<PAGE>
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 June 30, 1999
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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
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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)
295 Interlocken Boulevard #500 Broomfield, CO 80021
--------------------------------- ----------------------------
(Address of principle executive offices) (city) (state) (zip code)
(303) 444-1600
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Registrant's telephone number including area code
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(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 X NO
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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 July 30, 1999 was 9,448,620.
<PAGE>
ESOFT, INC. AND SUBSIDIARY
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
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<S> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements 3 - 14
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15 - 23
PART II OTHER INFORMATION 24 - 25
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
ESOFT, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1999
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 677,944 $ 1,765,216
Investment securities 1,991,541 -
Accounts receivable, net of allowance for doubtful
accounts 2,679,906 2,982,953
Inventories 1,577,666 743,732
Prepaid expense and other 188,084 99,238
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Total current assets 7,115,141 5,591,139
PROPERTY AND EQUIPMENT
Computer equipment 350,178 371,278
Furniture and equipment 248,299 330,478
Manufacturing tool and equipment 26,424 26,424
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624,901 728,180
Less accumulated depreciation (328,484) (386,321)
----------- -----------
Net property and equipment 296,417 341,859
OTHER ASSETS
Capitalized software costs, net of accumulated amortization 867,072 786,069
Deferred offering costs - 429,471
Other assets 7,039 18,628
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Total other assets 874,111 1,234,168
TOTAL ASSETS $ 8,285,669 $ 7,167,166
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</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
3
<PAGE>
ESOFT, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1999
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(UNAUDITED)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,358,081 $ 1,596,891
Revolving line of credit - 80,000
Marketing loan agreement 356,060 455,136
Note payable-bank 104,309 89,821
Deferred revenue 23,910 31,873
Customer deposits 248,287 -
Accrued expenses:
Payroll and payroll taxes 256,033 143,804
Other 234,332 693,107
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Total current liabilities 2,581,012 3,090,632
LONG TERM LIABILITIES
Note payable - 1,924,710
----------- ------------
Total liabilities 2,581,012 5,015,342
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share;
authorized 50,000,000 shares; 8,454,867 and
9,348,794 issued and outstanding December 31,
1998 and June 30, 1999, respectively 84,549 93,489
Additional paid-in capital 10,160,063 12,793,576
Notes receivable - (151,411)
Accumulated deficit (4,539,955) (10,583,830)
----------- ------------
Total stockholders' equity 5,704,657 2,151,824
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 8,285,669 $ 7,167,166
----------- ------------
----------- ------------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
4
<PAGE>
ESOFT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
1998 1999 1998 1999
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
REVENUES: $ 2,068,131 $ 1,526,111 $ 3,546,675 $ 2,689,219
COST OF GOODS SOLD: 883,594 839,604 1,575,684 1,545,735
----------- ----------- ----------- -----------
GROSS PROFIT 1,184,537 686,507 1,970,991 1,143,484
EXPENSES
Sales and marketing expense 821,235 1,152,930 1,382,272 3,421,638
General & administrative expense 653,604 1,547,587 1,107,488 2,902,864
Engineering expense 163,689 303,887 254,721 476,119
Software amortization costs 53,220 41,826 102,093 83,652
Research and development 102,985 61,708 175,748 181,894
----------- ----------- ----------- -----------
1,794,733 3,107,938 3,022,322 7,066,167
OTHER INCOME (EXPENSE):
Other expense - (95,782) - (95,782)
Gain on sale of property & equipment - 2,347 - 450
Interest income 20,803 9,182 19,896 34,130
Interest expense (10,549) (51,045) (11,762) (59,990)
----------- ----------- ----------- -----------
10,254 (135,298) 8,134 (121,192)
NET LOSS $ (599,942) $(2,556,729) $(1,043,197) $(6,043,875)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
BASIC AND DILUTED LOSS
PER COMMON SHARE: $ (0.09) $ (0.28) $ (0.18) $ (0.68)
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
BASIC AND DILUTED WEIGHTED AVERAGE SHARES
OUTSTANDING 6,966,295 9,059,228 5,830,922 8,829,594
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
5
<PAGE>
ESOFT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
PAID-IN NOTES ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL RECEIVABLE DEFICIT EQUITY
--------- -------- ---------- ---------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, January 1, 1999 8,454,867 $84,549 $10,160,063 $ - ($4,539,955) $ 5,704,657
Issuance of compensatory options - - 29,953 - - 29,953
Exercise of warrants and options 590,968 5,910 609,744 - - 615,654
Issuance of stock pursuant to
private placement, May 1999 156,250 1,563 594,219 - - 595,782
Issuance of warrants pursuant to
private placement of debt, June 1999 - - 1,192,030 - - 1,192,030
