<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[ X ] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For Period Ended September 30, 1998
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[ ] 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 00-23527
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eSoft, Inc.
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(Exact name of registrant as specified in its charter)
DELAWARE 84-0938960
------------------------ ------------------------
(State of Incorporation) (IRS Employer ID Number)
5335 Sterling Dr., Suite C Boulder, CO 80301
- ----------------------------------------- --------------------------
(Address of principle executive offices) (city) (state) (zip code)
(303) 444-1600
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Registrant's telephone number including area code
- -------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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 NO X
----- -----
Transitional Small Business Disclosure format (check one):
YES NO X
----- -----
The number of shares outstanding of the Registrant's $0.01 par value common
stock on October 28, 1998 was 6,746,002.
<PAGE> 2
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
ESOFT, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash $ 102,837 $ 4,789,665
Receivables:
Trade, net of allowance for doubtful accounts 199,832 2,285,031
Subscription receivable 200,000 --
Inventories 94,607 491,193
Prepaid expense and other 24,799 348,253
Note receivables 20,000 17,571
Deferred income taxes 18,000 18,000
----------- -----------
Total current assets 660,075 7,949,713
PROPERTY AND EQUIPMENT, AT COST
Computer equipment 119,544 195,658
Furniture and equipment 143,157 220,138
----------- -----------
262,701 415,796
Accumulated depreciation (147,881) (188,921)
----------- -----------
Net property and equipment 114,820 226,875
CAPITALIZED SOFTWARE COSTS, NET OF ACCUMULATE
AMORTIZATION 651,470 556,158
OTHER ASSETS
Deferred offering costs 280,896 --
Other assets 17,539 9,724
----------- -----------
TOTAL ASSETS $ 1,724,800 $ 8,742,470
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
2
<PAGE> 3
ESOFT, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(UNAUDITED)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Note Payable - bank $ 75,757 $ 51,924
Accounts payable 174,754 708,822
Deferred revenue 46,622 181,136
Accrued expenses and other 91,949 505,214
Due to related party -- 100,000
Note payable - related party - current 20,000 --
----------- -----------
Total current liabilities 409,082 1,547,096
Deferred tax liability - net 180,000 180,000
Convertible notes payable - related parties 355,903 --
----------- -----------
Total liabilities 944,985 1,727,096
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share;
authorized 50,000,000 shares; 2,433,158 and
6,728,002 issued and outstanding December 31,
1997 and September 30, 1998, respectively 24,332 67,281
Additional paid-in capital 1,135,432 8,807,490
Accumulated deficit (379,949) (1,859,397)
----------- -----------
Total stockholders' equity 779,815 7,015,374
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 1,724,800 $ 8,742,470
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
3
<PAGE> 4
ESOFT, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998 1997 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES $ 305,532 $ 1,480,199 $ 787,794 $ 3,335,139
COST OF GOODS SOLD 59,193 530,889 240,083 1,229,429
----------- ----------- ----------- -----------
GROSS PROFIT 246,339 949,310 547,711 2,105,710
EXPENSES
Sales and marketing expense 50,858 710,702 117,975 1,587,972
General & administrative expense 56,535 765,554 235,349 1,564,761
Engineering expense 8,239 168,435 25,853 373,160
Software amortization cost 30,690 53,220 92,070 155,313
Research and development -- (2,750) -- 12,908
----------- ----------- ----------- -----------
146,322 1,695,161 471,247 3,694,114
OTHER INCOME (EXPENSE)
Interest income 1,247 95,199 1,915 115,095
Interest expense (7,204) (876) (23,922) (6,139)
----------- ----------- ----------- -----------
(5,957) 94,323 (22,007) 108,956
NET INCOME (LOSS) $ 94,060 $ (651,528) $ 54,457 $(1,479,448)
=========== =========== =========== ===========
NET INCOME (LOSS) PER COMMON SHARE
Basic $ 0.06 $ (0.10) $ 0.04 $ (0.29)
Diluted $ 0.05 $ (0.10) $ 0.03 $ (0.29)
Basic weighted average shares
outstanding 1,512,573 6,679,415 1,347,570 5,061,780
=========== =========== =========== ===========
Diluted weighted average shares
outstanding 1,868,476 6,679,415 1,703,473 5,061,780
=========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
4
<PAGE> 5
ESOFT, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
PAID-IN ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL DEFICIT EQUITY
---------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1997 2,433,158 $ 24,332 $ 1,135,432 ($ 379,949) $ 779,815
Issuance of warrants pursuant to -- -- 438 -- 438
private placement, January 1998
Issuance of stock pursuant to
private placement net, of offering costs,
February 1998 290,000 2,900 184,082 -- 186,982
Issuance of stock pursuant to option
