<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For Period Ended June 30, 2000
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from ___________ to ___________
Commission File Number 00-23527
eSoft, Inc.
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(Exact name of small business issuer as specified in its charter)
DELAWARE 84-0938960
--------------------------------- ------------------------
(State or other jurisdiction (IRS Employer ID Number)
of incorporation or organization)
295 Interlocken Boulevard, #500
Broomfield, CO 80021
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(Address of Principal Executive Offices)
(303) 444-1600
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(Issuer's Telephone Number, Including Area Code)
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
--- ---
Transitional Small Business Disclosure format (check one):
YES NO X
--- ---
The number of shares outstanding of the Registrant's $0.01 par value common
stock on July 31, 2000 was 16,060,508.
<PAGE>
eSOFT, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION Page
----
<S> <C>
Item 1. Consolidated Financial Statements 3 - 14
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15 - 26
PART II OTHER INFORMATION 27 - 30
</TABLE>
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
eSOFT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
December 31, June 30,
1999 2000
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 8,576,055 $ 16,756,825
Accounts receivable:
Trade, less allowance of $310,453 and $324,616 for
doubtful accounts 1,454,471 2,247,165
Other 912,500 1,449,500
Inventories 672,691 335,500
Prepaid expenses and other 158,261 372,198
------------ ------------
Total current assets 11,773,978 21,161,188
------------ ------------
PROPERTY AND EQUIPMENT
Computer equipment 718,122 926,547
Furniture and equipment 326,092 389,066
Automobile -- 17,000
Leasehold improvements 176,314 189,034
Less accumulated depreciation (660,904) (806,876)
------------ ------------
Net property and equipment 559,624 714,771
------------ ------------
OTHER ASSETS
Capitalized software costs, net of accumulated amortization 702,417 271,024
Deferred financing costs 283,215 224,708
Other assets 39,557 --
------------ ------------
Total other assets 1,025,189 495,732
------------ ------------
TOTAL ASSETS $ 13,358,791 $ 22,371,691
============ ============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
3
<PAGE>
eSOFT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
December 31, June 30,
1999 2000
------------ ------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 831,496 $ 743,568
Deferred revenue 289,590 668,218
Accrued expenses:
Payroll and payroll taxes 185,983 247,376
Other 454,815 501,870
------------ ------------
Total current liabilities 1,761,884 2,161,032
LONG TERM LIABILITIES
Convertible debenture 1,198,254 1,361,507
------------ ------------
Total liabilities 2,960,138 3,522,539
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, par value $.01 per share;
Authorized 100,000,000 shares; 14,289,075 and
16,056,708 issued and outstanding December
31, 1999 and June 30, 2000, respectively 142,890 160,567
Additional paid-in capital 24,999,820 50,565,661
Subscriptions receivable (39,704) (12,508,987)
Accumulated deficit (14,704,353) (19,368,089)
------------ ------------
Total stockholders' equity 10,398,653 18,849,152
------------ ------------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 13,358,791 $ 22,371,691
============ ============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
4
<PAGE>
eSOFT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED FOR THE THREE MONTHS ENDED
JUNE 30, JUNE 30,
1999 2000 1999 2000
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
REVENUES:
Product $ 3,576,551 $ 4,494,903 $ 1,854,634 $ 2,291,102
Services 230,286 1,236,000 230,286 317,000
------------ ------------ ------------ ------------
Total revenues 3,806,837 5,730,903 2,084,920 2,608,102
------------ ------------ ------------ ------------
COST OF GOODS SOLD:
Product 1,902,692 2,391,857 1,018,082 1,240,369
Services -- 165,502 -- 64,118
------------ ------------ ------------ ------------
Total cost of goods sold 1,902,692 2,557,359 1,018,082 1,304,487
GROSS PROFIT 1,904,145 3,173,544 1,066,838 1,303,615
------------ ------------ ------------ ------------
EXPENSES:
Sales and marketing expense 3,802,828 3,685,100 1,343,525 2,130,093
General & administrative expense 3,486,911 2,249,184 1,942,831 1,119,131
Engineering expense 715,089 1,023,017 423,372 468,012
Software amortization costs 83,652 431,393 41,826 132,393
Research and development expense 355,710 481,465 148,616 278,893
------------ ------------ ------------ ------------
Total Expenses 8,444,190 7,870,159 3,900,170 4,128,522
------------ ------------ ------------ ------------
Loss from operations (6,540,045) (4,696,615) (2,833,332) (2,824,907)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Realized gain(loss) on sale 292,634 -- 146,317 --
Unrealized gain(loss) (183,189) -- -- --
Interest income 34,130 305,643 9,182 202,636
Interest expense (59,990) (272,764) (51,045) (135,980)
Other (84,433) -- (87,985) --
------------ ------------ ------------ ------------
Total Other Income (Expense) (848) 32,879 16,469 66,656
------------ ------------ ------------ ------------
NET LOSS $ (6,540,893) $ (4,663,736) $ (2,816,863) $ (2,758,251)