Issuance of notes receivable for exercise of
options and warrants, net of collections 146,709 1,467 207,567 (151,411) - 57,623
Net loss for the six months ended June 30, 1999 - - - - (6,043,875) (6,043,875)
--------- -------- ---------- ---------- ------------ -----------
BALANCE, June 30, 1999 9,348,794 $93,489 $12,793,576 ($151,411) ($10,583,830) $ 2,151,824
--------- -------- ---------- ---------- ------------ -----------
--------- -------- ---------- ---------- ------------ -----------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
6
<PAGE>
ESOFT, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED JUNE 30,
1998 1999
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<S> <C> <C>
OPERATING ACTIVITIES
Net loss from operations $ (1,043,197) $ (6,043,875)
Adjustments to reconcile net loss to net cash used
in operating activities
Depreciation & software amortization 157,965 143,121
Gain on sale of assets - (450)
Provision for losses on accounts receivable 34,033 106,678
Amortization of discount on investments - (8,459)
Amortization of debt discounts and offering costs - 123,870
Issuance of compensatory options 23,200 29,953
Amortization of warrant valuation granted for prepaid
consulting - 101,767
Changes in operating assets and liabilities:
Accounts receivable - trade (1,684,470) (409,725)
Inventories (4,398) 833,934
Other assets 9,850 (11,589)
Prepaid expenses (134,137) (12,920)
Accounts payable 402,952 238,810
Accrued expenses 126,425 98,261
Deferred revenue 43,572 7,963
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Net cash used in operating activities (2,068,205) (4,802,661)
INVESTING ACTIVITIES
Proceeds from investments - 2,000,000
Purchase of equipment (175,259) (110,121)
Proceeds from sale of assets 6,466 5,661
Capitalized software costs (60,000) (2,650)
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Net cash (used in) provided by investing activities (228,793) 1,892,890
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
7
<PAGE>
<TABLE>
<S> <C> <C>
CASH FLOW FROM FINANCING ACTIVITIES
Due to related party 100,000 -
Payment on related party borrowings (20,000) -
Proceeds from subscription receivable 200,000 56,487
Proceeds from line of credit, net 50,000 80,000
Payments on short term debt (18,334) (25,412)
Proceeds from short term debt - 110,000
Proceeds from long term debt 250,984 -
Payments on long term debt (53,378) -
Proceeds from issuance of convertible debt - 3,000,000
Debt offering costs paid - (340,821)
Proceeds from exercise of options and
warrants and sale of stock 7,515,259 1,116,789
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Net cash provided by financing activities 8,024,531 3,997,043
INCREASE IN CASH 5,727,533 1,087,272
CASH: BEGINNING OF PERIOD 299,232 677,944
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CASH: END OF PERIOD $ 6,026,765 $ 1,765,216
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SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
Common Stock issued for subscriptions receivable - $ 269,947
Warrants issued in connection with debt offering - $ 1,095,578
Warrants issued to consultants - $ 96,452
Issuance of notes receivable for exercise
of options and warrants - $ 207,898
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
8
<PAGE>
ESOFT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The consolidated interim financial statements include the accounts of
eSoft, Inc. and its wholly-owned subsidiary Apexx Technology, Inc.
("Apexx"), (collectively, eSoft or the "Company") and have been
prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures are
adequate to make the information presented not misleading.
These statements reflect all adjustments, consisting of normal
recurring adjustments, which in the opinion of management, are
necessary for fair presentation of the information contained therein.
It is suggested that these consolidated financial statements be read in
conjunction with the financial statements and notes thereto included in
the Company's Annual Report on Form 10-KSB for the year ended December
31, 1998. The Company follows the same accounting policies in
preparation of interim reports.
The consolidated financial statements of the Company for the three and
six months ended June 30, 1999 and 1998 have been restated to give
retroactive effect to the merger with Apexx on May 25, 1999, which has
been accounted for using the pooling of interests method and, as a
result, the financial position, results of operations and cash flows
are presented as if the combining companies had been consolidated for
all periods presented and the consolidated statement of stockholders'
equity reflect the accounts of eSoft as if the additional common stock
issued in connection with the merger had been issued for all periods
presented. It is further suggested that these consolidated financial
statements be read in conjunction with the supplemental consolidated
financial statements and notes thereto included in the Company's
Current Report on Form 8-K filed with the Securities & Exchange
Commission on August 9, 1999.
Results of operations for the interim periods are not necessarily
indicative of annual results.
2. Business Acquisition
Effective May 25, 1999, the Company completed the merger (the "Merger")
with Apexx located in Boise, Idaho which provided for the exchange of
all of the outstanding stock of Apexx for shares of eSoft common stock
and for the conversion of all Apexx stock options into eSoft stock
options
9
<PAGE>
ESOFT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
to acquire 1,356,003 shares of eSoft common stock. The Merger has been
accounted for as a pooling of interests.
