<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                  FORM 10-KSB


 X       Annual report pursuant to Section 13 or 15(d) of the Securities 
---      Exchange Act of 1934
   

                  For the fiscal year ended December 31, 1998

                                       Or

---      Transition report pursuant to section 13 or 15 (d) of the Securities 
         Exchange Act of 1934


                       Commission file number: 00 - 23527

                               eSoft, Incorporated 
             ------------------------------------------------------
             (Exact name of Registrant as specified in its charter)

           Delaware                                  84-0938960  
------------------------------               ----------------------------
State or other jurisdiction of               I.R.S. Employer I. D. Number
incorporation or organization)

5335 Sterling Drive, Suite C,  Boulder,  Colorado        80301
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Address of principal executive offices)                (zip code)
                     

Registrant's telephone number, including area code:    (303) 444-1600
                                                       --------------
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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
                                                              ----------------------------
</TABLE>

         Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X   No
                                             ---     ---
         Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein and will not be included
herein, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of the Form 10-KSB
or any amendment to this Form 10-KSB: X.
                                     ---
         State issuer's revenues for its most recent fiscal year:   $ 3,867,600
                                                                    -----------

         Shares of common stock, $.01 par value, outstanding as of March 16,
1999: 7,144,368 shares. Aggregate market value of voting stock held by
non-affiliates of the registrant on March 16, 1999, $18,222,594.

         Documents incorporated by reference:  None.

         Transitional Small Business Disclosure Format (check one): 
                 Yes        No  X  
                     ---       ---                                            


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                              eSoft, Incorporated
                                  FORM 10-KSB
                               TABLE OF CONTENTS

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Part I                                                                                                     Page
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         Item 1.    Description of Business ...........................................................      3

         Item 2.    Description of Property............................................................     12

         Item 3.    Legal Proceedings .................................................................     12

         Item 4.    Submission of Matters to a Vote of Security Holders ...............................     12


Part II
-------

         Item 5.    Market for Common Equity and Related Stockholder Matters ..........................     14

         Item 6.    Management's Discussion and Analysis or Plan of Operation .........................     15

         Item 7.    Financial Statements ..............................................................     22

         Item 8.    Changes in and Disagreements with Accountants on Accounting .......................     23
                    and Financial Disclosure

Part III
--------

         Item 9.    Directors and Executive Officers; Compliance with Section 16(a) ...................     23
                    of the Exchange Act

         Item 10.   Executive Compensation ............................................................     25

         Item 11.   Security Ownership of Certain Beneficial Owners and Management ....................     29

         Item 12.   Certain Relationships and Related Transactions ....................................     29

Part IV
-------

         Item 13.   Exhibits and Reports on Form 8-K ..................................................     31
</TABLE>


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                                  eSoft, Inc.
                                  FORM 10-KSB
                           FORWARD-LOOKING STATEMENTS

         Statements made in this Form 10-KSB that are not historical or current
facts are "forward-looking statements" made pursuant to the safe harbor
provisions of Section 27A of the, Securities Act of 1993 ("The Act") and
Section 21E of the Securities Exchange Act of 1934. These statement often can
be identified by the use of terms such as "may," "will," "expect," "believes,"
"anticipate," "estimate," or "continue," or the negative thereof. The Company
intends that such forward-looking statements be subject to the safe harbors for
such statements. The Company wishes to caution readers not to place undue
reliance on any such forward-looking statements, which speak only as of the
date made. Any forward-looking statements represent management's best judgment
as to what may occur in the future. However, forward-looking statements are
subject to risks, uncertainties and important factors beyond the control of the
Company that could cause actual results and events to differ materially from
historical results of operations and events and those presently anticipated or
projected. These factors include adverse economic conditions, entry of new and
stronger competitors, inadequate capital, unexpected costs, failure to gain
product approval in 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 the Company's all-in-one Internet
appliance business and prospects include the possibility that a competitor will
develop a more comprehensive or less expensive all-in-one Internet appliance
solution, delays in market awareness of eSoft and its products, possible delays
in eSoft's marketing strategy, which could have an immediate and material
adverse effect by placing the Company behind its competitors. The Company
disclaims any obligation subsequently to revise any forward-looking statements
to reflect events or circumstances after the date of such statement or to
reflect the occurrence of anticipated or unanticipated events.

                                     PART I

ITEM 1.  DESCRIPTION OF BUSINESS

CORPORATE HISTORY

         eSoft was incorporated under the laws of the State of Colorado on
March 3, 1984. On February 17, 1998, eSoft merged into a newly formed Delaware
corporation, and was thus reincorporated in the State of Delaware. On March 16,
1998 the Company completed a public offering of it 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. The Company delisted from
the Vancouver Stock Exchange on September 9, 1998.
eSoft has no subsidiaries.

         Until the Mid 1990's, the Company developed and sold a computer
bulletin board software product known as TBBS. TBBS software allowed secure
access to a company's computer system through direct dial-in access for
multiple users for on-going messaging, file transfer, and data access. With the
rapid rise of the use of the Internet as a method to share the same
functionality of the TBBS system, demand for the TBBS products began to
decline. In 1993 in response to the growth of the Internet the Company started
design and development of the IPAD (Internet Protocol ADapter) which was
initially targeted at small Internet Service Providers (ISP). The Company
introduced its first IPAD, the IPAD 5000 in late 1995. This product was focused
at the small Internet Service Provider. The Company refocused its market
efforts on small-to-medium entities with the design and release of the IPAD
1200 and IPAD 2500 in November of 1997.




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         Until late 1995, the Company's revenues were generated solely from the
sale of TBBS software system however, the growth of the Internet continued to
erode the Company's sales of the TBBS product line. The Company continues to
generate residual revenues from the sale of TBBS software. However, the Company
does not plan to provide further development, except for year 2000 compliance
issues.

         A new product line of Internet Protocol ADapters (IPAD) was designed
for the small-to-medium size business user and launched in November 1997. The
IPAD was designed to be a total Internet/Intranet connectivity solution without
the complexity and high cost of traditional solutions. The IPAD's design
combines Internet hardware and communications software, which does not require
extensive technical knowledge to support. The product provides an economical
and easily installed product to connect local area networks (LANs) of
small-to-medium size businesses, institutions, or educational sites to the
Internet. The IPAD was designed to permit the customer to utilize existing
personnel to administer the ongoing configuration of the installed product. The
Company's products permit the connection to the Internet through all major data
transmission choices such as dial-up 56 kbps modems, ISDN, cable modem, DSL, or
a dedicated leased line up to a full T1 speed, through national Internet access
providers. The IPAD product line provides the necessary Internet related
features permitting customers to have e-mail, basic web page hosting, their own
domain name, secure firewall, and dial-in remote access for its users. The
software includes a basic Web Server, Telnet, an FTP Server, an E-mail Server,
a Remote Access Server, a DNS, and a Packet-Filtering Firewall.

         The IPAD product lines utilize personal computer technology such as an
Intel Pentium CPU, with a minimum configuration of 8 MB of Ram: a 2.1 GB hard
drive; and a 1.44 MB floppy drive. Unlike competing products in the
marketplace, the IPAD does not operate on a UNIX platform but rather is a
proprietary operating system. This system allows for a high degree of
individual customization on the larger systems to better address the needs of
individual customers.

         Through September 4, 1997, eSoft had elected to be taxed as a
"S-corporation" for U.S. income tax purposes. Under this election eSoft was
essentially taxed as a partnership, so instead of corporate income taxes, the
stockholders were taxed individually on their proportional share of eSoft's
taxable income. eSoft withdrew the S-corporation election after September 4,
1997 and is now subject to U.S. corporate income taxes.

CURRENT DEVELOPMENTS

         The Company proposed the merger with Apexx Technology, Inc. (Apexx) of
Boise Idaho and signed a Definitive Merger Agreement dated January 25, 1999.
The proposed merger requires the vote of the shareholders of both companies to
approve the merger. The transaction proposes the Company issue 2,947,368 shares
of the Company's common stock for all the issued and outstanding shares and
options of Apexx. Additionally, the Company extended Apexx a working capital
line of credit of $500,000 with up to an additional $500,000 operating line of
credit provided both boards of the companies approve such increases. The
transaction requires the Company to complete an S-4 registration statement. In
conjunction with the signing of the Definitive Merger Agreement the Company
executed an agreement to purchase products from Apexx to sell through its
distribution channels. In the first quarter of 1999, the Company will
discontinue the sales of the IPAD 1200 and replace it with Apexx's TEAM
Internet(TM) 100. The TEAM Internet(TM) 100 has much of the same functionality
as the IPAD 1200. The Apexx sales team will begin selling the IPAD 2500 to
replace the TEAM Internet(TM) 300 system they previously sold to its higher end
customers. Additionally, the Company will add in February 1999, four of the
Apexx channel development representatives to the Company's payroll to augment
its sales staff providing an integrated sales force.

         As part of the Definitive Merger Agreement, eSoft and Apexx are 
currently conducting a joint marketing program for the benefit of both
companies. Under this combined marketing program the products known by the
Company as IPAD is being re-branded utilizing the Apexx product name of TEAM
Internet(TM). 




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The Company, under the marketing program, is anticipating incurring
$800,000 of marketing costs. Should the proposed merger not occur the Company
under this combined marketing program will have expended significant resources
to promote the TEAM Internet(TM) brand name rather than the "IPAD" brand. Under
this marketing plan the Company will focus on selling the TEAM Internet(TM) 100
and TEAM Internet(TM) 2500 (formerly known as the IPAD 2500) products only. The
proposed combined marketing program inaugurated a direct mail campaign during
February through March 1999 to focus on potential users and VARs of the
all-in-one appliance Internet connection. If the merger does not occur, the
several month lapse in marketing eSoft products under the "IPAD" brand will
make it somewhat difficult for eSoft to reenter the market using the IPAD brand
name. This marketing program comprises a direct mail program of 680,000 pieces
to potential end users of the Company's and Apexx products. The Company, under
the plan, is also targeting 238,000 free standing inserts in business journals
in Seattle, Los Angles, Atlanta, Boston, Dallas, New York, and San Francisco
focusing on potential end users. Additionally, a 55,000 piece direct mail
campaign targeted at Value Added Resellers (VARs) and directed at educating
these entities to the all-in-one appliance is formulated around this program.
The Company and Apexx anticipate generating approximately 13,500 qualified
leads from this program.

NARRATIVE DESCRIPTION OF BUSINESS

         The Company is a technology-based company that has developed an
Internet connectivity software and hardware solution permitting businesses to
connect to the Internet. This technology will empower businesses for the first
time to install and operate shared connectivity to the Internet without highly
specialized technical expertise and empower the small-to-medium size business
to proactively use the Internet.