============ ============ ============ ============
BASIC AND DILUTED LOSS PER
COMMON SHARE $ (.65) $ (.31) ($ .27) $ (.18)
============ ============ ============ ============
BASIC AND DILUTED WEIGHTED
AVERAGE SHARES OUTSTANDING 10,074,001 15,020,743 10,303,605 15,606,309
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
5
<PAGE>
eSOFT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
Common Stock Additional Total
---------------------- Paid-in Subscriptions Accumulated Stockholders'
Shares Amount Capital Receivable Deficit Equity
---------- -------- ----------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE January 1, 2000 14,289,075 $142,890 $24,999,820 $ (39,704) $(14,704,353) $ 10,398,653
Exercise of warrants and options 483,230 4,833 540,197 -- -- 545,030
Issuance of common stock for bonus 2,812 28 38,460 -- -- 38,488
Collection of notes receivable for
exercise of options and warrants -- -- -- 30,717 -- 30,717
Issuance of common stock pursuant
to private placement 640,796 6,408 12,493,592 -- -- 12,500,000
Issuance of notes receivable for
common stock 640,795 6,408 12,493,592 (12,500,000) -- --
Net loss for the six months
ended June 30, 2000 -- -- -- -- (4,663,736) (4,663,736)
---------- -------- ----------- ------------ ------------ ------------
BALANCE June 30, 2000 16,056,708 $160,567 $50,565,661 $(12,508,987) $(19,368,089) $ 18,849,152
========== ======== =========== ============ ============ ============
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
6
<PAGE>
eSOFT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS ENDED
JUNE 30,
1999 2000
----------- -----------
<S> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES
Net loss from operations $(6,540,893) $(4,663,736)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation & software amortization 133,094 577,365
Provision for losses on accounts receivable 21,211 14,163
Amortization of discount on investments (8,459) --
Amortization of debt discounts and financing costs 123,870 221,760
Amortization of warrant valuation granted
for prepaid consulting 101,767 --
Issuance of compensatory options 29,953 --
Issuance of common stock for bonuses -- 38,488
Proceeds from sale of securities available for sale 36,872 --
Realized loss from sale of securities available for sale 146,317 --
Changes in operating assets and liabilities:
Accounts receivable - trade (305,469) (806,857)
Other accounts receivable -- (537,000)
Inventories 847,291 337,191
Prepaid expenses (52,595) (213,937)
Other assets (11,589) 39,557
Accounts payable 394,449 (87,928)
Accrued expenses 210,518 108,448
Deferred revenue 28,527 378,628
----------- -----------
Net cash used in operating activities (4,845,136) (4,593,858)
----------- -----------
CASH FLOW FROM INVESTING ACTIVITIES
Proceeds from sale of investments 2,000,000 --
Purchase of property and equipment (106,115) (301,119)
Deposits on leased facilities 85,000 --
Additions to capitalized software (2,650) --
----------- -----------
Net cash provided by (used in) investing activities 1,976,235 (301,119)
----------- -----------
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
7
<PAGE>
eSOFT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
1999 2000
----------- -----------
<S> <C> <C>
CASH FLOW FROM FINANCING ACTIVITIES
Proceeds from stock subscription receivable 56,487 30,717
Proceeds from line of credit, net 80,000 --
Payments on short term debt (46,229) --
Proceeds from short term debt 117,794 --
Proceeds (re-payment) from margin loan on investments (39,544) --
Proceeds from issuance of convertible debt 3,000,000 --
Debt offering costs paid (340,819) --
Proceeds from exercise of options and warrants
and sale of common stock 1,116,789 13,045,030
----------- -----------
Net cash provided by financing activities $ 3,944,478 $13,075,747
INCREASE IN CASH 1,075,577 8,180,770
CASH: BEGINNING OF PERIOD 732,384 8,576,055
----------- -----------
CASH: END OF PERIOD $ 1,807,961 $16,756,825
=========== ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
Cash paid for interest $ 5,491 $ 50,000
Common stock issued for subscriptions receivable $ 269,947 --
Warrants issued in connection with debt offering $ 1,095,578 --
Warrants issued to consultants $ 96,452 --
Common stock issued to Gateway -- 12,500,000
</TABLE>
The accompanying notes are an integral part of the
consolidated financial statements.
8
<PAGE>
eSOFT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Basis of Presentation
The consolidated interim financial statements include the accounts of
eSoft, Inc. and its two wholly-owned subsidiaries, Apexx Technology, Inc.
("Apexx") and Technologic, Inc. ("Technologic"), (collectively eSoft or the
"Company") and have been prepared by the Company, without audit, pursuant
to the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations, although the Company believes that the disclosures are
adequate to make the information presented not misleading.
These statements reflect all adjustments, consisting of normal
recurring adjustments, which in the opinion of management, are necessary
for fair presentation of the information contained therein. It is suggested
that these consolidated financial statements be read in conjunction with
the financial statements and notes thereto included in the Company's Annual
Report on Form 10-KSB for the year ended December 31, 1999. The Company
follows the same accounting policies in preparation of interim reports.
