<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 March 31, 2000
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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
- ------------------------------- --------------------------------
(303) 444-1600
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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
----- -----
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 May 1, 2000 was 16,054,594.
<PAGE>
eSoft, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION Page
----
<S> <C>
Item 1. Consolidated Financial Statements 3 - 13
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14 - 19
PART II OTHER INFORMATION 20 - 24
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 - CONSOLIDATED FINANCIAL STATEMENTS
eSoft, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1999 2000
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 8,576,055 $ 6,340,614
Accounts receivable:
Trade, less allowance of $310,453 and $225,615 for doubtful
accounts 1,454,471 1,962,420
Trade, related party 912,500 1,756,500
Inventories 672,691 618,583
Prepaid expenses and other 158,261 352,519
------------ ------------
Total current assets 11,773,978 11,030,636
------------ ------------
PROPERTY AND EQUIPMENT
Computer equipment 718,122 815,930
Furniture and equipment 326,092 356,300
Leasehold Improvements 176,314 175,915
Less accumulated depreciation (660,904) (722,813)
------------ ------------
Net property and equipment 559,624 625,332
------------ ------------
OTHER ASSETS
Capitalized software costs, net of accumulated amortization 702,417 403,417
Deferred financing costs 283,215 253,191
Other assets 39,557 -
------------ ------------
Total other assets 1,025,189 656,608
------------ ------------
TOTAL ASSETS $ 13,358,791 $ 12,312,576
============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
3
<PAGE>
eSoft, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1999 2000
------------ ------------
(UNAUDITED)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 831,496 $ 1,067,319
Deferred revenue 289,590 432,496
Customer deposits - 31,718
Accrued expenses:
Payroll and payroll taxes 185,983 233,590
Other 454,815 513,175
------------ ------------
Total current liabilities 1,761,884 2,278,298
LONG TERM LIABILITIES
Convertible debenture 1,198,254 1,279,764
------------ ------------
Total liabilities 2,960,138 3,558,062
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share;
authorized 50,000,000 shares; 14,289,075 and
14,520,840 issued and outstanding December 31,
1999 and March 31, 2000 142,890 145,208
Additional paid-in capital 24,999,820 25,229,051
Notes receivable (39,704) (9,907)
Accumulated deficit (14,704,353) (16,609,838)
------------ ------------
Total stockholders' equity 10,398,653 8,754,514
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 13,358,791 $ 12,312,576
============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
4
<PAGE>
eSoft, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
1999 2000
------------ ------------
<S> <C> <C>
REVENUES:
Product $ 1,721,917 $ 2,203,801
Services - 919,000
------------ ------------
Total revenues 1,721,917 3,122,801
------------ ------------
COST OF GOODS SOLD:
Product 884,610 1,151,488
Services - 101,384
------------ ------------
Total cost of goods sold 884,610 1,252,872
------------ ------------
GROSS PROFIT 837,307 1,869,929
------------ ------------
OPERATING EXPENSES:
Sales and marketing expense 2,459,303 1,555,007
General and administrative expense 1,544,080 1,130,053
Engineering expense 291,717 555,005
Software amortization costs 41,827 299,000
Research and development 207,094 202,572
------------ ------------
4,544,021 3,741,637
------------ ------------
Loss from operations (3,706,714) (1,871,708)
------------ ------------
OTHER INCOME (EXPENSE):
Other income 3,552 -
Realized gain(loss) on sale of investments 146,317 -
Unrealized gain(loss) on investments (183,189) -
Interest income 24,948 103,007
Interest expense (8,945) (136,784)
------------ ------------
(17,317) (33,777)
------------ ------------
NET LOSS $ (3,724,031) $ (1,905,485)
============ ============