conversion February 1998 60,000 600 29,400 -- 30,000
Issuance of stock pursuant to stock
grant February 1998 90,000 900 (900) -- --
Issuance of stock pursuant to IPO
net of offering costs, March 1998 1,550,000 15,500 993,650 -- 1,009,150
Issuance of stock for IPO fee shares,
March 1998 110,000 1,100 (1,100) -- --
Issuance of stock for note conversion,
March 1998 355,903 3,560 352,343 -- 355,903
Issuance of stock pursuant to private
placement, March 1998 50,000 500 49,500 -- 50,000
Issuance of stock pursuant to exercise
of agents' warrants, April 1998 250,000 2,500 247,500 -- 250,000
Issuance of compensatory options,
April 1998 -- -- 69,600 -- 69,600
Issuance of stock pursuant to private
placement, net of offering costs, June 1998 1,468,941 14,689 5,459,704 -- 5,474,393
Issuance of stock pursuant to stock
options and warrant exercised July -
September 1998 70,000 700 69,300 70,000
Issuance of warrants for services,
July - September 1998 218,541 218,541
Net loss for the nine months ended September
30, 1998 -- -- -- (1,479,448) (1,479,448)
----------- ----------- ----------- ----------- -----------
BALANCE, September 30, 1998 6,728,002 $ 67,281 $ 8,807,490 ($1,859,397) $ 7,015,374
=========== =========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
5
<PAGE> 6
ESOFT, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
SEPTEMBER 30,
1997 1998
----------- -----------
<S> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES
Net Income (loss) from operations $ 54,457 $(1,479,448)
Adjustments to reconcile net cash provided by (used in) operating activities:
Depreciation & software amortization 113,283 196,246
Provision for losses on accounts receivables -- 177,930
Provision for inventory obsolescence -- 18,000
Amortization of warrants -- 52,521
Issuance of compensatory options -- 46,400
Changes in operating assets and liabilities: (increase) decrease in:
Accounts receivable - trade (36,455) (2,262,199)
Inventories (17,314) (414,586)
Other assets -- 7,815
Prepaid expenses (125,034) (134,434)
Increase (decrease) in:
Accounts payable 46,584 534,068
Accrued expenses 1,532 413,265
Deposits 42,788 --
Deferred revenue (44,734) 134,514
----------- -----------
Net cash provided by (used in) operating activities 35,107 (2,709,908)
CASH FLOW FROM INVESTING ACTIVITIES
Purchase of equipment (3,277) (153,095)
Capitalized software costs (196,878) (60,000)
Notes receivable - related parties -- 1,806
----------- -----------
Net cash used in investing activities (200,155) (211,289)
CASH FLOW FROM FINANCING ACTIVITIES
Principal (payments) on borrowings (19,174) (23,833)
Proceeds from subscription receivable 116,000 200,000
Due to related party -- 100,000
Deferred offering costs (45,484) --
Proceeds (payment) from related party borrowings 20,000 (20,000)
Proceeds from issuance of promissory notes 100,000 --
Net proceeds sale of stock, warrants and options 347,354 7,351,858
----------- -----------
Net cash provided by financing activities 518,696 7,608,025
INCREASE (DECREASE) IN CASH 353,648 4,686,828
CASH: BEGINNING OF PERIOD 20,750 102,837
----------- -----------
CASH: END OF PERIOD $ 374,398 $ 4,789,665
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
6
<PAGE> 7
ESOFT, INC.
NOTES TO FINANCIAL STATEMENTS
1. INTERIM FINANCIAL INFORMATION
In the opinion of management, the accompanying unaudited financial
statements contain all adjustments necessary to present fairly the
financial position as of September 30, 1998 and the results of
operations and statement of cash flows for the periods presented. The
results of operations for the nine month periods ending September 30,
1998 and 1997 are not necessarily indicative of results to be expected
for the full year.
2. TRADE RECEIVABLES
The following information summarizes trade receivables:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
-------- ----------
<S> <C> <C>
Accounts Receivable 247,832 2,510,031
Less allowance for doubtful accounts (48,000) (225,000)
-------- ----------
$199,832 $2,360,031
======== ==========
</TABLE>
The Company has ten distributors and/or telecommunication companies
(telecos) which accounted for 57% of the Company's sales through the
nine months ending September 30, 1998 and 87% of the third quarter
sales. Sales for the third quarter were composed of 62% for
international destinations and 38% for the domestic market. Sales
composition through nine months ending September 1998 include 50% for
international destinations and 50% for the domestic market. The ten
distributors that make up the majority of the Company's nine months
sales represent 49% of the total accounts receivable, with one customer
representing 28% of our total accounts receivable on September 30,
1998.
The Company has three distributors and/or telcos which each comprise
10% or more of the sales through the nine months ending June 30, 1998.
The three distributors and/or telcos represent 21%, 15% and 14%
respectively of the nine months sales revenue.
The Company, with regard to its foreign sales, does not take the risk
of foreign currency fluctuation. All sales are designated as payment in
U.S. denominated funds at the time of sale.
7
<PAGE> 8
ESOFT, INC.
