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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
/ / TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES ACT OF
1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 00-23527
eSOFT, INCORPORATED
DELAWARE 84-0938960
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
295 INTERLOCKEN BOULEVARD, SUITE 500, BROOMFIELD, COLORADO 80021
(303) 444-1600
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
CHECK WHETHER THE ISSUER: (1) FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION
13 OR 15(d) OF THE EXCHANGE ACT DURING THE PAST 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 / /
CHECK IF NO DISCLOSURE OF DELINQUENT FILERS IN RESPONSE TO ITEM 405 OF
REGULATION S-B IS CONTAINED IN THIS FORM, AND NO DISCLOSURE WILL BE CONTAINED,
TO THE BEST OF THE ISSUER'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION
STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-KSB OR ANY
AMENDMENT TO THIS FORM 10-KSB. / /
THE ISSUER'S REVENUES FOR ITS MOST RECENT FISCAL YEAR WERE: $9,080,000
THE AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES OF THE
ISSUER WAS $274,333,249 AS OF FEBRUARY 28, 2000.
THE NUMBER OF SHARES OF COMMON STOCK OUTSTANDING WAS 14,457,708 SHARES AS OF
FEBRUARY 28, 2000.
TRANSITIONAL SMALL BUSINESS DISCLOSURE FORMAT. YES / / NO /X/
DOCUMENTS INCORPORATED BY REFERENCE
Items 10, 11 and 12 of Part III of this Annual Report on Form 10-KSB are
hereby incorporated by reference to the Registrant's definitive Proxy Statement
for its Annual Stockholders Meeting to be held on May 18, 2000, which Proxy
Statement will be filed on or before 120 days after December 31, 1999.
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ESOFT, INCORPORATED
FORM 10-KSB
TABLE OF CONTENTS
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PART I PAGE
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ITEM 1. DESCRIPTION OF BUSINESS.....................................3
ITEM 2. DESCRIPTION OF PROPERTY....................................17
ITEM 3. LEGAL PROCEEDINGS..........................................17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........18
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS...18
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION..20
ITEM 7. FINANCIAL STATEMENTS.......................................26
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE........................27
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS; COMPLIANCE WITH
SECTION 16(a) OF THE EXCHANGE ACT..........................27
ITEM 10. EXECUTIVE COMPENSATION....................................30
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................30
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............30
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K..........................30
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ESOFT, INC.
FORM 10-KSB
FORWARD-LOOKING STATEMENTS
Statements made in this Form 10-KSB that are not historical or current
facts are "forward-looking statements" within the meaning 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," "believe," "anticipate," "estimate," or "continue,"
or the negative thereof. eSoft intends that such forward-looking statements be
subject to the safe harbors for such statements. We wish 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 eSoft 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 our
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 United States or foreign countries and failure to capitalize upon
access to new markets. Additional risks and uncertainties that may affect
forward-looking statements about eSoft's all-in-one Internet appliance business
and prospects include the possibility that a competitor will develop a more
comprehensive or less expensive Internet appliance solution, delays in market
awareness of eSoft and its products, possible delays in eSoft's marketing
strategy, and failure of our strategic partners to successfully implement their
marketing strategies, each of which could have an immediate and material adverse
effect by placing the Company behind its competitors. For a fuller description
of certain of these important factors that could cause actual results to differ
materially from those currently anticipated or projected, please see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." eSoft 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.
PART I
TEAM INTERNET IS A REGISTERED TRADEMARK OF eSOFT, INC.
ITEM 1. DESCRIPTION OF BUSINESS
COMPANY BACKGROUND
We are a leader in providing Linux-based software solutions that enable
small-to-medium sized businesses to easily and cost effectively connect to the
Internet. Our Team Internet, Interceptor and redphish-TM- products offer a
plug-and-play solution that permits organizations to easily set up shared
e-mail, web access and hosting, firewall security, remote access, content
filtering, managed services and business-to-business applications. Because our
software solutions replace the need for multiple costly products (often from
multiple vendors), we can
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offer small-to-medium sized businesses a powerful value proposition to solving
their Internet connectivity and security needs.
Our software solutions target small-to-medium sized businesses 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. However, 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 principal offices are located at 295 Interlocken Boulevard, Suite 500,
Broomfield, Colorado 80021, and our telephone number is (303) 444-1600. We were
incorporated in Colorado in 1984 and were reincorporated in Delaware in February
1998.
Effective May 25, 1999, the Company completed the merger with Apexx
Technology, Inc. ("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 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 with
Technologic, Inc. ("Technologic") located in Norcross, Georgia which provided
for the exchange of all of the outstanding stock of Technologic for 1,244,435
shares of eSoft common stock and for the conversion of all Technologic stock
options into eSoft stock options to acquire 180,565 shares of eSoft common
stock. The Merger has been accounted for as a pooling of interests.
INDUSTRY BACKGROUND
DRAMATIC GROWTH IN THE USE OF THE INTERNET
The Internet is rapidly becoming a critical resource for business. An
increasing number of companies use the Internet to enable fast and efficient
communications between constituents of their enterprise. According to
International Data Corporation ("IDC"), an independent research company, the
number of worldwide Internet users is expected to grow from 159 million in 1998
to 510 million in 2003, and worldwide e-commerce revenues are expected to
increase from approximately $50 billion to more than $1.3 trillion during the
same period. The increasing
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use of the Internet by consumer and business users is primarily attributable to
easier, faster and cheaper access to the Internet, greater diversity and
availability of Internet access devices and increased availability of Internet
applications and enhanced services. In addition, the increasing utility of the
Internet and the availability of new technologies that enable advanced
capabilities, such as real-time communication, collaboration and electronic
commerce, are compelling businesses and other organizations to use the Internet
to maintain Web sites, access critical business information and communicate more
effectively with employees, customers and business partners.
BANDWIDTH CONSTRAINTS CREATED THE NEED FOR BROADBAND ACCESS
The increasing use of the Internet as an essential communications and
transaction medium has resulted in a dramatic increase in data traffic. The
volume of data traffic over telecommunications networks has already surpassed
traditional voice traffic. Industry sources predict that voice will account for
less than 1% of traffic by 2004.
Due to the increased demands for high-bandwidth data traffic and enhanced
voice services, service providers are increasingly installing higher speed
access equipment. These higher speed broadband technologies include:
- digital subscriber line, or DSL, over traditional copper twisted-pair
wiring;
- cable modem technology over coaxial cable; and
- broadband wireless technology
SMALL TO MEDIUM-SIZED BUSINESSES INCREASINGLY DEMAND FULL-TIME
DEDICATED INTERNET CONNECTION APPLICATIONS
Most small-to-medium-sized businesses currently access the Internet using
multiple low-speed dial-up connections with a limited number of applications.
For example, less than 5% of U.S.-based small businesses access the Internet
through any type of shared server, router, or Internet access appliance. Growth
of the Internet and availability of low cost broadband access have led small to
medium-sized businesses to seek dedicated full-time Internet connections.
Through dedicated broadband connections, small to medium-sized businesses can
streamline internal operations by facilitating employee communications, e-mail,
file sharing, and research and analysis. With the emergence of affordable
broadband access, small to medium-sized businesses have access to more powerful
information technology and value added applications previously only available to
larger businesses, such as:
- web hosting appliances;
- business-to-business application services;
- virtual private networks;
- remote information technology services;
- voice over Internet protocol; and
- robust firewall protection.
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TRADITIONAL DEDICATED ACCESS INTERNET SOLUTIONS ARE ILL-SUITED FOR SMALL TO
MEDIUM-SIZED BUSINESSES
Businesses traditionally establish an on-line presence by deploying
general-purpose servers and complex network technologies. General-purpose
servers manage a wide variety of tasks such as database, e-mail, network
management, file management and application services. Existing Internet
infrastructure solutions for small-to-medium sized businesses with dedicated
Internet access pose limitations that include:
- HIGHER COST, COMPLEXITY AND LACK OF INTEGRATION. Traditional solutions
for applications such as home pages, e-mail, firewalls and routing
often require multiple products from multiple vendors and involve high
acquisition, integration and ownership costs. Small-to-medium sized
businesses with limited budgets and scarce technology skills are thus
discouraged from adopting such products.
- LACK OF MODULARITY AND SCALABILITY. The lack of modularity and
scalability in these traditional solutions limit the ability of
businesses to add and remove certain Internet-based applications as
their needs change. Additional functionality typically results in
additional hardware and services, adding to the cost and complexity.
NEW SERVER APPLIANCES ADDRESS THE PARTICULAR REQUIREMENTS OF SMALL TO
MEDIUM-SIZED BUSINESSES
A new category of network infrastructure devices that combine hardware and
software to effectively deliver network-based applications are called server
appliances. These server appliances address the challenges faced by
small-to-medium sized organizations and web hosting and application service
providers in implementing their Internet infrastructures. The custom-design of
server appliances allows them to provide either one or more dedicated
applications. For example, applications such as Internet firewalls, enhanced
email servers and web-based content filtering can be implemented as component of
a server appliance, eliminating the need for on-site technical expertise and
complex software integration. As a result, server appliances:
- are easy to install, use and administer;
- are easy to integrate with other infrastructure components;
- have a low acquisition price and low total cost of ownership; and
- deliver robust and scalable performance.
These beneficial qualities of server appliances allow small-to-medium sized
organizations to quickly and cost-effectively establish an online presence. In
addition, server appliances allow large organizations to easily supplement their
existing general-purpose servers by utilizing application specific server
appliances. The use of these specific server appliances limits conflicting
capacity demands on the general-purpose servers commonly used in large
organizations. Server appliances also allow service providers to increase
profits by offering value-added services.
According to Dataquest, an industry research firm, the server appliance
market is expected to grow from $2.2 billion in 1999 to approximately $15.8
billion by 2003, a 64% compounded annual growth rate. Approximately $2.0 billion
of this $15.8 billion market opportunity is expected to be revenue that server
appliances will take from the market
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opportunity of traditional servers.
OPEN SOURCE OPERATING SYSTEMS SUCH AS LINUX OFFER A COST-EFFECTIVE AND
RELIABLE ALTERNATIVE TO TRADITIONAL SOLUTIONS THAT USE PROPRIETARY
OPERATING SYSTEMS
Both proprietary operating systems, such as Windows, and open source
operating systems, such as Linux, may be used in server appliances. Open source
software can be copied, modified and distributed with few restrictions. Open
source software is freely available and can be downloaded from the Internet.
Popular open source software is constantly manufactured and improved by a great
many developers who collaborate by exchanging suggestions, information and
source code. The ever-expanding Internet and increasingly affordable computing
resources have helped this collaborative effort to grow. All of these factors
have led more and more developers to become involved in open source projects,
which has resulted in an increase in the frequency of software releases, and an
increase in the speed of feature development and error correction.
Open source software such as Linux is increasingly popular with companies
seeking cost-effective, reliable, secure Internet service infrastructure. The
Linux operating system provides a cost-effective, reliable and easy to manage
platform for server appliances. For small to medium-sized businesses, Linux
offers the following benefits:
- BETTER APPLICATION INTEGRATION. Because the Linux source code is open,
server appliance vendors may have a better understanding of the
interaction of all system components, which allows them to more
thoroughly coordinate their applications with the operating system and
improve system stability.
- LOWER COST BASE. Linux is available at no cost and therefore can be
incorporated in a system without the need for royalty payments or
significant internal research and development costs, thereby reducing
overall product costs.
- SHORTER DEVELOPMENT CYCLES. The collaborative nature of the worldwide
developer base for Linux enables server appliance vendors to improve
their products more quickly than they can improve products based on
proprietary operating systems such as Windows.
- REMOTE MANAGEABILITY. Linux systems can be managed remotely over the
Internet. Problems can often be diagnosed and corrected without a
service call to the customer site, reducing both support costs and
customer downtime. With remote management, technicians can serve more
customers in the same amount of time.
The Linux operating system is the fastest growing Internet operating
system. Linux operates on approximately 31% of Internet servers polled, more
than any other single operating system, according to an April 1999 survey by the
Internet Operating System Counter. In addition, an August 1999 IDC report stated
that the use of Linux grew at an annual rate of 181% in 1998. This report also
projected that Linux will be the fastest growing operating system through 2003.
According to Dataquest, the Linux-based server appliance market is expected to
grow at approximately 72% per annum between 1999 and 2003. Dataquest estimates
that by
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2003, Linux will represent approximately 24% of the total server appliance
market, or $3.8 billion.
To date, no server appliance vendors have focused their businesses on
delivering high quality Linux-optimized products through established original
equipment manufacturers ("OEM"). These server appliance vendors are primarily
dependent on proprietary operating systems and hardware platforms. As a result,
these products do not offer the flexibility that small and medium-sized
businesses require and do not offer the brand-reliance and global distribution
capabilities that they have come to expect.
THE eSOFT SOLUTION
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.
Through our redphish-TM- program, we license our software to large OEMs, such
as Intel and Hewlett Packard, as well as broadband service providers. Our
products can provide all of the users on a LAN with a shared dedicated
Internet connection, enabling small-to-medium sized businesses to establish
and enhance their Web presence and conduct business and electronic commerce
on the Internet. Our Linux-based Internet connectivity software solutions
allow our customers to access the Internet in a reliable, secure and flexible
manner. Our Internet applications facilitate the migration from limited,
dial-up analog modems to an economical, feature-rich, easy-to-use Internet
communications device. We believe that we are well positioned to become the
leading provider of Internet solutions for small-to-medium sized businesses
by offering the following advantages:
INTEGRATED PLUG-AND-PLAY SOLUTIONS
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.
LOW ACQUISITION AND OWNERSHIP COSTS
Success in the small-to-medium sized business market requires solutions
that do not require large capital expenditures. The emergence of low cost high
speed Internet access through technologies that include DSL and cable modems
provides an affordable Internet connection strategy. But, the customer also
requires a general-purpose server that facilitates connectivity for multiple
users over a shared connection. Both the low initial cost and low ongoing cost
of our products provide a significant competitive advantage for the end user of
our products.
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Without an Internet connectivity appliance, businesses must piece together
a "traditional solution," consisting of appropriate hardware and software.
Technical expertise is required to design, build, install and support this
traditional solution. Small-to-medium sized businesses that use our products pay
substantially less to acquire the technology that connects their businesses to
the Internet, and they do not need to hire in-house technical expertise to
install and maintain our Internet solution. Thus, our products allow the
small-to-medium sized business to realize both initial and ongoing cost
improvements over a traditional solution. The following table illustrates
typical costs associated with traditional versus eSoft solutions:
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TRADITIONAL SOLUTION eSOFT SOLUTION
- - ----------------------------------------- ------------------------------------
COMPONENT COST COMPONENT COST
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Intel-based server class PC Team Internet appliance:
with Microsoft NT, Exchange (Intel-based server
server, Web server, utilities $5,000 class PC with Linux,
Email server, Web
server, utilities) $1,895
ICSA certified Firewall ICSA certified Firewall
Appliance 5,000 software Included
Router 1,800 Router Included
Configuration and Installation 3,500 Configuration and
Installation 500
First year of support and First year of support
upgrades 10,000 and upgrades 495
------- -------
First year total cost $25,300 First year total cost $2,890
Subsequent annual cost $10,000 Subsequent annual cost $495
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EASY TO INSTALL AND MAINTAIN
Our products are pre-configured and include a simple set-up procedure
designed to enable a non-technical person to deploy the products in minimal
time. In addition, our products are easy to use and can be administered from any
Internet-accessible location. Our web-based user interface shields the end-users
from technical complexities and minimizes the need for trained information
technology staff. Ease of installation and maintenance enables our customers to
achieve a quick time to market for our customers' offerings.
EFFICIENCY OF SHARED ACCESS
With the advent of DSL and cable modem technologies, high speed dedicated
Internet access has become affordable for small and medium size businesses. Our
products provide the linchpin technology that allows multiple users within a
business to simultaneously share one Internet connection. With shared dedicated
access, businesses achieve both expense and productivity improvements when
compared to traditional single user dial-up access.
ROBUST AND RELIABLE LINUX-BASED ARCHITECTURE
Our products use a version of the Linux operating system, an open source
operating system that undergoes a continuous cycle of enhancement by a global
community of open source developers. We customize Linux by tailoring the source
code to work effectively with our applications and target hardware platforms.
Our open source operating system is designed to work with hardware components to
provide a reliable and stable environment upon which we and third party
developers can develop applications with a rapid time to market. In addition,
because
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the Linux source code is royalty free and open, we believe our products will
attract a large community of third party application developers.
MODULAR, SCALABLE ARCHITECTURE
Our software products are built using modular architecture, allowing
scalability to fit the customers' growing needs. We provide our Internet
application services in a modular offering that grows with the customers' needs.
As the complexity of data traffic management handled by our Internet appliances
increases, additional software modules can be added. 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.
STRATEGY
Our objective is to be the leading provider of Internet software solutions
that enable small-to-medium sized businesses to easily and cost-effectively
connect to the Internet, establish and enhance their presence and conduct
business and electronic commerce on the Web. Key elements of our strategy
include the following:
EXPAND CUSTOMER BASE THROUGH SOFTWARE LICENSING TO OEMS
In the past, eSoft has relied primarily on our 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-TM-
is a software licensing program that provides major hardware manufacturers
(OEM's) and Internet Service Providers with a complete appliance solution
that can be delivered on their hardware or third party platforms. Through
redphish-TM-, we leverage our expertise in software development and delivery,
along with our partners expertise in hardware design, manufacturing and
distribution. Our redphish-TM- program is specifically designed to greatly
increase market penetration with our licensed products by utilizing the
distribution capabilities of our redphish-TM- partners. In 1999, we signed
our first two redphish-TM- 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-TM- partners. Our strategy is to
continue to aggressively develop additional redphish-TM- licensing
partnerships with key hardware and service providers.
DEVELOP AND EXTEND RECURRING REVENUE STREAMS
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.
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DEVELOP NEW/COMPLEMENTARY SOFTWARE PRODUCTS THAT ADDRESS THE NEEDS OF
SMALL-TO-MEDIUM SIZED BUSINESSES
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.
DEVELOP MANAGED SERVICES INFRASTRUCTURE
Many of our customers lack in-house technical expertise and they have
requested that we provide them with some form of managed services. Examples
include managed security and database backup. We are developing a managed
services infrastructure that will facilitate delivery of these services.
PROVIDE MANAGED SERVICES OFFERING
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. We intend to
add LAN management and database backup to our managed services. 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.
EXPAND BUSINESS TO BUSINESS PARTNERSHIPS WITH LEADING PROVIDERS
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.
CONTINUE TO INVEST IN WORLDWIDE GROWTH
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.