BASIC AND DILUTED LOSS PER
COMMON SHARE $ (.38) $ (.13)
============ ============
BASIC AND DILUTED WEIGHTED
AVERAGE SHARES OUTSTANDING 9,841,845 14,306,065
============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
5
<PAGE>
eSoft, INC. AND SUBSIDIARIES
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, 2000 14,289,075 $ 142,890 $ 24,999,820 $ (39,704) $(14,704,353) $ 10,398,653
Exercise of warrants and options 231,017 2,310 184,592 - - 186,902
Issuance of common stock for compensation 748 8 19,639 - - 19,647
Collection of notes receivable for
exercise of options and warrants - - - 29,797 - 29,797
Issuance of compensatory options - - 25,000 - - 25,000
Net loss for the three months ended
March 31, 2000 - - - - (1,905,485) (1,905,485)
---------- ------------ ------------ ---------- ------------ ------------
BALANCE, March 31, 2000 14,520,840 $ 145,208 $ 25,229,051 $ (9,907) $(16,609,838) $ 8,754,514
========== ============ ============ ========== ============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
6
<PAGE>
eSoft, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
MARCH 31,
1999 2000
--------- --------
<S> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES
Net loss from operations $(3,724,031) $(1,905,485)
Adjustments to reconcile net loss to net cash used in operating
activities: 84,385 360,909
Depreciation & software amortization
Loss on sale of assets 10,536 -
Provision for losses on accounts receivable 67,211 62,696
Amortization of discount on investments (8,459) -
Amortization of debt discounts and financing costs - 111,534
Amortization of warrant valuation granted for prepaid
Consulting 52,469 -
Issuance of compensatory options 8,911 25,000
Issuance of common stock for bonuses - 19,647
Proceeds from sale of trading securities 36,872 -
Realized loss from sale of trading securities 146,317 -
Changes in operating assets and liabilities:
Accounts receivable - trade 171,958 (570,645)
Accounts receivable - related party - (844,000)
Inventories 337,523 54,108
Prepaid expenses (81,305) (184,427)
Other assets (24,830) 29,726
Accounts payable 659,151 235,823
Customer deposits - 31,718
Accrued expenses (175,718) 105,967
Deferred revenue 84,257 142,906
--------- --------
Net cash used in operating activities (2,354,753) (2,324,523)
--------- --------
INVESTING ACTIVITIES
Proceeds from sale of investments 2,000,000 -
Purchase of property and equipment (53,428) (127,617)
Deposits on leased facilities 85,000 -
Additions to capitalized software (2,650) -
--------- --------
Net cash provided by (used in) investing activities 2,028,922 (127,617)
--------- --------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
7
<PAGE>
eSoft, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
1999 2000
----------- -----------
<S> <C> <C>
CASH FLOW FROM FINANCING ACTIVITIES
Proceeds from stock subscription receivable - 29,797
Proceeds from line of credit, net 165,000 -
Payments on short term debt (13,722) -
Proceeds from short term debt 117,794 -
Re-payment on margin loan on investments (39,544) -
Proceeds from exercise of options and warrants
and sale of Stock 351,956 186,902
----------- -----------
Net cash provided by financing activities 581,484 216,699
----------- -----------
INCREASE (DECREASE) IN CASH 255,653 (2,235,441)
CASH: BEGINNING OF PERIOD 732,384 8,576,055
----------- -----------
CASH: END OF PERIOD $ 988,037 $ 6,340.614
=========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS AND
NON-CASH FINANCING ACTIVITIES
CASH PAID DURING THE PERIOD FOR:
Interest $ 4,674 $ 25,000
=========== ===========
NON-CASH FINANCING ACTIVITIES:
Common stock issued for subscriptions receivable $ 193,947 -
=========== ===========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
8
<PAGE>
eSoft, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The consolidated interim financial statements include the accounts of
eSoft, Inc. and its two wholly-owned subsidiaries, Apexx Technology, Inc.
("Apexx") and Technologic, Inc. ("Technologic"), (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, 1999. The Company
follows the same accounting policies in preparation of interim reports.