NOTES TO FINANCIAL STATEMENTS
3. NOTES PAYABLES:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
---------- -----------
<S> <C> <C>
Notes Payables
On January 3, 1997, the Company borrowed $100,000 from a bank, bearing interest
at 12% per annum and was payable with monthly installments of $3,325 with the
balance due on April 3, 1998. On April 5, 1998, the loan was extended to October
5, 1998 with monthly installment payments of $3,325 and a final payment of
$51,924 due October 5, 1998. The loan is collateralized by all assets of the
Company. Subsequent to September
98 the loan was paid in full. $ 75,757 $ 51,924
========== ===========
Related Party:
Two notes payable on demand to an officer, director and stockholder of the
Company, interest payable monthly at 7% per annum, the note was paid in full in
May 1998. $ 20,000 $ -
========== ===========
</TABLE>
4. NET INCOME (LOSS) PER SHARE
Basic earnings (loss) per share is calculated by dividing the net
income(loss) by the weighted average common shares outstanding during
the period. For purposes of computing diluted earnings per share,
dilutive securities are not included when the effect is anti-dilutive.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998 1997 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Basic weighted average common shares
outstanding 1,512,573 6,679,415 1,347,570 5,061,780
Convertible debt 355,903 - 355,903 -
--------- --------- --------- ---------
Diluted weighted average common shares and
assumed conversions outstanding 1,868,476 6,679,415 1,703,473 5,061,780
========= ========= ========= =========
</TABLE>
Options and warrants to purchase 1,596,418 shares of common stock were
not included in the computation of diluted earnings per share because
their effect was anti-dilutive for the period ending September 30,
1998. Options and warrants to purchase 674,600 shares of common stock
of which 60,000 shares were exercisable were not included in the
computation of diluted earnings per share based the treasury method
calculations for the period ending September 30,1997.
8
<PAGE> 9
ESOFT, INC.
NOTES TO FINANCIAL STATEMENTS
5. DUE TO - RELATED PARTY
The Company accepted subscription agreements for the private placement
of 150,000 shares of the Company's common stock at $1.00 per share in
March 1998. From the total private placement Philip Becker, the CEO &
CTO of the Company, subscribed to purchase 100,000 shares of the
Company's common stock. All private placement require the Company to
seek the approval of the Vancouver Stock Exchange which may or may not
permit such transactions. Due to the ownership level of the shareholder
increasing to 20% of the outstanding shares in March 1998 the issuance
of the common stock was subsequently restricted by the Vancouver Stock
Exchange in May 1998. The Vancouver Stock Exchange authorized the
Company to issue the shares, subject to shareholder approval of the
private placement to Philip Becker. If shareholder approval is not
received, the funds are required to be remitted to the subscriber
immediately. The Company has scheduled a shareholders' meeting,
December 4, 1998, to seek approval for the above referenced
transaction.
6. REVENUE RECOGNITION
The Company recognizes revenue at the time products are shipped to its
customers. Provision is made currently for estimated product returns
which may occur under programs the Company has with its customers.
Revenue from support and update service agreements is deferred at the
time the agreement is executed and recognized ratably over the
contractual period. The Company recognizes revenues from customer
training and consulting services when such services are provided. All
costs associated with licensing of software products, support and
update services and training and consulting services are expensed as
incurred.
7. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
See Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations page 16 for recently issued
accounting standards.
9
<PAGE> 10
FORWARD-LOOKING STATEMENTS
Statements made in this Form 10-QSB that are not historical or
current facts are "forward-looking statements" made pursuant to the
safe harbor provisions of Section 27A of the Securities Act of 1933
("The ACT") and Section 21E of the Securities Exchange Act of 1934.