PRODUCTS AND SERVICES
We design, develop and market products to address the needs of small and
medium sized
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businesses to communicate economically on the Internet. Our products are based
on the Linux operating system, an operating system known for its high
reliability, performance, scalability, customizability and low memory
requirements. We have invested in the development of proprietary technology for
our products that include core applications, software toolkits, management
tools, system maintenance daemons and clustering technologies. We believe that
end users will benefit from our open source model by having many additional
applications available to them.
Our solutions can be classified into four broad categories: Internet server
products, software licensing, Internet services and technical services. These
categories of products are described below.
INTERNET SERVER PRODUCTS
All models of the TEAM Internet products are designed to remove traditional
barriers to entry for complete Internet connectivity. More importantly, for
small-to-medium sized businesses, our TEAM Internet system is a complete,
plug-and-play solution that can be installed and maintained by non-technical
personnel at a fraction of the cost of the typical large system solution. The
TEAM Internet product family enables a small-to-medium sized business to connect
their LAN to the Internet supporting from 2 to over 200 users. It provides all
of the components an organization needs to develop, manage and monitor its
Intranet or external web presence. By providing an affordable high performance,
secure, reliable, and easy to install and administer Internet presence, TEAM
Internet enables small-to-medium sized businesses to tap into the promise of
wide area networking on the Internet with full local control of their electronic
mail, web site, domain name, and remote access, while enjoying complete security
behind a firewall.
THE MODEL 100:
An Edge of network appliance capable of connecting 2-25 users on a small
local area network to the Internet by dial-up, xDSL, cable modem, or ISDN.
The Model 100 includes all the necessary servers in one easily managed
appliance: router, firewall, proxy server, email server, web server, FTP
server, and remote access server.
THE MODEL 200:
An Edge of network appliance capable of connecting 5-100 users on a local
area network to the Internet by dial-up, xDSL, cable modem, ISDN and leased
lines (T1, frame relay) The Model 200 includes all the necessary servers
in an easily managed appliance: router, firewall, proxy server, email
server, web server, FTP server, and remote access server.
THE MODEL 300:
An Edge of network appliance capable of connecting 50-250 users on a local
area network to the Internet by dial-up, xDSL, cable modem, ISDN and leased
lines (T1, frame relay) The Model 300 includes all the necessary servers in
an easily managed appliance:
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router, firewall, proxy server, email server, web server, FTP server, and
remote access server.
THE INTERCEPTOR:
A VPN-firewall appliance capable of connecting 2-250 users on a local area
network to the Internet behind an ICSA certified, policy-based firewall.
The Interceptor allows networks to create customized security policies for
access to or from the network. The Interceptor features a VPN server for
offering access to remote users, and for connecting branch offices together
across the public Internet securely.
SOFTWARE LICENSING
We announced in April 1999 our intention to license our software and
services through a program known as "redphish-TM-." The objective of the
redphish-TM- program is to expand our distribution capabilities through third
party OEM agreements with leading hardware manufacturers and broadband service
providers. redphish-TM- 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. We believe that the redphish-TM- 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.
Our redphish-TM- 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. By utilizing
the distribution capabilities of our large partners, we expect to rapidly deploy
redphish-TM- platforms throughout the world. Our program is based on revenue
sharing, which provides incentive at every point of the distribution chain.
INTERNET SERVICES
Internet services that compliment and expand our managed firewall offering
are intended to provide a range of remote, managed service offerings for end
users, many of which will be offered as monthly, subscription-based services,
creating a recurring revenue stream for both us and our value-added resellers.
As customers implement additional Internet-based functions within their
organizations, they will look to eSoft to provide these services, from database
backup to managed security.
TECHNICAL SUPPORT SERVICES
End-users and redphish-TM- customers can also purchase, from the Company,
an annual
13
<PAGE>
contract for technical support of the products hardware. The technical support
services provide telephone support addressing the customers' technical
implementation of the product. The annual contract also includes free access to
product upgrades and updates during the term of the contract. Technical support
services are designed to address installation of the product as well as helping
customers understand networking basics that can help them optimize their network
configuration. In addition, customers requiring help with ongoing system
administration can use the service to get answers to their questions. The
technical support organization is structured so that incoming calls can be
routed appropriately based upon who is calling in (End User or Value Added
Reseller). This ensures that support calls are being routed to the individual
that is most familiar with the scope of the problem, thus reducing on-line help
time spent on technical support problem investigation. The focus of the
Technical Services Support area is to achieve 100% customer satisfaction,
coupled with the continued push for a 100% same day problem resolution for
opened trouble tickets.
CONCENTRATION OF SALES
One customer accounted for more than 10% of the Company's total revenue
during the year ended December 31, 1999. This customer represented 18% of the
Company's revenue for the fiscal year ended December 31, 1999, and accounted
for 34% of gross accounts receivable at December 31, 1999. During the fiscal
year ended December 31, 1998, the Company had one customer that accounted for
10% or more of the Company's total revenue during that period. This customer
represented 19% of the Company's revenue for the fiscal year ended December
31, 1998 and represented 53% of the Company's gross accounts receivable at
December 31, 1998.
CONCENTRATION OF PURCHASES
During the fiscal years ended December 31, 1999 and December 31, 1998,
the Company had three vendors and one vendor, respectively, that accounted
for 10% or more of the Company's purchases during those periods. For the
fiscal year ended December 31, 1999, these three vendors represented 78% of
the total purchases. For the fiscal year ended December 31, 1998, this vendor
represented 15% of the total purchases. Management believes that should any
of these relationships be terminated, suitable replacements can be found in a
timely manner.
MANUFACTURING OPERATIONS
We currently outsource the manufacturing of most of our products to a third
party manufacturer. Peak Industries, a Colorado based subcontract manufacturer,
provides the company with a complete turnkey solution, which includes material
acquisition, build, test, and quality assurance functions to ISO 9001
specifications. The major goals of our outsourcing strategy are as follows:
- To continue focusing on cost reduction, through creative material
acquisition, strategic alliances, and through qualified sources of less
expensive alternate parts;
- To negotiate labor costs for the build, test, and quality assurance
processes, based
14
<PAGE>
upon higher volumes produced, resulting in decreased learning curves; and
- To give equal opportunity to the bidders for "best and final"
quotations by sharingcompetitive bid information.
In late 1999, we improved our online ordering systems to achieve
accuracy and speed for single unit order placement in response to an
increased need for custom or individually configured single unit drop
shipments. Our new online ordering systems have assisted outside
manufacturing sources to become efficient when producing multiple variations
of products capable of being shipped directly to the customer within a 24
hour period from order request.
We plan to continue to outsource the manufacturing of our products during
2000. We expect that we will need to add a second U.S. manufacturer during 2000
to meet our projected domestic demand for our products. We also plan to use this
second U.S. manufacturer as a disaster occurrence redundancy site, as well as a
back-up site in the event of material shortages or quality assurance problems.
Going forward, outsourcing for new products will be steered to suppliers capable
of supporting the technology needs for the products.
We continue to manufacture in house, small volumes of certain legacy
products. These legacy products will remain at our facility, so that we are able
to continue the aggressive drive for cost reductions to support product price
erosion, coupled with anticipated discounts required for OEM situations.
INTELLECTUAL PROPERTY
Team Internet is a registered trademark of eSoft. We have no patents, but
we regard our software as proprietary and we attempt to protect it by relying
upon copyrights, trade secret laws, internal non-disclosure agreements and
transferability restrictions incorporated into our software license agreements.
We provide our software products under a perpetual paid-up license agreement.
Title to the software does not transfer to the customer. Program source listings
are not released, which we believe further protects unauthorized transfers of
our proprietary information, as well as the confidentiality of our trade
secrets. We also use a combination of software programming and hardware devices
to protect our products from unauthorized use or duplication.
COMPETITION
The markets for our products, services and subscribers are intensely
competitive, highly fragmented and characterized by rapidly changing technology,
evolving industry standards, price competition and frequent new product
introductions. A number of companies offer products that compete with one or
more of our products.
We believe we compete favorably on the principal factors that will draw end
users to a server appliance product, which include:
15
<PAGE>
- depth of product functionality;
- ability to work with network components utilizing other operating
systems such as Windows NT;
- scalability;
- product quality and performance;
- open systems architecture;
- strength of channel;
- brand name recognition;
- competitive pricing; and
- customer support.
Our current and prospective competitors include original equipment
manufacturers, product manufacturers of Internet connectivity products, and
manufacturers of shared Internet access devices. Companies offering competitive
products vary in scope and breadth of products and services offered and include:
- general purpose server manufacturers such as Compaq Computer, Dell
Computer, Hewlett-Packard Company, IBM, and Sun Microsystems, some of
which, including Compaq, IBM and Sun Microsystems, have recently begun
manufacturing dedicated versions of their general purpose server
products for sale as server appliances;
- Internet appliance device manufacturers such as Cobalt Networks,
Encanto Networks, Freegate, and Whistle Communications (recently
acquired by IBM);
- manufacturers of Internet access solutions aimed at the small-to
medium-sized businesses such as Ramp Networks and Netopia;
RESEARCH AND DEVELOPMENT EXPENDITURES
We conduct research and development through internal research projects.
Costs are incurred from time to time, in specific projects that employ existing
technologies for which feasibility has previously been established to develop
applications. Production costs for the development of the software used for
which technological feasibility has been established but before the product is
ready for sale, are capitalized when broad applications are identified within
its existing product lines. Costs for which technological feasibility had been
established, which were capitalized in 1999, totaled $2,650. We capitalized
$405,000 for such expenditures in 1998. We incurred $724,000 of expenses
relating to research and development costs in 1999, compared to $735,000 in
1998.
GOVERNMENT REGULATIONS
We continue to have our products built and tested to meet specific
government regulations, including FCC, UL, and CE requirements. In early 1999,
we received approval to add the Japanese Voluntary Control Council certification
label to our model 100, 200, 300, and 2500 products.
16
<PAGE>
EMPLOYEES
As of March 2000, we had ninety-nine full-time employees. This number
includes thirty-seven in engineering/technical support, twelve in operations,
ten in marketing, thirty-two in sales, and eight in administrative personnel.
Additionally, we utilized five contractors/temporary employees until full
time personnel were located. None of our employees are represented by a labor
union, and we believe that our relations with our employees are good.
ITEM 2. DESCRIPTION OF PROPERTY
The Company maintains leased facilities in the locations listed below.
<TABLE>
<CAPTION>
CURRENT
SQUARE TERM OF ANNUAL
FUNCTION LOCATION FEET LEASE LEASE COSTS
- - -------- -------- ------ ------- -----------
<S> <C> <C> <C> <C>
Corporate 295 Interlocken Blvd., 13,618 5/31/2004 $310,736
Headquarters Suite 500
Broomfield, CO 80021
Atlanta Office 2900 Gateway Drive, 9,300 4/30/2003 $ 83,728
Suite 950
Norcross, GA 30071
Boise Office 1020 West Main Street 240 6/30/2000 $ 2,100
Boise, ID 83702
London 1000 Great West Road 170 5/3/2000 $ 11,133
Brentford, Middlesex
London, England TW8 9HH
Singapore 360 Ubi Road ##02-03 400 2/1/2002 $ 12,301
Singapore 408826
</TABLE>
In April 1999, we relocated our corporate headquarters, shipping and
assembly facilities into one location. An additional corporate headquarters
lease, the London lease, and the Singapore lease were entered into in the
beginning of 2000.
ITEM 3. LEGAL PROCEEDINGS
On or about November 4, 1999, Latin American Marketing Services,
Inc.("LAMS") filed an action against eSoft and Jeffrey Finn, our President
and Chief Executive Officer, in the District Court for Boulder County, State
of Colorado. In the complaint, LAMS alleges that it had a contract to provide
marketing and sales consulting services for eSoft in Latin America that was
breached by eSoft's failure to pay LAMS certain commissions and to reimburse
it for certain expenses. LAMS is seeking damages of approximately $80,000. We
intend to defend this action vigorously.
17
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We did not submit any matters to a vote of our stockholders during the
fourth quarter of 1999.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On March 16, 1998 we completed an initial public offering of our common
stock in Canada on the facilities of the Vancouver Stock Exchange. The price
to the public in the initial public offering was $1.00 per share. On August
6, 1998, the Company's stock began trading on the Nasdaq SmallCap Market
under the symbol "ESFT". The Company delisted from the Vancouver Stock
Exchange on September 9, 1998.
The range of high and low bid quotations for the Company's Common Stock as
quoted (without retail markup or markdown and without commissions) on the
Vancouver Stock Exchange, or Nasdaq SmallCap Market as applicable, for the past
two fiscal years is provided below. The figures shown below do not necessarily
represent actual transactions:
<TABLE>
<CAPTION>
HIGH BID LOW BID
<S> <C> <C>
1999 FISCAL YEAR
Fourth Quarter $ 42.86 $ 3.00
Third Quarter $ 6.13 $ 2.63
Second Quarter $ 4.75 $ 2.13
First Quarter $ 5.94 $ 2.75
1998 FISCAL YEAR
Fourth Quarter $ 7.50 $ 2.125
Third Quarter $ 8.00 $ 2.875
Second Quarter $ 5.35 $ 4.25
First Quarter $ 9.00 $ 4.95
</TABLE>
As of December 31, 1999, there are approximately 300 record holders of
our common stock.
18
<PAGE>
We intend, for the foreseeable future, to retain all earnings, if any, for
the development of our business opportunities. The payment of future dividends
will be at the discretion of our board of directors and will depend upon, among
other things, future earnings, capital requirements, our financial condition and
general business conditions.
The transfer agent for our common stock is The Trust Company of Bank of
Montreal, with offices at First Bank Tower 5th Floor, 595 Burrard Street,
Vancouver, B.C. V7X1L7.
We have never declared a dividend on our common stock.
19
<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
The following discussion should be read together with the Company's
consolidated financial statements and accompanying notes. The consolidated
financial statements give retroactive effect to the mergers with Apexx and
Technologic, and 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 Apexx and Technologic had been consolidated with eSoft for
all years presented. See Note 1 to the consolidated financial statements.
FISCAL YEAR ENDED DECEMBER 31, 1999 COMPARED TO FISCAL YEAR
ENDED DECEMBER 31, 1998
In 1999 revenues totaled $9,080,000 versus revenue of $9,610,000 in
1998. This represents a decrease of $530,000 or 6% over the comparable
period in 1998. Product sales have decreased due to a large one time sale
to a distributor in the fourth quarter of 1998. In 1999, the Company
focused on selling product directly to resellers and de-emphasized selling
through the distribution network. Furthermore, the decrease in revenue 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, during the first quarter of 1999, 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 December
31, 1999, the Company experienced sales growth of $795,000 or 36% revenue
growth over the 1999 third quarter results, which was mainly due to revenue
recognized on licensing and enginerring fees from Intel. The Company signed
a software license and development agreement with Intel, Inc., which calls
for license fees of $1,750,000 and software development fees of $750,000,
to be paid according to the completion of stages of production, and the
acceptance of the product by Intel, Inc.
The Company distributes its products in seven sales territories in the
United States, which are covered by a combination of external and internal
sales representatives and three foreign territories in Europe, Latin
America, and the Asia Pacific, consistent with its strategy to reduce
distribution of its product through distributors. In the latter part of
1999, the Company hired a Vice President of Sales and four foreign sales
representatives in Europe and Asia. The Company intends to focus additional
sales efforts on international territories in 2000.
Gross profit margin in 1999 was $5,506,000, 61% of revenue, compared
to $5,814,000, 60% in 1998. In 1999, revenue of $1,880,000 was generated
from engineering fees charged for the development of software and also the
licensing of software. The margin on software development activities is
93%, which is significantly higher than the margin of product sales, which
is 52%. The gains in gross margin that related to software development and
licensing activities were
20
<PAGE>
affected by reduced margins associated with price decreases of the TEAM
Internet 2500. In addition, the replacement of the IPAD 1200 with Apexx's
TEAM Internet 100, selling at lower gross margins, caused margins to
decrease. Margins are expected to increase with the continued licensing of
the software and the replenishment of the TEAM Internet 100 inventory at
lower costs.
Selling, General and Administrative, Engineering, Research &
Development expenses, and software amortization costs increased $5,261,000
or 49% from $10,688,000, which is 111% of revenue in 1998 to $15,949,000 or
176% of revenue in 1999. Sales and marketing expenses increased $1,402,000
or 31% from $4,576,000 in 1998 to $5,978,000 in 1999. The significant
increases in expenditures are attributed to the addition of sales personnel
and related expenditures in connection with the Company's strategy to
develop sales channels domestically and internationally. In addition, an
extensive marketing campaign was launched to rebrand the products in
connection with the merger with Apexx. General and administrative expense
increased $3,441,000 or 82% from $4,206,000 in the 1998 period compared to
total expenses of $7,647,000 in 1999. Approximately $1,625,000 of the
increase can be attributed to costs associated with the Apexx and
Technologic mergers. There was also an increase in bad debt expense for the
write off of the remaining balance of a receivable in the amount of
$1,635,000. This receivable was due from a distributor of the Company's
products into Japan. Additional increases related to salaries, consultants,
convertible debenture financing fees, and printing fees for prior
Securities Exchange Commission filings. Engineering and technical support
expenses increased $450,000 or 46% from $982,000 in 1998 to $1,432,000 in
1999. The increase is primarily attributable to salaries in connection
with increased headcount and moving expenses related to the mergers.
Amortization of software development costs total $167,000 for 1999 and
$189,000 for 1998.
Interest expense increased $500,000 during 1999 from $28,000 in 1998
to $528,000 in 1999. This increase is primarily attributable to the
interest and discount amortization on the convertible subordinated
debentures and amortization of deferred financing costs. Interest income
decreased $104,000 or 62% during 1999. Funds received from a private
placement at the end of the second quarter in 1998 generated interest,
which did not recur in 1999.
Income Taxes
At December 31, 1999, 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.
Net losses totaled ($10,786,000) for 1999, compared to the
($4,240,000) loss for 1998, an increase in the loss of ($6,546,000)
over the same period. The net loss is primarily associated with the decline
in product sales revenue, decline in gross margin on sales of certain
products, increased Selling, General and Administrative expenses necessary
to ramp quarterly sales growth rates, the write off of the balance of a
significant receivable, and the costs associated with the Apexx and
Technologic mergers. Losses are anticipated to continue through 2000 due to
continued market expansion.
21
<PAGE>
Subsequent event
On February 22, 2000, the Company signed a master software license and
service agreement with Gateway, Inc. Monthly license and managed services
fees will be paid to the Company on a quarterly basis.
LIQUIDITY AND CAPITAL RESOURCES
On May 14, 1999, eSoft received $500,000 from a stockholder in
exchange for 156,250 common shares at a price of $3.20.