The consolidated financial statements of the Company for the three months
ended March 31, 1999 have been restated to give retroactive effect to the
mergers with Apexx on May 25, 1999 and Technologic on September 10, 1999,
which have 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 mergers 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 and
8-K/A for Apexx was filed with the Securities & Exchange Commission on
August 9, 1999 and for Technologic on September 27, 1999, and
November 17, 1999, respectively.
Results of operations for the interim periods are not necessarily
indicative of annual results.
2. Business Acquisitions
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 1,591,365 shares
of eSoft common stock and for the conversion of all Apexx stock
9
<PAGE>
eSoft, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
options into eSoft stock options to acquire 1,356,003 shares of eSoft
common stock. The Merger has been accounted for as a pooling of interests.
Effective September 10, 1999, the Company completed the merger (the
"Merger") with Technologic located in Norcross, Georgia, which provided for
the exchange of all of the outstanding stock of Technologic for 1,244,436
shares of eSoft common stock and for the conversion of all Technologic
stock options into eSoft stock options to acquire 180,555 shares of eSoft
common stock. The Company also issued 75,000 shares of the Company's common
stock to the investment bankers of Technologic in connection with the
merger. The Merger has been accounted for as a pooling of interests. Merger
costs of about $725,000 in relation to this merger were expensed during the
third quarter, which include bankers fees, audit fees, legal fees, and
printing fees.
<TABLE>
<CAPTION>
POOLING COMPANY NATURE OF OPERATIONS MERGER DATE
<S> <C> <C>
Apexx Technology, Inc. Internet connectivity solutions May 25, 1999
Technologic, Inc. Internet connectivity solutions September 10, 1999
</TABLE>
Revenue, net loss and net loss per common share of eSoft, as previously
reported and combining Apexx and Technologic as consolidated for the
periods presented are as follows:
<TABLE>
<CAPTION>
REVENUE:
Three Months Ended March 31, 1999
<S> <C>
eSoft, as previously reported $ 553,067
Apexx 610,041
Technologic 558,809
-----------
eSoft, consolidated, as restated $ 1,721,917
===========
NET LOSS:
Three Months Ended March 31, 1999
eSoft, as previously reported $(2,729,323)
Apexx (757,823)
Technologic (236,885)
-----------
eSoft, consolidated, as restated $(3,724,031)
===========
</TABLE>
10
<PAGE>
eSoft, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
<TABLE>
<CAPTION>
NET LOSS PER COMMON SHARE:
Three Months Ended March 31, 1999
<S> <C>
As previously reported:
Basic and diluted $ (0.39)
Consolidated, as restated:
Basic and diluted $ (0.38)
</TABLE>
3. Trade Receivables
The following information summarizes accounts receivable:
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1999 2000
------------ ---------
<S> <C> <C>
Accounts Receivable 1,764,924 2,188,035
Allowance for doubtful accounts (310,453) (225,615)
----------- -----------
$ 1,454,471 $ 1,962,420
=========== ===========
</TABLE>
The Company did not have any customers which accounted for 10% or more
of the sales through the three months ending March 31, 2000. International
sales represented approximately 26% of revenue for the three months ending
March 31, 2000.
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. Trade Receivable-Related Party related
During 1999, the Company has entered into an agreement with a
stockholder of the Company, to jointly architect and design certain
software applications. The agreement grants the stockholder of the Company
the right to use or sell the stockholder's products, which include the
Company's software, as well as the right to modify the software and related
products. The Company has recognized revenue of $2,450,000 to date in
accordance with the percentage of completion method of which $1,756,500 is
due to the Company at March 31, 2000. Subsequent to March 31, 2000,
$587,500 of the balance has been received.
5. Subscription Receivable
The Company 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. At March 31, 2000, $1,845 of interest receivable
has been recognized and $67,938 has been paid on these notes receivable.