<TABLE>
<CAPTION>
Pooling Company Nature of Operations Merger Date
--------------- -------------------- -----------
<S> <C> <C>
Apexx Technology, Inc. Internet connectivity solutions May 25, 1999
</TABLE>
Revenue, net loss and net loss per common share of eSoft and Apexx as
consolidated for the periods presented are as follows:
<TABLE>
<CAPTION>
REVENUE:
Three Months Ended June 30, 1998 1999
----------- -----------
restated
<S> <C> <C>
esoft $ 1,121,008 $ 476,421
Apexx 954,564 1,296,554
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eSoft, consolidated $ 2,068,131 $ 1,526,111
<CAPTION>
Six Months Ended June 30, 1998 1999
----------- -----------
restated
esoft $ 1,854,940 $ 1,029,488
Apexx 1,705,735 2,155,439
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eSoft, consolidated $ 3,546,675 $ 2,689,219
<CAPTION>
NET LOSS:
Three Months Ended June 30, 1998 1999
----------- -----------
restated
eSoft $ (532,679) $(2,895,262)
Apexx (10,024) 190,435
----------- -----------
esoft, consolidated $ (599,942) $(2,556,729)
</TABLE>
10
<PAGE>
<TABLE>
<CAPTION>
Six Months Ended June 30, 1998 1999
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restated
<S> <C> <C>
eSoft $ (827,920) $(5,624,585)
Apexx (110,651) (141,730)
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esoft, consolidated $(1,043,197) $(6,043,875)
<CAPTION>
NET LOSS PER COMMON SHARE:
Three Months Ended June 30, 1998 1999
----------- -----------
restated
<S> <C> <C>
As previously reported:
Basic and diluted $ (0.10) N/A
Consolidated:
Basic and diluted $ (0.09) $ (0.28)
<CAPTION>
Six Months Ended June 30, 1998 1999
----------- -----------
As previously reported:
Basic and diluted $ (0.19) N/A
Consolidated:
Basic and diluted $ (0.18) $ (0.68)
</TABLE>
3. Trade Receivables
The following information summarizes accounts receivable:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1999
----------- -----------
<S> <C> <C>
Accounts Receivable 2,947,147 3,356,872
Allowance for doubtful accounts (267,241) (373,919)
----------- -----------
$ 2,679,906 $ 2,982,953
----------- -----------
----------- -----------
</TABLE>
The Company had one customer which accounted for 10% or more of the
sales through the six months ending June 30, 1999. This customer
represented 20% of the Company's revenue for the six months ended June
30, 1999. Additionally, this customer represented 6% of total accounts
receivable at June 30, 1999. The Company has nine distributors which
accounted for 39% of the Company's sales through the six months ending
June 30, 1999.
11
<PAGE>
ESOFT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company with regard to its foreign sales does not take the risk of
foreign currency fluctuation. All sales are designated as payment in US
denominated funds at the time of sale.
4. Subscription Receivable
The Company issued two promissory notes receivable in the amounts of
$56,487 and $75,411 on March 10, 1999 and March 24, 1999 resulting from
the exercise of 49,550 and 66,150 warrants with an exercise price of
$1.15, by Transition Partners Limited and Copeland Consulting Group,
Inc., respectively. At the time of exercise, $1,157 was paid in cash.
The notes are due in March 2000 without interest and at 12% penalty
interest thereafter and are secured by the shares of common stock being
issued. At June 30, 1999, $56,487 has been paid. The Company also
issued promissory notes receivable in the amount of $76,000 to
employees during June 1999. The notes are due in June 2001 with annual
interest at the rate of 5.75% due upon maturity and are secured by the
shares of common stock being issued. The notes become due and payable
upon termination of employment.
5. Notes Payable
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1999
------------ ------------
<S> <C> <C>
Note payable to bank, payable in monthly installments of $3,171,
including interest at prime plus 1.5% (9.25% at December 31, 1998),
maturing March 15, 2002, equipment, inventory, and accounts
receivable are provided as collateral, due on demand as a result of
the Apexx merger. $ 104,309 $ 89,821
----------- -----------
----------- -----------
Term note payable to a small business investment company. Interest is
at 5% per annum, payable quarterly. Principal due June 2002. The
note, in the principal amount of $3,000,000, has been discounted by
$1,095,578. The discount, which is
</TABLE>
12
<PAGE>
<TABLE>
<S> <C> <C>
being amortized through June 2002, represents the value assigned to
766,773 stock purchase warrants which were granted to the lender.
The value of the discount has been calculated using the
Black-Scholes option pricing model. The stock purchase warrants are
exercisable through June 2002 to purchase an equal number of common
shares at a per share price of $4.4994. The unamortized discount at
June 30, 1999 was $1,075,290. The note is convertible at any time
at the investor's option into a fixed number of shares of eSoft
common stock at $3.9125 per share, subject to certain antidilution
provisions and adjustments. The Company has the ability, under
certain circumstances, to obligate the investor to convert the
debentures into common stock and to exercise the warrants. The
investor has the option to purchase an additional $5 million of
debentures, together with associated warrants, in two subsequent
tranches. Under certain circumstances, the Company may require the
investor to purchase $2 million of additional debentures, which
would be convertible at $3.9125 per share, together with warrants
to purchase 511,182 shares of common stock with an exercise price
of $4.4994 per common share. The third tranche of $3 million of
debentures would be convertible at the lower of (i) the Company's
then current market price or (ii) $5.50, but in no event less than
$3.9125 per share. The third tranche of debentures would be
accompanied by warrants with an exercise price of 115% of the third
tranche debenture conversion price. The debentures are manditorily
convertible if the average Per Share Market Value over thirty
consecutive trading days exceeds 200% of the exercise price of
the warrants. $ - $ 1,924,710
----------- -----------
----------- -----------
</TABLE>
6. Net Loss per Share
Basic loss per share is calculated by dividing the net loss by the
weighted average common shares
13
<PAGE>
ESOFT, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
outstanding during the period. For purposes of computing diluted
earnings per share, dilutive securities are not included when the
effect is antidilutive.