The consolidated financial statements of the Company for the three
months and six months ended June 30, 1999 have been restated to give
retroactive effect to the mergers with Apexx on May 25, 1999 and
Technologic on September 10, 1999, which have been accounted for using the
pooling of interests method and, as a result, the financial position,
results of operations and cash flows are presented as if the combining
companies had been consolidated for all periods presented and the
consolidated statement of stockholders' equity reflect the accounts of
eSoft as if the additional common stock issued in connection with the
mergers had been issued for all periods presented. It is further suggested
that these consolidated financial statements be read in conjunction with
the supplemental consolidated financial statements and notes thereto
included in the Company's Current Report on Form 8-K and 8-K/A filed with
the Securities & Exchange Commission on August 9, 1999 and September 27,
1999, respectively.
Results of operations for the interim periods are not necessarily
indicative of annual results.
2. Business Acquisitions
Effective May 25, 1999, the Company completed the merger (the
"Merger") with Apexx located in Boise, Idaho which provided for the
exchange of all of the outstanding stock of Apexx for 1,591,365 shares of
eSoft common stock and for the conversion of all Apexx stock
9
<PAGE>
eSOFT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
options into eSoft stock options to acquire 1,356,003 shares of eSoft
common stock. The Merger has been accounted for as a pooling of interests.
Effective September 10, 1999, the Company completed the merger (the
"Merger") with Technologic located in Norcross, Georgia which provided for
the exchange of all of the outstanding stock of Technologic for 1,244,436
shares of eSoft common stock and for the conversion of all Technologic
stock options into eSoft stock options to acquire 180,565 shares of eSoft
common stock. The Company also issued 75,000 shares of the Company's common
stock to the investment bankers of Technologic in connection with the
merger. The Merger has been accounted for as a pooling of interests. Merger
costs of about $725,000 in relation to this merger were expensed during the
third quarter, which include bankers fees, audit fees, legal fees, and
printing fees.
<TABLE>
<CAPTION>
Pooling Company Nature of Operations Merger Date
--------------- --------------------- -----------
<S> <C> <C>
Apexx Technology, Inc. Internet connectivity solutions May 25, 1999
Technologic, Inc. Internet connectivity solutions September 10, 1999
</TABLE>
Revenue and net loss of eSoft, Apexx and Technologic as consolidated
for the periods presented are as follows:
<TABLE>
<S> <C>
REVENUE:
Six Months Ended June 30, 1999
eSoft through May 25, 1999 $ 970,647
Apexx through May 25, 1999 1,090,821
-----------
Subtotal 2,061,468
eSoft/Apexx from May 25 to June 30, 1999 627,751
Technologic through June 30, 1999 1,117,618
-----------
eSoft, consolidated $ 3,806,837
NET LOSS:
Six Months Ended June 30, 1999
eSoft through May 25, 1999 $(4,661,057)
Apexx through May 25, 1999 $ (600,674)
-----------
Subtotal (5,261,731)
eSoft/Apexx from May 25 to June 30, 1999 (782,144)
Technologic through June 30, 1999 (497,018)
-----------
eSoft, consolidated $(6,540,893)
</TABLE>
Intercompany sales of approximately $496,000 have been eliminated
during the period.
10
<PAGE>
eSOFT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
3. Account Receivable - Trade
The following information summarizes accounts receivable:
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
----------- -----------
<S> <C> <C>
Accounts Receivable $ 1,764,924 2,571,781
Allowance for doubtful accounts (310,453) (324,616)
----------- -----------
$ 1,454,471 $ 2,247,165
=========== ===========
</TABLE>
The Company did not have any customers which accounted for 10% or more
of the sales through the six months ending June 30, 2000, or which
individually had outstanding balances which accounted for more than 10% of
the total outstanding accounts receivable balance as of June 30, 2000.
International sales represented approximately 25% of revenue for the six
months ending June 30, 2000 and approximately 38% of outstanding accounts
receivable at June 30, 2000.
The Company with regard to its foreign sales does not take the risk of
foreign currency fluctuation. All sales are designated as payment in US
denominated funds at the time of sale.
4. Accounts Receivable -Other
During 1999, the Company entered into an agreement with a shareholder
of the Company to jointly architect and design certain software
applications. The agreement grants the stockholder of the Company the right
to use or sell the stockholder's products, which include the Company's
software, as well as the right to modify the software and related products.
The Company has recognized revenue of $2,500,000 to date in accordance with
the percentage of completion method of which $1,175,000 is due the Company
at June 30, 2000. The Company has also entered into other various licensing
and engineering development agreements during the year, of which the
receivable balance at June 30, 2000 is $274,500.
5. Subscriptions Receivable
The Company issued promissory notes receivable in the amount of
$76,000 to employees during June 1999 in exchange for the issuance of
common stock. The notes are full recourse, and are due in June 2001 with
annual interest at the rate of 5.75% due upon maturity and are secured by
the shares of common stock being issued. The notes become due and payable
upon termination of employment. At June 30, 2000, $7,000 in principal and
$1,987 of interest receivable remained outstanding.
11
<PAGE>
eSOFT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In addition, on April 26, 2000, eSoft entered into a Common Stock and
Warrant Purchase and Investor Rights Agreement with Gateway Companies, Inc.
("Gateway") for the investment of $25,000,000 in exchange for 1,281,591
shares of common stock, calculated at $19.507 per share. Should an
underwritten public offering occur within nine months of the closing, the
price of the stock would be adjusted to the lower of $19.507 or a 6.5%
discount from the public offering price of the stock. Accordingly, should
the price be adjusted, the Company would be required to issue additional
shares of common stock to Gateway. The payment of the purchase price is to
be made in two equal installments, with 50% paid at closing (April 26,
2000), and 50% paid ninety days after the closing. At the same time,
warrants to purchase 600,000 shares of common stock were issued to Gateway.