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. 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 and are exercisable until June
10, 2002. A discount in relation to the warrants was recorded in the amount
of $1,299,663, which is being amortized through June 10, 2002. The Company
has the ability, under certain circumstances, to obligate the investor to
convert the debentures into common stock and to exercise the warrants.
On September 15, 1999, eSoft received $1,950,000, net of a 2.5%
discount, from a placement of $2,000,000 of 5% convertible subordinated
debentures due in 2002. Interest is payable in cash. 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
anti-dilution provisions and adjustments. The investor also received
warrants to purchase 511,182 shares of common stock with an exercise price
of $4.4994 per common share and are exercisable until June 10, 2002. The
value of the warrants, 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 life
of the debentures and recorded as non-cash interest expense. At December
31, 1999, the unamortized original issue discount was $801,746. The Company
has the right, under certain circumstances, to require the investor to
convert the debentures into common stock and to exercise the warrants.
As part of the debenture financing described above, the investor has
the option to purchase an additional $3,000,000 of 5% convertible
subordinated debentures, together with associated warrants, in one
subsequent tranche. The $3,000,000 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 would be
accompanied by warrants with an exercise price of 115% of the debenture
conversion price.
Net proceeds from the placement of $5,000,000 of 5% convertible
subordinated debentures were approximately $4,397,000 after offering
expenses. A.G. Edwards & Sons, Inc. acted as the placement agent for the
debentures and received warrants to purchase 127,795 shares of common stock
in connection with its services as placement agent. These warrants were
valued at $300,000 and are included in deferred financing costs at December
22
<PAGE>
31, 1999, to be amortized over the life of the debentures. In addition,
under the terms of the private placement, the Company paid the agent a
placement fee of 6% of the gross proceeds.
The 5% convertible debentures relating to the June 10, 1999 placement
were converted into 766,773 shares of common stock in the fourth quarter.
Accrued interest at the time of the conversion was paid in stock. The
conversion of the debentures, the related discount and the related deferred
financing resulted in $1,435,000 being recorded to equity. In addition, the
related warrants to purchase 766,773 shares were exercised in the fourth
quarter, resulting in $3,450,000 being paid to the Company.
In the fourth quarter, the Company completed a private placement to
Intel, Inc. of 666,666 shares of its common stock at a price of $4.50 per
share for a total offering and net cash proceeds to the Company of
$3,000,000.
The Company's cash position on December 31, 1999 was $8,576,000 an
increase of $7,844,000 from 1998 primarily due to the maturation of
investments, the net proceeds from the issuance of convertible debt in the
amount of $4,397,000, the proceeds from a private placement in the amount
of $3,000,000 and $7,140,000 from the exercise of options and warrants. The
Company's working capital has improved significantly over the last twelve
months, primarily from private debt and equity financing activities. At
December 31, 1999 the Company's working capital was $10,012,000 an increase
of $5,556,000 from December 31, 1998. Management anticipates continuing
losses in support of the growth initiatives and, coincidentally, expects
continued negative cashflow from operations in 2000. 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
reevaluated the collectibility of a significant receivable from a
distributor that sells products into Japan and has written off the balance
of $1,635,000. The Company has established a direct relationship with the
end-customer in Japan that allows for direct order processing and
collection of payments, as well as direct involvement with the end-customer
on market development and support activities. Management believes that
establishing this direct relationship is in the best long-term interests of
the Company. The Company is evaluating the alternatives with respect to
recovering the receivable from the distributor and does not anticipate any
significant write-offs of other accounts receivable. The allowance for
doubtful accounts is $310,000 at December 31, 1999. The decrease in
inventories from 1998 resulted from improved inventory management with
respect to sales volume. The Company has expended $162,000 in capital
expenditures, of which $30,000 was related to furniture for the new
headquarters and $30,000 was related to computer software. Similar
capital expenditures are expected to occur in 2000 in relation to
the expected continued growth of the Company. 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.
The Company anticipates it will continue to pursue acquisitions that
complement and leverage the existing technology base as part of its
growth strategy. If acquisitions are consummated, additional capital
may be required.
Management believes that the Company will continue to incur losses
until the end of 2000, when sales growth is anticipated to reach a level to
offset the aggressive sales growth
23
<PAGE>
strategy. Further, management believes that it has access to capital in the
form of additional short and/or long term credit facilities, and
additional equity financing through strategic investors or private
placements. Management anticipates it will continue to have access to
additional capital through these sources in the amounts necessary to
support its growth plans.
Subsequent event
A binding letter of intent between the Company and Gateway, Inc.,
regarding a Common Stock and Warrant Purchase Agreement, was signed
February 22, 2000 for the investment of $25,000,000 in exchange for common
stock to be issued at a 6.5% discount to the five consecutive trading day
average of the common stock ending on the second trading day prior to
the date of execution of the letter of intent. The payment of the purchase
price will be made in two equal installments, with 50% paid at closing and
50% paid ninety days after closing. Warrants to purchase 600,000 shares
of common stock at the same purchase price will be issued at closing,
vesting in accordance with performance milestones as indicated in the
agreement.
CASH FLOW
Net cash used in operating activities for the year ended December 31,
1999 was $8,765,000 compared with $5,471,000 for the year ended December
31, 1998. The increase of $3,294,000 for the 1999 period compared to the
1998 period was primarily due to an increase in the Company's net loss.
This increase in net loss was primarily the result of the decline in
product sales revenue, decline in gross margin on sales of certain
products, increased selling, general and administrative expenses resulting
from the write-off of the balance of a significant receivable, and the
costs associated with the Apexx and Technologic mergers.
Net cash provided by investing activities for the twelve months ended
December 31, 1999 was $1,933,000 compared with $2,830,000 used by investing
activities for the twelve months ended December 31, 1998. The increase of
$4,763,000 for the 1999 period compared to the 1998 period was primarily
due to $2,000,000 of investments made in 1998 maturing during 1999. In
addition, purchases of property and equipment decreased approximately
$266,000 due to operations being more established at that point in time.
Net cash provided by financing activities for the twelve months ended
December 31, 1999 was $14,676,000 compared with $7,806,000 for the twelve
months ended December 31, 1998. The increase of $6,870,000 for the 1999
period compared to the 1998 period was primarily due to net proceeds of
approximately $4,397,000 received as a result of the issuance of
convertible subordinated debentures. Proceeds of $500,000 were received
from a private stock transaction resulting in the issuance of 156,250
shares of common stock. In addition, $3,000,000 was received from a private
stock transaction resulting from the issuance of 666,666 shares of common
stock. The exercise of options and warrants resulted in cash proceeds of
$7,140,000. Additional financing activities during 1999 included the
collection of the proceeds from subscriptions receivable, and payments and
proceeds from the line of credit and short term debt. Financing activities
during 1998 included private transactions with officers, directors, and
consultants, the exercise of warrants and employee options, proceeds from
the line of credit,
24
<PAGE>
conversion of promissory notes, and deferred offering costs.
Impact of Recently Issued Accounting Standards
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" requires companies to record derivatives on the balance
sheet as assets or liabilities, measured at fair market value. Gains
or losses resulting from changes in the values of those derivatives
are accounted for depending on the use of the derivative and whether
it qualifies for hedge accounting. The key criterion for hedge
accounting is that the hedging relationship must be highly effective
in achieving offsetting changes in fair value or cash flows. SFAS No.
133, which was amended by SFAS 137, is effective for fiscal years
beginning after June 15, 2000. Management believes that the adoption
of SFAS No. 133 will have no material effect on its financial
statements.
25
<PAGE>
ITEM 7. CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Certified Public Accountants -
BDO Seidman, LLP F -2
Independent Auditors' Report -
Balukoff, Lindstrom & Co., P.A. F -3
Consolidated Balance Sheet at December 31, 1999 F-4 - F-5
Consolidated Statements of Operations for the
Years Ended December 31, 1999 and 1998 F-6
Consolidated Statements of Stockholders' Equity
for the Years Ended December 31, 1998 and 1999 F-7
Consolidated Statements of Cash Flows for the
Years Ended December 31, 1999 and 1998 F-8 - F-9
Summary of Accounting Policies F-10 - F-16
Notes to Consolidated Financial Statements F-17 - F-38
</TABLE>
26
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL
DISCLOSURES
None
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS; COMPLIANCE WITH SECTION 16(A) OF THE
EXCHANGE ACT
Our directors and executive officers are listed below. Directors are
elected as described below under "Election of Directors." Executive officers
are elected by the Board of Directors and hold office until their successors are
elected and qualified. There are no committees of the Board of Directors.
<TABLE>
<CAPTION>
NAME AGE POSITIONS
<S> <C> <C>
Philip L. Becker 51 Chairman, Chief Technical Officer,
and Director
Jeffrey Finn 1 40 President, Chief Executive Officer
and Director
Jason M. Rollings 38 Vice President of Operations
Amy Beth Hansman 30 Chief Accounting Officer, and
Secretary
Robert C. Hartman 39 Vice President of Engineering
William S. Hickman 41 Vice President of Sales
Jane Merickel 36 Vice President of Marketing
Brian Cohen 44 Vice President of Strategic
Relations and Director
Perry Flinn 45 Vice President of Technology
Richard Rice 1, 2 49 Director
Richard Eyestone 1, 2 54 Director
Frederick Frank 68 Director
</TABLE>
- - ------------------------------
1 member of the audit committee
2 member of the compensation committee
27
<PAGE>
BIOGRAPHICAL INFORMATION
PHILIP L. BECKER. Mr. Becker is our Chairman, Chief Technical Officer and
director of the Company. Mr. Becker was employed with Martin Marietta Aerospace
as a computer systems designer from 1971 to 1983. In 1983 he founded Becker
Systems as a computer communications consulting firm. Mr. Becker established the
Company in 1984 to manufacture and market his bulletin board product, TBBS. Mr.
Becker served as President of the Company until September, 1997. Mr. Becker
received a B.S. in Electrical Engineering from Vanderbilt University in 1969.
Mr. Becker has been a director of CANnect Communications, Inc. since February
1997.
JEFFREY FINN. Mr. Finn has been the President, Chief Executive Officer and
a director of the Company since November 1998. Formerly Senior Vice President of
Sales and Marketing Strategy from July 1996 to October 1998 at Evolving Systems,
Inc., a company specializing in software solutions for the telecommunications
industry, Mr. Finn from April 1990 to March 1996 was a founder of Prairie
Systems, where he designed and launched a number of innovative
telecommunications software products and services.
JASON M. ROLLINGS. Mr. Rollings has been our Vice President of Operations
since October 1997. Mr. Rollings was employed with Hi-Tech Manufacturing, a
printed circuit board and computer manufacturer, as Director of Manufacturing
from April 1995 to November 1997, as Director of Manufacturing for Codar
Technology Inc., a military computer manufacturer, from September 1988 to March
1995, and as Manufacturing Operations Manager for Century Data Inc., a computer
software company, from September 1983 to August 1988. Mr. Rollings has
successfully completed the Xerox Business Management System program at Anaheim,
California, and programs in Executive Management, Facilities Management and
Effective Management Systems.
AMY BETH HANSMAN. Ms. Hansman has been our Chief Accounting Officer since
May 1999. Ms. Hansman was employed as the Manager of Operational Audit at ICG
Communications, Inc., a competitive local exchange company during 1998, as
Manager of Royalty Audit at PolyGram Records, Inc. from 1996 to 1997, and as
Supervising Senior Accountant at KPMG Peat Marwick in NY, NY from 1992 to 1996.
ROBERT C. HARTMAN. Mr. Hartman has been our Vice President of Engineering
since 1993. From 1990 to 1993 he was employed by the Company as a Senior
Software Engineer. Mr. Hartman served as President of Spark Software, a computer
consulting company, from 1986 to 1990. Mr. Hartman was employed with Automatix,
Inc. as a Senior Software Engineer and Project Leader from 1983 to 1986. Mr.
Hartman received both B.S. (1982) and M.S. (1983) degrees in Computer Science
from Rensselaer Polytechnic Institute.
WILLIAM SCOTT HICKMAN. Mr. Hickman has been our Vice President of Sales
since October, 1999. He was employed as Vice President of Sales at Research
Systems Inc. for 2 years, and managing director for Sun's Microsystems Eastern
European operations for 10 years. He holds a Bachelor's of Science degree in
Industrial Engineering from Stanford University and an MBA from Harvard Business
School.
JANE MERICKEL. Ms. Merickel, has been our Vice President of Marketing since
December 1998. Ms. Merickel was the Director of Product Marketing for Evolving
Systems, Inc., a company specializing in software solutions for the
telecommunications industry, from January to December 1998. She was employed in
a variety of positions by MCI during the Friends & Family marketing campaign
from July 1991 to December 1997, and was the Executive Senior Manager of local
sales and service at the time of her departure from MCI.
28
<PAGE>
BRIAN COHEN. Mr. Cohen has been our Vice President of Strategic
Relationships since September 1999. He was the President, CEO & Founder of
Technologic, Inc., a leading provider of Internet security appliances from 1992
to 1999, the Vice President of Business Development (and various other
positions) at Dun & Bradstreet Software from 1980 to 1991, and Systems Engineer,
Electronic Data Systems from 1977 to 1979.
PERRY FLINN. Mr. Flinn has been our Vice President of Technology since
September 1999. He was VP Technology, CTO and Co-founder of Technologic, Inc.
from August 1996 to September 1999, the VP Engineering of Technologic from
January 1994 to August 1996, the Director of Engineering of Technologic from
September 1992 to January 1994. He was employed as Senior Software Architect for
SecureWare, Inc., a provider of government and military grade multi-level
security technology for the UNIX operating system, from June 1988 to September
1992, as Supervisor of Communications and Networking for MASSCOMP Corporation, a
manufacturer of high performance computer systems for real-time data acquisition
and control, from March 1986 to June 1988, as senior software engineer for
MASSCOMP from January 1984 to March 1986.
RICHARD RICE. Mr. Rice has been a director of eSoft since March of 1998.
Mr. Rice has been the President Chief Executive Officer and director of CANnect
Communications, Inc., a telecommunications company that provides voice, data and
Internet services to the Canadian market, since March 1998. Mr. Rice founded the
Costwatch Consulting Group, Inc., a telecommunications consulting company in
1989.
RICHARD EYESTONE. Mr. Eyestone has been a director of eSoft since March of
1999. From July 1991 to August 1998, he served as Senior Vice President of
Product and Market Management and Vice President of U.S. sales for Bay Networks.
Prior to this position, Mr. Eyestone held various sales and product management
roles at several firms included Wellfleet, PictureTel and Masscomp. Mr. Eyestone
currently sits on the board of several high-tech start-up and early stage
companies.
FREDERICK FRANK. Mr. Frank was appointed as a director of eSoft in November
of 1999. He is currently the vice chairman and a director of Lehman Brothers,
Inc., where he became a partner in 1969. Prior to his role at Lehman Brothers,
he was co-director of research as well as vice president and director of Smith,
Barney & Co., Inc. Mr. Frank is on the boards of Digital Arts & Sciences,
Physician Computer Network, Pharmaceutical Product Development, Diagnostic
Product Corporation and Management Advisory Board and the Salk Institute. Mr.
Frank holds an undergraduate degree from Yale University, a MBA from Stanford
University and a C.F.A. degree.
ELECTION OF DIRECTORS
Article III of eSoft's Bylaws establishes what is known as a "classified
board of directors," with three classes of directors designated as Class I,
Class II, and Class III. Each class is elected to serve for a three-year term,
with each class up for election in different years so that in any one-year, only
one-third of all directors are up for election. At each annual meeting of
stockholders, the successors to the class of directors whose terms expire at
that meeting are elected to serve as directors for a three-year term.
The current members of eSoft's board of directors, along with their Class
designation, are as follows: Jeffrey Finn (Class I), Philip Becker (Class III),
Richard Rice (Class III), Dick Eyestone (Class II), Richard Rice (Class III),
and Frederick Frank (Class I). Class I directors will serve until the year 2002
annual stockholder meeting, Class II directors will serve until the year 2000
annual stockholder meeting, and Class III directors will serve until the year
2001 annual stockholder meeting.
29
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
Item 10 will be included in the Proxy Statement for our Annual Meeting of
Stockholders to be held on May 18, 2000.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Item 11 will be included in the Proxy Statement for our Annual Meeting of
Stockholders to be held on May 18, 2000.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Item 12 will be included in the Proxy Statement for our Annual Meeting of
Stockholders to be held on May 18, 2000.
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
The following Exhibits are filed herewith or have been previously filed
with the Securities and Exchange Commission and are incorporated by reference
herein:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
<S> <C>
3.1 Certificate of Incorporation of eSoft, Inc. (filed with Amendment No. 1
to Registration Statement on Form 10-SB on February 18, 1998 and
incorporated herein by reference).
3.2 Amendment to Certificate of Incorporation of eSoft, Inc. (filed with
Registration Statement on Form S-4 on March 19, 1999 and incorporated
herein by reference).
3.3 Bylaws of eSoft, Inc. (filed with Registration Statement on Form 10-SB
on December 22, 1997 and incorporated herein by reference).
4.1 eSoft, Inc. Equity Compensation Plan (as amended through May 20, 1999)
(filed with Registration Statement on Form S-8 on November 17, 1999 and
incorporated herein by reference).
4.2 Apexx Technology Incorporated Restricted Stock Option Plan (filed with
Registration Statement on Form S-8 on June 7, 1999 and incorporated
herein by reference).
4.3 Apexx Technology Incorporated Founders Non-Qualified Stock Option Plan
(filed with Registration Statement on Form S-8 on June 7, 1999 and
incorporated herein by reference).
4.4 Apexx Technology Incorporated 1998 Stock Plan (filed with Registration
Statement on Form S-8 on June 7, 1999 and incorporated herein by
reference).
4.5 Apexx Technology Incorporated 1994 Stock Plan (filed with Registration
Statement on Form S-8 on June 7, 1999 and incorporated herein by
reference).
4.6 Technologic, Inc. 1994 Stock Option Plan (filed with Registration
Statement on Form S-8 on
</TABLE>
30
<PAGE>
<TABLE>
<S> <C>
November 17, 1999 and incorporated herein by reference).
4.7 Amendment to Technologic, Inc. 1994 Stock Option Plan (filed with
Registration Statement on Form S-8 on November 17, 1999 and
incorporated herein by reference).
4.8 Debenture dated June 10, 1999 between eSoft, Inc. and Brown Simpson
Strategic Growth Fund, Ltd. (filed with Current Report on Form 8-K on
June 28, 1999 and incorporated herein by reference).
4.9 Debenture dated June 10, 1999 between eSoft, Inc. and Brown Simpson
Strategic Growth Fund, L.P. (filed with Current Report on Form 8-K on
June 28, 1999 and incorporated herein by reference).