Options and warrants to purchase 4,108,635 and 2,913,421 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
June 30, 1999 and 1998.
7. Private Placement
On May 14, 1999, eSoft received $500,000 from a stockholder in exchange
for 156,250 common shares at a price of $3.20. Other expense with a
corresponding credit to paid-in capital was recognized for the
incremental discount on the transaction in the amount of $95,782.
8. Proposed Private Placement
The Company is negotiating possible private financing through the
issuance of common stock or the issuance of convertible subordinated
debentures. The Company intends to use the proceeds for working capital
and funding acquisitions.
9. Proposed Plan of Merger
The Company has signed a letter of intent to merge with Technologic
("Technologic"), a privately held company headquartered in Norcross,
Georgia. eSoft will exchange approximately 1.5 million shares of
eSoft's common stock for all of the shares, options and warrants of
Technologic. The companies intend for the acquisition to be accounted
for as a pooling of interests. The completion of the transaction is
subject to several conditions, including execution of a definitive
purchase agreement and approval of the agreement by both companies'
boards of directors and Technologic shareholders. The anticipated
completion date for the transaction is August 31, 1999.
14
<PAGE>
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 business and prospects include
the possibility that a competitor will develop a more comprehensive or less
expensive 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
TEAM INTERNET IS A REGISTERED TRADEMARK OF ESOFT, INC.
The primary market pursued by the Company to date consists of
small-to-medium sized 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 SMB segment 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. Internet penetration has been
estimated to increase from 54.9% of small business PC owners in 1998 to 68.5%
in 2002. The number of small businesses online is expected to increase from
3.2 million in 1998 to 4.6 million in 2002. Most importantly for the SMB
market, the Company's TEAM Internet system is a complete, plug-and-play
solution that can be installed and maintained by non-technical personnel
15
<PAGE>
and at a fraction of the cost of the typical large system solution. The TEAM
Internet 100 is a system that can connect a business Local Area Network (LAN)
with up to 50 users to the Internet using a single Internet address. It
provides all of the components an organization needs to develop, manage, and
monitor its Intranet or external web presence. The TEAM Internet 2500 can
connect up to 500 users on a LAN to the Internet. The Company has focused its
distribution strategy on Value Added Resellers (VARs) who offer Local Area
Network solutions to the SMB. In order to serve these VARs, the Company
enters into agreements with leading distributors. The Company is exploring
other avenues for distribution and also is focusing its efforts on
telecommunication and distribution companies in the European, Latin American,
and Asian markets.
The Company continued to add Channel Development Representatives (CDRs)
in key cities in the United States. The purpose of the CDRs is to assist VARs
with lead generation and market pull-through of products to end-users. In
1999, the Company added seven CDRs. The Company continues to make a concerted
and aggressive effort to market eSoft and educate the market as to the
all-in-one appliance alternatives for the SMB.
The Company has completed a merger with Apexx of Boise, Idaho, on May
25, 1999. As a result of the transaction, the Company issued 1,591,365 shares
of the Company's common stock for all of the issued and outstanding shares of
Apexx. Additionally, the Company extended Apexx a working capital line of
credit of $500,000. The eSoft shares issued in exchange for outstanding Apexx
shares were registered under an S-4 registration statement, which became
effective April 20, 1999. In conjunction with the signing of the Definitive
Merger Agreement, the Company executed an agreement to purchase products from
Apexx to sell through its distribution channels. The Company elected to
utilize the Apexx TEAM Internet brand name across the product lines of both
companies. In the first quarter, the Company has de-emphasized the sales of
the IPAD 1200 and replaced it with Apexx's TEAM Internet 100. The TEAM
Internet 100 is a system that can connect a business LAN of up to 50 users to
the Internet using a single Internet address. It provides all of the
components an organization needs to develop, manage, and monitor its Intranet
or external web presence. In the first quarter, the Company integrated the
Apexx sales and marketing departments. The Company intends to distribute the
TEAM Internet products through direct sales, VARs, network integrators,
distributors, and overseas sales agents.
Management expects the new company to have greater opportunities to
expand market share for Internet access products, to have increased research
and product development ability, to have more leverage to compete in its
industry, to expand and diversify its distribution channels, and to further
its ability to raise capital in order to finance the anticipated growth.