         The Company's target market being pursued consists of small-to-medium
size businesses. The Company believes these businesses find it beneficial to
host their own Internet infrastructure rather than rely upon an Internet
service provider for all of their Internet access and connectivity needs. The
Company's goal is to deliver the whole integrated ".com" experience to the
small-to-medium size business segment including: easy e-mail set-up and
delivery, simple to use web-page design and hosting, knowledgeable and reliable
technical support and customer service, consulting and delivery of file
transfer solutions. Other markets being pursued by the Company consists of
Internet Service Providers (ISP), telecommunication (Telco's) companies which
can benefit from an integrated all in one connectivity product to the Internet.

         The Company believes that over the long term most small-to-medium size
businesses, high speed access to the Internet will become increasingly
important. It is the belief that the small-to-medium size businesses will
continue to rely upon an ISP in order to gain that advantage if it were not
available in Internet connectivity products such as the Company's IPAD
products. With new advancements in Internet software, however, individual
companies, without a great deal of software expertise, can now assume many of
the responsibilities and functions which has been carried out by ISP on their
behalf. This includes control over a router, firewall, remote access server, a
web server, and mail server. Perhaps most importantly, rather than paying an
ISP substantial fees in order to offer Internet access to each of many
employees, the IPAD products can provide such services to a growing company and
its employees in a much more cost effective manner. With the Company's all in
one appliance, a small-to-medium size business can, manage or control their own
".com" experience and, receive reliable and dependable Internet presence,
achieve status of "yourcompanynamehere.com" on their company communications,
provide secure Internet access for its customers, employees and trading
partners through a certified firewall, and run their businesses without fear of
being trapped in a technological communication obsolescence. The simplicity and
support of the Company's product line will allow small business to get
everything ".com" has to offer, without the hassle, without having to become
technology experts and without having to piece-meal everything together.





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         In June of 1998 the Company refocused its distribution strategy to a
two-tier model moving away from direct selling to the VARs and Resellers. With
the two tier distribution approach the Company signed up Comstor, TechData, CHS
Latin America, Ingram Micro, Advantage Telecom, and ASI as distributors. These
distributors sell to approximately 35,000 VARs and Resellers. To supplement the
distributors the Company employs channel development representatives (CDRs).
The purpose of the CDRs and manufacturer's reps is to assist our distributors
with lead generation and market pull-through of products in channel to VARs,
Resellers, and end users. In 1998 the Company trained and deployed CDRs in
Atlanta, Denver, Dallas, Orange County, and San Antonio, and signed Affinity
Marketing Canada a manufacturer's rep firm covering Vancouver, Calgary,
Edmonton, Toronto, Ottawa, Montreal and Quebec City. The Company anticipates
adding additional CDRs in Seattle, San Francisco, Chicago, Washington DC,
Miami, Phoenix area, in the first quarter of 1999.

         The Company focused distribution in Europe through the signing of a
distributer, Telindus SA. While the Company was encouraged by initial IPAD
evaluations, management was disappointed in its overall efforts to expand its
European sales through its original distributor. As a result, the Company is
exploring other avenues for distribution and refocusing its efforts on
telecommunication and cable companies in the European market. A U.S.-based
distributor and network product developer named eNetCO, was engaged in
September with IPAD distribution rights in Japan. eNetCO personnel have
introduced the IPAD into Japanese distribution opportunities and through its
efforts signed NTT Electronics Corp. (NEL) in February 1999. The agreement
provides NEL with exclusive distribution rights in Japan and non-exclusive
distribution rights in other Asia-Pacific countries. NEL is a subsidiary of
Nippon Telegraph and Telephone Corp. (NYSE: NTT). In August 1998, the Company
consummated an exclusive contract with Telecom Soluciones, one of the two
Argentinian telephone companies in that country. Telecom Soluciones received
exclusive rights to market the IPAD 1200 and 2500 products in Argentina for a
limited period subject to volume requirements. The agreement included an
initial order in excess of $500,000 which was delivered in the third quarter of
1998. Additionally, progress was made with potential sales to other
telecommunications companies in Latin America, including Peru and Mexico.

         Another distribution channel the Company is pursuing is the Telco
companies that provide data access lines. In the third quarter 1998, the
Company introduced its eStar alliance program. The eStar program provides
Telco's with comprehensive solutions where the Company brings together
financing, an ISP, and a company to install the IPAD throughout the U.S. in
small-to-medium size business. The program combines the strengths of a national
leasing company (Transamerica Distribution Finance), a national systems
integrator (IBM Global Services) and Internet Access Providers to enable
Telco's to deliver a complete Internet package in their respective markets. The
Company to date has had limited success with the program and has signed up
three Telco resellers to join this program.

         The Company hopes to establish one or more strategic alliance
relationships with synergistic companies such as computer or network product
manufacturers, large system integration companies or telecommunications
companies, Internet Service Providers, software filtering companies, and office
automation products which will permit the IPAD products to be sold in
conjunction with other products and telecommunications services. No such
relationships have been established to date and there is no assurance that the
negotiation of such a relationship will be successfully completed. If the
Company establishes such relationships, it may become heavily dependent upon
such strategic alliance partners to maintain and expand its presence in the
marketplace and the greater economic resources of the other parties to such
relationships, may force significant reductions in prices at which the Company
can sell its products and thus adversely affect its margins and potential for
profits. Additionally, the Company may, from time to time, explore other
acquisition opportunities that will leverage the technology base opening new
markets for its products.



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PRODUCTS AND SERVICES

         The IPAD family of products provides the necessary hardware and
software to connect company networks to the Internet. The products provide
network security features as well as email and access to the World Wide Web. In
addition, the IPAD contains server software to host web pages, host secure file
exchange sites (using FTP), manage Internet domain names like esoft.com using a
DNS server, and e-mail server. The products also contain a robust network
security firewall that keeps hackers from accessing computer data on the
company network. The firewall technology used in the IPAD 1200 is certified by
the International Computer Security Association (ICSA) to withstand vigorous
intrusion attacks by hackers. The IPAD 2500 and 5000 use the same versions of
the firewall technology, but are not yet certified by the ICSA. The products
are easy to setup and configure using any standard web browser (such as
Microsoft Internet Explorer or Netscape Navigator). Ongoing administration of
the system, such as adding email accounts, can be done using the same web
browser. In conjunction with a user supplied modems, the IPAD 2500 provide
remote access capability which allows users to dial into the system and
securely access the company network or the Internet from remote locations. All
IPAD models support connections to the Internet utilizing communication
interfaces including: modem, ISDN, Ethernet, leased-line, cable, and xDSL. They
also support connecting to computer networks that use common network interfaces
like Ethernet (either 10 or 100 Mbps variety) and Token Ring.

IPAD 5000

         The IPAD 5000 is a rugged, rack mountable system designed for use by
ISP's, companies with large Wide Area Networks (WAN), and/or large Local Area
Networks (LAN). This product requires a higher degree of technical knowledge to
implement then other IPAD models, but in return it is far more flexible and
configurable than the other models. The hardware includes the ability to
customize each unit with up to five different communications interfaces that
allow connecting up to four separate LAN's, or up to forty remote offices, or
up to 96 simultaneous dial-in, remote access users. In addition, the software
can service a nearly unlimited number of e-mail boxes, domain names, and web
sites, with the only limitation being disk space used by each. This product is
sold direct to end customers due to the complexity of the product.

IPAD 2500

         The IPAD 2500 is a small desktop system focused on the market for
small-to-medium size businesses. Unlike the IPAD 5000, the IPAD 2500 is a
plug-and-play device with limited configuration options. Limiting the options
allows the product to be configured and maintained by a person with very
limited technical knowledge about networking or the Internet. A standard IPAD
2500 has the ability to simultaneously connect the users of a single LAN and
two dial-in remote access users to the Internet. Optionally, the system can be
expanded to allow users on another LAN to be connected to the Internet, or the
total number of dial-in remote access users that can be connected to the
Internet can be expanded to eight.

IPAD 1200

         This product is a small desktop system that can connect a business LAN
of up to 150 users to the Internet using a single Internet address. The product
is designed for unsophisticated users who want their network connected to the
Internet in a matter of hours. It only allows a single LAN utilizing any of the
supported network interfaces, and two dial-in remote access users to be
connected to the Internet using any supported communication interface. The
product is designed for mass production without customization for specific
client needs allowing unsophisticated users to easily configure and maintain
the system. This product will be replaced with the Team Internet 100 in the
first quarter of 1999.

TBBS Software

         The Company expects to continue to generate residual revenues from the
sale of TBBS software. However, since the market for TBBS is progressively
declining in favor of more sophisticated 



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communications products, the Company does not expect any further development or
upgrading of the software. The only recent upgrade for the product was
completed in October 1998 to bring the software into compliance with Y2K.

Accessories

         In regard to the Model 5000 (and to a lesser degree with the IPAD
2500), customers can order additional communication or network interfaces and
accessories to more effectively configure a device to suit their needs. Aside
from an Ethernet card (used to support cable or xDSL connections), users have
the option, with certain models, of purchasing a modem, ISDN adapter,
interfaces for T1 and fractional T1 leased lines, Token Ring adapter, as well
as extra serial interfaces.

Technical Support Services

         Users can also purchase, from the Company, an annual contract for
technical support of the products hardware and software. 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.

Upgrades and Updates

         The Company plans two updates per year which includes minor
enhancements and bug fixes. Updates are free and typically available over the
Internet from the Company's web site. The Company plans two upgrades per year
which includes major enhancements and bug fixes. Upgrades are distributed free
of charge via floppy disc to those with annual technical support contracts and
for a fixed fee to clients without software support agreements. A current
upgrade is scheduled for February 1999.

CONCENTRATION OF SALES

         During the fiscal year ended December 31, 1998, the Company had two
customers that accounted for 10% or more of the product sales during that
period. These two customers represented 46% and 13% of the Company's revenue
for the fiscal year ended December 31, 1998. In 1998, the customer representing
13% of the total sales of the Company, was a foreign customer with the accounts
receivable at December 31, 1998 of $256,785. Additionally, these two customers
represented 87% of the Company's accounts receivable at December 31, 1998. With
such concentration of its sales, the Company is exposed to significant declines
in revenue in future periods if one or more of the large customers discontinue
or substantially reduces its purchases in future periods. Moreover, the
Company's credit risk concentration makes it more vulnerable to a default in
payment. See Note 12 to the Financial Statements for further discussion. In
addition, the larger customers are electronic products distributors and
telecommunication companies in foreign countries that have recently become
distributors of the products and have purchased significant quantities of the
products to establish inventories of the distributors and their affiliated
resellers or dealers or end customers. Unless the products are promptly resold
to end users, future sales to these distributors and telecommunication
companies will likely decline. No one customer accounted for more than 10% of
the Company's total revenue or accounts receivables during the year ended
December 31, 1997.

CONCENTRATION OF PURCHASES

         During the fiscal year ended December 31, 1998, the Company had two
vendors that accounted for 10% or more of the Company's purchases during that
period. These two vendors represented approximately 60% of the total purchases
for the fiscal year ended December 31, 1998. With such concentration of
purchases, the Company is exposed to these suppliers of product for its
finished goods should these entities be unable to support the Company in the
future. The Company has explored alternative suppliers for its major supplier
of the base unit hardware; however the Company may not be able to quickly
execute and have delivery from these alternative suppliers to meet demand. An
inability to source this product from other suppliers would likely have a
material adverse impact on the Company's ability to attain or maintain
profitability.