The warrants carry a strike price of $19.507, equal to the purchase price
of the common stock. In addition, this strike price may be adjusted in
accordance with any change in the purchase price of the common stock as
discussed above. The warrants vest based upon certain performance
milestones as indicated in the agreement. At this time, management has
estimated the fair value of the warrants to be nominal. However, the
Company will be required to remeasure the warrants at each reporting date.
The fair value of the warrants will be reflected in shareholders' equity,
and changes in the fair value of the warrants will be reflected in the
current period as a charge to operating expense.
As of August 11, 2000, Gateway had not made the second payment to
eSoft. A stock certificate for 640,795 shares, or approximately one-half of
the shares purchased by Gateway, is currently being held in escrow by
Norwest Bank Colorado National Association and cannot be released by the
escrow agent without eSoft's consent. In addition, eSoft is currently in
possession of an irrevocable proxy executed by Gateway giving eSoft the
power to vote the 640,795 shares of eSoft common stock held in escrow.
eSoft has been in discussions with Gateway regarding the timing and terms
of the $12.5 million deferred purchase price, but has not come to any
resolution with Gateway regarding this matter. eSoft is continuing to
pursue discussions with Gateway, but no assurance can be given regarding
the likely outcome of these discussions. The Company has demanded that
Gateway make payment pursuant to the agreement. eSoft is also considering
what other specific actions it will take with respect to the Gateway
payment obligation, which may include the pursuit of legal remedies.
6. Convertible debenture
In September 1999, the Company issued to the same debenture holder
$2,000,000 of unsecured 5% Convertible Debentures issued at a 2.5%
discount, due June 10, 2002 ("Debentures") and stock purchase warrants
("warrants") with a right to purchase an aggregate of 511,182 shares of
common stock, par value $.01 per share, at an exercise price of $4.4994,
The principal amount of the Debenture is convertible at any time at the
investor's option into a fixed number of shares of eSoft common stock at
$3.9125 per share, subject to certain anti-dilution provisions and
adjustments. The Company has the ability, under certain circumstances, to
obligate the investor to
12
<PAGE>
eSOFT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
convert the debentures into common stock and to exercise the warrants. The
investor has the option to purchase an additional $3 million of debentures,
together with warrants to purchase shares of common stock of the Company
equal to the quotient obtained by dividing $3 million by the conversion
price for the debentures with an exercise price of 115% of the debenture
conversion price. The additional $3 million of debentures would be
convertible at the lower of (i) the Company's then current market price or
(ii) $5.50, but in no event less than $3.9125 per share. The debentures are
manditorily convertible if the average per share market value over thirty
consecutive trading days exceed 200% of the exercise price of the warrants.
The Black Scholes value of the warrants issued, of $846,607 plus an initial
discount of $50,000 related to the aforementioned 2.5% discount, for a
total of $896,607, was recorded as an original issue discount and is being
amortized over the term of the debentures and recorded as non-cash interest
expense. At June 30, 2000, the balance of the unamortized original issue
discount was $638,493. The balance of the Convertible Debentures at June
30, 2000 of $1,361,507, represents the original face value of the remaining
outstanding debentures, of $2,000,000 less the balance of the unamortized
discount, of $638,493.
7. Net Loss per Share
Basic loss per share is calculated by dividing the net loss by the
weighted average common shares outstanding during the period. For purposes
of computing diluted earnings per share, dilutive securities are not
included when the effect is anti-dilutive.
Options and warrants to purchase 4,388,028 and 3,776,499 shares of
common stock and notes convertible into 0 shares and 511,182 shares were
not included in the computation of diluted earnings per share because their
effect was anti-dilutive for the period ending June 30, 1999 and 2000.
13
<PAGE>
FORWARD-LOOKING STATEMENTS
Statements made in this Form 10-QSB that are not historical or current
facts are "forward-looking statements" made pursuant to the safe harbor
provisions of Section 27A of the Securities Act of 1933 (the "Securities
Act") and Section 21E of the Securities Exchange Act of 1934. These
statements often can be identified by the use of terms such as "may,"
"will," "expect," "believes," "anticipate," "estimate," "approximate" or
"continue," or the negative thereof. The Company intends that such
forward-looking statements be subject to the safe harbors for such
statements. The Company wishes to caution readers not to place undue
reliance on any such forward-looking statements, which speak only as of the
date made. Any forward-looking statements represent management's best
judgment as to what may occur in the future. However, forward-looking
statements are subject to risks, uncertainties and important factors beyond
the control of the Company that could cause actual results and events to
differ materially from historical results of operations and events and
those presently anticipated or projected. These factors include adverse
economic conditions, entry of new and stronger competitors, inadequate
capital, unexpected costs, failure to gain product approval in foreign
countries and failure to capitalize upon access to new markets. Additional
risks and uncertainties which may affect forward-looking statements about
the Company's business and prospects include the possibility that a
competitor will develop a more comprehensive or less expensive solution,
delays in market awareness of eSoft and its products, possible delays in
eSoft's marketing strategy, which could have an immediate and material
adverse effect by placing eSoft behind its competitors. Additional risks
and uncertainties are described in the Company's most recently filed Annual
Report on Form 10-KSB for the fiscal year ended December 31, 1999. The
Company disclaims any obligation subsequently to revise any forward-looking
statements to reflect events or circumstances after the date of such
statement or to reflect the occurrence of anticipated or unanticipated
events.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
TEAM INTERNET IS A REGISTERED TRADEMARK OF eSOFT, INC.