These statement often can be identified by the use of terms such as
"may," "will," "expect," "believes," "anticipate," "estimate,"
"approximate" or "continue," or the negative thereof. The Company
intends that such forward-looking statements be subject to the safe
harbors for such statements. The Company wishes to caution readers not
to place undue reliance on any such forward-looking statements, which
speak only as of the date made. Any forward-looking statements
represent management's best judgment as to what may occur in the
future. However, forward- looking statements are subject to risks,
uncertainties and important factors beyond the control of the Company
that could cause actual results and events to differ materially from
historical results of operations and events and those presently
anticipated or projected. These factors include adverse economic
conditions, entry of new and stronger competitors, inadequate capital,
unexpected costs, failure to gain product approval in foreign countries
and failure to capitalize upon access to new markets. Additional risks
and uncertainties which may affect forward-looking statements about the
Company's IPAD business and prospects include the possibility that a
competitor will develop a more comprehensive or less expensive IPAD
solution, delays in market awareness of eSoft and its products,
possible delays in eSoft's marketing strategy, which could have an
immediate and material adverse effect by placing eSoft behind its
competitors. The Company disclaims any obligation subsequently to
revise any forward-looking statements to reflect events or
circumstances after the date of such statement or to reflect the
occurrence of anticipated or unanticipated events.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The primary market being pursued by the Company consists of
small-to-medium size businesses (SMB) that wish to initiate or expand
their connection and presence on the Internet. The Company believes
that the SMB market is not only expanding exponentially into the
Internet arena, but also requires a solution that is more cost
effective and easier to install and maintain than systems typically
available for the Fortune 1000 companies. The Company further believes
that, for reasons of internal control and additional cost reduction,
the SMB segment finds it beneficial to host their own hardware and
software systems rather than rely upon a remote Internet service
provider. For the higher end IPAD model 5000, a secondary target market
includes Internet service providers, enterprise level operations and
special applications. The Company believes that a significant portion
of the expansion of Internet usage--now doubling every 100 days with an
estimated 62,000,000 U.S. Internet users at the end of 1997--is from
the SMB segment that comprises the largest portion of the installed
local area networks and increasingly recognizes the importance of the
Internet to grow their business and improve productivity. Up until the
introduction of the Company's IPAD products, the only alternatives for
Internet connection and presence were either complete reliance on a
remote Internet service provider, or the installation and support of a
complex, expensive in-house system configuration. With the IPAD system
and advancements in the telecommunications and Internet technologies,
businesses can now assume most of the responsibilities and functions
which heretofore have been provided on their behalf by Internet service
providers. Most importantly for the SMB market, the IPAD system is a
complete, plug-and-play solution that can be installed and maintained
by non-technical personnel and at a fraction of the cost of the typical
large system solution. The IPAD functionality includes an integrated
router, firewall, domain name server, worldwide web server, remote
access server and e-mail server for the Intranet and Internet. The
Company's primary distribution strategy is the classical two-tier
distribution channel, but with a concentration on those distributors,
VARs and resellers that focus on the network and telecommunications
segments.
10
<PAGE> 11
During the third quarter, the Company anticipated signing
agreements with three additional distributors. Subsequently to
September 30th the Company signed a distribution agreement with CHS
Electronics. Domestically, the Company fell short of its goal and only
signed one regional distributor, SED International and anticipates
signing a third distributor in the fourth quarter. SED, located in
Tucker, Georgia, with sales revenues of $646 million in distribution of
microcomputer products, has eight sales and warehouse offices located
across the US. SED International has a total database of 50,000
customers with approximately 15,000 active customers with approximately
40% - 50% of the customers in the networking arena. A U.S.-based
distributor and network product developer named eNetCo, was engaged in
September with IPAD distribution rights in Japan. eNetCo personnel have
introduced the IPAD into some Japanese distribution opportunities and
the Company expects continued progress in the fourth quarter. While the
Company is encouraged by initial IPAD evaluations by a European cable
company, management was disappointed in its overall efforts to expand
its European sales through its original distributor, Telindus SA. As a
result, the Company is exploring other avenues for distribution and
refocusing its efforts on telecommunication and cable companies in the
European market.
In August, the Company consummated a contract with Telecom
Soluciones, one of two Argentinian telephone companies. Telecom
Soluciones received exclusive rights to market the IPAD 1200 and 2500
products in Argentina for a limited period subject to volume
requirements. The agreement included an initial IPAD system delivery in
excess of $500,000. Additionally, progress was made with potential for
fourth quarter sales to other telecommunications companies in Peru and
Chile. The Company expects to continue the discussions in these
countries through the fourth quarter, as well as restart activities in
Brazil and Mexico.
The Company completed negotiations, in the third quarter of its
eStar alliance program, with the respective parties, anticipating early
fourth quarter completion of contracts. The program combines the
strengths of a national leasing company, a national systems integrator
and Internet access providers to enable telecommunication companies to
deliver a complete Internet package to their SMB market.
The Company continues to add Channel Development Representatives
(CDRs) and in the third quarter hired, trained and deployed CDRs in
Washington DC area, Chicago, Denver, Dallas, and San Antonio, and is in
discussions with a company with manufacturer's representatives in the
large Canadian cities. The purpose of the CDRs and manufacturer's reps
is to assist our distributors with lead generation and market
pull-through of our products in channel to VARs and system integrators.
In its third quarter, the Company added a total of seven distribution
sales personnel plus a sales representative in the eStar
telecommunications program. In the fourth quarter, the Company will
make a concerted and aggressive effort, through the use of its
distributor databases and CDRs to grow market awareness of eSoft and
its family of IPAD products. The Company will conduct a minimum of ten
seminars with the assistance of its distributors to introduce eSoft
products to VARs and end users and to educate the market about the all-
in-one appliance alternatives for the SMB. The Company anticipates
adding an additional sales representative for the eStar program and
seven more CDRs in the fourth quarter.
In the third quarter, the Company recruited Frankie Benning as
director of channel sales with responsibilities for all distribution in
the United States and Canada. Ms. Benning comes to eSoft from Netscape
Communications Corp. where she was distribution sales manager. Ms.
Benning has 10 years experience building channel development programs
for companies such as Intel and Hewlett Packard.