As part of the Definitive Merger Agreement, the Company conducted a
marketing program in the first quarter, where the products known by the
Company as IPAD are being re-branded utilizing the Apexx product name of TEAM
Internet.
16
<PAGE>
Under the marketing program the Company incurred $933,000 of marketing costs.
Under this marketing plan the company will focus on selling the TEAM Internet
100 and TEAM Internet 2500 (formerly known as the IPAD 2500) products. The
proposed combined marketing program inaugurated a direct mail campaign during
February through May 1999 to focus on potential users and VARS of the
all-in-one appliance Internet connection. This marketing program comprised a
direct mail program of 710,000 pieces to potential end users of the Company's
products. The Company, under the plan, also targeted 238,000 free standing
inserts in business journals focusing on potential end users. Additionally, a
55,000 piece direct mail campaign targeted at VARs and directed at educating
these entities to the all-in-one appliance was formulated around this
program. The Company has generated 5,000 leads from this program.
The Company has recently announced a new business strategy with three
primary areas of focus: Internet Access Products, Internet Services, and
Software Engineering Services. The Internet Access Products effort will build
on the Company's core business of developing, marketing and selling the
Company's market-leading TEAM Internet product line of Internet access
products. Internet Services will focus on creating value by aggregating
resellers and customers into a virtual community for the delivery of products
and services by e-commerce and other Internet-based offerings. The Software
Engineering Services activities will concentrate on the growing domestic and
international demand for Linux-based software, leveraging the professional
Linux engineering and development competencies and skills of the Company.
This plan leverages the existing Internet and Linux software strengths of the
Company, while addressing the demands and requirements of the marketplace.
Management believes its aggressive pursuit of this strategy will have
both short-term and long-term effects on its operations. Outside financing
will be utilized for the continued expansion of its sales and marketing
efforts, as well as support of its extended receivable terms to its new
distributors. Some personnel additions are also anticipated in the technical
support and engineering departments. The Company also expects to expand its
customer support organization. With the increase in headquarters staff, the
Company relocated to a larger facility in early 1999. In addition to these
near-term effects, the Company expects that the use of e-commerce and the
online community to complement eSoft's traditional reseller and distribution
channels will enable the Company to develop a larger marketplace more rapidly
and efficiently. However, with the aggressive market expansion, the Company
anticipates consuming working capital to meet this continued growth curve for
the near term. As a result of expenses incurred in support of the expansion,
the Company anticipates future losses. The Company expects to turn profitable
in 2000.
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 TEAM Internet 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 negotiations of such
17
<PAGE>
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.
eSoft has signed a letter of intent for eSoft to acquire Technologic
("Technologic"), a privately held company headquartered in Norcross, Georgia.
eSoft will exchange approximately 1.5 million shares of eSoft's common stock
for all of the shares, options and warrants of Technologic. Through this
acquisition, eSoft will leverage Technologic's strengths in advanced firewall
security applications and Virtual Private Network ("VPN") technology to
accelerate eSoft's goal of becoming a worldwide market leader in Internet
Appliances. eSoft will market the Technologic products through its more than
600 domestic and international resellers, online and telemarketing channels.
The companies intend for the acquisition to be a pooling-of-interests.
The completion of the transaction is subject to several conditions, including
execution of a definitive purchase agreement and approval of the agreement by
both companies' boards of directors and Technologic shareholders. The
anticipated completion date for the transaction is August 31, 1999.
Liquidity and Capital Resources
The Company's cash position on June 30, 1999 was $1,765,000, an increase
of $1,087,000 from year end primarily due to the maturation of investments
and the proceeds from the issuance of convertible debt. The Company's working
capital at June 30, 1999 was $2,501,000 a decrease of $2,033,000. Investments
of $1,992,000 matured during the first quarter, from which the proceeds were
utilized to support operations. Management anticipates continuing losses in
support of the growth curve, 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. The
decrease in inventories from year end resulted from improved inventory
management with respect to sales volume. TEAM Internet 2500 accounted for
$324,000 or 44% of the total inventory at June 30, 1999. The Company has
expended $110,000 in capital expenditures, of which $30,000 was related to
furniture for the new headquarters, and $30,000 was for leasehold
improvements. Management believes that its current cash position, the
anticipated cash receipts from receivables, and the anticipated private
placement funding will be sufficient to meet its working capital needs for
the foreseeable future.
On May 14, 1999, eSoft received $500,000 from a stockholder in exchange
for 156,250 common shares at a price of $3.20. Other expense with a
corresponding credit to paid-in capital was recognized for the incremental
discount on the transaction in the amount of $95,782.
18
<PAGE>
On June 10, 1999, eSoft received $3,000,000 from a placement of 5%
convertible subordinated debentures due in 2002. Interest is payable in cash
or, at the Company's option, in shares of common stock. The debentures are
convertible at any time at the investor's option into a fixed number of
shares of eSoft common stock at $3.9125 per share, subject to certain
antidilution provisions and adjustments. The investor also received warrants
to purchase 766,773 shares of common stock with an exercise price of $4.4994
per common share. The warrants have a three year term. A discount in relation
to the warrants was recorded in the amount of $1,095,578, which is being
amortized over three years. The Company has the ability, under certain
circumstances, to obligate the investor to convert the debentures into common
stock and to exercise the warrants.