Our products provide all of the components an organization needs to
develop, manage, and monitor its Intranet, external web presence and
Internet-based applications. Our Linux-based applications such as web
hosting, business-to-business communications, virtual private networks,
remote information technology services and firewall protection are designed
to coexist with multiple hardware platforms. Our software applications and
operating system are engineered to provide a fully integrated, secure and
reliable solution.
Our software solutions target small-to-medium sized businesses that
typically have between ten and two hundred desktop computers connected to a
local area network, or LAN. The availability of low cost, high speed
bandwidth, through technologies such as cable modems and digital subscriber
line or DSL is driving small-to-medium sized business demand for full time
Internet access across their LANs. The SMB segment comprises the largest
portion of the installed local area networks and increasingly recognizes
the importance of the Internet to grow their business and improve
productivity. Internet penetration has been estimated to increase from
54.9% of small business PC owners in 1998 to 68.5% in 2002. The number of
small businesses online is expected to increase from 3.2 million in 1998 to
4.6 million in 2002.
14
<PAGE>
Our products enable small-to-medium sized businesses to establish and
enhance their Web presence and conduct business and electronic commerce on
the Internet. Most of the end users of our products are relatively price
sensitive, and most have limited in-house technical expertise. eSoft's
products are designed to provide cost-effective Internet connectivity
solutions that are easy to install and maintain by the end user's existing
personnel. Our TEAM Internet product is a complete, stand-alone
plug-and-play Internet connectivity solution that can be installed and
maintained by non-technical personnel at a fraction of the cost of a
traditional solution. Our products can provide all of the users on a LAN
with a shared dedicated Internet connection, which allows our customers to
achieve both expense and productivity improvements when compared to
traditional single user dial-up access. In addition, our Linux-based
Internet connectivity software solutions allow our customers to access the
Internet in a reliable, secure and flexible manner. Our software products
are built using modular architecture, allowing scalability to fit the
customers' growing needs. The ability to easily add additional Internet
appliances and application services provides an evolution path that allows
customers to develop their network services and its architecture according
to their needs without a high upfront investment. Our Internet applications
facilitate the migration from limited, dial-up analog modems to an
economical, feature-rich, easy-to-use Internet communications device. In
addition, we market and sell the Interceptor and Instagate products that
were developed by Technologic. These products are UNIX-based products that
address firewall and virtual private network ("VPN") requirements of
businesses.
In addition to our core services, we currently offer managed firewall
services, URL screening, and web filtering. Managed services provide
flexibility in meeting the needs of small to medium-sized businesses during
each stage of their development. We design our managed services offerings
to allow smaller businesses to outsource the infrastructure and services
necessary to support the use of these applications. Our remote management
of these services allows our clients to focus on their core competencies.
Over the past year, eSoft has been working to design and develop a
next-generation broadband services platform that builds on the attributes
and feature-sets of the TEAM Internet, Interceptor and Instagate products.
The new product is a highly modular, flexible and scalable Linux-based
architecture specifically designed to address the evolving requirements of
small-to-medium enterprises who establish a broadband connection to the
Internet. 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. In
addition, the product architecture enables the rapid introduction of new
applications and services that can be remotely configured and installed on
an existing system, thereby addressing new or additional requirements of
the end user, and creating an incremental, recurring revenue stream for
eSoft and its partners.
eSoft has been active in marketing this next generation broadband
services platform to major hardware manufacturers (OEMs). During 1999, we
launched our redphish-TM- program. redphish-TM- is targeting the licensing
of our next-generation software, along with certain customization or
modifications from our professional engineering services, in order to
create highly specialized or
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customized offerings for hardware manufacturers and broadband service
providers to integrate into their own offerings. This allows us to leverage
our expertise in software development and delivery, along with our
partners' expertise in hardware design, manufacturing and distribution. We
believe that the redphish-TM- program 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.
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 to medium-sized customers.
Delivered initially as a basic Internet connectivity solution, this
platform can later serve as a foundation for additional products and
services, such as enhanced e-mail, virtual private networking, and
business-to-business applications. Our program is based on revenue sharing,
which provides incentive at every point of the distribution chain. In 1999,
we signed our first two redphish-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.
In the second quarter of 2000, we launched our Smart DSL program,
which focuses on a subscription-based model that minimizes the cash outlay
requirements for our customers and generates a more predictable recurring
revenue stream associated with each sale. Previously, most of our product
revenue was generated from one-time product sales. This approach maximized
short-term revenue, but made ongoing revenue predictions difficult. 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.
