<PAGE>

                       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.

<PAGE>

                               ESOFT, INCORPORATED

                                   FORM 10-KSB

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
PART I                                                                  PAGE
<S>                                                                     <C>


      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

</TABLE>

                                       2
<PAGE>

                                   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

                                       3
<PAGE>

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

                                       4
<PAGE>

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.

                                       5
<PAGE>

     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

                                       6
<PAGE>

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

                                       7
<PAGE>

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.

                                       8
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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:

<TABLE>
<CAPTION>

          TRADITIONAL SOLUTION                       eSOFT SOLUTION
-----------------------------------------   ------------------------------------
COMPONENT                           COST    COMPONENT                      COST
<S>                              <C>        <C>                        <C>
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

</TABLE>

     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

                                       9
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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.

                                       10
<PAGE>

     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

                                       11
<PAGE>

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:

                                       12
<PAGE>

     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