As part of the debenture financing, the investor has the option to
purchase an additional $5 million of debentures, together with associated
warrants, in two subsequent tranches. Under certain circumstances, the
Company may require the investor to purchase $2 million of additional
debentures, which would be convertible at $3.9125 per share, together with
warrants to purchase 511,182 shares of common stock with an exercise price of
$4.4994 per common share. The third tranche of $3 million of debentures would
be convertible at the lower of (i) the Company's then current market price or
(ii) $5.50, but in no event less than $3.9125 per share. The third tranche of
debentures would be accompanied by warrants with an exercise price of 115% of
the third tranche debenture conversion price. A.G. Edwards & Sons, Inc. acted
as the placement agent for the debentures.
Net proceeds were approximately $2,675,000 after offering expenses.
Under the terms of the private placement, the Company has agreed to pay the
agent a placement fee of 6% of the gross proceeds. The Company intends to use
the proceeds of the offering for working capital.
The Company is planning on raising funds through the private placements
of common stock or the issuance of convertible subordinated debentures. The
Company intends to use the proceeds of the offering for working capital and
funding of acquisitions.
Cash Flow
Net cash used in operating activities for the six months ended June 30,
1999 was $4,803,000 compared with $2,068,000 for the six months ended June
30, 1998. The increase of $2,735,000 for the 1999 period compared to the 1998
period was primarily due to an increase in the net loss. This resulted from
additional employees hired in the sales department for the expansion of
domestic and foreign territories. Also, the intensive marketing efforts of
the newly formed marketing department regarding the rebranding campaign of
the IPAD products contributed to the loss. There were also merger related
costs of about $900,000 incurred during 1999 for legal, accounting and
consulting fees, relocation costs and integration of the companies related to
the Merger.
Net cash provided by investing activities for the six months ended
June 30, 1999 was $1,893,000 compared with $229,000 used by investing
activities for the six months ended June 30,
19
<PAGE>
1998. The increase of $2,122,000 for the 1999 period compared to the 1998
period was primarily due to $2,000,000 of investments maturing during the
quarter. In addition, purchases of property and equipment decreased about
$65,000 due to operations being more established at that point in time.
Net cash provided by financing activities for the six months ended June
30, 1999 was $3,997,000 compared with $8,025,000 for the six months ended
June 30, 1998. The decrease of $4,028,000 for the 1999 period compared to the
1998 period was primarily due to $5,531,000 for the net proceeds from the
June private placement of 1,468,941 shares of common stock, and the
$1,400,000 received from the net proceeds of the 1998 public offering of
1,550,000 shares. Additional financing activities during the six months ended
June 30, 1998 included private transactions with officers, directors, and
consultants, the exercise of 250,000 warrants and 60,000 employee options,
proceeds from the line of credit, conversion of promissory notes, and
deferred offering costs. In June 1999, net proceeds of $2,675,000 were
received as a result of the issuance of convertible subordinated debentures.
Additional financing activities during the six months ended June 30, 1999
included exercise of options and warrants, proceeds from subscriptions
receivable, and payments and proceeds from the line of credit and short term
debt.
RESULTS OF OPERATIONS FOR THREE MONTHS ENDED JUNE 30, 1999
COMPARED TO THE THREE MONTHS ENDED JUNE 30, 1998
Quarterly revenues totaled $1,526,000 versus revenue of $2,068,000 for
the comparable quarter in 1998. This represents a decrease of $542,000 or 26%
over the comparable quarter in 1998. The decrease is partly associated with a
price decrease of the TEAM Internet 2500, which was necessary in order to
remain competitive in the market place. In addition, most of the distributors
in place during the first quarter 1998 signed agreements in mid to late 1998
containing termination clauses, which preclude the Company from recognizing
revenue until the product has been sold through to resellers. During the
first quarter, in connection with the proposed Apexx merger the Company
de-emphasized the sales of the IPAD 1200 and replaced it with Apexx's TEAM
Internet 100. For the quarter ending June 30, 1999, the Company experienced
sales growth of $363,000 or 31% revenue growth over the 1999 first quarter
results.
Gross profit margin in the current quarter was 45% of revenue $687,000
compared to 57% $1,185,000 for the three months ended June 30, 1998. The
decrease is associated with the price decrease of the TEAM Internet 2500 with
no corresponding decrease in the Company's cost. In addition, the replacement
of the IPAD 1200 with Apexx's TEAM Internet 100 caused margins to decrease.
Once the TEAM Internet 100 inventory is replenished, margins are expected to
increase.