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MARKETING PLAN

         The IPAD system is considered a horizontal product offering--it can be
applied to virtually any vertical industry market in North America or overseas.
Further, Internet related industry trends strongly indicate that the majority
of the small-to-medium size businesses (5 to 150 users) are moving to provide
their employees access to the power of the Internet. Typically, the
small-and-medium size business owners require technology to be relatively
inexpensive and simple to install and maintain. The Company believes the IPAD
is positioned to become the leader in systems that provide the requisite
all-in-one Internet connectivity, services and support functionality at a very
competitive price. The Company is focusing on providing integrated solutions
empowering businesses to pro actively use the Internet. The Company is
developing a vision to become the ".com" experts for small-to-medium size
business.

         Product competition is in the form of complex and expensive
multi-system offerings i.e. Microsoft's NT and Back Office Small Business
Server; suppliers of several Internet connectivity routers/firewalls; and a
handful of other manufacturers who claim to provide all-in-one functionality.
The Internet appliance market is sometimes known as the all-in-one, thin server
or micro server market which generally refers to ready-to-use appliance
requiring a minimum amount of effort to install and operate. The IPAD is
quickly differentiated from each of these competitors via one or more
ease-of-use, price, functionality and security features.

         The IPAD pricing strategy is to remain competitively priced against
the competition's perceived all-in-one functionality, and significantly less
expensive than the multi-system alternatives. The marketing programs will
assist in differentiating the IPAD price as compared to the router/firewall
only offerings and position the Company to deliver the whole integrated ".com"
experience to small-to-medium size business. While some price degradation may
be necessary due to competitive pressures and market penetration/market share
positions, the Company intends to price the products to build substantial
market share. The IPAD will continue to be sold as an integrated
hardware/software unit so as to ensure simple installation and maintenance.

         The Company intends to distribute the IPAD through two tier
distributors, VAR's and network integration companies, overseas sales agents,
overseas telecommunications companies and over the Internet. Over time, as
VAR's and network integrators are recruited in sufficient quantities, the
direct sales effort will probably subside except in support of a lead
generation program. The Company has added CDRs in 1998 and will continue to add
incremental CDR's in certain market places and the Company utilizes experienced
sales agents in Europe, Latin America and Asia. Marketing and sales programs
are being put in place to recruit VAR's and network integration companies in
North America. Agreements with distributors have been implemented to
geographically dispersed inventory and to provide as much access to the product
by the Value added resellers.

         The Company's marketing program will re-brand the IPAD as Team
Internet with the proposed merger of Apexx. The direct marketing program
includes direct mail targeted at end users in small-to-medium size companies to
generate 13,500 leads for the sales process. Additional direct mail programs
will focus on companies that inform small-to-medium size business as to
solutions to connecting to the Internet, including Value Added Resellers,
Telecommunication resellers, Internet Service Providers, Internet Access
Providers as well as Cable companies. This program will focus resellers to
promote our products to end users. The product focus will be the IPAD 100 and
the IPAD 2500. Programs will also target telecommunications organizations that
sell Internet connections and related products into any industry segment. To
assist in creating more customer awareness of the company and its products, as
well as in support of a lead generation program, the Company will be
implementing a direct mail campaign and telemarketing programs. The Company
anticipates significantly increasing its marketing budget for this direct mail,
product branding, advertising and promotion activities.




                                     -9-
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         The marketing and sales budget for 1999 includes the addition of
direct sales personnel (Channel Development Reps) and sales support
representatives, VP of International Sales, international program manager, and
a channel marketing manager.

OPERATIONS

         Currently, with respect to the IPAD 1200 and 2500, the Company
purchases a base unit (hardware, loaded software, and Local Area Network feed)
from suppliers. The IPAD 1200 and 2500 are received in as base units and prior
to shipment the required feed interface (56K modem, ISDN, etc.) is installed at
its facility in Colorado. The TEAM Internet(TM) product being sold in 1999 will
be purchased from Apexx. The more complex IPAD 5000 is purchased as components
and is assembled and configured at its Colorado facility for shipment to the
user. The Company has contracted with a manufacturer in Holland to assemble its
product for the IPAD 1200 and 2500 with the components shipped from the
Company's stock. The manufacturer in Europe purchases communication connection
devices, on the Company's behalf, that are specific to the European market for
final assembly and shipment to users in Europe.

INTELLECTUAL PROPERTY

         The Company has no patents, but regards its software as proprietary
and attempts to protect it by relying upon copyrights, trade secret laws,
internal non-disclosure agreements and transferability restrictions
incorporated into its software license agreements. The Company provides its
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 the Company believes further protects unauthorized transfers of
the Company's proprietary information, as well as the confidentiality of the
Company's trade secrets. The Company also uses a combination of software
programming and hardware devices to protect its products from unauthorized use
or duplication.

COMPETITION

         The Internet connectivity business is highly competitive. A number of
the Company's competitors are very well established in the marketplace, with
larger sales volumes, broader brand name recognition and a wider base of
technical resources. As the market expands for products that perform in a
manner similar to that of the IPAD product line, it is expected that a broader
range of both small and large industry participants will enter the market with
competing products, as there are comparatively few barriers to entry. As
competition increases, industry margins on system sales may decline. There can
be no assurance that the Company will be able to effectively compete against
such competitors given their entrenched market presence, or that the Company
will be able to attain and maintain anticipated gross margins over time.

         Competition among the industry participants is based upon a number of
factors including product features, type of user primarily serviced, reputation
of the manufacturer, ease of installation or use, reliability, cost, service
availability and other factors. The Company believes that its principal
competitive advantages are the product features, simplicity and ease of
installation and the availability of technical support for the product and the
customer. The Company's products are also designed to meet the specific needs
of the small-to-medium size business that are the Company's target markets. For
example, while many Internet connectivity devices are Unix-based systems
designed to support more complex operations generally required by larger
corporations, the Company's products emphasize use of a system that is thought
by management to be more user friendly as compared to those operating on Unix
platforms.

         The Company's competitors are comprised of both well-established and
recognized industry participants and smaller corporations in some respects
similar to the Company. Both groups produce products that in terms of
fundamental connectivity attributes are similar to those currently offered by
the 

                                     -10-
<PAGE>   11





Company. Most of these competitors have greater financial resources than
the Company; two companies that are primary competitors have raised between $20
million and $40 million of equity capital. Additionally, one of the companies
has had an investment made by Intel Corporation. Among the more prominent
industry participants at present is Apexx. Other direct competitors include
Whistle Communications, Inc. of Foster City, California; FreeGate Corporation
of Sunnyvale, California and Cobalt Networks, Inc. of Mountain View,
California. Sun Microsystems, Inc. a major producer of computer workstations,
also offers Internet servers that accommodate high-volume Web site management.
While many other companies offer products that are either advertised or
perceived as containing most of the all-in-one feature set, the Company
believes many of these products provide less functionality than the IPAD and
other all-in-one systems. These products include for example, simple routers
and firewalls, a router and web server combination and a router and e-mail
server combination.

         As is the case with the Company, most industry competitors produce an
array of products. Some are relatively inexpensive entry level devices, which
in some respects can be compared to the IPAD 100. Typically, these are designed
with no significant degree of individual customization. Some products are
similar to the IPAD 5000 in that they provide for a substantial degree of
customization, and can accommodate multiple interfaces, and more than one
hundred individual users on a LAN with little difficulty.

         Cross-comparisons indicate that several competing products incorporate
features similar to those offered by IPAD products (in terms of hardware and
software components), although they may provide varying degrees of
functionality, which in turn accounts for pricing variances. Products that
would likely compete with either the IPAD 1200 or the IPAD 2500 products can
either cost more or less in relation to the IPAD depending upon their technical
specifications.

         Some competitors already possess well-established distribution
networks or have formed strategic collaborations with key industry players.
Others, such as Sun Microsystems, Inc., have much greater technical and
financial resources than the Company. The ability of the Company to effectively
compete against such firms cannot be assured, as they are already well
established.

RESEARCH AND DEVELOPMENT EXPENDITURES

         The Company conducts 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 1998 totaled
$405,000. The Company capitalized $221,000 for such expenditures in 1997. The
Company incurred $13,000 of expenses relating to research and development costs
in 1998, compared to $57,000 in 1997.

GOVERNMENT REGULATIONS

         The Company purchases its computer hardware in the United States and
requires FCC approval. The Company has performed product testing at accredited
test facilities and the IPAD 2500 has passed the FCC tests. The Company's IPAD
5000 is also FCC compliant. The components utilized to assembled the finished
product utilizes UL approved components. The Company purchases its IPAD 2500
completed product from manufacturing facilities that are ISO 9000 certified.
Within the United States, the market and the rate of market growth are both
considered to be sufficiently large as to be able to absorb all of the
Company's projected output through at least the next two years. The Company has
acquired requisite CE product approval and certification from appropriate
agencies that would permit marketing of its IPAD




                                     -11-
<PAGE>   12



products in the European Union. The company has entered into a contract for
manufacture of its IPAD 2500 in Holland. The contract manufacturer was chosen
for its existing requisite approvals and ISO 9000 certification. The TEAM
Internet(TM) 100 purchased from Apexx has all the prerequisite approvals as the
IPAD 2500.

EMPLOYEES

         As of December 31, 1998, the Company had thirty-one full-time
employees. That number includes seven engineers/technical support, three
operations, two marketing, thirteen sales persons; and six administrative
personnel. Additionally, the Company utilized three consultants for temporary
management positions until full time personnel are located. No employee is
represented by a labor union and the Company believes its employees' relations
to be 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 Headquarters          5335 Sterling Dr. Suite C      5,300      10/31/2000      $ 58,000
                                     Boulder, CO

     Shipping and Assembly           6560 Odell Place #G            2,878       4/30/99        $ 27,624
                                     Boulder, CO
</TABLE>

         The Company has executed a lease to relocate its corporate
headquarters, shipping and assembly facilities into one location. The
anticipated date of occupancy for the new facility is April 1, 1999. The new
facility will include 13,618 square feet with annual rental payments of
$173,000. The new lease will expire May 31, 2004. The Company is being fully
released from its lease on its current Corporate headquarters. eSoft believes
that this new facility will be adequate for its needs for the foreseeable
future.

ITEM 3.  LEGAL PROCEEDINGS

         There are no material legal proceedings pending to which the Company
(or any of its officers or directors in their capacities as such) is a party,
or to which the property of the Company is subject. Management of the Company
is not aware of any material proceedings being contemplated.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         A special meeting of the shareholders of the Company was held on
December 4, 1998. The purpose of the special meeting was to approve certain
proposed amendments to the Company's Certificate of incorporation and Bylaws,
as well as amendments to the Company's 1998 Stock Option Plan and to approve
the issuance of certain shares to Mr. Becker, the President and CEO as required
by the Vancouver Stock Exchange.