Smart DSL offers not only DSL's high speed Internet access, but also
provides valuable features important for small- to medium-sized businesses
in a single, upgradable "smart box." These features include RAS, VPN,
firewall security, Web site hosting, unlimited e-mail, and long-term
management of the broadband connection and applications. This eliminates
the historical complications small businesses faced when trying to
integrate many different features, numerous pieces of hardware, several
versions of software and more than one access provider into a DSL solution.
Deployed through existing telephone lines, a broadband solution like DSL is
a logical and economical choice for businesses wanting to tap into the full
potential of the Internet and improve communication and work collaboration.
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 complementary products to
our customers, further enhancing our life-of-customer relationship and long
term revenue stream. We are aggressively moving forward with this program
and expect to introduce the program into six different cities by the end of
the year.
DSL is fast becoming an integral component of small- to medium-sized
business communication strategies, where speed and accessibility are core
to succeeding in today's competitive marketplace. According to
International Data Corporation of Framingham, Mass., the U.S. will
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experience a 200 percent compound annual growth rate for DSL circuits over
the next few years, with primarily small- to medium-sized businesses
accounting for about 25 percent of DSL service.
Application solution providers, or ASPs, offer solutions that provide
shared application content to end-users on a need-to-access basis. However,
most ASPs do not have a means for delivery of local information at the
business site. Over time, we believe that a local application presence (of
some components) will be a necessary differentiator for success with
ASP-based solutions. eSoft will seek to expand its relationships with ASPs
worldwide, looking for best-of-breed solutions for various market segments.
Widespread availability of broadband Internet access is a global
phenomenon. We plan to continue to expand our direct presence in key non-US
markets. We have established offices in Singapore and the United Kingdom.
We also expect to establish a local presence in Japan, Korea, and other key
European and Asian locations.
The Company expects to use outside financing for the continued company
wide expansion. Additional employees in sales, marketing, engineering, and
operations will be hired in connection with increased market penetration.
With the current increase in headquarters staff and SmartDSL personnel, the
Company leased additional space in 2000. With the aggressive market
expansion, the Company anticipates consuming working capital to meet this
continued growth curve for the near term. As a result of the transition to
a subscription-based revenue model and an increase in expenses incurred in
support of the expansion, the Company anticipates future losses. The
Company expects to turn profitable in 2001 through the increase in sales
and related margins, while keeping General and Administrative expenses
fairly constant.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash position on June 30, 2000 was $16,757,000 an
increase of $8,181,000 from year end primarily due to the equity investment
by Gateway. The Company's working capital at June 30, 2000 was $18,700,000,
an increase of $8,688,000 from December 31, 1999. Management anticipates
continuing losses in support of the growth initiatives and, thus expects
continued negative cash flow. The Company is increasing efforts to reduce
the present accounts receivable balance through more stringent collection
efforts of the current customer base in an attempt to reduce the days sales
outstanding. The Company has analyzed its accounts receivable and adjusted
its allowance for doubtful accounts to $325,000 at June 30, 2000. Other
accounts receivable relate to software development fees and licensing fees
from long-term development contracts, which are due upon completion of
certain performance criteria. In addition, subscriptions receivable are
related to the equity investment by Gateway. The Company has expended
$301,000 in capital expenditures, mainly attributable to additional
computers purchased for new employees, and a videoconferencing system
intended to enhance communications among the offices, and leasehold
improvements related to additional space leased. 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.
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CASH FLOW
Net cash used in operating activities for the six months ended June
30, 2000 was $4,594,000 compared with $4,845,000 for the six months ended
June 30, 1999, a decrease of $251,000 for the 2000 period compared to the
1999 period. The Company's net loss at June 30, 2000 was ($4,664,000), a
decrease of $1,877,000 from June 30, 1999. This decrease in net loss was
primarily the result of the intensive marketing campaign done in 1999
regarding the rebranding of the IPAD products. There were also merger
related costs incurred during 1999 for legal, accounting, banking, and
consulting fees. Offsetting these decreases were the increase in accounts
receivable of ($1,344,000) related to software development and licensing.
Other items impacting the cash used in operating activities during the six
months ended June 30, 2000 were adjustments of $577,000 for depreciation
and amortization and $222,000 for amortization of debt discounts and
financing costs. In addition, prepaid expenses increased ($214,000),
inventories decreased $337,000, accounts payable decreased ($88,000),
accrued expenses increased $108,000 and deferred revenue increased
$379,000.
Net cash used in investing activities for the six months ended June
30, 2000 was $301,000 compared with $1,976,000 provided by investing
activities for the six months ended June 30, 1999. The decrease of
$2,277,000 for the 2000 period compared to the 1999 period was primarily
due to $2,000,000 of investments maturing during 1999. In addition,
purchases of property and equipment amounted to about $301,000 during 2000
due to the expansion of the facilities to support the increase in
headcount in the Smart DSL department and the engineering department.
Net cash provided by financing activities for the six months ended
June 30, 2000 was $13,076,000 compared with $3,944,000 for the six months
ended June 30, 1999. The increase of $9,132,000 for the 2000 period
compared to the 1999 period was primarily due to $12,500,000 for the
proceeds from the equity investment by Gateway. In June 1999, proceeds of
$3,000,000 were received as a result of the issuance of convertible
subordinated debentures. Additional financing activities during the six
months ended June 30, 1999 included exercise of options and warrants,
proceeds from subscriptions receivable, and payments and proceeds from
the line of credit and short term debt.