11
<PAGE>
eSoft, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
6. Convertible debenture
In September 1999, the Company issued $2,000,000 of unsecured 5%
Convertible Debentures issued at a 2.5% discount, due June 10, 2002
("Debentures") and stock purchase warrants ("warrants") with a right to
purchase an aggregate of 511,182 shares of common stock, par value $.01 per
share, at an exercise price of $4.4994, The principal amount of the
Debenture 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 anti-dilution 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 $3 million of debentures, together
with warrants to purchase shares of common stock of the Company equal to
the quotient obtained by dividing $3 million by the conversion price for
the debentures with an exercise price of 115% of the debenture conversion
price. The additional $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 debentures are manditorily
convertible if the average per share market value over thirty consecutive
trading days exceed 200% of the exercise price of the warrants. The Black
Scholes value of the warrants issued, of $846,607 plus an initial discount
of $50,000 related to the aforementioned 2.5% discount, for a total of
$896,607, was recorded as an original issue discount and is being amortized
over the term of the debentures and recorded as non-cash interest expense.
At March 31, 2000, the balance of the unamortized original issue discount
was $720,236. The balance of the Convertible Debentures at March 31, 2000
of $1,279,764, represents the original face value of the remaining
outstanding debentures, of $2,000,000 less the balance of the unamortized
discount, of $720,236.
7. Net Loss per Share
Basic loss per share is calculated by dividing the net 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.
Options and warrants to purchase 3,001,162 and 3,351,556 shares of
common stock and notes convertible into 0 and 511,182 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
March 31, 1999 and 2000, respectively.
8. Subsequent event
On April 26, 2000, eSoft entered into a Common Stock and Warrant
Purchase and Investor Rights Agreement with Gateway Companies, Inc. for
the investment of $25,000,000 in exchange for 1,281,592 shares of common
stock, calculated at $19.507 per share. Should an underwritten public
offering occur within nine months of the closing, the number of shares
would be adjusted in accordance with the agreement to a 6.5% discount to
the public offering price. The payment of the purchase price is to be
made in two equal
12
<PAGE>
eSoft, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
installments, with 50% paid at closing (April 26, 2000), and 50% paid
ninety days after the closing. Warrants to purchase 600,000 shares of
common stock at the same purchase price were also issued at the closing,
vesting in accordance with performance milestones as indicated in the
agreement.
13
<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 statements 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, possible delays
in the marketing strategy or efforts of eSoft's strategic partners, or
delays in eSoft's shift to a subscription based model of product
delivery, each of 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.
Our products provide all of the components an organization needs to
develop, manage, and monitor its Intranet, external web presence and
Internet-based applications. Our Linux-based applications such as web
hosting, business-to-business communications, virtual private networks,
remote information technology services and firewall protection are designed
to coexist with multiple hardware platforms. Our software applications and
operating system are engineered to provide a fully integrated, secure and
reliable solution.
Our software solutions target small-to-medium sized businesses (SMB)
that typically have between ten and two hundred desktop computers connected
to a local area network, or LAN. The availability of low cost, high speed
bandwidth, through technologies such as cable modems and digital subscriber
line or DSL is driving small-to-medium sized business demand for full time
Internet access across their LANs. The SMB segment comprises the largest
portion of the installed local area networks and these businesses
increasingly recognize the importance of the Internet to grow their
business and improve productivity. Internet penetration has been
estimated to increase from
14
<PAGE>
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.