The Company completed the quarter ended September 30, 1998 with
revenues of $1,480,000 or 384% growth over the comparable quarter in
1997. The average quarter-on-quarter growth rate over the last six (6)
quarters has been 40%. The Company has year-to-date sold into the
channel in excess of 1,000 units.
11
<PAGE> 12
To continue this steep growth ramp, the Company must continue through
1998 to expand the distribution channels with the addition of other
large and regional distributors. In order for the Company to maintain
the continued growth the distributor channel must deliver sell through
and the all-in-one appliance must continue to be accepted as an
alternative to current technology for connection to the Internet. The
Company will significantly increase its sales and marketing
expenditures to support the channel expansion and telecommunications
marketing strategies. Sales efforts in the fourth quarter will focus on
developing increased market pull-through of product in the channel. The
Company will also continue to explore and develop the international
marketplace. The Company will explore product line unbundling and
expansion with commensurate increases in engineering staff, as well as
expanding its customer support organization. With the increase in
headquarters staff, the Company will begin to plan a relocation to a
larger facility in early 1999.
Management believes its aggressive pursuit of distribution
channels will have both short-term and long-term effects on its
operations. Cash flow from operations is anticipated to be utilized for
the continued expansion of its sales and marketing efforts, as well as
supporting its extended receivable terms to new distributors. Some
personnel additions are also anticipated in the technical support and
engineering departments. In addition to these near-term effects, the
Company expects that these efforts will expand its installed base of
IPADs and continue its growth path. However, with the aggressive market
expansion, the Company anticipates consuming working capital to meet
this continued growth curve for the near term. Additionally, the
Company anticipates future losses as a result of expenses incurred in
support of the aggressive expansion of the sales force to accomplish
the proposed growth curve. The Company anticipates turning profitable
in 1999.
The Company hopes to establish one or more strategic alliance
relationships with synergistic companies such as computer or network
product manufacturers, large system integration companies or
telecommunications companies which will permit the IPAD products to be
sold in conjunction with other products and telecommunications
services. No such relationships have been established to date and there
is no assurance that the negotiation of such a relationship will be
successfully completed. If the Company establishes such relationships
it may become heavily dependent upon such strategic alliance partners
to maintain and expand its presence in the marketplace and the greater
economic resources of the other parties to such relationships may force
significant reductions in prices at which the Company can sell its
products and thus adversely affect its margins and potential for
profits.
LIQUIDITY AND CAPITAL RESOURCES
During the first quarter, the Company completed a $340,000 private
placement in February and March 1998 of 340,000 shares of the Company's
common stock, at a price of $1.00 per share to officers, directors, key
employees and consultants of the Company including a subscription for
50,000 shares, included in above at a price of $1.00 which was
collected in April 1998.
In the first quarter the Company converted the non-interest
bearing note payable to related parties in the amount of $355,903 into
355,903 shares of the Company's common stock at a price of $1.00 per
share.
In March 1998, the Company completed its initial public offering
in Canada of 1,550,000 shares of the Company's common stock at an
offering price of $1.00 per share. Additionally, the Agent was issued
110,000 shares of the Company's common stock in the Canadian Offering
along with warrants to purchase 250,000 shares of the Company's common
stock at a price of $1.00 for the first 12 months and at a price of
$1.15 for the next 12 months. The Agent, subsequent to March 31, 1998,
exercised its right to purchase
12
<PAGE> 13
250,000 shares of common stock. The net cash proceeds to the Company
from the IPO was approximately $906,000 after payment of expenses of
approximately $644,000.
In April 1998, eSoft issued 250,000 shares of its common stock at
a price of $1.00 per share for a total of $250,000, upon the exercise
of agent warrants issued in conjunction with the Company's March 1998
Initial Public Offering to its Canadian Agents.
On June 15, 1998, eSoft completed the private placement of
1,468,941 shares of its common stock at a price of $4.25 per share for
a total offering of $6,243,000. The net cash proceeds to the Company
from the private placement were approximately $5,474,000 after payment
of expenses of the offering, estimated at $261,000, and payment of
$507,825 (8.13% of the offering price) commissions to the Agent,
SubAgents, and Finders who were issued warrants to purchase 159,318
(10.85% of the offered shares) shares of the Company's common stock at
a price of US $4.25 in the first year and US $4.90 in the second year.
In the third quarter, eSoft issued 70,000 shares of its common
stock at a price of $1.00 per share for a total of $ 70,000 upon the
exercise of options and warrants.