RESULTS OF OPERATIONS FOR THREE MONTHS ENDED JUNE 30, 2000
COMPARED TO THE THREE MONTHS ENDED JUNE 30, 1999
Quarterly revenues totaled $2,608,000, of which $2,291,000 was related
to product and $317,000 was related to services, versus revenue of
$2,085,000 for the comparable quarter in 1999, of which $1,855,000 was
related to product and $230,000 was related to services. In total, revenue
increased $523,000 or 25% over the comparable quarter in 1999. Product
sales increased 24% for the three months ending June 30, 2000 compared to
the three months ending June 30, 1999. The increase is partly due to the
addition of sales people towards the end of 1999 in the international
markets of Europe, Latin America and the Asia Pacific. International sales
accounted for 25% of product revenue in 2000. Services revenue increased
38% for the three months ending June 30, 2000 compared to the three months
ending June 30, 1999. The services revenue was generated from engineering
fees for development of software and related licensing fees mainly in
connection with agreements with Intel, Inc., Gateway, and 3Com.
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Gross profit margin in the current quarter was $1,304,000, which is
50% of revenue compared to $1,067,000, which is 51% of revenue for the
three months ended June 30, 1999. Gross margin on product was 46% and 45%
for the three months ending June 30, 2000 and 1999, respectively. During
the current quarter, a higher concentration of sales were made up of the
Instagate and Interceptor products which have more favorable margins. On
the other hand certain items were sold on auction sites at little
above cost and certain unusable items were sold as scrap. Additional
obsolete items have been identified and reserved during the current
quarter. Gross profit margin relating to services has decreased from
100% for the three months ending June 30, 1999 to 80% for the three months
ending June 30, 2000. The decrease is due to the services revenue in 1999
being made up of licensing fees which have no costs associated with them.
In 2000, the services revenue is made up of licensing fees and non
recurring engineering fees, which do have costs associated with them,
although they are minimal.
Selling, General and Administrative Expenses increased $229,000 or 6%
from $3,900,000 for the quarter ending June 30, 1999 to $4,129,000 for the
quarter ending June 30, 2000. Sales and marketing expenses increased
$786,000 from $1,344,000 in 1999 to $2,130,000 in 2000. The increase is
associated with lead generation expenses, more intense product marketing
efforts, and marketing efforts in connection with the start up of the Smart
DSL offering. The sales department salaries and related expenses also
increased in relation to about seventeen additional sales people hired.
General and administrative expenses decreased $824,000 from $1,943,000 in
1999 compared to $1,119,000 for the current quarter. This decrease can be
attributed to banking fees, consulting fees and printing fees recognized in
1999 associated with the Apexx merger. Engineering expenses increased
$45,000 from $423,000 in 1999 to $468,000 in 2000. Amortized software
development costs total $132,000 for the current quarter, compared to
$42,000 in the first quarter of 1999. This increase is associated with the
impairment of certain capitalized software.
Interest expense increased $85,000 in the three months ended June 30,
2000 from $51,000 in 1999 to $136,000 in 2000. The additional interest is
due to the interest and discount amortization on the convertible
subordinated debentures and amortization of deferred offering costs.
Interest income increased $194,000 in the quarter in relation to additional
cash on hand related to a substantial equity investments by Gateway in the
beginning of the quarter and the exercise of warrants and options in the
fourth quarter of 1999.
Net loss from operations was ($2,758,000) for the three months ended
June 30, 2000, compared to ($2,817,000) for the same period in 1999, a
decrease in the loss of $59,000 over the same period. The net losses are
associated with the increased Selling, General and Administrative expense
necessary to support its current business strategy. Losses are anticipated
to continue through the current fiscal year due to expenditures in support
of continued growth and market penetration.
RESULTS OF OPERATIONS FOR SIX MONTHS ENDED JUNE 30, 2000
COMPARED TO THE SIX MONTHS ENDED JUNE 30, 1999
Revenues for six months of operations totaled $5,731,000 of which
$4,495,000 was related to product and $1,236,000 was related to services,
compared to revenues of $3,807,000 for the same period in 1999 of which
$3,577,000 was related to product and $230,000 was related to services.
This represents an increase of $1,924,000 or 51% over the comparable six
month period in 1999. Product sales increased 26% for the six months ending
June 30, 2000 compared to the six months ending June
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30, 1999. The increase is partly due to the addition of sales people
towards the end of 1999 in the international markets of Europe, Latin
America and the Asia Pacific. In 2000, international sales accounted for
25% of product revenue. There were also more sales to end users and
resellers, which are discounted less than sales to distributors. Services
revenue increased 437% for the six months ending June 30, 2000 compared to
the six months ending June 30, 1999. During 2000, the services revenue was
mainly generated from engineering fees for development of software and
related licensing fees in connection with agreements with Intel, Inc.,
Gateway, 3Com, and Compaq.