4.10 Stock Purchase Warrant dated June 10, 1999 between eSoft, Inc. and Brown
Simpson Strategic Growth Fund, Ltd. (filed with Current Report on Form
8-K on June 28, 1999 and incorporated herein by reference).
4.11 Stock Purchase Warrant dated June 10, 1999 between eSoft, Inc. and Brown
Simpson Strategic Growth Fund, L.P. (filed with Current Report on Form
8-K on June 28, 1999 and incorporated herein by reference).
10.1 Securities Purchase Agreement dated as of June 10, 1999 among eSoft,
Inc., Brown Simpson Strategic Growth Fund, Ltd. and Brown Simpson
Strategic Growth Fund, L.P. (filed with Current Report on Form 8-K on
June 28, 1999 and incorporated herein by reference).
10.2 Registration Rights Agreement dated as of June 10, 1999 among eSoft,
Inc., Brown Simpson Strategic Growth Fund, Ltd. and Brown Simpson
Strategic Growth Fund, L.P.. (filed with Current Report on Form 8-K
on June 28, 1999 and incorporated herein by reference).
10.3 eSoft, Inc. Stock Purchase and Investor Rights Agreement, dated
November 12, 1999 (filed with Schedule 13D filed on January 11, 2000
and incorporated herein by reference).
10.4 Registration Rights Agreement dated September 2, 1997 between Transition
Partners, Ltd., Pantheon Capital Ltd. and eSoft (filed with Registration
Statement on Form 10-SB on December 22, 1997 and incorporated herein by
reference).
10.5 Form of Employee Confidentiality Agreement (filed with Amendment No. 1
to Registration Statement on Form 10-SB on February 18, 1998 and
incorporated herein by reference).
10.6* Transition Agreement dated, November 1, 1999 between Philip Becker
and eSoft.
10.7 Employment Agreement between Jeffrey Finn and eSoft (filed with
Registration Statement on Form S-4 on March 19, 1999 and incorporated
herein by reference).
10.8 Employment Agreement dated March 6, 1998 between Robert C. Hartman and
eSoft (filed with Amendment No. 1 to Registration Statement on Form
SB-2, filed March 24, 1998 and incorporated herein by reference).
10.9 Employment Agreement by and between eSoft, Inc. and Brian E. Cohen
(filed with current report on Form 8-K on September 27, 1999 and
incorporated herein by reference).
10.10 Employment Agreement by and between eSoft, Inc. and Perry Flinn (filed
with current report on Form 8-K on September 27, 1999 and incorporated
herein by reference).
10.11 Employment Letter dated October 7, 1997 between Jason M. Rollings and
eSoft (filed with Amendment No. 2 to Registration Statement on Form
SB-2, filed April 17, 1998 and incorporated herein by reference).
10.12 Employment Agreement, dated December 15, 1998, between Jane Merickel and
eSoft (filed with Registration Statement on Form S-4 on March 19, 1999
and incorporated herein by reference).
10.13* Employment Agreement, dated November 4, 1999, between Scott Hickman and
eSoft.
10.14* Employment Agreement, dated May 1, 1999 between Amy Beth Hansman and
eSoft.
21.1* Subsidiaries of the Registrant
23.1* Consent of BDO Seidman, LLP
23.2* Consent of Balukoff, Lindstrom & Co., PA
27.1* Financial Data Schedule
</TABLE>
* Filed herewith.
31
<PAGE>
REPORTS ON FORM 8-K
During the last quarter of the period covered by this report, we filed the
following reports on Form 8- K:
1. Form 8-K/A dated November 17, 1999, in which we filed, pursuant to
Item 7, audited financial statements for the period ended December 31,
1998 and unaudited financial statements for the period ended June 30,
1999 of Technologic, Inc., as well as pro forma financial statements
that give effect to eSoft's acquisition of Technologic, Inc.
2. Form 8-K dated November 24, 1999, in which we filed, pursuant to Item
7, audited financial statements of eSoft for the period ended December
31, 1998, restated to reflect eSoft's acquisition of Technologic, Inc.
3. Form 8-K/A dated December 13, 1999, in which we filed, pursuant to
Item 7, a consent of eSoft's auditors.
32
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amended report to be
signed on its behalf by the undersigned, thereunto duly authorized.
ESOFT, INC.
By: /s/ Jeffrey Finn
---------------------------
Name: Jeffrey Finn
Title: President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
amended report has been signed by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signatures Title Date
/s/ Philip Becker
- - ----------------------
Philip Becker Chairman of the Board, Chief March 30, 2000
Technical Officer
/s/ Jeffrey Finn
- - ----------------------
Jeffrey Finn Director, President and Chief March 30, 2000
Executive Officer (Principal
Executive Officer)
/s/ Brian Cohen
- - ----------------------
Brian Cohen Director, Vice President of March 30, 2000
Strategic Relations
/s/ Richard Eyestone
- - ----------------------
Richard Eyestone Director March 30, 2000
/s/ Richard Rice
- - ----------------------
Richard Rice Director March 30, 2000
33
<PAGE>
/s/ Frederick Frank
- - ----------------------
Frederick Frank Director March 30, 2000
34
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors
eSoft, Inc. and subsidiaries
Broomfield, Colorado
We have audited the accompanying consolidated balance sheet of eSoft, Inc. and
subsidiaries as of December 31, 1999, and the related consolidated statements of
operations, stockholders' equity and cash flows for the years ended December 31,
1999 and 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits. We did not audit the financial
statements of Apexx Technology, Inc., a wholly owned subsidiary, which financial
statements reflect total revenues of approximately $3,808,000 for the year ended
December 31, 1998. Those financial statements were audited by another auditor
whose report has been furnished to us, and our opinion, insofar as it relates to
the amounts included for Apexx Technology, Inc., is based solely on the report
of the other auditor.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditor provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditor, the
consolidated financial statements referred to above present fairly, in all
material respects, the financial position of eSoft, Inc. and subsidiaries at
December 31, 1999 and the results of their operations and their cash flows for
the years ended December 31, 1999 and 1998, in conformity with generally
accepted accounting principles.
/s/ BDO Seidman, LLP
Denver, Colorado
March 1, 2000
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Directors
Apexx Technology, Inc.
Boise, Idaho
We have audited the statement of operations, changes in stockholders' deficit,
and cash flows for the year ended December 31, 1998 of Apexx Technology, Inc.
The financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the results of operations and cash flows of Apexx
Technology, Inc. for the year ended December 31, 1998 in conformity with
generally accepted accounting principles.
The Company's financial statements have been prepared assuming that it will
continue as a going concern. The Company's significant operating losses raise
substantial doubt about its ability to continue as a going concern. The
financial statements do not include any adjustments that might result from
the outcome of this uncertainty.
/s/ Balukoff, Lindstrom & Co., P.A.
Boise, Idaho
February 4, 1999
F-3
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 31, 1999
- - ------------- -----------
<S> <C>
ASSETS
CURRENT:
Cash and cash equivalents $ 8,576,055
Accounts receivable:
Trade, less allowance of $310,453 for doubtful accounts 1,454,471
Trade, related party (Note 2) 912,500
Inventories (Note 3) 672,691
Prepaid expenses and other 158,261
-----------
Total current assets 11,773,978
-----------
PROPERTY AND EQUIPMENT:
Computer equipment 718,122
Furniture and equipment 326,092
Leasehold improvements 176,314
-----------
1,220,528
Less accumulated depreciation 660,904
-----------
Net property and equipment 559,624
-----------
OTHER ASSETS:
Capitalized software development costs, net of accumulated
amortization of $481,758 702,417
Deferred financing costs, net (Note 5) 283,215
Other 39,557
-----------
Total other assets 1,025,189
-----------
$13,358,791
===========
</TABLE>
SEE ACCOMPANYING SUMMARY OF ACCOUNTING POLICIES AND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-4
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, 1999
- - ------------- -----------
<S> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT:
Accounts payable $ 831,496
Deferred revenue 289,590
Accrued expenses:
Payroll and payroll expenses 185,983
Other 454,815
------------
Total current liabilities 1,761,884
CONVERTIBLE DEBENTURE (Note 4) 1,198,254
------------
Total liabilities 2,960,138
------------
COMMITMENTS AND CONTINGENCIES (Notes 8 and 11)
STOCKHOLDERS' EQUITY (Notes 4, 9 and 10):
Preferred stock, $.01 par value, 5,000,000 shares authorized,
none outstanding --
Common stock, $.01 par value, 50,000,000 shares authorized,
14,289,075 shares issued and 142,890
Additional paid-in capital 24,999,820
Notes receivable (39,704)
Accumulated deficit (14,704,353)
------------
Total stockholders' equity 10,398,653
------------
$13,358,791
============
</TABLE>
SEE ACCOMPANYING SUMMARY OF ACCOUNTING POLICIES AND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-5
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 1998
- - ----------------------- ------------ ------------
<S> <C> <C>
REVENUES:
Product Sales $ 7,199,351 $ 9,609,964
Services (Note 2) 1,880,296 --
------------ ------------
Total revenues 9,079,647 9,609,964
COST OF GOODS SOLD:
Product 3,438,872 3,796,175
Services (Note 2) 134,823 --
------------ ------------
Total cost of goods sold 3,573,695 3,796,175
GROSS PROFIT 5,505,952 5,813,789
------------ ------------
EXPENSES:
Selling and marketing 5,978,259 4,575,906
General and administrative 7,647,350 4,206,168
Engineering 1,432,264 982,097
Research and development 723,671 734,567
Amortization of software costs 167,305 189,399
------------ ------------
Total costs and expenses 15,948,849 10,688,137
------------ ------------
LOSS FROM OPERATIONS (10,442,897) (4,874,348)
------------ ------------
OTHER (INCOME) EXPENSE:
Interest income (64,467) (167,888)
Interest expense 527,967 28,277
Realized gain on trading securities (109,445) (234,940)
Unrealized gain on trading securities -- (72,361)
Other income, net (11,348) (25,238)
------------ ------------
Total other (income) expense 342,707 (472,150)
------------ ------------
Loss before income tax benefit (10,785,604) (4,402,198)
Income tax benefit (Note 7) -- (162,000)
------------ ------------
NET LOSS $(10,785,604) $ (4,240,198)
============ ============
BASIC AND DILUTED LOSS PER COMMON SHARE $ (1.00) $ (.50)
============ ============
WEIGHTED-AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING BASIC AND DILUTED 10,782,235 8,433,839
============ ============
</TABLE>
SEE ACCOMPANYING SUMMARY OF ACCOUNTING POLICIES AND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-6
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Retained
Common Stock Additional Earnings Total
----------------------- Paid-in Notes (Accumulated Stockholders'
YEAR ENDED DECEMBER 31, 1998 AND 1999 Shares Amount Capital Receivable Deficit) Equity
- - -------------------------------------- ------------ --------- ------------ ---------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, January 1, 1998 5,275,059 $ 52,751 $ 2,182,701 $ -- $ 186,509 $ 2,421,961
Issuance of compensatory options -- -- 106,413 -- -- 106,413
Issuance of warrants for prepaid
consulting services -- -- 214,649 -- -- 214,649
Exercise of warrants and options 442,372 4,424 396,076 -- -- 400,500
Issuance of common stock pursuant
to initial public offering, (net of
offering costs of $540,850) 1,550,000 15,500 993,650 -- -- 1,009,150
Issuance of common stock pursuant to
private placements, (net of offering
costs of $866,449) 1,995,281 19,952 5,916,908 -- -- 5,936,860
Issuance of common stock to employees 90,000 900 89,100 -- -- 90,000
Issuance of common stock for offering fees 110,000 1,100 (1,100) -- -- --
Issuance of common stock pursuant to
conversion of notes payable 355,903 3,559 352,344 -- -- 355,903
Repurchase of common stock (123,942) (1,239) (34,901) -- -- (36,140)
Cash dividend paid by pooled company -- -- -- -- (250,000) (250,000)
Net loss for the year -- -- -- -- (4,240,198) (4,240,198)
------------ --------- ------------ ------- ------------ ------------
BALANCE, December 31, 1998 9,694,673 96,947 10,215,840 -- (4,303,689) 6,009,098
Issuance of options to distributor -- -- 15,644 -- -- 15,644
Issuance of compensatory options -- -- 40,584 -- -- 40,584
Issuance of options to consultants -- -- 73,584 -- -- 73,584
Exercise of warrants and options 2,768,506 27,684 7,112,299 -- -- 7,139,983
Issuance of stock pursuant to
private placement, May 1999 156,250 1,563 498,437 -- -- 500,000
Issuance of common stock for
payment on accounts payable 5,500 55 21,945 -- -- 22,000
Issuance of warrants pursuant to
private placement of debt, June 1999 -- -- 1,478,325 -- -- 1,478,325
Issuance of common stock pursuant
to private placement, November 1999 666,666 6,666 2,993,330 -- -- 2,999,996
Issuance of common stock to brokers 75,000 750 289,875 -- -- 290,625
Issuance of common stock for bonus 7,080 71 26,227 -- -- 26,298
Issuance of warrants pursuant to
placement of debt, September 1999 -- -- 968,308 -- -- 968,308
Issuance of notes receivable for
exercise of options and warrants,
net of collection 146,709 1,467 207,567 (39,704) -- 169,330
Issuance of common stock pursuant to
convertible debt (net of unamortized
discount and financing costs of $1,564,550) 766,773 7,668 1,427,782 -- -- 1,435,450
Interest expense paid in stock upon
conversion of debt 1,918 19 15,013 -- -- 15,032
Reclassification of Technologic, Inc.
subchapter S-corporation losses -- -- (384,940) -- 384,940 --
Net loss for the year -- -- -- -- (10,785,604) (10,785,604)
------------ --------- ------------ -------- ------------ ------------
BALANCE, December 31, 1999 14,289,075 $ 142,890 $ 24,999,820 $(39,704) $(14,704,353) $ 10,398,653
============ ========= ============ ======== ============ ============
</TABLE>
SEE ACCOMPANYING SUMMARY OF ACCOUNTING POLICIES AND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-7
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
YEAR ENDED DECEMBER 31, 1999 1998
- - ------------------------------------------------ ------------ -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(10,785,604) $(4,240,198)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 351,599 475,958
Proceeds from sale of trading securities 292,634 234,940
Realized gain from sale of trading securities (109,445) (234,940)
Unrealized (gain) loss from sale of trading securities -- (72,361)
(Gain) loss on sale of assets (450) 1,013
Amortization of discount on investments (8,459) (71,624)
Amortization of debt discounts and financing costs 399,889 --
Issuance of common stock for compensation 26,298 90,000
Provision for losses on accounts receivable 1,632,872 212,981
Interest income on subscription receivable (1,792) --
Deferred tax expense (benefit) -- (162,000)
Issuance of compensatory options 40,584 106,413
Issuance of consultant options 73,584 --
Issuance of common stock to brokers 290,625 --
Amortization of warrant valuation granted for prepaid
consulting 107,494 --
Issuance of distributor options 15,644 --
Issuance of stock for interest 15,032 --
Non-cash additions to notes payable -- 47,189
Changes in operating assets and liabilities:
Accounts receivable (256,362) (2,377,716)
Other acccounts receivable (912,500) --
Inventories 945,198 (1,128,616)
Other assets (32,518) (335)
Prepaid expenses (6,059) --
Accounts payable (643,780) 946,981
Accrued expenses and other (229,739) 596,795
Deferred revenue 30,283 104,224
------------ -----------
Net cash used in operating activities (8,764,972) (5,471,296)
------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of investments 2,000,000 --
Purchase of investments -- (1,919,917)
Proceeds from sale of assets 12,289 2,722
Purchase of property and equipment (161,861) (428,332)
Deposit on leased facilities 85,000 (85,000)
Advances on non-operating notes receivable - employee -- (15,000)
Payments received from non-operating notes receivable -
employee -- 20,443
Additions to capitalized software (2,650) (405,000)
------------ -----------
Net cash provided by (used in) investing activities 1,932,778 (2,830,084)
============ ===========
</TABLE>
F-8
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CONTINUED)
<TABLE>
<CAPTION>
INCREASE (DECREASE) IN CASH AND CASH EQUUIVALENTS
YEAR ENDED DECEMBER 31, 1999 1998
- - -------------------------------------------------- ------------ -----------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of stock, warrants and options $ 10,639,979 $ 8,753,809
Proceeds from the issuance of convertible debt 4,950,000 --
Debt offering costs paid (552,767) (1,126,405)
Purchase of common stock -- (36,140)
Payment of cash dividend -- (250,000)
Proceeds from stock subscription receivable 171,122 200,000
Proceeds from short-term debt 122,513 668,872
Payments on short-term debt (615,438) (390,000)
Proceeds from long-term debt -- 125,879
Payments on long-term debt -- (25,581)
Proceeds (repayment) from margin loan on investments (39,544) 39,544
Proceeds from line of credit, net -- (58,600)
Payments on borrowings -- (75,757)
Payments from related party borrowings -- (20,000)
------------ -----------
Net cash provided by financing activities 14,675,865 7,805,621
------------ -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 7,843,671 (495,759)
CASH AND CASH EQUIVALENTS, beginning of year 732,384 1,228,143
------------ -----------
CASH AND CASH EQUIVALENTS, end of year $ 8,576,055 $ 732,384
============ ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 113,046 $ 28,313
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND
FINANCING ACTIVITIES:
Common stock issued for conversion of debt, net of unamortized
discount and financing costs $1,564,950 1,435,450 355,903
Common stock issued for offering costs -- 1,100
Warrants issued for prepaid consulting services -- 214,649
Warrants issued in connection with debt offering 2,446,633 --
Common stock issued for payment of accounts payable 22,000 --
Issuance of notes receivable for exercise of options and warrants 39,704 --
Financing costs paid in 1997 for 1998 offering -- 280,896
============ ===========
</TABLE>
SEE ACCOMPANYING SUMMARY OF ACCOUNTING POLICIES AND
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
F-9
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
SUMMARY OF ACCOUNTING POLICIES
BUSINESS eSoft, Inc. (the "Company" or "eSoft"), a Delaware
corporation, develops and markets internet connectivity
solutions. The Company has developed software, which is
integrated with a hardware component that allows local area
networks to connect with the internet. The software also
contains full access control for its remote access features.
The Company also resells related connectivity accessories.
The Company previously had developed and sold software for
the bulletin board market. The majority of the Company's
products are manufactured by external sources. In 1999, 78%
of the components for the Company's products were purchased
from three external sources. In 1998, 60% of the components
for the Company's products were purchased from two external
sources.
The Company was previously a Colorado corporation and was
merged into a newly formed Delaware corporation as of
February 17, 1998 of the same name with the Colorado
corporation ceasing to exist. The transaction was accounted
for on a basis similar to a pooling of interests with no
change in the historical financial statements of eSoft. The
newly formed corporation had no operations prior to the
merger.