Our products enable small-to-medium sized businesses to establish
and enhance their Web presence and conduct business and electronic
commerce on the Internet. Most of the end users of our products are
relatively price sensitive, and most have limited in-house technical
expertise. eSoft's products are designed to provide cost-effective
Internet connectivity solutions that are easy to install and maintain by
the end user's existing personnel. Our TEAM Internet product is a
complete, stand-alone plug-and-play Internet connectivity solution that
can be installed and maintained by non-technical personnel at a fraction
of the cost of a traditional solution. Our products can provide all of
the users on a LAN with a shared dedicated Internet connection, which
allows our customers to achieve both expense and productivity
improvements when compared to traditional single user dial-up access. In
addition, our Linux-based Internet connectivity software solutions allow
our customers to access the Internet in a reliable, secure and flexible
manner. Our software products are built using modular architecture,
allowing scalability to fit the customers' growing needs. The ability to
easily add additional Internet appliances and application services
provides an evolution path that allows customers to develop their
network services and its architecture according to their needs without a
high upfront investment. Our Internet applications facilitate the
migration from limited, dial-up analog modems to an economical,
feature-rich, easy-to-use Internet communications device.
In addition to our core services, we currently offer managed services
including firewall management, virtual private network management, URL
screening, web filtering, spam filtering and content filtering. Managed
services provide flexibility in meeting the needs of small to medium-sized
businesses during each stage of their development. We design our managed
services offerings to allow smaller businesses to outsource the
infrastructure and services necessary to support the use of these
applications. Our remote management of these services allows our clients to
focus on their core competencies. In the future, we intend to add LAN
management and database backup to our managed services.
eSoft has been expanding its customer base through software licensing
to major hardware manufacturers (OEMs). In the past, eSoft has relied
primarily on its own sales force, and value added resellers signed up by
our sales force, to sell and distribute our products. During 1999, we
launched our redphish(TM) program. redphish combines licensing of our
software with professional engineering services in order to create highly
specialized or customized offerings for hardware manufacturers and
broadband service providers to integrate into their own offerings. This
allows us to leverage our expertise in software development and delivery,
along with our partners' expertise in hardware design, manufacturing and
distribution. We believe that the redphish program is highly complementary
to our Internet Server products activities, as it greatly improves our
distribution capabilities and helps to drive product requirements, and that
it enables us to gain time to market advantages in developing new software
features, as well as building out our distribution network. The product
architecture roadmap has a modular design that utilizes an Internet gateway
providing small and medium-sized businesses with basic Internet
connectivity and e-mail capabilities. The architecture provides for modular
applications that provide functions such as web server, firewall, enhanced
e-mail, virtual private networks and web screening. This architecture is
designed to enable us to quickly create a bundled offering specific to
third party manufacturer's requirements.
15
<PAGE>
Our redphish program provides a vehicle through which major hardware
manufacturers can deliver customized Internet connectivity and
"edge-of-network" solutions to their small and medium-sized customers.
Delivered initially as a basic Internet connectivity solution, this
platform can later serve as a foundation for additional products and
services, such as enhanced e-mail, virtual private networking, and
business-to-business applications. Our program is based on revenue sharing,
which provides incentive at every point of the distribution chain. In 1999,
we signed our first two redphish partners, Intel Corporation and
Hewlett-Packard Corporation. Both companies plan to distribute eSoft
licensed software beginning in the year 2000. In early 2000, we added
Compaq Corporation and Gateway, Inc. to our list of redphish partners. Our
strategy is to continue to aggressively develop additional redphish
licensing partnerships with key hardware and service providers.
During 1999, most of our product revenue was generated from one-time
product sales. This approach maximized short-term revenue, but made ongoing
revenue predictions difficult. Now, we are moving aggressively toward a
subscription-based model, which minimizes the cash outlay requirements for
our customers and generates a more predictable recurring revenue stream
associated with each sale. The subscription model applies to both our core
gateway technology and to optional snap-in modules, such as enhanced
firewall, web filtering, and many other applications. eSoft believes that a
subscription-based pricing model will result in better predictability of
future revenue, and will also better suit the cash flow requirements of our
small and medium size business customers. As we move forward, we expect
that our pricing model will be restructured to emphasize monthly licensing
fees as opposed to one-time revenue. Monthly fees will be associated with
both our base products and follow on offerings. After small to medium size
businesses address their initial connectivity and security requirements,
they tend to become more sophisticated in their use of the Internet, and
they require corresponding new capabilities to address their needs. For
example, web content filtering, virtual private networking, and specific
business-to-business applications are often desired. Our strategy is to
develop and license complimentary products to our customers, further
enhancing our life-of-customer relationship and long term revenue stream.