Selling, General and Administrative, Engineering and R&D Expenses
increased $1,313,000 or 73% from $1,795,000 for the quarter ending June 30,
1998 to $3,108,000 for the quarter ending June 30, 1999. Sales and marketing
expenses increased $332,000 from $821,000 in 1998 to $1,153,000 in 1999. The
significant increases in expenditures are attributed to the addition of the
marketing department late in December 1998 and the addition of sales people
in order to expand
20
<PAGE>
sales efforts domestically and internationally. There are six employees in
the newly formed Marketing Department, and three CDRs have been added in the
Sales Department. General and administrative expense increased $894,000 from
$654,000 in 1998 compared to $1,548,000 for the current quarter. The majority
of the increase can be attributed to merger costs, salaries, and consultants.
Engineering and tech support expenses increased $140,000 from $164,000 in
1998 compared to $304,000 in 1999. The increase relates to additional
employees and moving expenses related to the merger. The SG&A will continue
to grow with the anticipated addition of new hires to augment the Company in
all departments as growth in revenues dictates. Amortized software
development costs total $42,000 for the quarter.
Interest expense increased $40,000 in the three months ended June 30,
1999 from $11,000 in 1998 to $51,000 in 1999. The additional interest is due
to the interest and discount amortization on the convertible subordinated
debentures and amortization of deferred offering costs. Interest income
decreased $12,000 in the quarter. This decrease is associated with funds
received from the completion of the private placement at the end of the
second quarter in 1998.
Net loss from operations was ($2,557,000) for the three months ended
June 30, 1999, compared to ($600,000) for the same period in 1998, an
increase in the loss of ($1,957,000) 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. Merger costs also
contributed to the increase. Losses are anticipated to continue through the
current fiscal year due to expenditures in support of continued growth and
additions of new hires.
RESULTS OF OPERATIONS FOR SIX MONTHS ENDED JUNE 30, 1999
COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1998
Revenues for six months of operations totaled $2,689,000 compared to
revenues of $3,547,000 for the same period in 1998. This represents a
decrease of $858,000 or 24% over the comparable six month period in 1998. The
decrease is partly associated with a price decrease of the TEAM Internet
2500, which was necessary in order to remain competitive in the market place.
In addition, most of the distributors in place during the first quarter 1998
signed agreements in mid to late 1998 containing termination clauses, which
preclude the Company from recognizing revenue until the product has been sold
through to resellers. During the first quarter, in connection with the
proposed Apexx merger the Company de-emphasized the sales of the IPAD 1200
and replaced it with Apexx's TEAM Internet 100.
Gross profit margin was 42% of revenue $1,143,000 compared to 56%
$1,971,000 for the six months ended June 30, 1998. The decrease is
associated with the price decrease of the TEAM Internet 2500 with no
corresponding decrease in the Company's cost. In addition, the replacement of
the IPAD 1200 with Apexx's TEAM Internet 100 caused margins to decrease. Once
the TEAM Internet 100 inventory is replenished, margins are expected to
increase. Furthermore, approximately 36% of the first quarter sales of 1999
were comprised of network interface cards sold to eNetCo, in which the gross
profit margin was 36%. The sales of these
21
<PAGE>
cards in 1999 were made in relation to sales of TEAM Internet products to
eNetco at the end of 1998.
Selling, General and Administrative, Engineering and R & D Expenses
(SG&A) increased $4,044,000 or 134% from $3,022,000 for the first six months
in 1998 to $7,066,000 for the same six months in the 1999 period. Sales and
marketing expenses increased $2,040,000 from $1,382,000 in 1998 to $3,422,000
in 1999. The significant increases in expenditures are attributed to the
addition of the marketing department late in December 1998 and the addition
of sales people in order to expand sales efforts domestically and
internationally. There are six employees in the newly formed Marketing
Department, and seven CDRs have been added in the Sales Department. In
addition, an extensive marketing campaign was launched to rebrand the
products. General and administrative expense increased $1,796,000 from
$1,107,000 in the 1998 period compared to total expenses of $2,903,000 in
1999. The majority of the increase can be attributed to merger costs,
salaries, consultants, and printing fees for SEC filings. Engineering
expenses increased $221,000 from $255,000 for the six months ending June 1998
to $476,000 for the same period in 1999. The increase is associated with
salaries and moving expenses related to the merger. Amortized software
development costs total $84,000 for the period.
Interest expense increased $48,000 in the six months ended June 30, 1999
from $12,000 in 1998 to $60,000 in 1999. The additional interest is due to
the interest and discount amortization on the convertible subordinated
debentures and amortization of deferred offering costs. Interest income
increased $14,000 for the six month period. This increase is associated with
funds received from the completion of the private placement at the end of the
second quarter in 1998.
Net losses from operations totaled ($6,044,000) for the six months ended
June 30, 1999, compared to ($1,043,000) loss for the same period in 1998, an
increase in the loss of ($5,001,000) 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.
Income Taxes
At June 30, 1999, a valuation allowance for 100% of the deferred tax
asset has been recorded, as Management of the Company is not able to
determine that it is more likely than not that its deferred tax assets will
be realized. The Company has recorded a valuation allowance primarily related
to the uncertainty of realizing operating loss carryforwards subject to
limitations under Section 382 of the Internal Revenue Code.