         The first proposal was to amend Article 4 of the Company's Certificate
of Incorporation to authorize the Company to issue up to 5,000,000 shares of
Preferred Stock. The proposal would amend Article 4 of the Company's
Certificate of Incorporation to increase the number of authorized shares of
Capital Stock to 55 million shares and to authorize up to 5,000,000 shares of
Preferred Stock, par value $.01 per share. The 


                                     -12-
<PAGE>   13



shares were voted as follows: For the Proposal 3,433,138 shares, Against the
Proposal 191,175 shares, Abstaining 9,455 shares.

         The second proposal was to amend Article 7 of the Company's
Certificate of Incorporation, and Article II of the Company's Bylaws to provide
that stockholders may not take action by written consent in lieu of a vote at a
stockholders meeting. The shares were voted as follows: For the Proposal
3,135,878 shares, Against the Proposal 253,446 shares, Abstaining 244,444
shares.

         The third proposal was to adopt amendments to Article 11 of the
Company's Certificate of Incorporation and Article X of the Company's Bylaws to
provide that the Bylaws may only be amended by the stockholders upon the vote
of at least 2/3 of the Company's outstanding voting stock. The shares were
voted as follows: For the Proposal 3,405,182 shares, Against the Proposal
221,536 shares, Abstaining 7,050 shares.

         The fourth proposal was to adopt an amendment to Article II of the
Bylaws to eliminate the right of stockholders to call a special meeting of the
stockholders. The shares were voted as follows: For the Proposal 3,026,922
shares, Against the Proposal 361,602 shares, Abstaining 245,244 shares.

         The fifth proposal was to amend Article III of the Company's Bylaws to
institute a classified Board of Directors with staggered terms by creating
three class of directors. The shares were voted as follows: For the Proposal
3,374,372 shares, Against the Proposal 255,146 shares, Abstaining 4,250 shares.

         The sixth proposal presented was to approve certain amendments to the
Company's Stock Option Plan. The proposed amendments would increase the number
of shares of common stock on which the Company is authorized to grant options
to officers, directors, employees and consultants of the Company from 900,000
shares to 1,700,000 shares. Additionally, a number of provisions that had been
included in the Plan adopted and amended February 1998, to meet certain
requirements of the Vancouver Stock Exchange where the Company's stock was
originally listed, were eliminated. The shares were voted as follows: For the
Proposal 3,493,792 shares, Against the Proposal 126,901 shares, Abstaining
13,075 shares.

         The seventh proposal was to approve the issuance of shares to Mr.
Philip Becker subscribed to and paid for in March 1998. Mr. Becker had agreed
with the Vancouver Stock Exchange that the acceptance of his subscription would
be subject to stockholder approval so that certain restrictions that otherwise
would be imposed on those shares by the Vancouver Stock Exchange would not
apply. The shares were voted as follows: For the Proposal 3,397,882 shares,
Against the Proposal 185,145 shares, Abstaining 50,741 shares.

         On the basis of the vote Proposals 1, 5, 6 and 7 were declared to have
passed and proposals 2, 3 and 4 defeated and not to have passed.




                                     -13-
<PAGE>   14




                                    PART II

ITEM 5.  MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

         On March 16, 1998 the Company completed a public offering of it 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 Nasdaq SmallCap Market and the Vancouver Stock Exchange for the past fiscal
year is provided below. The figures shown below do not necessarily represent
actual transactions:

<TABLE>
<CAPTION>

                  1998 Fiscal Year          High Bid          Low Bid
                  ----------------          --------          -------
<S>                                        <C>               <C>
                  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>

         There are approximately 1,500 holders of Common Stock of the Company.

         The Company intends, for the foreseeable future to retain all
earnings, if any, for the development of its business opportunities. The
payment of future dividends will be at the discretion of the Company's board of
directors and will depend upon, among other things, future earnings, capital
requirements, the Company's financial condition and general business
conditions.

         The transfer agent for the Company's common stock is The Trust Company
of Bank of Montreal with offices at First Bank Tower 6th Floor, 595 Burrard
Street, Vancouver, B.C. V7X1L7.

The Company has never declared a dividend on its common stock and it is
anticipated that any earnings will be retained for use in its business for the
foreseeable future.




                                     -14-
<PAGE>   15



ITEM 6.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND 
         RESULTS OF OPERATION

       FISCAL YEAR ENDED DECEMBER 31, 1998 COMPARED TO FISCAL YEAR ENDED
                               DECEMBER 31, 1997

         Beginning at the end of December 1997, the Company began expanding
sales, marketing, general and administrative personnel to develop an emerging
market for the all in-one-appliance for Internet access. During the Company's
fiscal year, the Company expended considerable time and resources to expand its
market share of the new emerging market for the all in one Internet appliance.
In an effort to further develop, market, and service these new products to the
small-to-medium size business in fiscal 1998, the Company expanded in all
departments, by adding 16 new employees, located in four states. This
represented an 89% increase in personnel over 1997. Additionally, the Company
expended substantial resources resulting from becoming a public company and
registering various private placements.

         As a consequence of the matters mentioned above, meaningful
comparisons of the changes in the Company's operating results to its fiscal
year ended December 31, 1997 is difficult to make. During the year ended
December 31, 1998, the Company incurred a net loss in the amount of $2,941,000,
compared to a net loss in the amount of $355,000 for the year ended December
31, 1997. During 1999, the Company intends to continue rapid expansion of sales
and marketing expenditures to develop a North American wholesale distribution
network, which will likely result in significantly increased selling, general
and administrative expenses and capital expenditures to meet this rapid
expansion.

         REVENUES - In 1998 revenues increased $2,635,000, or 214% from
$1,233,000 in 1997 to $3,868,000 in 1998. The Company in 1997 expanded its
product line and in 1998 began focusing on selling directly to VARs and end
users targeting the small-to-medium size business market until June 1998. In
June 1998 the Company transitioned to a two-tier distribution strategy to
provide additional access to VARs, resellers, and network consultants.
Additionally, the Company was able to leverage the robust IPAD operating system
and growth of the Internet in foreign countries and generate substantial
revenues from international sales. The IPAD product was qualified for
connection to the telecommunication backbone of Argentina, Peru, Chile, Mexico,
Spain and Japan. These qualifications permitted the Company to generate 18% of
its revenues for the year from product destined to the international and
Canadian marketplace. The remaining 82% of the Company's revenues occurred from
sales of product destined to end users in the United States. From August to
November of 1998, the Company added channel development representatives (CDRs)
in six major cities to work with VARs, resellers, and distributors to generate
product recognition. The Company expended substantial resources in developing
the marketplace for the IPAD family of products. The Company added a total of
seven employees in the sales area, including a Director of Sales, in 1998. The
Company in 1998 generated residual revenues from its TBBS software of
approximately $50,000 for the year compared to $62,000 in 1997.

         GROSS MARGINS - The Company's gross profit margins in 1998 were
approximately 65% compared to 65% in 1997. The 1998 margins remained flat due
to the continued vigilance of the Company in outsourcing production of the
product to a contract manufacturer. The outsourcing of the manufacturing
permitted the Company to maintain its cost of the product without the addition
of more assembly labor, as volumes continued to grow during the year.

         SELLING, GENERAL AND ADMINISTRATIVE, ENGINEERING AND R & D EXPENSES
(SG&A) - Increased from $962,000 (78% of sales) in fiscal 1997, to $5,773,000
(149% of sales) in 1998. This resulted in a 500% increase in SG&A expenditures
over the previous fiscal year. The increased expenditures were attributed to
the overt activities in 1998 of building the Company's distribution, marketing
and sales network in an emerging marketplace for the all-in-one appliance.
These expenditures were targeted at building the organization by hiring
professional management, personnel and consultants totaling 34 individuals in
1998 compared to 18 employees and consultants in 1997. General and
Administrative (G&A) expenses increased 




                                     -15-
<PAGE>   16


from $507,000 in 1997 to $2,370,000 in 1998, or a 368% increase. The increases
over the 1997 expenditures arose in support of the Company's continued
expansion of its marketing efforts and the increased expenses associated with
becoming a public company. In 1998 general and administrative salaries and
employee benefits increased by $534,000, consulting and legal expenses
increased by $584,000, travel expenses increased by $122,000, bad debts
increased by $151,000, stockholders' relations expenses increased by $75,000,
filing fees increased by $51,000, and rent expense increased by $54,000.
Selling and Marketing expenditures increased from $226,000 in 1997 to
$2,612,000 in 1998; salaries and employee benefits increased by $1,014,000,
travel expenses increased by $292,000, consulting expense increased by
$564,000. Engineering and technical support expenditures increased from $56,000
in 1997 to $589,000 in 1998. Engineering and technical support; salaries and
employee benefits increased by $261,000 and consulting expense increased by
$161,000. These costs increased in the support of building an organization that
can continue to expand the growth of its all-in-one appliance both domestically
and internationally.

         RESEARCH AND DEVELOPMENT EXPENDITURES - The Company conducts 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 new 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 the
Company's existing product lines. Costs for which technological feasibility had
been established, which were capitalized in 1998, totaled $405,000. The Company
capitalized $221,000 for such expenditures in 1997. The Company incurred
$13,000 in expenses relating to research and development costs in 1998,
compared to $57,000 in 1997.

         OTHER INCOME (EXPENSES) - Interest income totaled $168,000, an
increase of $164,000 over 1997. The increase was associated with the fund
raising activities which occurred in 1998 and the investment income from those
funds. Interest expense totaled ($7,000) in 1998 compared to ($31,000) in 1997
a decrease of $24,000. The decrease was due to the pay down and payoff of a
term loan in October 1998 from proceeds of the Company's equity funding in
1998.

         NET LOSS - The Company incurred a loss of $2,941,000 in 1998, compared
to a loss of $355,000 in 1997. The loss from operations, before income taxes,
in 1998 was $3,103,000, compared to $193,000 from operations in 1997. The
increased losses are the results of the Company aggressive expansion of its
product line, marketing efforts, and the hiring of a professional management
team to grow the Company in an emerging market.

         INCOME TAXES AND NET OPERATING LOSSES - As discussed in Note 5 to the
accompanying financial statements, the Company in 1998 recognized a 100%
valuation allowance on its net deferred tax asset since it could not be
determined if it was more likely than not it would be realized. The Company has
$2,700,000 in net operating loss carryforwards with expirations through 2019.
The utilization of certain of the loss carryforwards are limited under Section
382 of the Internal Revenue Code.

         Management believes that higher levels of operating expenditures will
continue through 1999 in order to continue the expansion of the Company's
product into an emerging market. The Company anticipates to continue to
generate operating losses to attain market penetration. The Company anticipates
that an aggressive marketing strategy and its acquisition activities See
"Current Developments" will help establish the Company as a leader in the
market segment.



                                     -16-
<PAGE>   17



      LIQUIDITY AND CAPITAL RESOURCES FOR THE YEAR ENDED DECEMBER 31, 1998

CAPITAL AND DEBT FINANCING

         During the first quarter, 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, key employees The Company received $186,982
from the offering net of offering costs.