Application solution providers, or ASPs, offer solutions that provide
shared application content to end-users on a need-to-access basis. However,
most ASPs do not have a means for delivery of local information at the
business site. Over time, we believe that a local application presence (of
some components) will be a necessary differentiator for success with
ASP-based solutions. eSoft will seek to expand its relationships with ASPs
worldwide, looking for best-of-breed solutions for various market segments.
Widespread availability of broadband Internet access is a global
phenomenon. We plan to continue to expand our direct presence in key non-US
markets. During 1999, we established an office in Singapore and during
early 2000, we established an office in the United Kingdom. We also expect
to establish a local presence in Japan, Korea, and other key European and
Asian locations.
The Company expects to use outside financing for the continued company
wide expansion. Additional employees in sales, marketing, engineering, and
operations will be hired in connection with increased market penetration.
With the current increase in headquarters staff,
16
<PAGE>
the Company leased additional space in early 2000. 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 2001 through the
increase in sales and related margins, while keeping operating expenses
fairly constant.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash position on March 31, 2000 was $6,341,000 a
decrease of $2,235,000 from year end primarily due to funding operating
losses. The Company's working capital at March 31, 2000 was $8,752,000 a
decrease of $1,260,000 from December 31, 1999. Management anticipates
continuing losses in support of the growth initiatives and, thus expects
continued negative cash flow. 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
the days sales outstanding. The Company has analyzed its accounts
receivable and adjusted its allowance for doubtful accounts to $226,000
at March 31, 2000. Accounts receivable, related party relate to software
development fees and licensing fees, which are recognized in accordance
with guidelines noted in Statements of Position (SOP) 97-2, "Software
Revenue Recognition" and SOP 81-1, "Accounting for Performance of
Construction - Type and Certain Production-Type Contracts". The Company
has expended $128,000 in capital expenditures, mainly attributable to
additional computers purchased for new employees, and a
videoconferencing system intended to enhance communications among the
offices. Management believes that its current cash position, the
anticipated cash receipts from receivables, and available sources of
additional capital will be sufficient to meet its working capital needs
for the foreseeable future.
Subsequent event
On April 26, 2000, eSoft entered into a Common Stock and Warrant
Purchase and Investors Rights Agreement with Gateway Companies, Inc. for
the investment of $25,000,000 in exchange for 1,281,592 shares of common
stock, calculated at $19.507 per share. Should an underwritten public
offering occur within nine months of the closing, the number of shares
would be adjusted in accordance with the agreement to a 6.5% discount to
the public offering price. The payment of the purchase price is to be
made in two equal installments, with 50% paid at closing (April 26,
2000), and 50% paid ninety days after the closing. Warrants to purchase
600,000 shares of common stock at the same purchase price were also
issued at the closing, vesting in accordance with performance milestones
as indicated in the agreement.
CASH FLOW
Net cash used in operating activities for the three months ended March
31, 2000 was $2,325,000 compared with $2,355,000 for the three months ended
March 31, 1999, a decrease of $30,000. The Company's net loss at March 31,
2000 was ($1,905,000), a decrease of $1,819,000 from March 31, 1999. This
decrease in net loss was primarily the result of the intensive marketing
campaign done in 1999 regarding the rebranding of the IPAD products. There
were also merger related costs incurred during 1999 for legal, accounting,
banking, and consulting fees. The increase in accounts receivable of
$1,415,000, mainly related to software development and licensing, also
17
<PAGE>
contributed to the use of operating funds. Other items impacting the cash
used in operating activities were adjustments of $361,000 for depreciation
and amortization and $112,000 for amortization of debt discounts and
financing costs. In addition, accounts payable increased $236,000, accrued
expenses increased $106,000, customer deposits increased 32,000, and
deferred revenue increased $143,000.