The Company's cash position on September 30, 1998 was $4,790,000,
a decrease of $1,157,000 from the previous quarter. The Company's
working capital at September 30, 1998 was $ 6,403,000, a decrease of
$391,000 from the second quarter. To support the hiring of new
employees in the period with office equipment and demo units, the
Company has expended $153,000 year to date in capital expenditures with
$35,000 in equipment purchased this quarter. Management anticipates
continuing losses in support of the growth, and thus its cash position
will continue to decrease. Additionally, in the near term, with new
distributors being added to continue market development, the Company
anticipates its accounts receivable to increase. The Company is
increasing efforts to reduce the present Accounts Receivable balance
through more stringent collection efforts of the current customer base
in an attempt to reduce days outstanding. Inventories grew
significantly consuming cash and at the end of the quarter inventories
was $509,000. The increase is associated with the inability to
presently forecast feed mixes installed in the IPAD. The Company had
$196,000 or 38% of the total inventory in modem, ISDN and ISDN-Europe
modems in stock at the end of the quarter. Management believes that its
current cash position and the anticipated receipts will be sufficient
to meet its working capital needs for the foreseeable future.
Cash Flow
During the nine months ended September 30,1998, cash increased by
$4,687,000. Adjustments to reconcile net loss ($1,480,000) resulted in
adjustments of the use of funds of $491,000 from depreciation,
amortization of software costs, provision for loss on accounts
receivables and issuance of compensatory options and warrants for
services. Funds used in operating activities were ($2,710,000). Funds
of $1,090,000 were provided from operating activities from an increase
of $534,000 in accounts payable, $413,000 from an increase in accrued
expenses, an increase in deferred revenue of $135,000 and an increase
of 8,000 in other assets. Operating funds of ($2,811,000) were used to
finance the ($2,262,000) increase in accounts receivable, ($415,000)
increases in inventories and ($134,000) increase in prepaids.
Investment activities came from investments in capital equipment of
($153,000), capitalized software development costs ($60,000) and an
increase in notes receivable of $1,800 for a total use of funds for
investment activities of ($211,000). Financing activities provided net
$7,608,000 of cash proceeds from conversion of debt, stock offerings,
option and warrant conversion, and debt increases and repayments. Net
cash in the amount of $1,597,000 was received during the period from
the Company's IPO, private placements and warrant and option conversion
of 2,380,000 shares of the Company's common stock and $5,474,000 from
the June private placement. $200,000 from the collection of
subscription receivable and
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<PAGE> 14
$100,000 from a stock subscription agreement was accepted but
restricted as explained in related party transaction Note 5. Principal
payments and debt repayments of ($44,000). A deferred offering costs
from the completion of the Company's fund raising from financing
activities and compensatory warrant compensation totaling $281,000. Non
cash items of debt conversion of $356,000 on the Company's indebtedness
reduced.
The Company anticipates expending an additional $175,000 for
capital expenditures this fiscal year. eSoft will continue to
capitalize software development costs consistent with its strategy of
the development of IPAD software for the marketplace.
RESULTS OF OPERATIONS FOR THREE MONTHS ENDED SEPTEMBER 30, 1998
COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 1998
Quarterly revenues totaled $1,480,000 versus revenue of $306,000
for the comparable quarter in 1997. This represents an increase of
$1,175,000 or 384% over the comparable quarter in 1997. The increase is
associated with the continued expansion of the Company's sales effort
of IPAD products both domestically and in the international market. The
Company in the quarter added one domestic distributor and two
international distributor for a total of 540 revenue units shipped in
the quarter into the channel. Of this 237 revenue units were shipped
domestically and 303 revenue units were shipped for international
distribution. This broadened product line over 1997, along with the
expanded sales and marketing efforts both domestically and abroad,
resulted in the Company posting significant sales growth. The Company,
has experienced an average growth rate of 40% per quarter since the
release of the IPAD 1200 and 2500. For the quarter ending September
1998 the Company experienced sales growth of $387,000 or 32% revenue
growth over the second quarter results.
Gross profit margin in the current quarter was 64% of revenue
($949,000) compared to 62% ($696,000) for the three months ended June
30, 1997. The increase is associated with transition to delivery of
more IPAD 2500 in the quarter versus pervious quarters. Gross profits
would have been higher, however an $18,000 reserve was taken for TBBS
inventories and the transition to the new IPAD box. It is anticipated
that the margins will be maintained at this level through the remainder
of the fiscal year with the present distribution strategy.
Selling, General and Administrative, Engineering and R & D
Expenses (SG&A) increased $1,549,000 or 1,058% from $146,000 in 1997 to
$1,695,000 for the quarter ending September 1998. Sales and marketing
expenses increased $660,000 from $51,000 in 1997 to $711,000 in 1998.
The significant increases in expenditures are attributed to the
addition of sales and marketing personnel, consultants and outside
services, travel expenses, commission and marketing programs required
to accomplish the ramp of the Company's anticipated sales growth rates.