Year 2000 Effect
22
<PAGE>
The TEAM Internet and IPAD product lines have no known susceptibility to
the year 2000 issues. The testing completed on the product lines to date has
lead the Company to believe that the products will not be affected by a
connection to a non-compliant Y2K system. However the Company's testing does
not cover every possible computing environment. Accordingly, some customers
may have Y2K problems with products that the Company believes are Y2K
compliant. All new products and upgrades introduced by the Company will be
Y2K compliant. The Company has reviewed its internal systems, including its
accounting system, and has found them to be Y2K compliant. The Company's
internal operations and business are also dependent upon the
computer-controlled systems of third parties such as suppliers, customers and
service providers. Management believes that absent a systematic failure
outside the control of the Company, such as a prolonged loss of electrical or
telephone service, Y2K problems at such third parties will not have a
material impact on the Company. The Company has no contingency plan for
systemic failures such as loss of electrical or telephone service. The
Company's contingency plan in the event of a non-systemic failure is to
establish relationships with alternative suppliers or vendors to replace
failed suppliers or vendors. Spending by the Company on compliance to date
has not been material. Other year 2000 items are not anticipated to be
material.
Impact of Recently Issued Accounting Standards
None.
23
<PAGE>
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
Votes taken on May 20, 1999 included the following:
1. Proposal to approve an amended and restated agreement and plan of merger
dated as of January 25, 1999 by and between the Company, eSoft
Acquisition Corporation and Apexx
2. Proposal to elect Jeffrey Finn as a Class I director of the Company
3. Proposal to amend the Company's equity incentive plan to increase the
number of shares issuable under the plan from 1,700,000 shares to
2,900,000 shares
24
<PAGE>
4. Proposal to approve other such matters as may properly be presented at
the annual and special meeting or any postponement or adjournment thereof
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.
On June 9, 1999, the Company filed a Current Report on
Form 8-K, dated May 14, 1999, to report, under Item 2, the
acquisition of Apexx Technology, Inc. in a merger, and to report,
under Item 5, the sale and issuance of 156,250 shares of Common
Stock.
On June 25, 1999, the Company filed a Current Report on
Form 8-K, dated June 10, 1999, to report, under Item 5, the sale and
issuance of Convertible Subordinated Debentures for gross proceeds
of $3,000,000.
25
<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.
eSoft, Inc.
(Registrant)
Date: August 16, 1999 /s/ Jeffrey Finn
-------------------- ------------------------------
Jeffrey Finn
President, Chief Operating Officer
Date: August 16, 1999 /s/ Amy Beth Hansman
-------------------- ------------------------------
Amy Beth Hansman
Chief Accounting Officer
26
<PAGE>
Exhibit Index
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
27.1 Financial Data Schedule
27.2 Financial Data Schedule-Restated
</TABLE>
27
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENTS OF OPERATIONS AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 1,765,216
<SECURITIES> 0
<RECEIVABLES> 3,356,872
<ALLOWANCES> (373,919)
<INVENTORY> 743,732
<CURRENT-ASSETS> 5,591,139
<PP&E> 728,180
<DEPRECIATION> (386,321)
<TOTAL-ASSETS> 7,167,166
<CURRENT-LIABILITIES> 3,090,632
<BONDS> 1,924,710
93,489
0
<COMMON> 0
<OTHER-SE> 2,058,335
<TOTAL-LIABILITY-AND-EQUITY> 7,167,166
<SALES> 2,689,219
<TOTAL-REVENUES> 2,689,219
<CGS> 1,545,735
<TOTAL-COSTS> 7,066,167
<OTHER-EXPENSES> 61,202
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 59,990
<INCOME-PRETAX> (6,043,875)
<INCOME-TAX> 0
<INCOME-CONTINUING> (6,043,875)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (6,043,875)
<EPS-BASIC> (0.68)
<EPS-DILUTED> (0.68)
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AND CONSOLIDATED STATEMENTS OF OPERATIONS AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 6,026,765
<SECURITIES> 0
<RECEIVABLES> 2,193,934
<ALLOWANCES> (86,859)
<INVENTORY> 493,671
<CURRENT-ASSETS> 8,839,225
<PP&E> 617,171
<DEPRECIATION> (277,728)
<TOTAL-ASSETS> 9,795,735
<CURRENT-LIABILITIES> 1,504,856
<BONDS> 117,752
82,495
0
<COMMON> 0
<OTHER-SE> 7,910,632
<TOTAL-LIABILITY-AND-EQUITY> 9,795,735
<SALES> 3,546,675
<TOTAL-REVENUES> 3,546,675
<CGS> 1,575,684
<TOTAL-COSTS> 3,022,322
<OTHER-EXPENSES> (19,896)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11,762
<INCOME-PRETAX> (1,043,197)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,043,197)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,043,197)
<EPS-BASIC> (0.18)
<EPS-DILUTED> (0.18)
</TABLE>