Effective May 25, 1999, the Company completed the merger
with Apexx Technology, Inc. ("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
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 with Technologic, Inc. ("Technologic") located in
Norcross, Georgia which provided for the exchange of all of
the outstanding stock of Technologic for 1,244,435 shares of
eSoft common stock and for the conversion of all Technologic
stock options into eSoft stock options to acquire 180,565
shares of eSoft common stock. The Merger has been accounted
for as a pooling of interests.
F-10
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
SUMMARY OF ACCOUNTING POLICIES
<TABLE>
<CAPTION>
Number of
eSoft Shares
Pooled Company Nature of Operations Merger Date Issued
----------------------- ---------------------- --------------- --------------
<S> <C> <C> <C>
Apexx Technology, Inc. Internet connectivity May 25, 1999 1,591,365
Solutions
Technologic, Inc. Internet connectivity September 10, 1999 1,244,435
solutions
</TABLE>
The consolidated financial statements give retroactive
effect to the mergers, 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 Apexx and Technologic had been consolidated
with eSoft for all years presented. The consolidated
statements 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.
PRINCIPLES OF The consolidated financial statements include the accounts
CONSOLIDATION of the Company and its wholly owned subsidiaries, Apexx and
Technologic. All significant intercompany accounts and
transactions have been eliminated in consolidation.
CASH EQUIVALENTS The Company considers cash and all highly liquid
investments purchased with an original maturity of three
months or less to be cash equivalents.
F-11
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
SUMMARY OF ACCOUNTING POLICIES
INVESTMENT Investment securities are classified as either
SECURITIES held-to-maturity, available-for-sale or trading. Investment
securities classified as held-to-maturity are stated at
cost, adjusted for amortization of premiums and accretion of
discounts. It is management's intention and it has the
ability to hold investment securities classified as
held-to-maturity and, accordingly, adjustments are not made
for temporary declines in their market value below amortized
cost. Investment securities classified as available-for-sale
are carried at their estimated market value with unrealized
holding gains and losses, net of tax, reported as a separate
component of stockholders' equity until realized. Investment
securities classified as trading are carried at estimated
market value. Unrealized holding gains and losses for
trading securities are included in the statements of
operations. Gains and losses on securities sold are
determined based on the specific identification of the
securities sold. At December 31, 1999 the Company did not
hold any investment securities.
INVENTORIES Inventories, consisting primarily of purchased goods, are
valued at the lower of cost (weighted-average) or market.
PROPERTY AND Property and equipment are stated at cost. Depreciation is
EQUIPMENT computed using the straight-line method over the estimated
useful lives (ranging from three to seven years) of the
assets.
Depreciation expense for the years ended December 31, 1999
and 1998, was $184,294 and $179,405.
CAPITALIZED Costs incurred internally in creating software products for
SOFTWARE COSTS resale are charged to expense until technological
feasibility has been established upon completion of a detail
program design. Thereafter, all software development costs
are capitalized until the point that the product is ready
for sale and subsequently reported at the lower of amortized
cost or net realizable value. In accordance with Statement
of Financial Accounting Standard ("SFAS") No. 86, the
Company recognizes the greater amount of annual amortization
of capitalized software costs under 1) the ratio of current
year revenues by product, to the product's total estimated
revenues method or 2) over the products estimated economic
useful life by the straight-line method.
F-12
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
SUMMARY OF ACCOUNTING POLICIES
LONG-TERM The Company applies SFAS No. 121, "Accounting for the
ASSETS Impairment of Long-Lived Assets." Under SFAS No. 121,
long-lived assets and certain intangibles are evaluated for
impairment when events or changes in circumstances indicate
that the carrying value of the assets may not be recoverable
through the estimated undiscounted future cash flows
resulting from the use of these assets. When any such
impairment exists, the related assets will be written down
to fair value.
REVENUE The Company follows the guidance of Statement of Position
RECOGNITION ("SOP") 97-2, "Software Revenue Recognition." SOP 97-2
provides guidance on when revenue should be recognized and
in what amounts for licensing, selling, leasing or otherwise
marketing computer software.
The Company recognizes certain revenue at the time products
are shipped to its customers. Provision is made currently
for estimated product returns which may occur. Revenue from
support and update service agreements is deferred at the
time the agreement is executed and recognized ratably over
the contractual period. The Company recognizes revenues from
customer training and consulting services when such services
are provided. All costs associated with licensing of
software products, support and update services, and training
and consulting services are expensed as incurred.
A portion of sales is made to distributors under terms
allowing certain rights of return and price protection on
unsold product held by the distributors. Revenue on these
sales are recognized upon sell-through to the end user.
In accordance with SOP 97-2, and in conjunction with
SOP 81-1, "Accounting for Performance of Construction-Type
and Certain Production-type Contracts", the Company accounts
for certain software development contracts (Note 2) using
the percentage of completion method.
F-13
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
SUMMARY OF ACCOUNTING POLICIES
For contracts accounted for under the
percentage-of-completion method, the amount of revenue
recognized is the percentage of total contract price that
the direct labor costs expended to date bear to the
anticipated final direct labor costs, based upon current
estimates of the cost to complete the contract. Contract
costs primarily include labor and general and administrative
costs are charged to expense. As contracts can extend over
one or more accounting periods, revisions in costs and
earnings estimated during the course of the work are
reflected during the accounting period in which the facts
that require such revisions become known.
ADVERTISING The Company records advertising expense in the period the
expense is incurred. For the years ended December 31, 1999
and 1998, the Company recorded $558,953 and $688,753 in
advertising expense.
INCOME TAXES The Company follows the provisions of SFAS No. 109,
"Accounting for Income Taxes," which requires use of the
"liability method". Accordingly, deferred tax liabilities
and assets are determined based on the temporary differences
between the financial statement and tax bases of assets and
liabilities, using the enacted tax rates in effect for the
year in which the differences are expected to reverse.
Through the September 10, 1999, acquisition of Technologic
by eSoft, Technologic elected under the Internal Revenue
Code to be an S-Corporation. Subsequent to September 10,
1999, the Company is taxed as a U.S. C Corporation.
Accordingly, the accumulated deficit of Technologic at
the date of acquisition totaling $384,940 has been
reclassified to additional paid-in capital.
F-14
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
SUMMARY OF ACCOUNTING POLICIES
NET LOSS The Company follows the provisions of SFAS No. 128,
PER SHARE "Earnings Per Share." SFAS No. 128 provides for the
calculation of "Basic" and "Diluted" earnings per share.
Basic earnings per share includes no dilution and is
computed by dividing income or loss available to common
stockholders by the weighted average number of common shares
outstanding for the period. Diluted earnings per share
reflect the potential dilution of securities that could
share in the earnings of an entity, similar to fully diluted
earnings per share. In loss periods, dilutive common
equivalent shares are excluded, as the effect would be
anti-dilutive. Basic and diluted earnings per share are the
same for all periods presented.
For the years ended December 31, 1999 and 1998, total stock
options and stock warrants of 3,409,797 and 3,513,450; and
debt convertible into 495,591 common shares of stock for the
year ended December 31, 1999, were not included in the
computation of diluted earnings per share because their
effect was anti-dilutive.
USE OF ESTIMATES The preparation of financial statements in conformity with
generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the
financial statements and revenues and expenses during the
reporting period. Actual results could differ from those
estimates and assumptions.
CONCENTRATIONS Credit risk represents the accounting loss that would be
OF CREDIT RISK recognized at the reporting date if counterparties failed to
completely perform as contracted. Concentrations of credit
risk, whether on or off the balance sheet, that arise from
financial instruments exist for groups of customers or
groups of counterparties when they have similar economic
characteristics that would cause their ability to meet
contractual obligations to be similarly effected by changes
in economic or other conditions.
F-15
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
SUMMARY OF ACCOUNTING POLICIES
Concentrations of credit risk with respect to trade accounts
receivable are generally limited since customers are
dispersed across geographic areas. On-going credit
evaluations of customers' financial condition are performed
and, generally no collateral is required. The Company
maintains an allowance for potential losses based on
management's analysis of possible uncollectible accounts.
FAIR VALUE OF The Company believes the book value of financial instruments
FINANCIAL approximates their fair value.
INSTRUMENTS
STOCK OPTIONS The Company applies Accounting Principles Board Opinion
AND WARRANTS ("APB") 25, "Accounting for Stock Issued to Employees," and
related Interpretations in accounting for all stock option
plans. Under APB 25, compensation cost is recognized for
stock options granted at prices below the market price of
the underlying common stock on the date of grant.
SFAS No. 123, "Accounting for Stock-Based Compensation,"
requires the Company to provide pro forma information
regarding net income as if compensation cost for the
Company's stock option plans had been determined in
accordance with the fair value based method prescribed in
SFAS No. 123.
COMPREHENSIVE The Company has adopted SFAS No. 130, "Reporting
INCOME Comprehensive Income". Comprehensive income is comprised of
net income and all changes to the statements of
stockholders' equity, except those due to investment by
stockholders, changes in paid in capital and distributions
to stockholders. SFAS No. 130 does not impact the Company's
financial statements for 1999 and 1998.
IMPACT OF RECENTLY SFAS No. 133, "Accounting for Derivative Instruments and
ISSUED ACCOUNTING Hedging Activities" requires companies to record derivatives
PRONOUNCEMENTS on the balance sheet as assets or liabilities, measured at
fair market value. Gains or losses resulting from changes in
the values of those derivatives are accounted for depending
on the use of the derivative and whether it qualifies for
hedge accounting. The key criterion for hedge accounting is
that the hedging relationship must be highly effective in
achieving offsetting changes in fair value or cash flows.
SFAS No. 133, which was amended by SFAS 137, is effective
for fiscal years beginning after June 15, 2000. Management
believes that the adoption of SFAS No. 133 will have no
material effect on its financial statements.
RECLASSIFICATION Certain items included in the prior year's financial
statements have been reclassified to conform to the current
presentation.
F-16
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS Revenue, net loss and net loss per common share of eSoft,
COMBINATION after the Apexx and Technologic mergers for the year ended
December 31, 1998 are as follows:
<TABLE>
<CAPTION>
Year Ended December 31, 1998
----------------------- -----------
<S> <C>
REVENUE:
eSoft, as previously reported $ 3,867,600
Apexx 3,808,106
Technologic 1,934,258
-----------
eSoft, as restated $ 9,609,964
===========
NET LOSS:
eSoft, as previously reported $(2,940,662)
Apexx (885,953)
Technologic (413,583)
-----------
eSoft, as restated $(4,240,198)
===========
NET LOSS PER COMMON SHARE:
As previously reported basic and diluted: $ (.54)
As restated basic and diluted: $ (.50)
</TABLE>
2. TRADE The Company has entered into an agreement with a stockholder
RECEIVABLE- of the Company, to jointly architect and design certain
RELATED PARTY 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 $1,650,000 during the year
ended December 31, 1999, in accordance with the percentage
of completion method of which $912,500 is due to the Company
at year end.
F-17
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31, 1999
--------------------------------------- --------
<S> <C>
Finished goods $560,828
Raw materials 134,538
--------------------------------------- --------
695,366
Less reserve for obsolescence 22,675
--------------------------------------- --------
$672,691
========
</TABLE>
F-18
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. CONVERTIBLE In June 1999, the Company issued $3,000,000 of unsecured 5%
TERM DEBENTURES Convertible Debentures due June 10, 2002 ("Debentures") and
stock purchase warrants ("warrants") with a right to
purchase an aggregate of 766,773 shares of common stock, par
value $.01 per share, at an exercise price of $4.4994. In
September 1999, the Company issued to the same debenture
holder $2,000,000 of Debentures, issued at a 2.5% discount,
due June 10, 2002 and 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 and interest amount of each Debenture 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 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.
F-19
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 1999, the initial $3,000,000 in debentures
had been fully converted into 766,773 common shares of the
Company. In addition, the investor had exercised warrants to
purchase 766,773 common shares of the Company. Upon
conversion, the carrying value of the initial debentures,
net of financing costs of $1,564,550 was recorded in equity.
The Black-Scholes value of the warrants issued, of
$2,146,270 plus an initial discount of $50,000 related to
the aforementioned 2.5% discount, for a total of $2,196,270,
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 December 31, 1999, the balance
of the unamortized original issue discount was $801,746,
representing the original amount of $2,196,270, less
amortization of $283,793 and the reclassification of the
remaining unamortized balance relating to the converted
debentures of $1,110,731. The balance of the Convertible
Debentures at December 31, 1999, of $1,198,254, represents
the original face value of the remaining outstanding
debentures, of $2,000,000 less the balance of the
unamortized discount, of $801,746.
F-20
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. DEFERRED In connection with the issuance of convertible debentures
FINANCING (Note 4), the Company incurred financing costs of $552,767
COSTS and issued stock purchase warrants ("warrants") to the
placement agent, with a right to purchase an aggregate
of 127,795 shares of common stock, par value $.01 per share,
at an exercise price of $3.96875. The value of the warrants,
which was determined using the Black Scholes valuation
model, was recorded as deferred financing costs of $300,363,
which is being amortized over the life of the debentures and
recorded as non-cash interest expense. As discussed in Note
4, in December 1999, the debt holder converted the initial
$3 million in debentures. In connection with the conversion,
the unamortized financing costs associated with the initial
debentures of $453,819 was recorded as additional paid-in
capital upon conversion of the debentures. At December 31,
1999, the unamortized financing costs were $283,215 and the
Company has expensed $116,096 during the year ended December
31, 1999, as non-cash interest expense.
6. RESEARCH AND During the years ended December 31, 1999 and 1998, the
DEVELOPMENT Company capitalized $2,650 and $405,000 of software
development costs. Amortization expense of capitalized
software development costs included in depreciation and
amortization for the years ended December 31, 1999 and 1998
amounted to $167,305 and $189,399. Research and development
costs were $723,671 and $734,567 for the years ended
December 31, 1999 and 1998.
Research and development expenditures during the following
periods were comprised as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 1998
-------------------------------- ---------- ----------
<S> <C> <C>
Payroll and related costs $ 640,647 $ 618,269
Purchased services 15,864 410,820
Other 69,810 110,478
---------- ----------
726,321 1,139,567
Less capitalized software costs 2,650 405,000
---------- ----------
$ 723,671 $ 734,567
========== ==========
</TABLE>
F-21
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. INCOME TAXES The provision for income taxes consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 1998
----------------------------------------------- ----------- -----------
<S> <C> <C>
DEFERRED BENEFIT:
Federal $ -- $ (148,000)
State -- (14,000)
----------- -----------
$ -- $ (162,000)
=========== ===========
</TABLE>
A reconciliation of the effective tax rate and the statutory
U.S. federal income tax rates are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 1998
----------------------------------------------- ----------- -----------
<S> <C> <C>
Federal tax benefit at the federal
statutory rate $(3,667,000) $(1,497,000)
State income tax benefit, net of
federal tax amount (377,000) (191,000)
Permanent differences 431,000 (110,000)
Compensation deduction related to
exercise of warrants and
non-qualified options (3,243,000) --
Other (253,000) 87,000
Losses not subject to tax (1) 385,000 153,000
Increase in valuation allowance 6,724,000 1,396,000
----------- -----------
Income tax benefit $ -- $ (162,000)
=========== ===========
</TABLE>
(1) Certain losses are not subject to tax at the corporate
level as Technologic, Inc. had elected to be taxed as
an S-corporation. Effective with the merger of eSoft
and Technologic, the S-corporation election has been
terminated.
F-22
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Temporary differences that give rise to a significant
portion of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1999 1998
------------------------------------------ ----------- -----------
<S> <C> <C>
Net operating loss carryforwards $ 7,601,000 $ 1,442,000
Tax credit carryforward 37,000 37,000
Accounts receivable 730,000 101,000
Inventory 9,000 22,000
Accruals 74,000 194,000
Options and warrants 75,000 66,000
----------- -----------
Total deferred tax asset 8,526,000 1,862,000
----------- -----------
Capitalized software costs (263,000) (325,000)
Property and equipment -- (2,000)
Other (13,000) (9,000)
----------- -----------
Total deferred tax liability (276,000) (336,000)
----------- -----------
Total 8,250,000 1,526,000
Less valuation allowance 8,250,000 1,526,000
----------- -----------
Net deferred tax asset (liability) $ -- $ --
=========== ===========
</TABLE>
F-23
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The valuation allowance of $8,250,000 at December 31, 1999,
was established because the Company has not been able to
determine that it is more likely than not that the deferred
tax assets will be realized.
At December 31, 1999, the Company had net operating loss
carryforwards of approximately $20,270,000 with expirations
through 2019. The utilization of certain of the loss
carryforwards is limited under Section 382 of the Internal
Revenue Code. Of this carryforward, approximately $9,500,000
resulted from compensation deductions for tax purposes
relative to stock option plans and warrants exercised. To
the extent net operating losses resulting from stock option
plan and warrant compensation deductions become realizable,
the benefit will be credited directly to additional paid-in
capital.
8. COMMITMENTS AND The Company leases certain of its facilities and equipment
CONTINGENCIES under noncancellable operating lease agreements, which
expire at various dates through 2004. Rent expense for the
years ended December 31, 1999 and 1998 was $293,876 and
$241,809.
In 1999, the Company executed a lease to relocate its
corporate headquarters and shipping and assembly facilities
into one location. The new facility lease expires in May
2004 and annual rental payments are $173,000. The Company
was fully released from its lease on its prior corporate
headquarters.
F-24
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Future minimum lease payments under noncancellable operating
leases are as follows:
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
2000 $ 356,000
2001 360,000
2002 374,000
2003 300,000
2004 120,000
----------
$1,510,000
==========
</TABLE>
SOFTWARE DEVELOPMENT AND LICENSE AGREEMENTS
The Company has entered into several software development
and license agreements related to software utilized in
certain of the Company's products. The agreements require
compensation or royalty payments based on percentages
(ranging from 2.5% to 33.3%) of applicable gross sales and
subject to certain maximum amounts per license as defined in
the agreements.
F-25
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
EMPLOYMENT AGREEMENTS
On September 2, 1997, the Company entered into an employment
agreement with an officer and a director that extends for a
thirty-six month period commencing on September 1, 1997.
Under the terms of the agreement, the Company is obligated
to pay the sum of $10,000 per month. In addition, the
officer and director was granted incentive stock options to
acquire 200,000 shares of common stock at a price of $1.00
per share for a period of five years. The options vest over
a 36-month period as follows: 7/36 of the options vested in
April 1998 and 1/36 of the options will vest on the first
day of each month thereafter. A quarterly performance bonus
equal to 10% of the Company's earnings, net of adjustments
for interest and taxes. In the event that the bonus exceeds
50% of the gross annual salary, the bonus will be capped at
the amount of the salary for the quarter. In 1999, a
transition agreement was signed, whereby the employment
agreement will terminate on April 30, 2000.