         During the first quarter, 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 shareholder approval of the
private placement to the officer which was received in December 1998 at which
time the shares were issued to the officer.

         During the first quarter, the Company issued 60,000 shares of its
common stock at a price of $0.50 per share for a total of $ 30,000 upon the
exercise of options. The company received $600 cash and a note receivable for
$29,400 to exercise the shares. The note was subsequently paid in May 1998.

         In the first quarter the Company converted the non-interest bearing
note payable to related parties in the amount of $355,903 into 355,903 shares
of the Company's common stock at a price of $1.00 per share.

         In March 1998, the Company completed its initial public offering 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 Agent, subsequent
to March 31, 1998, exercised its right to purchase 250,000 shares of common
stock. The net cash proceeds to the Company from the initial public offering
was approximately $1,009,000 after payment of expenses of approximately
$541,000.

         In April 1998, the Company issued 250,000 shares of its common stock
at a price of $1.00 per share for a total of $250,000, upon the exercise of
agent warrants issued in conjunction with the Company's March 1998 Initial
Public Offering to its Canadian Agents.

         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 approximately $5,480,000 after payment of expenses of the offering of
approximately $256,000, and payment of $507,825 (8.13% of the offering price)
commissions to the Agent, Sub-Agents, and Finders who were issued warrants to
purchase 159,318 (10.85% of the offered shares) shares of the Company's common
stock at a price of $4.25 in the first year and $4.90 in the second year.

         In the third quarter, the Company issued 70,000 shares of its common
stock at a price of $1.00 per share for a total of $70,000 upon the exercise of
options and warrants previously granted.

         In the fourth quarter, the Company issued 35,500 shares of its common
stock at a price of $1.00 per share for a total of $35,500 upon the exercise of
options and warrants previously granted.

         The equity financing that occurred in 1998 was utilized to expand the
Company's operations and support the losses that incurred from developing the
products in the emerging market place.

         Working capital at December 31, 1998, had increased to approximately
$4,707,000 from less than $251,000 at December 31, 1997. The increase in
working capital is associated directly with the above referenced equity
issuances that occurred in 1998. Non cash equity in the amount of $355,903 was
provided from the conversion of a convertible note payable.



                                     -17-
<PAGE>   18

         In the fourth quarter of fiscal 1998, the Company signed a letter of
intent to acquire all the outstanding stock of Apexx Technology, Inc. in
exchange for 2,947,368 of the Company's common stock. Under the terms of the
letter of intent the Company provided an operating line of credit of up to
$500,000 with an additional $500,000 may be advanced upon the written consent
and agreement of both boards of each company. The Company as of December 31,
1998 funded $300,000 of this commitment and subsequent to December 31, 1998
funded the remaining $200,000 of the operating line commitment. This commitment
to support both operations until closing may require the Company to
substantially establishing and fortify distribution and marketing channels of
distribution of both companies' product lines and may require additional fund
raising activities in the upcoming months.

CASH FLOW

         During the year ended December 31, 1998, the Company used cash from
operations in the amount of $4,283,000 compared to $24,000 in the prior year.
This is a result of working capital which was utilized to fund the large
increases in accounts receivables, inventories, accounts payables, accrued
expenses, and the increase in other current assets.

         Cash used in investing activities, totaled $2,761,000 during the year
ended December 31, 1998 compared to $263,000 in the prior year. The increase is
primarily attributed to the purchase of investments for invested funds, costs
incurred in the development of the Company's software products, purchase of
property plant and equipment for new personnel, and an advance on a note
receivable to Apexx.

         Cash provided by financing activities was $7,597,000 for the year
ended December 31, 1998 compared to $369,000 in the previous year. The Company
received net proceeds in the amounts of $7,493,000, from the sale of equity
securities, the exercise of stock options and stock subscriptions, during the
year. Principal repayments on debt obligations during the year were $96,000.

         The Company's negative cash flow from operations has primarily
resulted from an increase in accounts receivable and inventories resulting from
increased business activity and the Company attempting to anticipate demand for
its product correctly. Management believes this negative cash flow will
continue during 1999, due to the Company's intention to continue rapid
expansion of sales and marketing expenditures in order to develop a North
American wholesale distribution network. These actions are anticipated to
result in significantly increased selling, general and administrative expenses
and capital expenditures to meet this rapid expansion.

CAPITAL RESOURCES

         The Company's working capital has improved significantly over the last
12 months, primarily from external equity financing activities. The Company has
an excess of $4,707,000 of current assets over current liabilities as of the
1998 fiscal year end. Further, the Company had cash and securities of
$2,647,000 at December 31, 1998. Management anticipates the Company will
continue to invest significant resources in its marketing and sales activities
in 1999. The Company anticipates continuing to aggressively hire sales and key
management to meet its desired growth of the Company's product both
domestically and internationally. As staff is expanded, the Company will need
to invest in new equipment, and fund the expenses associated with these
additions. Management believes the Company will be able to raise additional
equity funding and secure working capital financing of its receivables as the
Company continues to aggressively expand in the emerging market.

         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.




                                     -18-
<PAGE>   19



         Management believes that the Company will continue to incur losses
until the end of 1999, when sales growth is anticipated to reach a level to
offset the aggressive sales growth 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. Management anticipates it
will continue to have access to additional capital through these sources in
amounts necessary to support its growth plans. In the event that cash flow from
operations, if any, together with the proceeds of any future financings, are
insufficient to meet these expenses, the Company will be required to
re-evaluate its planned expenditures and allocate its total resources in such
manner as the board of directors and management deems to be in the Company's
best interest.

IMPACT OF THE YEAR 2000 COMPUTER PROBLEM

         The Year 2000 ("Y2K") computer problem refers to the potential for
system and processing failures of date-related data as a result of
computer-controlled systems using two digits rather than four to define the
applicable year. For example, computer programs that have time-sensitive
software may recognize a date represented as "00" as the year 1900 rather than
the year 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.

State of Readiness of Our Product

         All new products and upgrades introduced by the Company will be Y2K
compliant. The Company has tested the remainder of the IPAD system and
connections of the IPAD product line to other systems utilizing standard
Internet protocols. The testing completed on the IPAD product line to date has
lead the Company to believe that the IPAD product will not be affected by a
connection to a non-compliant Y2K system. The Company has been testing its
existing products for use in the Year 2000 and beyond, and all IPAD products
produced after November 1, 1997 are Y2K compliant until 2036. The results of
the Company's testing suggest that the following versions of its products, are
Y2K compliant:

         - IPAD 1200, 2500, 5000v2.03 and up

         However, the Company's testing does not cover every possible computing
environment. Accordingly, some customers may have Y2K problems with products
that the company believes are Y2K compliant. The Company's customers may be
operating on older versions of hardware platform utilizing the above products
software. Early models of the IPAD 2500 and 4500 products shipped before
November 1, 1997 may include a BIOS in the computer hardware that is not Y2K
compliant. The number of IPAD units affected is estimated to be a small
percentage of the installed base. In early 1999 an IPAD software upgrade will
be released to correct the specific issues caused by use of the non-compliant
BIOS. In addition, there is a plan to replace the non-compliant BIOS with a Y2K
compliant BIOS if the customer prefers a hardware fix. The cost to the Company
of the IPAD software upgrade and/or a BIOS upgrade is not expected to be
material. Problems encountered by such customers could be quickly remedied
because of the availability of Y2K upgrades and updates for such products.

         The Company has tested the discontinued TBBS products that it no
longer markets for Y2K compliance, some of which might still be in use. The
Company's TBBS product had one deficiency associated with Y2K which was
corrected with a free update released in October 1998. The Company expects that
any customers that materially rely on such discontinued products will test them
for Y2K compliance and notify the Company if there are problems. The Company's
experience in developing Y2K compliant versions of its existing products,
suggests that if it is required to correct Y2K problems in such discontinued
products, it could do so without incurring material expenses. There will be
another free update released in the first quarter of 1999 to correct a similar
deficiency in TBBS add-on modules.



                                     -19-
<PAGE>   20




State of Readiness of our Internal Systems

         The Company may be affected by Y2K issues related to non-compliant
internal systems developed by the Company or by third-party vendors. The
Company has reviewed its internal systems, including its accounting system, and
have found them Y2K compliant. The Company is not currently aware of any Y2K
problem relating to any of its internal, material systems. It does not believe
that it has any material systems that contain embedded chips that are not Y2K
compliant.

         The Company's internal operations and business are also dependent upon
the computer-controlled systems of third parties such as suppliers, customers
and service providers. Management believes that absent a systemic failure
outside the control of the Company, such as a prolonged loss of electrical or
telephone service, Y2K problems at such third parties will not have a material
impact on the Company. The Company has no contingency plan for systemic
failures such as loss of electrical or telephone services. The Company's
contingency plan in the event of a non-systemic failure is to establish
relationships with alternative suppliers or vendors to replace failed suppliers
or vendors. Other than the previously described testing, and remedying problems
identified by testing or from external sources, the Company has no other
contingency plans or intention to create other contingency plans.

Cost Associated With Y2K Compliance

         The Company does not separately track expenditures relating to Y2K
compliance. Such expenditures are primarily absorbed within the product
development organization. Based on its overall development expenditures and the
amount of time people in the organization are spending on year 2000 compliance,
the Company believes that its spending on compliance to date has not been
material. Furthermore, based on its experiences to date, and its assessment
that all material internal systems and all currently marketed products are Y2K
compliant, the Company does not anticipate that costs associated with
remediating the Company's non-compliant products or internal systems will be
material.

Risks

         Any failure of the Company to make its products Y2K compliant could
result in a decrease in sales of its products, an increase in allocation of
resources to address Y2K problems of its customers without additional revenue
commensurate with such dedication of resources, or an increase in litigation
costs relating to losses suffered by the Company's customers due to such year
2000 problems. Failures of the Company's internal systems could temporarily
prevent it from processing orders, issuing invoices, and developing products,
and could require it to devote significant resources to correcting such
problems. But to the Company's knowledge, the internal accounting systems have
been attested by the supplier as Y2K compliant. Due to the general uncertainty
inherent in the year 2000 computer problem, resulting from the uncertainty of
the year 2000 readiness of third-party suppliers and vendors, the Company is
unable to determine at this time whether the consequences of Y2K failures will
have a material impact on its business, results of operations, and financial
condition.

NEW ACCOUNTING PRONOUNCEMENTS

         The Financial Accounting Standards Board has recently issued
Statements of Financial Accounting Standards that may affect the Company's
financial statements as follows:

         In June 1998 FASB issued 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 



                                      -20-
<PAGE>   21



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 is effective for fiscal years beginning after June 15, 1999.
Management believes that the adoption of SFAS No. 133 will have no material
effect on its financial statements.