Gross profit margin for the six months ending June 30, 2000
$3,174,000, which is 55% of revenue, compared to $1,904,000, which is 50%
of revenue for the six months ended June 30, 1999. The increase is
partially due to $1,236,000 of service revenue included in the six months
ending June 30, 2000, with related cost of goods of $166,000, and a gross
margin of 87%. The product gross margin for the current six months was 47%,
compared to 47% for the six months ended June 30, 1999. An increase in the
sales of higher margin product was offset by sales promotions in the
beginning of the year, such as discounts of fifty percent being given
to new customers or customers who purchased two of the same product. In
addition, reserves were established for certain obsolete inventory in 2000.
Selling, General and Administrative Expenses (SG&A) decreased $574,000
or 7% from $8,444,000 for the first six months in 1999 to $7,870,000 for
the same six months in the 2000 period. Sales and marketing expenses
decreased $118,000 from $3,803,000 in 1999 to $3,685,000 in 2000. In 1999
an extensive marketing campaign was launched with Apexx Technology for the
rebranding of the products in connection with the merger. Adding to the
decrease was the careful monitoring of how marketing dollars are best put
to use. Offsetting the decrease was the cost of additional sales people
hired to expand sales efforts domestically and internationally, and
marketing expenses related to the Smart DSL offering. General and
administrative expense decreased $1,238,000 from $3,487,000 in the 1999
period compared to total expenses of $2,249,000 in 1999. This decrease can
be attributed to the costs relating to the Apexx merger in 1999, which
include filing fees, audit fees, legal fees, banking fees, consulting fees,
and printing fees that did not recur in 2000. Engineering expenses
increased $308,000 from $715,000 for the six months ending June 1999 to
$1,023,000 for the same period in 2000. This increase was related to nine
additional engineers hired in response to the demand for software
development under the redphish program and increased travel in relation to
these projects as well. Engineering expenses also increased due to three
additional people hired for domestic technical support and technical
support services being contracted out for the european operations.
Furthermore, there were additional employees eligible for bonuses, and the
exercise of options taking place. Amortized software development costs
total $431,000 for the current quarter, compared to $84,000 in the 1999
period. This increase is associated with the life of the software being
reevaluated and amortization being accelerated through June 2000 for
certain older versions of software.
Interest expense increased $213,000 for the six months ended June 30,
2000 from $60,000 in 1999 to $273,000 in 2000. The additional interest is
due to the interest and discount amortization on the convertible
subordinated debentures and amortization of deferred offering costs.
Interest income increased $272,000 for the six month period in relation to
additional cash on hand related to a substantial equity investments by
Gateway in the beginning of the quarter and the exercise of warrants and
options in the fourth quarter of 1999.
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Net losses from operations totaled ($4,664,000) for the six months
ended June 30, 2000, compared to a ($6,541,000) loss for the same period in
1999, a decrease in the loss of $1,877,000 over the same period. The net
losses are associated with the Selling, General and Administrative expenses
necessary to support its current business strategy. Losses are anticipated
to continue through the current fiscal year due to expenditures in support
of continued growth and market penetration.
Income Taxes
At June 30, 2000, a valuation allowance of 100% of the deferred tax
asset has been recorded, as management of the Company is not able to
determine that it is more likely than not that its deferred tax assets will
be realized. The Company's operating loss carryforwards may be limited
under Section 382 of the Internal Revenue Code.
Other Matters
The Company has reviewed all other recently issued, but not yet
adopted, accounting standards in order to determine their effects, if any,
on the results of operations or financial position of the Company. Based on
that review, the Company believes that none of these pronouncements will
have a significant effect on current or future earnings or operations.
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PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company is not currently involved in any litigation other than
routine litigation arising in the ordinary course of business that, if
determined adversely, is not reasonably likely to have a material
adverse effect on the Company.
Item 2. CHANGES IN SECURITIES
Not applicable
Item 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders was held on May 18, 2000 and the
matters upon which the stockholders voted include:
1. Proposal to elect Brian Cohen and Richard Eyestone as Class II
directors of the Company. With respect to Richard Eyestone, the
number of votes cast For totaled 11,700,911, and the number of
votes cast Against/Abstained totaled 70,500. With respect to
Brian Cohen, the number of votes cast For totaled 11,700,971, and
the number of votes cast Against/Abstained totaled 69,600.
2. Proposal to amend the Company's Certificate of Incorporation to
increase the authorized capital stock from 50,000,000 to
100,000,000. The number of votes cast For totaled 11,418,581, and
the number of votes cast Against/Abstained totaled 352,830.
3. Proposal to amend the Company's equity incentive plan to increase
the number of shares issuable under the plan from 2,900,000
shares to 5,000,000 shares. The number of votes cast For totaled
5,059,802, and the number of votes cast Against/Abstained totaled
680,887.
Item 5. OTHER INFORMATION
Not applicable
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
27 Financial Data Schedules.
b) Reports on Form 8-K.
None
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SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Date: August 14, 2000 eSoft, Inc.
/s/ Jeffrey Finn
----------------------------------
Jeffrey Finn
President, Chief Executive Officer
/s/ Amy Beth Hansman
----------------------------------
Amy Beth Hansman
Chief Accounting Officer
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Exhibit Index
<TABLE>
<CAPTION>
Exhibit No. Description
----------- -----------
<S> <C>
27.1 Financial Data Schedule
27.2 Financial Data Schedule -Restated
</TABLE>
24