On November 6, 1998 the Company entered into an employment
agreement with an officer and director that extends for a
thirty-six month period commencing on November 9, 1998.
Under the terms of the agreement, the Company is obligated
to pay the sum of $15,000 per month. In addition, the
officer and director was granted incentive stock options to
acquire 400,000 shares of eSoft common stock at a price of
$4.00 per share for a period of four years. The options vest
over a 36-month period as follows: 7/36 of the options will
vest in June 1999 and 1/36 of the options will vest on the
first day of each month thereafter. The officer and director
is also eligible to receive incentive pay equal to 50% of
his annual salary paid quarterly based on objectives agreed
by officer and the Company's Board of Directors. The
incentive pay will be based as follows: one-third on
revenue, one-third on earnings and one-third on mutually
agreed quarterly objectives.
F-26
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company has entered into employment agreements with
seven other executive officers with a range of salary levels
and benefits. The term of these employment agreements is
either twenty-four months or thirty-six months, at salary
levels ranging from $7,500 to $10,000 per month. The
agreements are cancelable and terminate from December 2000
through April 2002. The employment agreements provide for
either a quarterly performance-based bonus ranging from
$10,000 to $15,000 or a 1% commission on gross sales, paid
on a monthly basis. In addition to monthly compensation and
quarterly bonuses, executives under these agreements have
received incentive stock options to purchase between 60,000
and 90,000 shares of eSoft common stock at exercise prices
ranging from $1.00 to $17.44 per share.
LITIGATION
The Company may be engaged in various litigation matters
from time to time in the ordinary course of business. In the
opinion of management, the outcome of any such litigation
will not materially affect the financial position, results
of operations, or cash flows of the Company.
9. STOCKHOLDERS' PRIVATE PLACEMENTS
EQUITY
In January 1998, the Company granted 90,000 shares of common
stock to certain employees for past services rendered to the
Company. The Company recognized $90,000 of compensation
expense based on the fair value of its common stock at that
date.
During the first quarter of 1998, the Company completed a
$290,000 private placement of 290,000 shares of the
Company's common stock, at a price of $1.00 per share to
officers, directors, and key employees. The Company received
$186,983 from the offering net of offering costs.
F-27
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the first quarter of 1998, the Company accepted stock
subscriptions of $150,000 from consultants and an officer of
the Company at a price of $1.00 per share. In March and
April 1998, $150,000 of the stock subscription was
collected. The Vancouver Stock Exchange required stockholder
approval of the private placement to the officer, which was
received in December 1998, at which time the shares were
issued to the officer.
In June 1998, the Company completed the private placement of
1,468,941 shares of its common stock at a price of $4.25 per
share for a total offering of $6,243,000. The net cash
proceeds to the Company from the private placement were
$5,479,568 after payment of expenses of the offering of
$255,607 and payment of $507,825 commissions to the agent,
sub-agents, and finders, who in addition were issued
warrants to purchase 159,318 shares of the Company's common
stock at a price of $4.25 per share in the first year and
$4.90 per share in the second year.
In 1998, the Company completed the private placement of
51,616 shares of its common stock at a price of $2.23 per
share. The net cash proceeds to the Company were $115,250.
In 1998, the Company completed the private placement of
34,724 shares of its common stock at a price of $.15 per
share. The net cash proceeds to the Company were $5,059.
In 1999, the Company completed the private placement of
156,250 shares of its common stock at a price of $3.20 per
share. The net cash proceeds to the Company were $500,000.
In November and December 1999, the 5% convertible debentures
relating to the June 10, 1999 placement were converted into
766,773 shares of common stock in the fourth quarter. The
conversion of the debentures, the related discount and the
related deferred financing resulted in $1,435,450 being
recorded to equity. In addition, the related warrants to
purchase 766,773 shares were exercised in the fourth
quarter, resulting in $3,450,000 being paid to the Company.
F-28
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In November 1999, the Company completed a private placement
of 666,666 shares of its common stock at a price of $4.50
per share for a total offering and net cash proceeds to the
Company of $3,000,000.
INITIAL PUBLIC OFFERING
In March 1998, the Company completed its initial public
offering ("IPO")in Canada of 1,550,000 shares of the
Company's common stock at an offering price of $1.00 per
share. Additionally, the agent was issued 110,000 shares of
the Company's common stock in the Canadian Offering along
with warrants to purchase 250,000 shares of the Company's
common stock at a price of $1.00 for the first 12 months and
at a price of $1.15 for the next 12 months. The net cash
proceeds to the Company from the IPO were approximately
$1,009,000 after payment of expenses of approximately
$541,000. In April 1998, the agent exercised its warrants at
a price of $1.00 per share and the Company issued 250,000
shares of its common stock.
CONVERSION OF DEBT
Prior to January 1, 1996, the Company entered into an
unsecured note agreement with the initial stockholder in the
amount of $125,000 with interest at 9% per annum, maturing
December 31, 1997. The Company also borrowed an additional
$111,598 from the stockholder under various unsecured demand
note agreements with interest at 7% per annum.
On June 21, 1996, the stockholder converted $130,555 of the
above notes into 341,454 shares of common stock. The
remaining amounts outstanding and additional advances from
the stockholder during 1996 were combined into a $239,903
unsecured demand note payable. The note bears interest at 7%
per annum and requires monthly interest payments of $1,399.
In October 1997, the note was amended which provides the
Company the option to convert the note into equity at the
price of the Company's contemplated initial public offering.
The note was payable in full on January 2, 1999.
F-29
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During 1997, the Company entered into an agreement with a
business consulting firm to provide services through May 31,
1998 in exchange for convertible notes payable totaling
$116,000. The convertible notes payable bear interest at a
rate of 12% per annum and were payable on January 2, 1999.
The notes were convertible into common stock, at the
Company's option, at the price of the Company's contemplated
initial public offering.
In March 1998, the holders of the above convertible notes
totaling $355,903 converted the notes into 355,903 shares of
common stock at a price of $1.00 per share.
10. STOCK OPTION In September 1998, the Board of Directors, and on December
PLAN AND 4, 1998, the stockholders, of the Company approved an
WARRANTS amended Equity Compensation Plan, originally adopted in
August 1997 (the "Plan"), which provides for incentive stock
options and non-statutory options to be granted to officers,
employees, directors and consultants to the Company. Options
to purchase up to 2,900,000 shares of the Company's common
stock may be granted under the Plan. Terms of exercise and
expiration of options granted under the Plan may be
established at the discretion of an administrative committee
appointed to administer the Plan or by the Board of
Directors if no committee is appointed, but no option may be
exercisable for more than five years. As of December 31,
1999, options to purchase 2,752,195 shares of the Company's
common stock are outstanding under the Plan.
Of the options granted in 1998, 196,461 were issued at a
price below fair market value at date of grant and,
accordingly, the Company recognized compensation expense of
$106,413 based on the difference between the exercise price
and the fair market value at the grant date. No options were
issued below fair market value at the date of grant during
1999. In 1999, the Company recognized compensation expense
of $40,584 in conjunction with the issuance of options for
director services.
F-30
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During 1998, the Company granted warrants to purchase
145,000 shares of common stock ranging from $1.00 to $6.98
per share to consultants. The warrants vest immediately and
expire at various dates through November 2003. Certain of
the consulting agreements are for twelve-month periods and,
therefore, the Company recorded an asset of $214,649 that is
being amortized over twelve months. In 1999 and 1998, the
Company recognized approximately $107,000 and $108,000, of
expense in conjunction with the above warrants.
During 1999, the Company granted warrants to purchase
227,500 shares of common stock ranging from $3.60 to $4.75
per share to consultants and distributors. The warrants vest
immediately and expire at various dates through June 2004.
In 1999, the Company recognized approximately $89,000 of
expense in conjunction with the above warrants.
The disclosures below include options issued by Apexx and
Technologic as if such options were issued for the purchase
of eSoft's common stock, and are based on the exchange ratio
of eSoft's common stock for Apexx's and Technologic's stock
options pursuant to the related merger agreements.
The Company applies APB 25 in accounting for stock options
and stock purchase warrants granted to employees. Had
compensation expense been determined based upon the fair
value of the awards at the grant date and consistent with
the method under SFAS 123, the Company's net loss and basic
and diluted loss per share would have been increased to the
pro forma amounts indicated in the following table.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1999 1998
--------------------------------- -------------- -------------
<S> <C> <C>
Net loss as reported $ (10,785,604) $ (4,240,198)
Net loss pro forma $ (11,864,223) $ (4,320,550)
Loss per share basic and diluted,
as reported $ (1.00) $ (.50)
Loss per share basic and diluted,
pro forma $ (1.10) $ (.51)
</TABLE>
F-31
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1999 1998
------------------------ --------------- ---------------
<S> <C> <C>
Dividend yield 0% 0%
Expected volatility 60 TO 70% 6 to 56.75%
Risk free interest rates 4.57 TO 6.04% 4.12 to 6.20%
Expected lives in years 2.18 TO 4 years 1.17 to 5 years
</TABLE>
F-32
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the status of the Company's stock option plan
and warrants granted as of December 31, 1999 and 1998 is
presented below:
<TABLE>
<CAPTION>
Options Warrants
------------------------ ---------------------------
Weighted
Average Weighted
Exercise Average
Shares Price Shares Exercise Price
----------- -------- --------- --------------
<S> <C> <C> <C> <C>
Outstanding,
January 1, 1998 1,469,320 $ .46 502,100 $ 1.00
Granted 1,533,742 2.59 554,318 3.20
Canceled (103,658) (1.40) -- --
Exercised (147,372) (.73) (295,000) (1.00)
----------- -------- --------- --------
Outstanding,
December 31, 1998 2,752,032 1.60 761,418 2.61
Granted 1,934,497 4.13 1,633,250 4.48
Canceled (756,185) (3.17) -- --
Exercised (1,178,149) (.75) (1,737,066) (3.68)
----------- -------- --------- --------
Outstanding
December 31, 1999 $ 2,752,195 3.31 657,602 $ 4.42
=========== ======== ========= ========
Exercisable
December 31, 1999 1,106,579 $ 2.05 657,602 $ 4.42
=========== ======== ========= ========
Exercisable
December 31, 1998 1,361,876 $ .55 761,418 $ 2.61
=========== ======== ========= ========
</TABLE>
<TABLE>
<CAPTION>
Options Warrants
---------------------------------------------------------- ------- --------
<S> <C> <C>
Weighted average fair value of options
and warrants granted during 1998 $ .76 $ 1.20
Weighted average fair value of options
and warrants granted during 1999 $ 2.15 $ 1.77
------ --------
</TABLE>
F-33
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information about exercisable
stock options and warrants at December 31, 1999.
<TABLE>
<CAPTION>
Outstanding Exercisable
------------------------------------- -----------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercisable Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
------------ ----------- ----------- ---------- ----------- ---------
<S> <C> <C> <C> <C> <C>
OPTIONS:
$ .10 168,312 2.92 $ 0.10 168,312 $ 0.10
.24.36 31,396 6.55 0.28 31,396 0.28
.40-.50 156,292 4.24 0.49 156,292 0.49
1.00 406,724 2.84 1.00 316,204 1.00
2.86-2.88 89,500 3.51 2.87 19,375 2.87
3.06-4.44 1,786,221 3.38 4.00 372,917 4.01
6.50-7.88 72,500 2.99 6.67 39,792 6.55
15.69-17.44 41,250 3.90 17.39 2,291 17.39
------------ ---------- ---- --------- --------- ---------
$ .10-17.44 2,752,195 3.36 $ 3.31 1,106,579 $ 2.05
============ ========== ==== ========= ========= =========
WARRANTS:
$ 4.25-4.68 648,977 3.09 $ 4.39 648,977 $ 4.39
5.34-6.98 8,625 3.50 6.98 8,625 6.98
------------ ---------- ---- --------- --------- ---------
$ 1.00-6.98 657,602 3.09 $ 4.42 657,602 $ 4.42
============ ========== ==== ========= ========= =========
</TABLE>
The weighted average grant date fair value of stock options
granted is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 1998
----------------------- -------- --------
<S> <C> <C>
Market value equal to exercise price $ 2.16 $ .73
Market value greater than exercise price -- .55
Market value less than exercise price 1.46 1.15
======== ========
</TABLE>
F-34
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The weighted average grant date fair value of warrants
granted is summarized as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999 1998
-------------------------------------------------- -------- --------
<S> <C> <C>
Market value equal to exercise price $ 2.09 $ .11
Market value greater than exercise price 1.71 --
Market value less than exercise price 2.34 2.24
======== ========
</TABLE>
11. RETIREMENT The Company has a Simple SEP pension plan which includes all
PLANS employees who have attained the age of 21 and have been
employed by the Company for one year. To be eligible to
participate in the plan, the employee must be reasonably
expected to receive compensation in the plan year of at
least $5,000. The Company matches employee contributions
dollar for dollar up to 3% of the employee's gross wages.
FOR the years ended December 31, 1999 and 1998, the Company
contributed $9,079 and $16,668 , on behalf of employees to
the retirement plan. As of September 10, 1999, this plan was
discontinued.
Effective January 1, 1995, the Company has a 401(k) plan
whereby employees, upon attaining 21 years of age, are
eligible to contribute up to the maximum percentage of their
salary allowable under applicable IRS Code Sections. The
Company may make discretionary matching contributions. The
Company made matching contributions for the years ended
December 31, 1999 and 1998 in the amounts of $14,444 and
$11,426. As of May 25, 1999, this plan was discontinued.
12. RELATED PARTY A director of the Company is also the President, Chief
TRANSACTIONS Executive Officer and a director of CANnect Communications,
Inc., which is a distributor of the Company's products in
Canada. CANnect purchased $47,000 of the Company's products
in 1998. There were no such purchases in 1999.
13. BUSINESS In 1998, the Company adopted SFAS No. 131, "Disclosures
SEGMENTS About Segments of an Enterprise and Related Information."
F-35
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the year ended December 31, 1999, the Company entered
into an agreement with a stockholder of the Company, to
jointly architect and design certain software applications
(Note 2). Currently, the Company's management does not
currently track software services as a separate segment,
and consequently, it will not report software services as
an individual segment below. As the Company's software
activities progress, it will begin to develop systems to
monitor this segment, and report its results
accordingly.
F-36
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents information by geographic area:
<TABLE>
<CAPTION>
Long-Lived
YEAR ENDED DECEMBER 31, 1999 Revenues(1) Assets
---------------------------- ----------- ----------
<S> <C> <C>
United States $7,855,000 $1,260,000
Latin America 616,000
Other Foreign countries 609,000 --
---------- ----------
$9,080,000 $1,260,000
========== ==========
</TABLE>
<TABLE>
<CAPTION>
Long-Lived
YEAR ENDED DECEMBER 31, 1998 Revenues(1) Assets
---------------------------- ----------- ----------
<S> <C> <C>
United States $8,128,000 $1,460,000
Foreign countries 1,482,000 --
---------- ----------
$9,610,000 $1,460,000
========== ==========
</TABLE>
(1) Revenues are attributed to countries based on location
of customer.
During 1998, product sales revenues generated by two
domestic customers represented $2,162,000 of the Company's
total sales. At December 31, 1998, accounts receivable from
these customers was $1,770,000.
During 1999, there were no product/revenue sales generated
by domestic customers that represented more than 10% of the
Company's total revenues. During 1999, service revenues
generated by one related party customer of $1,650,000 (Note
2) represented 18% of total revenues. At December 31, 1999,
accounts receivable from this customer was $912,500.
During the fourth quarter of 1999, the Company wrote-off
a receivable balance to bad debt expense of $1,635,000 from
a distributor. The Company does not anticipate any
significant write-offs of other accounts receivable at this
time.
F-37
<PAGE>
ESOFT, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
14. SUBSEQUENT On February 22, 2000, the Company signed a master software
EVENT license and service agreement with a computer
manufacturer/seller. Monthly license and managed services
fees will be paid to the Company on a quarterly basis.
A binding letter of intent between the Company and the
computer manufacturer/seller regarding a Common Stock and
Warrant Purchase Agreement, was signed February 22, 2000
for the investment of $25,000,000 by the computer
manufacturer/seller, in exchange for common stock to be
issued at a 6.5% discount to the five consecutive trading
day average of the common stock ending on the second trading
day prior to the date of execution of the letter of intent.
The payment of the purchase price will be made in two equal
installments, with 50% paid ninety days after closing.
Warrants to purchase 600,000 shares of common stock at the
same purchase price of the common shares will be issued at
closing, vesting in accordance with performance milestones
as indicated in the agreement.
F-38
<PAGE>
TRANSITION AGREEMENT AND RELEASE
This Transition Agreement and Release ("Agreement") is made between (i)
Philip L. Becker ("Employee") and (ii) eSoft, Inc., its affiliates, parents,
subsidiaries, successors and assigns and each of their respective officers,
directors, shareholders, and employees ("the Company"). Employee and the Company
are referred to collectively as the "Parties."
RECITALS
WHEREAS, Employee's employment with the Company has been governed by the
Employment Agreement, dated as of September 2, 1997 (the "Employment
Agreement");
WHEREAS, Employee and the Company mutually desire that Employee's
employment with the Company be terminated through Employee's resignation at a
future date;
WHEREAS, the Parties wish to resolve fully and finally any potential
disputes regarding Employee's employment with the Company; and
WHEREAS, in order to accomplish this end, the Parties are willing to enter
into this Agreement.
TERMS
NOW THEREFORE, in consideration of the mutual promises and undertakings
contained herein, the Parties to this Agreement agree as follows:
1. RESIGNATION AND TERMINATION OF EMPLOYMENT AGREEMENT.
a. Upon Employee's execution of this Agreement, all of Employee's
rights, entitlements, and obligations of any kind under the Employment Agreement
shall terminate (except as contemplated by Section 1.c. hereof) and Employee's
rights concerning his employment with the Company shall be governed by the terms
of this Agreement. Employee's termination shall be characterized as a
"resignation" effective at the end of the Transition Period set forth in
Paragraph 2 below. Employee shall remain as a member of the Company's Board of
Directors, and such membership shall not be affected by his resignation
hereunder. Except as stated in Paragraph 4, below, Employee agrees and
acknowledges that he is not entitled to any other payments, sums, or rights
resulting from or arising out of his Employment Agreement or the termination
thereof.
b. Within three days of Employee's execution of this Agreement,
Employee agrees to return to the Company any and all of the following: all
originals and copies of any Company property, whether in computer form or hard
copy form, Company information, Company records, or other Company data. Employee
agrees not to retain any such material or information after such date, unless
such information is regularly attainable by the public.