Net cash used in investing activities for the three months ended March
31, 2000 was $128,000 compared with $2,029,000 provided by investing
activities for the three months ended March 31, 1999. The decrease in cash
of $2,157,000 for the 2000 period compared to the 1999 period was primarily
due to $2,000,000 of investments maturing during the 1999. In addition,
purchases of property and equipment increased about $75,000 due to
expansion of facilities for increased headcount. The Company employed over
100 people at March 31, 2000.
Net cash provided by financing activities for the three months ended
March 31, 2000 was $217,000 compared with $581,000 for the three months
ended March 31, 1999. The decrease of $364,000 for the 2000 period compared
to the 1999 period was primarily due to a decrease of proceeds from
exercise of options and warrants of $165,000. In addition, net proceeds
from debt decreased $229,000.
RESULTS OF OPERATIONS FOR THREE MONTHS ENDED MARCH 31, 2000
COMPARED TO THE THREE MONTHS ENDED MARCH 31, 1999
Quarterly revenues totaled $3,123,000, of which $2,204,000 was related
to product and $919,000 was related to services, versus revenue of
$1,722,000 for the comparable quarter in 1999, all of which was related to
product. In total, revenue increased $1,401,000 or 81% over the comparable
quarter in 1999. Product sales increased 28% for the three months ending
March 31, 2000 compared to the three months ending March 31, 1999. The
increase is partly due to the addition of sales people towards the end of
1999 in the international markets of Europe, Latin America and the Asia
Pacific. International sales accounted for 26% of product revenue in 2000.
The services revenue was generated from engineering fees for development of
software and related licensing fees in connection with agreements with
Intel, Inc., and Compaq.
Gross profit margin in the current quarter was $1,870,000, which is
60% of revenue compared to $837,000, which is 49% of revenue for the three
months ended March 31, 1999. The increase is partially due to $919,000 of
software revenue included in the quarter ending March 31, 2000, with
related cost of goods of $101,000, and a gross margin of 89%. The product
gross margin for the current quarter was 48%, compared to 49% for the
quarter ended March 31, 1999. The decrease is a result of sales promotions
such as discounts of fifty percent being given to new customers or
customers who purchased two of the same product, which were not done in
1999.
Operating expenses decreased $802,000 or 18% from $4,544,000 for the
quarter ending March 31, 1999 to $3,742,000 for the quarter ending March
31, 2000. Sales and marketing expenses decreased $904,000 from $2,459,000
in 1999 to $1,555,000 in 2000. In 1999 an extensive marketing campaign was
launched with Apexx Technology for the rebranding of the products in
connection with the merger. Adding to the decrease was the careful
monitoring of how marketing dollars are best put to use. Offsetting the
decrease was the cost of additional sales
18
<PAGE>
people hired to expand sales efforts domestically and internationally.
General and administrative expenses decreased $414,000 from $1,544,000
in 1999 compared to $1,130,000 for the current quarter. This decrease
can be attributed to the costs relating to the Apexx merger in 1999,
which include filing fees, audit fees, legal fees, and printing fees
that did not recur in 2000. There were also about $300,000 in banking
and consulting fees related to the merger in the first quarter of 1999,
which did not recur in 2000. Engineering expenses increased $263,000
from $292,000 in 1999 to $555,000 in 2000. This increase was related to
six additional engineers hired in response to the demand for software
development under the redphish division and increased travel in relation
to these projects as well. Engineering expenses also increased due to
technical support services being contracted out for the european
operations, additional employees being eligible for bonuses, and the
exercises of options taking place. The Company will continue to closely
monitor the operating expenses. Amortized software development costs
total $299,000 for the current quarter, compared to $42,000 in the first
quarter of 1999. This increase is associated with the life of the
software being reevaluated and amortization being accelerated for
certain older versions of software.