These expenditures represent 53% or $373,000 of the total quarterly
sales and marketing expenditures. The Company, in the quarter, added
two (2) new hires in the Marketing department and seven (7) new hires
in the Sales department. The hiring of new Channel Development Reps is
anticipated to continue through the end of the fiscal year end. The
sales department continues to utilize outside consultants to develop
the international markets which is a significant portion of the sales
expenditures. General and administrative expense increased $709,000 or
1,254%, from $57,000 in the 1997 period compared to expenditures of
$766,000 for the current quarter. One of the significant increases is
associated with a $150,000 increase in bad debt expense in the quarter
representing 20% of the total G& A expense. Engineering and tech
support expenses increased to $168,000 for the three months ending
September 1998 with the majority of work being performed on system
sales support training and engineering upgrades and updates to the IPAD
system. The Company sales growth rate was 32% over the second quarter
while expenditures in the SG & A areas increased 36% over the previous
quarter. The
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<PAGE> 15
SG&A will continue to grow with the anticipated addition of new hires
to augment the Company in all departments. Amortized software
development costs total $53,000 for the period.
Interest expense decreased $6,300 in the three months ended
September 30,1998 from $7,200 in 1997 to $900 in 1998. This decrease in
interest expense is attributed to the conversion of a significant
portion of debt to equity in the first quarter and the continued pay
down of the bank loan in 1998. The bank loan was paid in full
subsequent to September 30, 1998. Interest income increased $94,000 in
the quarter. This increase is associated with completion of the private
placement at the end of the second quarter. The significant increase
relates to funds held in escrow with all interest being paid to the
Company in July when the escrow closed and reported all earnings.
Net Losses from operations was ($651,000) for the three months
ended September 30,1998, compared to $94,000 profit for the same period
in 1997, an increase in the loss of ($746,000) over the same period.
The net losses are associated with the increased SG&A necessary to
maintain a continued quarterly sales growth rate in expanding into this
market. Losses are anticipated to continue through the current fiscal
year due to expenditures leading sales growth rates and the addition of
new hires.
RESULTS OF OPERATIONS FOR NINE MONTHS ENDED SEPTEMBER 30, 1998
COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 1997
Revenues for nine months of operations totaled $3,335,000 compared
to revenues of $788,000 for the same period in 1997. This represents an
increase of $2,547,000 or 323% over the comparable nine month period in
1997. The increase is associated with the continued expansion of the
Company's sales effort of IPAD product both domestically and in the
international marketplace. The Company added three domestic
distributors and five international distributors, VARs and/or telcos in
the nine months of the year contributing $2,750,000 or 86% of the total
sales for the year.
Gross profit margin was 63% of revenue ($2,106,000) compared to
62% ($1,156,000) for the six months ended June 30, 1998. The slight
increase in gross profit margin is associated with no shipments of raw
material to Europe in the third quarter. In addition the product mix
changed to predominantly IPAD 2500 versus IPAD 1200 in which margin is
lower. Raw materials have been shipped from the U.S. to Europe
resulting in additional duties and freight costs in the first half of
the year. It is anticipated that the margins will be maintained at this
level through the remainder of the fiscal year with the current
two-tier distribution approach.
Selling, General and Administrative, Engineering and R & D
Expenses (SG&A) increased $3,223,000 or 684% from $471,000 for the nine
months in 1997 to $3,694,000 for the same nine months in the 1998
period. Sales and marketing expenses increased $1,470,000 from $118,000
in 1997 to $1,588,000 in 1998. The increases in expenditures are
attributed to the addition of sales and marketing personnel,
consultants and outside services, travel expenses, commission and
marketing programs required to meet the ramp of the Company's
anticipated sales growth rates. The Company has added twelve (12) sales
and sales support staff and five (5) marketing staff in 1998 in
addition to utilizing 5 sales agents to develop international markets.
The afore-mentioned expenditures represented 57% of the total year to
date expenditures for sales and marketing. General and administrative
expense increased $1,329,000 from $236,000 in the 1997 period compared
to total expenses of $1,565,000 year to date. Engineering tech support
expenses increased to $373,000 for the nine months ending September
1998 with the majority of work being performed on system sales support
training and engineering upgrades and updates to the IPAD system. The
Company has maintained an average of 40% quarter-on-quarter sales
growth rate over the last six quarters. To
15
<PAGE> 16
accomplish this sales ramp, the Company's SG & A increased an average
of 59% quarter-on-quarter over the last six quarters. Amortized
software development costs total $155,000 for the period.
Interest expense for the nine months ending September 1998
decreased $18,000 from $24,00 in 1997 to $6,000 in 1998. This decrease
in interest expense is attributed to the conversion of a significant
portion of debt to equity in the first quarter of 1998. The Company
additionally continues to pay down its term loan with the bank,
reducing interest expense. Interest income increased $113,000 for the
year to date period for a total of $115,000 for the nine months ended
September 1998. This increase is associated with completion of the
private placement at the end of the second quarter. The significant
increase relates to funds held in escrow, with all interest being paid
to the Company in July when the escrow closed.
Net losses from operations totaled ($1,479,000) for the nine
months ended September 30,1998, compared to $55,000 profit for the same
period in 1997, an increase in the loss of ($1,534,000) over the same
period. The net loss is associated with the increased SG&A necessary to
ramp quarterly sales growth rates. Losses are anticipated to continue
through the current fiscal year due to expenditures leading sales
growth rates.