<PAGE>
c. Notwithstanding the termination of Employee's employment under this
Agreement, all of the provisions, requirements and obligations set forth in
Section 8 of his Employment Agreement survive with full force and effect.
2. TRANSITION PAYMENT. For a period of six months commencing on the date of
this Agreement (the "Transition Period"), the Company shall pay Employee his
regular pay checks on the Company's regular pay cycle and periods, based on
Employee's current base salary, less all applicable deductions. Employee shall
not be entitled to any other compensation during the Transition Period.
3. BENEFITS. During the Transition Period, Employee shall continue to be
eligible to participate in such insurance programs (health, disability or life)
or such other health, dental or similar employee benefit programs for which he
is currently eligible for participation. Thereafter, Employee shall be entitled
to purchase coverage under COBRA at his own expense.
4. STOCK OPTIONS. During the Transition Period, options granted to Employee
for his service as an Employee ("Employee Options") shall continue to vest and
be exercisable in accordance with their terms. Thereafter, no further Employee
Options shall vest and all vested Employee Options that are unexercised and
unexpired may be exercised for a period of thirty days. Options granted to
Employee in connection with his service as a director of the Company shall not
be affected by this Agreement.
5. NO ADMISSION OF LIABILITY. The Parties agree that nothing contained
herein, and no action taken by any party hereto with regard to this Agreement,
shall be construed as an admission by any party of liability or of any fact that
might give rise to liability for any purpose whatsoever.
6. REPRESENTATIONS AND WARRANTIES. Employee represents and warrants as
follows:
a. he has read this Agreement and agrees to the conditions and
obligations set forth in it;
b. he voluntarily executes this Agreement after having had full
opportunity to consult with counsel and without being pressured or influenced by
any statement or representation of any person acting on behalf of the Company,
including its attorneys, officers, shareholders, directors, employees and
agents;
c. he has had at least twenty-one days in which to consider the terms
of this Agreement, and if he executes this agreement in less time it is with the
full understanding that he had the full twenty-one days if he so desired and
that he was not pressured by the Company or any of its representatives or agents
to take less time to consider the agreement;
2
<PAGE>
d. he has no knowledge of the existence of any lawsuit, charge, or
proceeding initiated by him against the Company or any of its officers,
directors, agents, or employees arising out of or otherwise connected with any
of the matters herein released;
e. he has not violated any of the provisions, requirements and
obligations set forth in Sections 8 or 9 of his Employment Agreement prior to
the execution of this Agreement;
f. he has been informed and understands that (i) to the extent that
this Agreement waives or releases any claims he might have under the Age
Discrimination in Employment Act, he may rescind his waiver and release within
seven calendar days of his execution of this Agreement, and (ii) any such
rescission must be in writing and hand delivered to the Company, or, if sent by
mail, postmarked within the seven-day period, sent by certified mail, return
receipt requested and addressed as follows:
Paula J. K. Martin, Esq.
Davis, Graham & Stubbs LLP
370 Seventeenth Street
Suite 4700
Denver, Colorado 80202;
and
g. he has full and complete legal capacity to enter into this
Agreement.
7. CONFIDENTIAL INFORMATION.
a. Except as herein provided, all discussions regarding this
Agreement, including, but not limited to, the amount of consideration, offers,
counteroffers or other terms or conditions of the negotiations or the agreement
reached, shall be kept confidential by Employee from all persons and entities
other than Employee's professional advisors (accountant, attorney or similar
person) or spouse. Employee may disclose the amount received in consideration of
the agreement only if necessary (i) for the limited purpose of making
disclosures required by law to agents of the local, state or federal
governments, (ii) for the purpose of enforcing any term of this Agreement, or
(iii) in response to compulsory process, and only then after giving the Company
reasonable advance notice of the compulsory process, if possible, and affording
the Company the opportunity to obtain any necessary or appropriate protective
orders. Employee represents that he has not discussed any information regarding
this Agreement with anyone other than the persons set forth above.
b. Employee shall not, without the Company's prior written approval,
use, disclose, or reveal to any person or entity any of the Company's trade
secrets or other
3
<PAGE>
confidential or proprietary information concerning the organization, business,
finances, plans, products, or technology of the Company or of any third party
which the Company or its affiliates is under an obligation to keep confidential
("Confidential Information"), except as required in the ordinary course of
performing duties hereunder. Employee shall not use or attempt to use any
Confidential Information in any manner which may injure or cause loss or may be
calculated to injure or cause loss whether directly or indirectly to the Company
or its Affiliates. The term "Confidential Information" shall include, but not be
limited to, the whole or any portion or phase of any confidential, or
proprietary or trade secret, scientific, technical, business, or financial
information, whether pertaining to the Company or its Affiliates or its or their
clients and customers, including but not limited to products, designs, methods,
know-how, techniques, systems, processes, works of authorship, customer lists,
projects, plans and proposals. Confidential Information includes, but is not
limited to, any improvements, modifications, or enhancements thereto, whether or
not in tangible or intangible form, and whether or not subject to copyright or
patent protection. All such Confidential Information is extremely valuable and
intended to be kept secret to the Company and its clients and customers; is the
sole and exclusive property of the Company or its clients and customers; and, is
subject to the restrictive covenants herein.
8. SEVERABILITY. If any provision of this Agreement is held illegal,
invalid, or unenforceable, such holding shall not affect any other provisions
hereof. In the event any provision is held illegal, invalid or unenforceable,
such provision shall be limited so as to effect the intent of the parties to the
fullest extent permitted by applicable law. Any claim by Employee against the
Company shall not constitute a defense to enforcement by the Company of this
Agreement.
9. ENFORCEMENT. The Release contained herein does not release any claims
for enforcement of the terms, conditions or warranties contained in this
Agreement. The Parties shall be free to pursue any remedies available to them to
enforce this Agreement.
10. ENTIRE AGREEMENT. This Agreement is the entire agreement between the
Parties. This Agreement supersedes any and all prior agreements, including but
not limited to the Employment Agreement, and cannot be modified except in
writing signed by all parties.
11. VENUE AND APPLICABLE LAW. This Agreement shall be interpreted and
construed in accordance with the laws of the State of Colorado, without regard
to its conflicts of law provisions.
12. COUNTERPARTS. This Agreement may be executed in counterparts. Facsimile
signatures will be accepted as originals.
4
<PAGE>
IN WITNESS WHEREOF, the Parties have executed this Agreement on the dates
written below.
/s/ Philip I. Becker
- - ------------------------------
Employee
Philip I. Becker
/s/ Jeff Finn
- - ------------------------------
The Company
eSoft, Inc.
by: Jeff Finn
its: CEO
5
<PAGE>
EMPLOYMENT AGREEMENT
This Employment Agreement ("Agreement") is made and entered into as of this
4th day of November, 1999, between eSoft, Inc., a Delaware corporation (the
"Company"), and SCOTT HICKMAN, an individual person (the "Executive").
RECITAL
A. The Company desires to employ the Executive as VICE PRESIDENT OF SALES,
and the Executive desires to be employed by the Company in such position upon
the terms and conditions set forth in this Agreement.
B. The Executive acknowledges that during the course of the Executive's
employment the Executive will receive or be exposed to certain confidential
information and trade secrets (collectively referred to as "Confidential
Information") of the Company. The Executive also acknowledges that this
Confidential Information is among the Company's most important assets and that
the value of this Confidential Information would be diminished or extinguished
by disclosure.
AGREEMENT
In consideration of the mutual promises contained herein, the receipt and
sufficiency of which are hereby acknowledged, the parties hereby agree as
follows:
1. EMPLOYMENT; POSITION; TERM. The Company hereby employs the Executive and
the Executive hereby accepts employment with the Company in the capacity of VICE
PRESIDENT OF SALES. Subject to Section 4, the term of Executive's employment
under this Agreement (the "Term") shall be for 24 months, beginning NOVEMBER 4,
1999 and ending OCTOBER 31, 2001.
2. DUTIES, RESPONSIBILITIES AND AUTHORITY. In the capacity as VICE
PRESIDENT OF SALES for the Company, the Executive shall have primary
responsibility for the sales and distribution of the Company's products,
software and services throughout the world. These responsibilities include
establishing and maintaining relationships with distributors, resellers, and
strategic business partners in each region. The Executive shall be responsible
for recruiting, hiring, directing, performing administrative functions, setting
and managing compensation and incentive plans for Regional Directors in each
region and other personnel as appropriate. The Executive shall have primary
responsibilities for meeting and exceeding the sales and revenue objectives
established for the Company. The Executive shall report to and be subject to the
direction and control of the President of the Company. The Executive shall
devote
<PAGE>
substantially all of Executive's full professional and managerial time and
effort to the performance of the duties as VICE PRESIDENT OF SALES and shall not
engage in other business activity or activities which, in the reasonable
good-faith judgement of the President of the Company, conflict with the
performance of duties under this Agreement.
3. COMPENSATION
a) SALARY. For services rendered under this Agreement, the Company
shall pay the Executive a salary at the rate of $9,167.00 per month.
(b) REVENUE INCENTIVE PAY. The Executive shall be eligible to receive
a quarterly Revenue Incentive Pay targeted at $30,000 per quarter at 100% of the
Company's Target Revenue ("Target"). The Revenue Incentive Pay is calculated as
Revenue Incentive Pay Factor (see below) times the Target. The Target for each
Quarter shall be outlined in a Incentive Compensation Plan for the Executive.
The payment of the Executive's Revenue Incentive Pay shall be made as soon as
practicable but no later than thirty (30) days following the end of the fiscal
quarter. The Revenue Incentive Pay shall be paid on a pro-rata basis for the
first quarter of employment (e.g. the period from November 4, 1999 through
December 31, 1999). The Revenue Incentive Pay Factor is calculated as follows:
<TABLE>
<CAPTION>
Revenue Attainment Revenue Incentive Pay
Factor
- - ------------------ ---------------------
<S> <C>
Below 85% 0.0%
85%-99% .8%
100%-110% 1.0%
Over 110% 1.2%
</TABLE>
(c) GROSS MARGIN INCENTIVE PAY. The Executive shall be eligible to
receive a quarterly Gross Margin Incentive Pay of $10,000 if the Company exceeds
its Gross Margin objective for the quarter. The Gross Margin incentive shall be
established in an Incentive Compensation Plan for the Executive. The payment of
the Executive's Gross Margin Incentive Pay shall be made as soon as practicable
but no later than thirty (30) days following the end of the fiscal quarter. .
The Gross Margin Incentive Pay shall be paid on a pro-rata basis for the first
quarter of employment (e.g. the period from November 4, 1999 through December
31, 1999).
(d) ANNUAL REVIEW. The Executive's salary, bonus, options and terms
of the severance in Section 7 of this Agreement shall be reviewed annually
beginning January 1, 2001 and may be increased as the Board deems appropriate,
but shall not be decreased during the term without mutual agreement.
(e) STOCK OPTIONS. The Executive has been granted incentive stock
options pursuant to the Company's Stock Option Plan to purchase up to 20,000
shares of the Company's common stock at an exercise price equal to the fair
market value of the Company's common stock on the day of the grant, subject to
board approval. Additionally, the Executive shall receive another grant of
incentive stock options pursuant to the Company's Stock Option
<PAGE>
Plan to purchase up to 40,000 shares of the Company's common stock on the
Executive's forty-fifth (45th) day of employment, subject to the Executive
being employed by the Company on that date, at an exercise price equal to the
fair market value of the Company's common stock on the 45th day of
employment, subject to board approval. Each grant of stock options shall vest
over a 36 month period with no vesting until the beginning of the eighth
month at which time seven-thirty-sixths (7/36) of the options will vest, and
then one-thirty-sixth (1/36) will vest after the beginning of each month
thereafter. Vesting shall occur as long as the Executive remains an employee
of the Company. The options, once vested shall have an expiration date of 4
years from the date of grant of the option. In addition, the Executive may
participate in stock option programs of the Company upon such terms as the
administrators of such programs in their discretion determine.
(f) BENEFITS AND VACATION. The Executive shall be eligible to
participate in such insurance programs (health, disability or life) or such
other health, dental, retirement or similar employee benefits programs as the
Board may approve, on a basis comparable to that available to other officers and
executive employees of the Company. The Executive shall be entitled to a minimum
of three (3) weeks of paid vacation per year. Vacation time may be accumulated
for up to one year beyond the year for which it is accrued and may be used any
time during such year. Any vacation time not used during such additional year
shall be forfeited. The value of any accrued but unused and unforfeited vacation
time shall be paid in cash to the Executive upon termination of Executive's
employment for any reason.
(g) REIMBURSEMENT OF EXPENSES. The Company shall reimburse the
Executive in a timely manner for all reasonable out-of-pocket expenses incurred
by the Executive in connection with the performance of Executive's duties under
this Agreement; provided that the Executive presents to the Company an itemized
accounting of such expenses including reasonable supporting data.
4. TERMINATION.
(a) TERMINATION BY THE COMPANY WITHOUT CAUSE. Notwithstanding
anything to the contrary contained herein but subject to Section 7 hereof, the
Company may, by delivering thirty (30) days' prior written notice to the
Executive, terminate the Executive's employment at any time without Cause (as
hereinafter defined).
(b) TERMINATION BY THE EXECUTIVE WITHOUT CAUSE. Notwithstanding
anything to the contrary contained herein but subject to Section 7 hereof, the
Executive may, by delivering thirty (30) days' prior written notice to the
Company, terminate the Executive's employment hereunder.
(c) TERMINATION BY THE COMPANY FOR CAUSE. The Company may terminate
the Executive's employment for Cause immediately upon written notice stating the
basis for such termination. "Cause" for termination of the Executive's
employment shall only be deemed to exist if the Executive has (i) breached this
Agreement and if such breach continues or recurs more than thirty (30) days
after notice from the Company specifying the action which
<PAGE>
constitutes the breach and demanding its discontinuance, (ii) exhibited willful
disobedience of lawful directions of the President or of the Board, or (iii)
committed gross malfeasance in performance of Executive's duties hereunder or
acts resulting in an indictment charging the Executive with the commission of a
felony; provided that the commission of acts resulting in such an indictment
shall constitute Cause only if a majority of the directors who are not also
subject to any such indictment determine that the Executive's conduct has
substantially adversely affected the Company or its reputation. A material
failure to perform Executive's duties hereunder that results from the disability
of the Executive shall not be considered Cause for Executive's termination.
(d) TERMINATION BY THE EXECUTIVE FOR CAUSE. The Executive may
terminate employment for Cause immediately upon written notice stating the basis
for such termination. "Cause" for termination of employment by the Executive
shall only be deemed to exist if the Company has breached this Agreement and if
such breach continues or recurs more than thirty (30) days after notice from the
Executive specifying the action which constitutes the breach and demanding its
discontinuance, or if the Company is engaged in unlawful activity or requests
the Executive to engage in unlawful activity.
5. DISABILITY. In the event of disability of the Executive during the term
hereof, the Company shall, during the continuance of Executive's disability but
only for a maximum of 90 days following the determination of disability, pay the
Executive the Executive's then current salary, as provided for in Section 3(a),
and adjusted pursuant to Section 3(b), and continue to provide the Executive all
other benefits provided hereunder. As used herein, the term "disability" shall
mean the complete and total inability of the Executive, due to illness, physical
or comprehensive mental impairment, to substantially perform all of Executive's
duties as described herein for a consecutive period of thirty (30) days or more.
6. DEATH. In the event of the death of the Executive, except with respect
to any benefits which have accrued and have not been paid to the Executive
hereunder, the provisions of this Agreement shall terminate immediately. The
Executive's estate shall have the right to receive compensation due to the
Executive as of and to the date of Executive's death and shall have the right to
receive an additional amount equal to one-twelfth (1/12th) of the Executive's
annual compensation then in effect.
7. SEVERANCE. In the event that the Executive's employment is terminated by
the Company other than for Cause or death of the Executive, or in the event
there is either a material change in the responsibilities of the Executive or a
loss of position within six (6) months after a Change of Control (as defined in
Section 12 of this Agreement), or if Executive terminates this Agreement for
Cause, the Executive shall be entitled to receive Executive's then current
salary and benefits, as provided for in Sections 3(a), 3(b) and 3(c), payable in
semi-monthly installments, for the greater of three (3) months or that number of
months which equals the number of years that have elapsed from the initial date
of this Agreement until the date of the Executive's termination by the Company;
PROVIDED, HOWEVER, that if any of such payments would (i) constitute a
"parachute payment" within the meaning of Section 280G of the Intemal Revenue
Code of 1986 (the "Code") and (ii) but for this provision, be subject to the
excise tax imposed by
<PAGE>
Section 4999 of the Code (the "Excise Tax"); the amount payable hereunder shall
be reduced to the largest amount which the Executive determines would not result
in any portion of the payments hereunder being subject to the Excise Tax. If the
Executive voluntarily resigns Executive's employment hereunder or if Executive's
employment is terminated for Cause, the Executive shall not be entitled to any
severance pay or other compensation beyond the date of termination of
Executive's employment.
8. COVENANT NOT TO COMPETE.
(a) During the continuance of the Executive's employment hereunder
and for a period of twelve (12) months after termination of the Executive's
employment hereunder, pursuant to section 4.b or 4.c hereof, the Executive shall
not engage in any business which competes with the Company or its affiliates
anywhere in the United States or Canada during the Executive's employment
hereunder or at the time of termination.
(b) The Executive shall not, for a period of twelve (12) months after
termination of the Executive's employment hereunder, pursuant to section 4.b or
4.c hereof, employ, engage or seek to employ or engage for himself or any other
person or entities, any individual who is or was employed or engaged by the
Company or any of its affiliates until the expiration of six (6) months
following the termination of such person's or entity's employment or engagement
with the Company or any of its affiliates.
9. TRADE SECRETS AND CONFIDENTIAL INFORMATION. During Executive's
employment by the Company and for a period of five (5) years thereafter, the
Executive shall not, directly or indirectly, use, disseminate, or disclose for
any purpose other than for the purposes of the Company's business, any
Confidential Information of the Company or its affiliates, unless such
disclosure is compelled in a judicial proceeding. Upon termination of
Executive's employment, all documents, records, notebooks, and similar
repositories of records containing information relating to any Confidential
Information then in the Executive's possession or control, whether prepared by
him or by others, shall be left with the Company or, if requested, returned to
the Company.
10. SEVERABILITY. It is the desire and intent of the undersigned parties
that the provisions of Sections 8 and 9 shall be enforced to the fullest extent
permissible under the laws in each jurisdiction in which enforcement is sought.