         In October 1998 FASB issued SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise" establishes accounting and
reporting standards for certain activities of mortgage banking enterprises and
other enterprises that conduct operations that are substantially similar to the
primary operations of a mortgage banking enterprise. SFAS No. 134 is effective
for the first fiscal quarter beginning after December 15, 1998. Management
believes that the adoption of SFAS No. 134 will have no material effect on its
financial statements.

         In February 1999 FASB issued SFAS No. 135, "Rescission of FASB
Statement No. 75 and Technical Corrections" SFAS No. 135 rescinds SFAS No. 75
"Deferral of the Effective Date of Certain Accounting Requirements for Pension
Plans of State and Local Governmental Units". GASB Statement No. 25, "Financial
Reporting for Defined Benefit Pension Plans and Note Disclosures for Defined
Contribution Plan", was issued November 1994, and establishes financial
reporting standards for defined benefit pension plans and for the notes to the
financial statements of defined contribution plans of state and local
governmental entities. Statement 75 is, therefore, no longer needed. This
statement also amends FASB Statement No. 35, "Accounting and Reporting by
Defined Benefit Pension Plans", to exclude from its scope plans that are
sponsored by and provide benefits for the employees of one or more state or
local governmental units. This statement also amends other existing
authoritative literature to make various technical corrections, clarify
meanings, or describe applicability under changed conditions. This statement is
effective for financial statements issued for fiscal years ending after February
15, 1999. Management believes that the adoption of SFAS No. 135 will have no
material effect on its financial statements.

         SOP 98-5, "Reporting on the Costs of Start-Up Activities," requires
that the costs of start-up activities, including organization costs, be
expensed as incurred. This Statement is effective for financial statements
issued for fiscal years beginning after December 15, 1998. Management believes
that the adoption of SOP 98-5 will have no material effect on its financial
statements.



                                     -21-
<PAGE>   22




ITEM 7.  FINANCIAL STATEMENTS

         Report of Independent Certified Public Accountants             F-1

         Balance Sheet - December 31, 1998                              F-2

         Statements of Operations - For the Years
         Ended December 31, 1998 and 1997                               F-4

         Statements of Stockholders' Equity - For the Years Ended
         December 31, 1997 and 1998                                     F-5

         Statements of Cash Flows - For the Years
         Ended December 31, 1998 and 1997                               F-6

         Summary of Accounting Polices                                  F-8

         Notes to Financial Statements                                  F-14





                                     -22-
<PAGE>   23
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS


To the Board of Directors
eSoft, Incorporated
Boulder, Colorado

We have audited the accompanying balance sheet of eSoft, Incorporated as of
December 31, 1998 and the related statements of operations, stockholders'
equity and cash flows for the years ended December 31, 1998 and 1997. 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 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 provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of eSoft, Incorporated at
December 31, 1998 and the results of its operations and its cash flows for the
years ended December 31, 1998 and 1997, in conformity with generally accepted
accounting principles.




Denver, Colorado
January 29, 1999



                                      F-1
<PAGE>   24



                                                             eSOFT, INCORPORATED

                                                                   BALANCE SHEET
================================================================================
<TABLE>
<CAPTION>

December 31,                                                                     1998
------------                                                                  ----------

ASSETS
<S>                                                                           <C>       
CURRENT:
  Cash and cash equivalents                                                   $  655,650
  Investment securities (Note 1)                                               1,991,541
  Accounts receivable, less allowance of $250,000 for possible losses          1,965,085
  Note receivable (Note 2)                                                       300,000
  Inventories (Note 3)                                                         1,254,696
  Prepaid expenses and other                                                     177,416
                                                                              ----------
Total current assets                                                           6,344,388
                                                                              ----------

PROPERTY AND EQUIPMENT:
  Computer equipment                                                             217,176
  Furniture and equipment                                                        187,464
                                                                              ----------
                                                                                 404,640
  Less accumulated depreciation                                                  205,688
                                                                              ----------
Net property and equipment                                                       198,952
                                                                              ----------
OTHER ASSETS:
  Capitalized software development costs,                                     
  net of accumulated amortization of $314,453                                    867,072
  Other                                                                            7,039
                                                                              ----------
Total other assets                                                               874,111
                                                                              ----------
TOTAL ASSETS                                                                  $7,417,451
                                                                              ==========

</TABLE>

           See accompanying summary of accounting policies and notes
                            to financial statements.


                                      F-2


<PAGE>   25
                                                             eSOFT, INCORPORATED

                                                       BALANCE SHEET (CONTINUED)
================================================================================
<TABLE>
<CAPTION>

December 31,                                                                     1998
------------                                                                 -----------


LIABILITIES AND STOCKHOLDERS' EQUITY
<S>                                                                          <C>        
CURRENT:
  Accounts payable                                                           $   968,533
  Deferred revenue                                                                23,910
  Customer deposits                                                              248,287
  Accrued expenses:
   Payroll and payroll taxes                                                     256,033
   Other                                                                         140,184
                                                                             -----------
Total current liabilities                                                      1,636,947
                                                                             -----------
COMMITMENTS AND CONTINGENCIES (NOTES 6 AND 13)

STOCKHOLDERS' EQUITY:
  Preferred stock, $.01 par value, 5,000,000                                          --
   shares authorized, none outstanding
  Common stock, $.01 par value, 50,000,000                                   
   shares authorized, 6,863,502 shares issued                                     68,635
   and outstanding
  Additional paid in capital                                                   9,032,480
  Accumulated deficit                                                         (3,320,611)
                                                                             -----------
Total stockholders' equity                                                     5,780,504
                                                                             -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY                                   $ 7,417,451
                                                                             ===========
</TABLE>

           See accompanying summary of accounting policies and notes
                            to financial statements.


                                      F-3

<PAGE>   26
                                                             eSOFT, INCORPORATED
                                                        STATEMENTS OF OPERATIONS
================================================================================
<TABLE>
<CAPTION>

Years Ended December 31,                                                            1998            1997
------------------------                                                        -----------      -----------

<S>                                                                             <C>              <C>        
REVENUES                                                                        $ 3,867,600      $ 1,233,137
                                                                                -----------      -----------

COSTS AND EXPENSES:
  Selling and marketing                                                           2,612,065          225,737
  General and administrative                                                      2,369,564          506,861
  Cost of revenue                                                                 1,357,463          429,601
  Engineering                                                                       588,933           55,653
  Amortization of software costs                                                    189,399          116,912
  Research and development (Note 4)                                                  12,908           56,671
                                                                                -----------      -----------

Total costs and expenses                                                          7,130,332        1,391,435
                                                                                -----------      -----------
                                                                                 
Loss from operations                                                             (3,262,732)        (158,298)
                                                                                -----------      -----------

OTHER (INCOME) EXPENSE:
  Interest (income) expense, net                                                   (161,083)          27,151
  Loss on sale of assets                                                              1,013            7,803
                                                                                -----------      -----------
                                                                                   
Total other (income) expense                                                       (160,070)          34,954   
                                                                                -----------      -----------
                                                                                 
Loss before income tax (benefit) expense                                         (3,102,662)        (193,252)

Income tax (benefit) expense (Note 5)                                              (162,000)         162,000   
                                                                                -----------      -----------
NET LOSS                                                                        $(2,940,662)     $  (355,252) 
                                                                                ===========      ===========
Basic and diluted loss per common share (Note 8)                                $     (0.54)     $     (0.23)
                                                                                ===========      ===========
Weighted-average number of                                                        
  common shares outstanding basic and diluted                                     5,493,276        1,536,884
                                                                                ===========      ===========
</TABLE>


           See accompanying summary of accounting policies and notes
                            to financial statements.


                                      F-4

<PAGE>   27
                                                             eSOFT, INCORPORATED

                                              STATEMENTS OF STOCKHOLDERS' EQUITY
================================================================================
<TABLE>
<CAPTION>
Years Ended December 31,                                Common Stock               Additional                         Total
                                                  --------------------------        Paid in        Accumulated     Stockholders'   
1997 and 1998                                        Shares         Amount          Capital          Deficit          Equity
-------------                                     -----------     -----------     -----------      -----------     ------------  
<S>                                               <C>           <C>             <C>              <C>              <C>        
BALANCE, January 1, 1997                            1,263,158     $    12,632     $   467,973      $   (24,697)     $   455,908

  Issuance of common stock pursuant to
   private placements, net of offering
   costs of $80,841 (Note 7)                          820,000           8,200         320,959               --          329,159
  Common stock subscribed (Note 7)                    350,000           3,500         346,500               --          350,000
  Net loss for the year                                    --              --              --         (355,252)        (355,252)
                                                  -----------     -----------     -----------      -----------      -----------  

BALANCE, December 31, 1997                          2,433,158          24,332       1,135,432         (379,949)         779,815

  Issuance of compensatory options (Note 9)                --              --          69,600               --           69,600
  Issuance of warrants for consulting
    services (Note 10)                                     --              --         214,649               --          214,649
  Exercise of warrants and options (Note 7)           415,500           4,155         381,345               --          385,500
  Issuance of common stock pursuant to
    initial public offering, net of    
    offering costs of $540,850 (Note 7)             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 (Note 7)                      1,908,941          19,089       5,797,460               --        5,816,549
  Issuance of common stock to
    employees (Note 7)                                 90,000             900          89,100               --           90,000
  Issuance of common stock for offering
    fees (Note 7)                                     110,000           1,100          (1,100)              --               --
  Issuance of common stock pursuant to
    conversion of notes payable (Note 7)              355,903           3,559         352,344               --          355,903
  Net loss for the year                                    --              --              --       (2,940,662)      (2,940,662)
                                                  -----------     -----------     -----------      -----------      -----------  

BALANCE, December 31, 1998                          6,863,502     $    68,635     $ 9,032,480      $(3,320,611)     $ 5,780,504
                                                  ===========     ===========     ===========      ===========      ===========  
</TABLE>


           See accompanying summary of accounting policies and notes
                            to financial statements.