YEAR 2000 EFFECT
The Company's TBBS product line has one deficiency associated with
year 2000 for which a correction is scheduled for a revision release in
October 1998. Older versions of the IPAD hardware have a BIOS
deficiency and this deficiency will be corrected in the product release
schedule for this fiscal year. The current IPAD product line has no
known susceptibility to year 2000 issues. The cost of the revision to
the TBBS and IPAD product is not expected to be material. The Company
has no present knowledge of any other internal systems having a year
2000 compliant problem. Other year 2000 items are not anticipated to be
material.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
The Financial Accounting Standards Board has recently issued
Statements of Financial Accounting Standards that may affect the
Company's financial statements as follows:
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No.130, Reporting
Comprehensive Income (SFAS 130), which establishes standards for
reporting and display of comprehensive income, its components and
accumulated balances. Comprehensive income is defined to include all
changes in equity except those resulting from investments by owners and
distributions to owners. Among other disclosures, SFAS 130 requires
that all items that are required to be recognized under current
accounting standards as components of comprehensive income be reported
in a financial statement that is displayed with the same prominence as
other financial statements. SFAS 130 has been adopted and there was no
affect on the financial statements.
Also, in June 1997, FASB issued SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information" which supersedes
SFAS No. 14, "Financial Reporting for Segments of a Business
Enterprise." SFAS No. 131 establishes standards for the way that public
companies report information about operating segments in annual
financial statements and requires reporting of selected information
about operating segments in interim financial statements issued to the
public. It also establishes standards for disclosures regarding
products and services, geographic areas and major customers. SFAS No.
131 defines operating segments as components of a company about which
separate financial information is available that is evaluated regularly
by the chief operating decision maker in deciding how to allocate
resources and in assessing performance. SFAS 131 is effective for
financial statements for periods beginning after December 15, 1997 and
requires comparative information for earlier years to be restated.
Because of the recent issuance of the standard, management has been
unable to fully evaluate the impact,
16
<PAGE> 17
if any, the standards may have on future financial statement
disclosures. Results of operations and financial position, however,
will be unaffected by implementation of this standard.
In October 1997, Statement of Position 97-2, Software Revenue
Recognition (SOP 97-2) was issued. The SOP provides guidance on when
revenue should be recognized and in what amounts licensing, selling,
leasing, or otherwise marketing computer software. SOP 97-2 is
effective for transactions entered into in fiscal years after December
15, 1997. In March 1998, SOP 98-4 was issued to defer for one year the
application of certain provisions of SOP 97-2. Because of the recent
issuance of these SOP's, management has been unable to fully evaluate
the impact, if any, these SOP's may have on future financial statement
disclosure.
In February 1998, the FASB issued SFAS No. 132, "Employer's
Disclosures about Pensions and Other Postretirement Benefits" which
standardizes the disclosure requirements for pensions and other
postretirement benefits and requires additional information on changes
in the benefit obligations and fair values of plan assets that will
facilitate financial analysis. SFAS No. 132 is effective for years
beginning after December 15, 1997 and requires comparative information
for earlier years to be restated, unless such information is not
readily available. Management believes the adoption of this statement
will have no material impact on the Company's financial statements.
17
<PAGE> 18
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
27 Financial Data Schedule.
b) Reports on Form 8-K.
none
18
<PAGE> 19
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.
eSoft, Inc.
(Registrant)
Date: October 28,1998 /s/ Philip Becker
----------------------- -------------------------------------
Philip Becker
Chairman, CEO
Date: October 28,1998 /s/ Thomas Tennessen
----------------------- -------------------------------------
Thomas Tennessen
Chief Financial Officer and Principal
Financial and Accounting Officer
19
<PAGE> 20
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
27 Financial Data Schedule.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 4,789,665
<SECURITIES> 0
<RECEIVABLES> 2,510,031
<ALLOWANCES> (225,000)
<INVENTORY> 491,193
<CURRENT-ASSETS> 7,949,713
<PP&E> 415,796
<DEPRECIATION> 188,921
<TOTAL-ASSETS> 8,742,470
<CURRENT-LIABILITIES> 1,547,096
<BONDS> 0
0
0
<COMMON> 67,281
<OTHER-SE> 6,948,093
<TOTAL-LIABILITY-AND-EQUITY> 8,742,470
<SALES> 3,335,139
<TOTAL-REVENUES> 3,335,139
<CGS> 1,229,429
<TOTAL-COSTS> 3,694,114
<OTHER-EXPENSES> 108,956
<LOSS-PROVISION> 12,930
<INTEREST-EXPENSE> 6,139
<INCOME-PRETAX> (1,479,448)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,479,448)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,479,448)
<EPS-PRIMARY> (0.29)
<EPS-DILUTED> (0.29)
</TABLE>