Accordingly, if any particular sentence or portion of either Section 8 or 9
shall be adjudicated to be invalid or unenforceable, the remaining portions of
such section nevertheless shall continue to be valid and enforceable as though
the invalid portions were not a part thereof. In the event that any of the
provisions of Section 8 relating to the geographic areas of restriction or the
provisions of Sections 8 or 9 relating to the duration of such Sections shall be
deemed to exceed the maximum area or period of time which a court of competent
jurisdiction would deem enforceable, the geographic areas and times shall, for
the purposes of this Agreement, be deemed to be the maximum areas or time
periods which a court of competent jurisdiction would deem valid and enforceable
in any state in which such court of competent jurisdiction shall be convened.
<PAGE>
11. INJUNCTIVE RELIEF. The Executive agrees that any violation by Executive
of the provisions contained in Sections 8 and 9 are likely to cause irreparable
damage to the Company, and therefore Executive agrees that if there is a breach
or threatened breach by the Executive of the provisions of said sections, the
Company shall be entitled to pursue an injunction restraining the Executive from
such breach, and Executive will make no objection to the form of relief sought.
Nothing herein shall be construed as prohibiting the Company from pursuing any
other available remedies for such breach or threatened breach.
12. MISCELLANEOUS
(a) NOTICES. Any notice required or permitted to be given under this
Agreement shall be directed to the appropriate party in writing and mailed or
delivered, if to the Company, to eSoft, Inc., to the attention of the President,
at 295 Interlocken Blvd, Broomfield, CO 80021, and if to the Executive, at 4677
Palmer Court Niwot Colorado 80503. Notification addresses may be changed with
written notice.
(b) BINDING EFFECT. This Agreement is a personal service agreement
and may not be assigned by the Company or the Executive, except that the Company
may assign this Agreement to a successor of the Company by merger,
consolidation, sale of substantially all of the Company's assets or other
reorganization (a "Change of Control"). Subject to the foregoing, this Agreement
shall be binding upon and inure to the benefit of the parties hereto and their
respective successors, assigns, and legal representatives.
(c) AMENDMENT. This Agreement may not be amended except by an
instrument in writing executed by each of the undersigned parties.
(d) APPLICABLE LAW. This Agreement is entered into in the State of
Colorado and for all purposes shall be governed by the laws of the State of
Colorado.
(e) ATTORNEY'S FEES. In the event either party takes legal action to
enforce any of the terms of this Agreement, the unsuccessful party to such
action will pay the successful party's reasonable expenses, including attorney's
fees, incurred in such action.
(f) ENTIRE AGREEMENT. This Agreement supersedes and replaces all prior
agreements between the parties related to the employment of the Executive by the
Company.
<PAGE>
SIGNATURES
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
first date mentioned above.
THE COMPANY:
By: /s/ Jeffrey Finn
-----------------------------
Jeffrey Finn
Chief Executive Officer
THE EXECUTIVE:
By: /s/ Scott Hickman
-----------------------------
Scott Hickman
<PAGE>
EMPLOYMENT AGREEMENT
This Employment Agreement ("Agreement") is made and entered into as of this
1ST day of May 1999, to become effective at the time set forth in Section 1
hereof, between eSoft, Inc., a Delaware corporation (the "Company"), and AMY
BETH HANSMAN, an individual person (the "Executive").
RECITAL
A. The Company desires to employ the Executive as CHIEF ACCOUNTING OFFICER,
and the Executive desires to be employed by the Company in such position upon
the terms and conditions set forth in this Agreement.
B. The Executive acknowledges that during the course of the Executive's
employment the Executive will receive or be exposed to certain confidential
information and trade secrets (collectively referred to as "Confidential
Information") of the Company. The Executive also acknowledges that this
Confidential Information is among the Company's most important assets and that
the value of this Confidential Information would be diminished or extinguished
by disclosure.
AGREEMENT
In consideration of the mutual promises contained herein, the receipt and
sufficiency of which are hereby acknowledged, the parties hereby agree as
follows:
1. EMPLOYMENT; POSITION; TERM. The Company hereby employs the Executive and
the Executive hereby accepts employment with the Company in the capacity of
CHIEF ACCOUNTING OFFICER. Subject to Section 4, the term of Executive's
employment under this Agreement (the "Term") shall be for 36 months, beginning
May 1, 1999 and ending April 30, 2002.
2. DUTIES, RESPONSIBILITIES AND AUTHORITY. In the capacity as CHIEF
ACCOUNTING OFFICER for the Company, the Executive shall have primary
responsibility for the establishment and maintenance of the Company's financial
policies and plans, accounting, budgeting, treasury, tax, insurance, investor
relations, financing, and human resources. Responsibilities also include the
Company's relationship with financial institutions, investors, and government
agencies. The Executive shall report to and be subject to the direction and
control of the President of the Company. The Executive shall devote
substantially all of Executive's full professional and managerial time and
effort to the performance of the duties as CHIEF ACCOUNTING OFFICER and shall
not engage in other business activity or activities which, in the reasonable
good-faith judgement of the President of the Company, conflict with the
performance of duties under this Agreement.
1
<PAGE>
3. COMPENSATION
(a) SALARY. For services rendered under this Agreement, the Company
shall pay the Executive a salary at the rate of $5,833.33 per month.
(b) BONUS. The Executive shall be eligible to receive a performance
bonus based upon mutually agreed company and department performance criteria for
each fiscal quarter of the Company completed during the term of this Agreement.
The target bonus pay at 100% of attainment is $10,000 per quarter. The payment
of the Executive's incentive pay shall be made as soon as practicable but no
later than sixty (60) days following the end of the quarter.
(d) STOCK OPTIONS. The Executive has been granted incentive stock
options pursuant to the Company's Stock Option Plan to purchase up to 35,000
shares of the Company's common stock at an exercise price equal to the fair
market value of the Company's common stock on the day of the grant, subject to
board approval. Shares shall vest over a 36 month period with no vesting until
the beginning of the eighth month at which time seven-thirty-sixths (7/36) of
the options will vest, and then one-thirty-sixth (1/36) will vest after the
beginning of each month thereafter. Vesting shall occur as long as the Executive
remains an employee of the Company. The options, once vested shall have an
expiration date of 4 years from the date of grant of the option. In addition,
the Executive may participate in stock option programs of the Company upon such
terms as the administrators of such programs in their discretion determine.
(e) ANNUAL REVIEW. The Executive's salary, bonus, options and terms
of the severance in Section 7 of this Agreement shall be reviewed annually
beginning January 1, 2000 and may be increased as the Board deems appropriate,
but shall not be decreased during the term without mutual agreement.
(f) BENEFITS AND VACATION. The Executive shall be eligible to
participate in such insurance programs (health, disability or life) or such
other health, dental, retirement or similar employee benefits programs as the
Board may approve, on a basis comparable to that available to other officers and
executive employees of the Company. The Executive shall be entitled to a minimum
of four weeks of paid vacation per year. Vacation time may be accumulated for up
to one year beyond the year for which it is accrued and may be used any time
during such year. Any vacation time not used during such additional year shall
be forfeited. The value of any accrued but unused and unforfeited vacation time
shall be paid in cash to the Executive upon termination of Executive's
employment for any reason.
(g) REIMBURSEMENT OF EXPENSES. The Company shall reimburse the
Executive in a timely manner for all reasonable out-of-pocket expenses incurred
by the Executive in connection with the performance of Executive's duties under
this Agreement; provided that the Executive presents to the Company an itemized
accounting of such expenses including reasonable supporting data and follows the
Company's travel policies.
2
<PAGE>
4. TERMINATION.
(a) TERMINATION BY THE COMPANY WITHOUT CAUSE. Notwithstanding
anything to the contrary contained herein but subject to Section 7 hereof, the
Company may, by delivering thirty (30) days' prior written notice to the
Executive, terminate the Executive's employment at any time without Cause (as
hereinafter defined).
(b) TERMINATION BY THE EXECUTIVE WITHOUT CAUSE. Notwithstanding
anything to the contrary contained herein but subject to Section 7 hereof, the
Executive may, by delivering thirty (30) days' prior written notice to the
Company, terminate the Executive's employment hereunder.
(c) TERMINATION BY THE COMPANY FOR CAUSE. The Company may terminate
the Executive's employment for Cause immediately upon written notice stating the
basis for such termination. "Cause" for termination of the Executive's
employment shall only be deemed to exist if the Executive has (i) breached this
Agreement and if such breach continues or recurs more than thirty (30) days
after notice from the Company specifying the action which constitutes the breach
and demanding its discontinuance, (ii) exhibited willful disobedience of lawful
directions of the President or of the Board, or (iii) committed gross
malfeasance in performance of Executive's duties hereunder or acts resulting in
an indictment charging the Executive with the commission of a felony; provided
that the commission of acts resulting in such an indictment shall constitute
Cause only if a majority of the directors who are not also subject to any such
indictment determine that the Executive's conduct has substantially adversely
affected the Company or its reputation. A material failure to perform
Executive's duties hereunder that results from the disability of the Executive
shall not be considered Cause for Executive's termination.
(d) TERMINATION BY THE EXECUTIVE FOR CAUSE. The Executive may
terminate employment for Cause immediately upon written notice stating the basis
for such termination. "Cause" for termination of employment by the Executive
shall only be deemed to exist if the Company has breached this Agreement and if
such breach continues or recurs more than thirty (30) days after notice from the
Executive specifying the action which constitutes the breach and demanding its
discontinuance, or if the Company is engaged in unlawful activity or requests
the Executive to engage in unlawful activity.
5. DISABILITY. In the event of disability of the Executive during the term
hereof, the Company shall, during the continuance of Executive's disability but
only for a maximum of 90 days following the determination of disability, pay the
Executive the Executive's then current salary, as provided for in Section 3(a),
and adjusted pursuant to Section 3(b), and continue to provide the Executive all
other benefits provided hereunder. As used herein, the term "disability" shall
mean the complete and total inability of the Executive, due to illness, physical
or comprehensive mental impairment, to substantially perform all of Executive's
duties as described herein for a consecutive period of thirty (30) days or more.
6. DEATH. In the event of the death of the Executive, except with respect
to any benefits which have accrued and have not been paid to the Executive
hereunder, the
3
<PAGE>
provisions of this Agreement shall terminate immediately. The Executive's estate
shall have the right to receive compensation due to the Executive as of and to
the date of Executive's death and shall have the right to receive an additional
amount equal to one-twelfth (1/12th) of the Executive's annual compensation then
in effect.
7. SEVERANCE. In the event that the Executive's employment is terminated by
the Company other than for Cause or death of the Executive, or in the event
there is either a material change in the responsibilities of the Executive or a
loss of position within six (6) months after a Change of Control (as defined in
Section 12 of this Agreement), or if Executive terminates this Agreement for
Cause, the Executive shall be entitled to receive Executive's then current
salary and benefits, as provided for in Sections 3(a) and 3(e), payable in
semi-monthly installments, for the greater of six (6) months or that number of
months which equals the number of years that have elapsed from the initial date
of this Agreement until the date of the Executive's termination by the Company;
PROVIDED, HOWEVER, that if any of such payments would (i) constitute a
"parachute payment" within the meaning of Section 280G of the Intemal Revenue
Code of 1986 (the "Code") and (ii) but for this provision, be subject to the
excise tax imposed by Section 4999 of the Code (the "Excise Tax"); the amount
payable hereunder shall be reduced to the largest amount which the Executive
determines would not result in any portion of the payments hereunder being
subject to the Excise Tax. If the Executive voluntarily resigns Executive's
employment hereunder or if Executive's employment is terminated for Cause, the
Executive shall not be entitled to any severance pay or other compensation
beyond the date of termination of Executive's employment.
8. COVENANT NOT TO COMPETE.
(a) During the continuance of the Executive's employment hereunder
and for a period of twelve (12) months after termination of the Executive's
employment hereunder, pursuant to section 4.b or 4.c hereof, the Executive shall
not engage in any business which competes with the Company or its affiliates
anywhere in the United States or Canada during the Executive's employment
hereunder or at the time of termination.
(b) The Executive shall not, for a period of twelve (12) months after
termination of the Executive's employment hereunder, pursuant to section 4.b or
4.c hereof, employ, engage or seek to employ or engage for himself or any other
person or entities, any individual who is or was employed or engaged by the
Company or any of its affiliates until the expiration of six (6) months
following the termination of such person's or entity's employment or engagement
with the Company or any of its affiliates.
9. TRADE SECRETS AND CONFIDENTIAL INFORMATION. During Executive's
employment by the Company and for a period of five (5) years thereafter, the
Executive shall not, directly or indirectly, use, disseminate, or disclose for
any purpose other than for the purposes of the Company's business, any
Confidential Information of the Company or its affiliates, unless such
disclosure is compelled in a judicial proceeding. Upon termination of
Executive's employment, all documents, records, notebooks, and similar
repositories of records containing information relating to any Confidential
Information then in the Executive's
4
<PAGE>
possession or control, whether prepared by him or by others, shall be left with
the Company or, if requested, returned to the Company.
10. SEVERABILITY. It is the desire and intent of the undersigned parties
that the provisions of Sections 8 and 9 shall be enforced to the fullest extent
permissible under the laws in each jurisdiction in which enforcement is sought.
Accordingly, if any particular sentence or portion of either Section 8 or 9
shall be adjudicated to be invalid or unenforceable, the remaining portions of
such section nevertheless shall continue to be valid and enforceable as though
the invalid portions were not a part thereof. In the event that any of the
provisions of Section 8 relating to the geographic areas of restriction or the
provisions of Sections 8 or 9 relating to the duration of such Sections shall be
deemed to exceed the maximum area or period of time which a court of competent
jurisdiction would deem enforceable, the geographic areas and times shall, for
the purposes of this Agreement, be deemed to be the maximum areas or time
periods which a court of competent jurisdiction would deem valid and enforceable
in any state in which such court of competent jurisdiction shall be convened.
11. INJUNCTIVE RELIEF. The Executive agrees that any violation by Executive
of the provisions contained in Sections 8 and 9 are likely to cause irreparable
damage to the Company, and therefore Executive agrees that if there is a breach
or threatened breach by the Executive of the provisions of said sections, the
Company shall be entitled to pursue an injunction restraining the Executive from
such breach, and Executive will make no objection to the form of relief sought.
Nothing herein shall be construed as prohibiting the Company from pursuing any
other available remedies for such breach or threatened breach.
12. MISCELLANEOUS.
(a) NOTICES. Any notice required or permitted to be given under this
Agreement shall be directed to the appropriate party in writing and mailed or
delivered, if to the Company, to eSoft, Inc., to the attention of the President,
at 295 Interlocken Blvd, #500, Broomfield, Colorado 80021, and if to the
Executive, at 12939 S. U.S. Hwy 285, Conifer, CO, 80433. Notification addresses
may be changed with written notice.
(b) BINDING EFFECT. This Agreement is a personal service agreement
and may not be assigned by the Company or the Executive, except that the Company
may assign this Agreement to a successor of the Company by merger,
consolidation, sale of substantially all of the Company's assets or other
reorganization (a "Change of Control"). Subject to the foregoing, this Agreement
shall be binding upon and inure to the benefit of the parties hereto and their
respective successors, assigns, and legal representatives.
(c) AMENDMENT. This Agreement may not be amended except by an
instrument in writing executed by each of the undersigned parties.
(d) APPLICABLE LAW. This Agreement is entered into in the State of
Colorado and for all purposes shall be governed by the laws of the State of
Colorado.
5
<PAGE>
(e) ATTORNEY'S FEES. In the event either party takes legal action to
enforce any of the terms of this Agreement, the unsuccessful party to such
action will pay the successful party's reasonable expenses, including attorney's
fees, incurred in such action.
(f) ENTIRE AGREEMENT. This Agreement supersedes and replaces all prior
agreements between the parties related to the employment of the Executive by the
Company.
SIGNATURES
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
first date mentioned above.
THE COMPANY:
By: /s/ Jeffrey Finn
---------------------------
Name: Jeffrey Finn
Title: Chief Executive Officer
THE EXECUTIVE:
By: /s/ Amy Beth Hansman
---------------------------
Amy Beth Hansman
6
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF ESOFT, INC.
<TABLE>
<CAPTION>
NAME OF SUBSIDIARY STATE OF INCORPORATION
<S> <C>
Apexx Technologies, Inc. Idaho
Technologic, Inc. Georgia
</TABLE>
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
eSoft, Incorporated
295 Interlocken Boulevard, Suite 500
Broomfield, Colorado 80021
We hereby consent to the incorporation by reference in the registration
statement of eSoft, Inc. on Form S-3 (File Nos. 333-82247, 333-82619,
333-89401,333-91705 and 333-86737) and on Form S-8 (File Nos. 333-80151,
333-91163 and 333-91161) of our report dated March 1, 2000 on our audits of
the consolidated financial statements of eSoft, Incorporated as of December
31, 1999 and 1998 and for each of the two years in the period ended December
31, 1999, which report is included in this Annual Report on Form 10-KSB.
/s/ BDO Seidman, LLP
- - ---------------------------------
BDO Seidman, LLP
Denver, Colorado
March 30, 2000
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC AUDITORS
To eSoft Incorporated:
As independent public accountants, we hereby consent to the incorporation by
reference of our report dated February 4, 1999, related to the balance sheet
of Apexx Technology, Inc. as of December 31, 1998 and the related statements
of operations, stockholders' deficit and cash flows for the year then ended
to be included in this Form 10KSB, into the Company's previously filed
Registration Statements on Form S-3 File Nos. 333-82247, 333-82619,
333-89401, 333-91705, and 333-86737 and Form S-8 File Nos. 333-80151,
333-91163 and 333-91161 each as filed with the Securities and Exchange
Commission. Our report contains an explanatory paragraph regarding Apexx
Technology, Inc.'s ability to continue as a going concern.
Balukoff, Lindstrom & Co., P.A.
Boise, Idaho
March 30, 2000
<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> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 8,576,055
<SECURITIES> 0
<RECEIVABLES> 2,677,424
<ALLOWANCES> (310,453)
<INVENTORY> 672,691
<CURRENT-ASSETS> 11,773,978
<PP&E> 1,220,528
<DEPRECIATION> (660,904)
<TOTAL-ASSETS> 13,358,791
<CURRENT-LIABILITIES> 1,761,884
<BONDS> 1,198,254
142,890
0
<COMMON> 0
<OTHER-SE> 13,215,901
<TOTAL-LIABILITY-AND-EQUITY> 13,358,791
<SALES> 9,079,647
<TOTAL-REVENUES> 9,079,647
<CGS> 3,573,695
<TOTAL-COSTS> 15,948,849
<OTHER-EXPENSES> (185,260)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 527,967
<INCOME-PRETAX> (10,758,604)
<INCOME-TAX> 0
<INCOME-CONTINUING> (10,785,604)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,785,604)
<EPS-BASIC> ($1.00)
<EPS-DILUTED> ($1.00)
</TABLE>