                                      F-5

<PAGE>   28
                                                             eSOFT, INCORPORATED

                                                        STATEMENTS OF CASH FLOWS
================================================================================
<TABLE>
<CAPTION>
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
Years Ended December 31,                                                           1998             1997
------------------------                                                       ------------     ------------

<S>                                                                            <C>              <C>         
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net loss                                                                     $(2,940,662)     $  (355,252)
  Adjustments to reconcile net loss to net
    cash used in operating activities:
      Depreciation and amortization                                                353,278          141,943
      Loss on sale of assets                                                         1,013            7,803
      Amortization of discount on investments                                      (71,624)              --
      Issuance of common stock for compensation                                     90,000               --
      Provision for losses on accounts receivable                                  202,440           48,000
      Provision for inventory obsolescence                                          59,440               --
      Deferred tax expense (benefit)                                              (162,000)         162,000
      Consulting expense incurred for note payable                                      --           41,000
      Issuance of compensatory options                                              69,600               --
      Changes in operating assets and liabilities:
        Accounts receivable                                                     (1,967,693)        (213,167)
        Inventories                                                             (1,219,529)         (35,948)
        Other assets                                                               (20,503)         (39,777)
        Accounts payable                                                           793,779          145,026
        Accrued expenses and other                                                 552,555           85,915
        Deferred revenue                                                           (22,712)         (11,348)
                                                                               -----------      -----------
Net cash used in operating activities                                           (4,282,618)         (23,805)
                                                                               -----------      -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
        Purchase of investments                                                 (1,919,917)              --
        Proceeds from sale of assets                                                 2,722               --
        Purchase of property and equipment                                        (144,593)         (21,989)
        Advances on non-operating notes                                            (15,000)         (20,000)
          receivable - employee
        Payments received from non-operating                                        20,443               --
          notes receivable - employee
        Additions to capitalized software                                         (405,000)        (221,139)
        Advances on non-operating notes receivable                                (300,000)              --
                                                                               -----------      -----------
Net cash used in investing activities                                           (2,761,345)        (263,128)
                                                                               -----------      -----------
</TABLE>


                                      F-6

<PAGE>   29
                                                             eSOFT, INCORPORATED

                                            STATEMENTS OF CASH FLOWS (CONTINUED)
================================================================================
<TABLE>
<CAPTION>
Years Ended December 31,                                                       1998             1997
------------------------                                                   ------------     ------------
<S>                                                                        <C>              <C>    
CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from sale of stock, warrants and options                          8,618,938          560,000
  Offering costs paid                                                       (1,126,405)         (80,841)
  Proceeds from stock subscription receivable                                  200,000               --
  Proceeds from borrowings                                                          --          100,000
  Payments on borrowings                                                       (75,757)         (24,243)
  Proceeds (payments) from related party borrowings                            (20,000)          20,000
  Deferred offering costs                                                           --         (205,896)
                                                                           -----------      -----------
Net cash provided by financing activities                                    7,596,776          369,020
                                                                           -----------      -----------
INCREASE IN CASH AND CASH EQUIVALENTS                                          552,813           82,087

CASH AND CASH EQUIVALENTS, beginning of year                                   102,837           20,750
                                                                           -----------      -----------
CASH AND CASH EQUIVALENTS, end of year                                     $   655,650      $   102,837
                                                                           ===========      ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
  Cash paid for interest                                                   $     6,805      $    31,012
                                                                           ===========      ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING
  AND FINANCING ACTIVITIES:
  Common stock issued for conversion of debt                               $   355,903      $        --
  Common stock issued for offering costs                                         1,100               --
  Warrants issued for consulting services                                      214,649               --
  Convertible notes payable issued for consulting
   services and deferred offering costs                                             --          116,000
  Common stock issued for subscription receivable                                   --          200,000

                                                                           ===========      ===========
</TABLE>

           See accompanying summary of accounting policies and notes
                            to financial statements.

                                     F-7

<PAGE>   30

                                                            eSOFT, INCORPORATED

                                                 SUMMARY OF ACCOUNTING POLICIES
===============================================================================


BUSINESS                        eSoft, Incorporated (the "Company" or "eSoft"),
                                a Colorado 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 1998, 60%
                                of the Company's product was purchased from two
                                suppliers. In 1997, there was no such
                                concentration of product purchased from
                                suppliers.

                                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.

                                Prior to June 30, 1996, eSoft and Philip L.
                                Becker, Ltd. ("PLB") operated as a combined
                                entity due to common ownership. eSoft, an
                                S-corporation, acted as the general partner of
                                PLB, a limited partnership. eSoft, as general
                                partner, owned 10% of the partnership while the
                                sole stockholder of eSoft owned the other 90%
                                individually. PLB was dissolved on June 30,
                                1996 and the assets were contributed to the
                                Company in exchange for common stock.

                                The contribution of assets was accounted for in
                                a manner similar to a pooling of interests (the
                                assets, liabilities and partnership capital
                                were contributed at book values) and,
                                accordingly, the Company's financial statements
                                have been presented to include the results of
                                operations as though the contribution of assets
                                occurred as of January 1, 1996.

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.

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
                                



                                      F-8

<PAGE>   31


                                                            eSOFT, INCORPORATED

                                                 SUMMARY OF ACCOUNTING POLICIES
==============================================================================

                                classified as trading are carried at estimated
                                market value. Unrealized holding gains and
                                losses for trading securities are included in
                                the statements of income. Gains and losses on
                                securities sold are determined based on the
                                specific identification of the securities sold.
                                At December 31, 1998, all investments are
                                classified as held-to-maturity.

INVENTORIES                     Inventories, consisting of purchased goods, are
                                valued at the lower of cost (weighted-average)
                                or market.

PROPERTY AND                    Property and equipment are stated at cost.
EQUIPMENT                       Depreciation is computed using the
                                straight-line method over the estimated useful
                                lives (generally five years) of the assets.

                                Depreciation expense for the years ended
                                December 31, 1998 and 1997, was $56,725 and
                                $25,031. 

CAPITALIZED                     Costs incurred internally in creating software 
SOFTWARE COSTS                  products for 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.

LONG-TERM                       The Company applies SFAS No. 121, "Accounting
ASSETS                          for the 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 RECOGNITION             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 

                                      F-9

<PAGE>   32


                                                            eSOFT, INCORPORATED

                                                 SUMMARY OF ACCOUNTING POLICIES
==============================================================================


                                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.

                                Software Revenue Recognition

                                The Company follows the guidance of Statement
                                of Position ("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.


INCOME TAXES                    The Company with consent of its
                                stockholder, through September 4, 1997, elected
                                under the Internal Revenue Code to be an
                                S-corporation. Subsequent to September 4, 1997,
                                the Company is taxed as a U.S. C-corporation.
                                Philip L. Becker, Ltd. elected to be taxed as a
                                partnership. In lieu of corporation income
                                taxes, the stockholder and partners were taxed
                                on their proportional share of the Company's or
                                partnership's taxable income. Therefore through
                                September 4, 1997, no provision for income
                                taxes has been made in the accompanying
                                financial statements.

                                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.
                                The provisions of SFAS No. 109 did not have an
                                impact until after September 4, 1997.


NET INCOME (LOSS)               The Company follows the provisions of SFAS No.
PER SHARE                       128, "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 reflects 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. 

USE OF ESTIMATES                The preparation of financial statements in 
                                conformity with generally accepted accounting
                                principles requires management to make
                                estimates and assumptions 


                                     F-10

<PAGE>   33
                                                            eSOFT, INCORPORATED

                                                 SUMMARY OF ACCOUNTING POLICIES
================================================================================

                                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
OF CREDIT RISK                  would be 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.

                                Concentrations of credit risk with respect to
                                trade accounts receivable are generally limited
                                due to 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 (See Note 12).

FAIR VALUE OF                   Unless otherwise specified, the Company
FINANCIAL                       believes the book value of financial
INSTRUMENTS                     instruments approximates their fair value.

STOCK OPTIONS                   The Company applies Accounting Principles Board
AND WARRANT                     Opinion ("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 INCOME            The Company has adopted SFAS No. 130, 
                                "Reporting 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. The adoption of
                                SFAS No. 130 does not impact the Company's
                                financial statements for 1998 and 1997.
                                

                                     F-11

<PAGE>   34


                                                            eSOFT, INCORPORATED

                                                 SUMMARY OF ACCOUNTING POLICIES
===============================================================================

PENSIONS AND                    The Company has adopted SFAS No. 132,
OTHER POST                      "Employers' Disclosure About Pensions and Other
RETIREMENT BENEFITS             Post Retirement Benefits." SFAS No. 132
                                standardizes the disclosure requirements for
                                pensions and other post retirement benefits and
                                requires additional information on changes in
                                the benefit obligations and fair values of plan
                                assets that will facilitate financial analysis.
                                The adoption of SFAS No. 132 does not impact
                                the Company's financial statement disclosures
                                for 1998 and 1997. 

IMPACT OF RECENTLY              SFAS No. 133, "Accounting for Derivative
ISSUED ACCOUNTING               Instruments and Hedging Activities" requires
PRONOUNCEMENTS                  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 is effective for fiscal years
                                beginning after June 15, 1999. Management
                                believes that the adoption of SFAS No. 133 will
                                have no material effect on its financial
                                statements.

                                SFAS No. 134, "Accounting for Mortgage-Backed
                                Securities Retained After the Securitization of
                                Mortgage Loans Held for Sale by a Mortgage
                                Banking Enterprise," establishes accounting and
                                reporting standards for certain activities of
                                mortgage banking enterprises and other
                                enterprises that conduct operations that are
                                substantially similar to the primary operations
                                of a mortgage banking enterprise. SFAS No. 134
                                is effective for the first fiscal quarter
                                beginning after December 15, 1998. Management
                                believes that the adoption of SFAS No. 134 will
                                have no material effect on its financial
                                statements.

                                SFAS No. 135, "Rescission of FASB Statement No.
                                75 and Technical Corrections," rescinds FASB
                                Statement No. 75, "Deferral of the Effective
                                Date of Certain Accounting Requirements for
                                Pension Plans of State and Local Governmental
                                Units." GASB Statement No. 25, "Financial
                                Reporting for Defined Benefit Pension Plans and
                                Note Disclosures for Defined Contribution
                                Plans," was issued November 1994, and
                                established financial reporting standards for
                                defined benefit pension plans and for the notes
                                to the financial statements of defined
                                contribution plans of state and local
                                governmental entities. Statement 75 is,
                                therefore, no longer needed. This Statement
                                also amends FASB Statement No. 35, "Accounting
                                and Reporting by Defined Benefit Pension
                                Plans," to exclude from its scope plans that
                                are sponsored by and provide benefits for the
                                employees of one or more state or local
                                governmental units.



                                     F-12

<PAGE>   35


                                                            eSOFT, INCORPORATED

                                                 SUMMARY OF ACCOUNTING POLICIES
==============================================================================

                                This Statement also amends other existing
                                authoritative literature to make various
                                technical corrections, clarify meanings, or
                                describe applicability under changed
                                conditions.

                                This Statement is effective for financial
                                statements issued for fiscal years ending after
                                February 15, 1999. Management believes that the
                                adoption of SFAS No. 135 will have no material
                                effect on its financial statements.

                                SOP 98-5, "Reporting on the Costs of Start-Up
                                Activities," requires that the costs of
                                start-up activities, including organization
                                costs, be expensed as incurred. This Statement
                                is effective for financial statements issued
                                for fiscal years beginning after December 15,
                                1998. Management believes that the adoption of
                                SOP 98-5 will have no material effect on its
                                financial statements.


RECLASSIFICATIONS               Certain items included in the prior year's 
                                financial statements have been reclassified to
                                conform to the current presentation.