Interest expense increased $128,000 in the three months ended March
31, 2000 from $9,000 in 1999 to $137,000 in 2000. 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 $78,000 in the quarter in relation to additional
cash on hand related to equity investments and the exercise of warrants and
options in the fourth quarter of 1999.
Net loss was ($1,905,000) for the three months ended March 31, 2000,
compared to ($3,724,000) for the same period in 1999, a decrease in the
loss of ($1,819,000) over the same period. The net losses and associated
decrease in the net loss is a result of increased operating expenses
necessary to support its current business strategy, which is offset by
increased revenues. Losses are anticipated to continue through the current
fiscal year due to expenditures in support of continued growth and market
penetration.
Income Taxes
At March 31, 2000, a valuation allowance of 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's operating loss carryforwards may be limited
under Section 382 of the Internal Revenue Code.
Year 2000 Compliance
To date, the Company has not experienced any material problems
resulting from the year 2000 issue, nor has it experienced any problems
from its suppliers or customers related to the year 2000 issue. eSoft
believes that as a result of the completed conversions to new hardware and
software, the year 2000 issue has been mitigated.
Impact of Recently Issued Accounting Standards
None.
19
<PAGE>
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company is not currently involved in any litigation other
than routine litigation arising in the ordinary course of
business that, if determined adversely, is not reasonably
likely to have a material adverse effect on the Company.
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 Schedules.
b) Reports on Form 8-K.
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
eSoft, Inc.
(Registrant)
Date: May 15, 2000 /s/ Jeffrey Finn
------------ -----------------
Jeffrey Finn
President, Chief Operating Officer
20
<PAGE>
Date: May 15, 2000 /s/ Amy Beth Hansman
------------ ---------------------
Amy Beth Hansman
Chief Accounting Officer
21
<PAGE>
Exhibit Index
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
27.1 Financial Data Schedule
27.2 Financial Data Schedule -Restated
</TABLE>
22
<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> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 6,340,614
<SECURITIES> 0
<RECEIVABLES> 3,944,535
<ALLOWANCES> (225,615)
<INVENTORY> 618,583
<CURRENT-ASSETS> 11,030,637
<PP&E> 1,348,145
<DEPRECIATION> (722,813)
<TOTAL-ASSETS> 12,312,576
<CURRENT-LIABILITIES> 2,278,300
<BONDS> 1,279,764
0
0
<COMMON> 145,206
<OTHER-SE> 8,619,213
<TOTAL-LIABILITY-AND-EQUITY> 12,312,576
<SALES> 3,122,801
<TOTAL-REVENUES> 3,122,801
<CGS> 1,252,872
<TOTAL-COSTS> 3,741,637
<OTHER-EXPENSES> (33,777)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 136,784
<INCOME-PRETAX> (1,905,485)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,905,485)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,905,485)
<EPS-BASIC> (0.13)
<EPS-DILUTED> (0.13)
</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> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 988,037
<SECURITIES> 0
<RECEIVABLES> 2,972,264
<ALLOWANCES> (380,452)
<INVENTORY> 1,280,366
<CURRENT-ASSETS> 5,210,796
<PP&E> 1,127,292
<DEPRECIATION> (533,060)
<TOTAL-ASSETS> 6,664,792
<CURRENT-LIABILITIES> 3,956,806
<BONDS> 0
0
0
<COMMON> 101,813
<OTHER-SE> 2,738,071
<TOTAL-LIABILITY-AND-EQUITY> 6,664,792
<SALES> 1,721,917
<TOTAL-REVENUES> 1,721,917
<CGS> 884,610
<TOTAL-COSTS> 4,544,021
<OTHER-EXPENSES> 17,317
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 8,945
<INCOME-PRETAX> (3,724,031)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,724,031)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,724,031)
<EPS-BASIC> (0.38)
<EPS-DILUTED> (0.38)
</TABLE>
