As previously disclosed in the Company's Annual Report on Form 10-K for
the fiscal year ended March 31, 1998, the Company's  operations  will need to be
funded during fiscal 1999 either with funds generated through operations or with
additional debt or equity financing.  If the Company's operations do not provide
funds sufficient to fund its operations and the Company seeks outside financing,
there can be no assurance that the Company will be able to obtain such financing
when  needed,  on  acceptable  terms or at all. In addition,  any future  equity
financing or convertible  debt financing would cause the Company's  shareholders
to incur  dilution  in  common  stock  holdings  as a  percentage  of the  total
outstanding shares.

Forward Looking Statements
--------------------------
         All  statements  other than  historical  statements  contained  in this
Report on Form 10-Q constitute  "forward looking  statements" within the meaning
of the Private  Securities  Litigation Reform Act of 1995.  Without  limitation,
these forward looking statements include statements regarding new products to be
introduced by the Company in the future, statements about the Company's business
strategy  and plans,  statements  about the  adequacy of the  Company's  working
capital and other financial resources, and in general statements herein that are
not of a historical nature.  Any Form 10-K, Annual Report to Shareholders,  Form
10-Q,  Form 8-K or press  release of the  Company may  include  forward  looking
statements.  In addition,  other  written or oral  statements  which  constitute
forward  looking  statements  have been made or may in the future be made by the
Company, including statements regarding future operating performance, short- and
long-term revenue and earnings estimates, backlog, the status of litigation, the
value of new  contract  signings,  and industry  growth rates and the  Company's
performance relative thereto. These forward-looking  statements rely on a number
of  assumptions  concerning  future  events,  and are  subject  to a  number  of
uncertainties  and other  factors,  many of which are  outside of the  Company's
control,  that  could  cause  actual  results  to  differ  materially  from such
statements.  These include, but are not limited to: risks associated with recent
operating  losses,  no assurance of  profitability,  the need to increase sales,
liquidity  deficiency  and in general  the other risk  factors  set forth in the
Company's  Annual  Report on Form 10-K for the fiscal year ended March 31, 1998.
The  Company  disclaims  any  intention  or  obligation  to update or revise any
forward looking statements whether as a result of new information, future events
or otherwise.



                                       11
<PAGE>
                           PART II. OTHER INFORMATION


ITEM 1.  LEGAL PROCEEDINGS

         Please see Note 4 to the Condensed  Consolidated  Financial  Statements
herein  and Note 6 to the  Consolidated  Financial  Statements  included  in the
Company's  Annual  Report on Form 10-K for the fiscal year ended March 31, 1998,
for information on various legal proceedings. There are no material developments
to report at this time.


ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

     c)   Issuances of equity  securities not registered under Securities Act of
          1933 are described in Note 5 of the Condensed  Consolidated  Financial
          Statements.

          The Company  believes that the sale of the Preferred  Stock was exempt
          from the securities registration  requirement pursuant to Section 4(2)
          of the Securities Act and Regulation D promulgated  thereunder in that
          the Preferred Stock was offered and sold only to accredited investors,
          each of which made written  representations  to the Company  regarding
          their status as an accredited investor,  their financial  satisfaction
          and  their  investment  intent.  The  certificates   representing  the
          Preferred  Stock were legended to indicate that they were  "restricted
          securities".

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

     a)   Exhibits:

          3.01 Restated Certificate of Incorporation of the Company.

          3.02 By-Laws of the Company  incorporated  herein by reference to 
               Exhibit 3.2 of the Company's Form 10-K for the year ended 
               March 31, 1997.

          4.01 Restated  Certificate of  Incorporation  of the Company (See Note
               3.01 above).

          4.02 By-Laws of the Company (See Note 3.02 above).

          10.03Convertible   Preferred  Stock  Purchase  Agreement  between  the
               Company and JNC Opportunity Fund, dated August 31, 1998.

          27   Financial Data Schedule

     b)   A Form  8-K was  filed by the  Company  on  October  15,  1998,  which
          covered:

          Item 2. Acquisition or Disposition of Assets.

               On September 30, 1998, the Company  completed the  acquisition of
               INET Interactive Network System, Inc., through the merger of INET
               into a wholly owned subsidiary of the Company.



                                       12
<PAGE>
                                   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.


DATE: November 16, 1998       COYOTE NETWORK SYSTEMS, INC.



                              By:   /s/ James J. Fiedler                       
                                    -----------------------------------
                                    James J. Fiedler
                                    Chairman of the Board and
                                    Chief Executive Officer
                                    (Principal Executive Officer)




                              By:   /s/ Brian A. Robson                
                                    -----------------------------------        
                                    Brian A. Robson
                                    Vice President and Controller
                                    (Principal Financial and Accounting Officer)



                                       13
<PAGE>