                                     F-13


<PAGE>   36
                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================

1. INVESTMENT                   A summary of the amortized cost and estimated
   SECURITIES                   market value of investment securities which
                                mature in six months is as follows:
<TABLE>
<CAPTION>
                                December 31, 1998         Amortized Cost       Gross        Gross       Estimated
                                                                            Unrealized    Unrealized      Market
                                                                               Gains        Losses        Value
                                =================         ===============   ===========   ===========   ==========
                                <S>                     <C>                 <C>          <C>           <C>
                                HELD TO MATURITY:
                                  Short-term zero           $1,991,541          $--          $--        $1,991,541
                                  coupon notes              ==========          ====         ====       ==========
</TABLE>

2. NOTE                         In December 1998, the Company entered into an
   RECEIVABLE                   adjustable rate line of credit with Apexx
                                Technology, Inc. in the amount of $500,000. The
                                note bears interest at prime plus 2% (9.75% at
                                December 31, 1998). At December 31, 1998, the
                                principal balance outstanding on the note was
                                $300,000. Subsequent to December 31, 1998, the
                                Company advanced an additional $200,000 to
                                Apexx (see Note 13).

3. INVENTORIES                  Inventories at December 31, 1998 consisted of
                                the following:

                                <TABLE>
                                <S>                                                                     <C>
                                Finished goods                                                          $1,314,136
                                Less reserve for obsolescence                                               59,440
                                                                                                        ----------
                                                                                                        $1,254,696
                                                                                                        ==========
</TABLE>

4. RESEARCH AND                 During the years ended December 31, 1998 and
   DEVELOPMENT                  1997, the Company capitalized $405,000 and
                                $221,139 of software development costs.
                                Amortization expense of capitalized software
                                development costs included in depreciation and
                                amortization for the years ended December 31,
                                1998 and 1997 amounted to $189,399 and
                                $116,912. Research and development costs were
                                $12,908 and $56,671 for the years ended
                                December 31, 1998 and 1997.


                                     F-14

<PAGE>   37
                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================

                                Research and development expenditures during
                                the following periods were comprised as
                                follows:

<TABLE>
<CAPTION>
                                Years Ended December 31,                                      1998          1997
                                                                                           ----------     --------
                                <S>                                                        <C>            <C>
                                Payroll and related costs                                  $       --     $131,627
                                Officer payroll                                                    --       50,000
                                Internet and telephone  expenses                                   --       30,056
                                Occupancy costs                                                    --       34,860
                                Purchased services                                            405,000           --
                                Other                                                          12,908       31,267
                                                                                           ----------     --------
                                                                                              417,908      277,810
                                Less capitalized software costs                               405,000      221,139
                                                                                           ----------     --------
                                                                                           $   12,908     $ 56,671
                                                                                           ==========     ========
</TABLE>

5. INCOME TAXES                 The provision for income taxes consisted of the
                                following:

<TABLE>
<CAPTION>
                                Years Ended December 31,                               1998                1997
                                                                                    ----------           --------
                                DEFERRED EXPENSE (BENEFIT):
                                <S>                                                 <C>                  <C>
                                Federal                                             $ (148,000)          $148,000
                                State                                                  (14,000)            14,000
                                                                                    ----------           --------
                                                                                    $ (162,000)          $162,000
                                                                                    ==========           ========
</TABLE>

                                     F-15

<PAGE>   38
                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================

                                A reconciliation of the effective tax rate and
                                the statutory U.S. federal income tax rates
                                are as follows:

<TABLE>
<CAPTION>
                                Years Ended December 31,                             1998          1997
                                ------------------------                         -----------    -----------
                                <S>                                              <C>            <C>
                                Federal tax benefit at the federal
                                   statutory rate                                $(1,055,000)   $   (66,000)
                                State income tax benefit, net of federal tax
                                   amount                                           (109,000)        (7,000)
                                Permanent differences                                (86,000)         1,000
                                Other                                                 65,000         (9,000)
                                Deferred tax expense due to S. Corp                       --        243,000
                                   termination
                                Increase in valuation allowance                    1,023,000             --
                                                                                 -----------    ----------- 
                                Income tax (benefit) expense                     $  (162,000)   $   162,000 
                                                                                 ===========    ===========
</TABLE>

                                Temporary differences that give rise to a
                                significant portion of the deferred tax
                                assets and liabilities are as follows:

<TABLE>
<CAPTION>
                                December 31,                                         1998
                                ------------                                     -----------
                                <S>                                              <C>
                                Net operating loss carryforwards                 $ 1,003,000
                                Accounts receivable                                   93,750
                                Inventory                                             22,000
                                Accruals                                             172,250
                                Options and warrants                                  66,000
                                                                                 -----------
                                Total deferred tax asset                           1,357,000
                                                                                 -----------
                                Capitalized software costs                          (325,000)
                                Other                                                 (9,000)
                                                                                 -----------
                                Total deferred tax liability                        (334,000)
                                                                                 -----------
                                Total                                              1,023,000
                                Less valuation allowance                           1,023,000
                                                                                 -----------
                                Net deferred tax asset (liability)               $        --
                                                                                 ===========
</TABLE>

                                     F-16

<PAGE>   39
                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================

                                The valuation allowance of $1,023,000 at
                                December 31, 1998, 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, 1998, the Company had net
                                operating loss carryforwards of approximately
                                $2,700,000 with expirations through 2019. The
                                utilization of certain of the loss
                                carryforwards are limited under Section 382 of
                                the Internal Revenue Code.

                                As stated in the summary of accounting
                                policies, the Company had elected to be taxed
                                as an S corporation. In lieu of the corporation
                                income taxes, the stockholders and partners
                                were taxed on their proportional share of the
                                Company's taxable income. The pro forma income
                                (loss) per common share if the Company was
                                subject to taxes (federal statutory rate of
                                34%) would be as follows:

<TABLE>
<CAPTION>
                                Year ended December 31,                                  1997
                                -----------------------                               ---------
                                <S>                                                   <C>
                                Loss before income taxes                              $(193,252)
                                Pro forma income tax benefit                             66,000
                                                                                      ---------
                                Pro forma net loss                                    $(127,252)
                                                                                      =========
                                Pro forma loss per share                              $   (0.08)
                                                                                      =========
</TABLE>

6.  COMMITMENTS                 Operating Leases
        
                                The Company leases certain of its facilities
                                and equipment under noncancellable operating
                                lease agreements which expire at various dates
                                through 2004. Rent expense for the years ended
                                December 31, 1998 and 1997 was $116,048 and     
                                $54,847.

                                Subsequent to December 31, 1998, the Company
                                executed a lease to relocate its corporate
                                headquarters and shipping and assembly
                                facilities into one location. The anticipated
                                date for the new facility is April 1, 1999. The
                                new facility lease expires in May 2004 and
                                annual rental payments are $173,000. The
                                Company is being fully released from its lease
                                on its current corporate headquarters.



                                     F-17

<PAGE>   40

                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================


                                Future minimum lease payments under
                                noncancellable operating leases as adjusted     
                                for new corporate headquarters lease are as
                                follows:

<TABLE>
<CAPTION>
                                Year Ending December 31,                                                              
                                ------------------------                                                              
                                <S>                               <C>        
                                1999                              $ 147,000  
                                2000                                182,000  
                                2001                                185,000  
                                2002                                186,000  
                                2003                                187,000  
                                Thereafter                           78,000  
                                                                  ---------  
                                                                  $ 965,000  
                                                                  =========  
</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.

                                During 1998, the Company entered into an
                                agreement to terminate the software development
                                agreements. The termination agreement required
                                the Company to pay $30,000 at the agreement's
                                inception; $30,000 no later than 15 days after
                                the Company completes its proposed public
                                offering but not later than December 31, 1998
                                if the proposed public offering is not
                                completed by that date; and the issuance of
                                stock warrants entitling the warrant holder,
                                for a period of two years from January 29, 1998
                                to purchase up to 20,000 shares of the
                                Company's common stock at a price of $1.00 per
                                share until one year after the closing of the
                                public offering and $1.15 per share until the
                                warrants expire. The required   $60,000 payment
                                was made in 1998.

                                In 1998, the Company entered into a software
                                development agreement with a company. The
                                development agreement required a payment of
                                $150,000 for a wireless product with VPN
                                capabilities to be integrated with the IPAD.
                                Additionally, in conjunction with its sales
                                efforts in Japan, the company was paid $195,000
                                to nationalize the interface of the IPAD for
                                the Japanese marketplace.


        
                                     F-18

<PAGE>   41
                                                            eSOFT, INCORPORATED

                                                  NOTES TO 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.

                                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.

                                The Company has entered into employment
                                agreements with four other executive officers
                                with a range of salary levels and benefits. The
                                term of these employment agreements is
                                thirty-six months, at salary levels ranging
                                from $7,500 to $11,000 per month. The
                                agreements terminate from December 2000 through
                                December 2001. The employment agreements
                                provide for either a quarterly
                                performance-based bonus ranging from $5,000 to
                                $12,500, 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 20,000 and
                                60,000 shares of eSoft common   stock at
                                exercise prices ranging from $1.00 to $6.15 per
                                share.

                                Future commitments under the above employment
                                agreements are $695,000, for 1999, 2000 and
                                2001.

                                     F-19

<PAGE>   42


                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================

                                The Company on November 10, 1998 served its
                                former President and COO with notice of
                                termination of services pursuant to his
                                employment agreement. The employment agreement
                                required ninety days prior notice of
                                termination of services. The agreement requires
                                payment of three months salary totaling $30,000
                                and participation in its employee benefits
                                program as severance beginning March 1, 1999.

7. STOCKHOLDERS'                Stock Split
   EQUITY
                                On August 27, 1997, the Board of Directors
                                authorized a stock split of 63.1579 to 1. All
                                references to common share and per share
                                amounts in the accompanying financial
                                statements have been retroactively restated to
                                reflect the effect of the stock split.

                                Private Placements

                                On September 12, 1997, the Company sold 820,000
                                shares of common stock for $410,000 in a
                                private placement. Warrants to purchase 414,600
                                shares of common stock were issued to
                                consultants and investors at an exercise price
                                of $1.00 per share. The warrants were modified
                                in January 1998 changing the term to one year
                                and fifteen days after the Company's shares are
                                listed for trading. If the shares are not
                                exercised within a year, the exercise price
                                increases to $1.15 for fifteen days. The net
                                proceeds to the Company after stock issuance
                                costs was $329,159.

                                In December 1997, the Company sold 350,000
                                shares of common stock for $350,000 in a
                                private placement. The Company granted the
                                promoter of the private placement warrants to
                                purchase an additional 87,500 shares of common
                                stock at $1 per share. The warrants expire
                                December 22, 1999.

                                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 $186,981 from the offering net of
                                offering costs.


                                     F-20


<PAGE>   43



                                                            eSOFT, INCORPORATED

                                                  NOTES TO 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 shareholder 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.

                                Initial Public Offering

                                In March 1998, the Company completed its
                                initial public offering 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 was 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.

                                Exercise of Stock Options and Warrants

                                In February 1998, the Company issued 60,000
                                shares of its common stock at $.50 per share
                                upon exercise of options previously granted.

                                In the third quarter of 1998, the Company
                                issued 70,000 shares of its common stock at a
                                price of $1.00 per share for a total of $70,000
                                upon the exercise of options and warrants
                                previously granted and are in addition to
                                issuances previously described.


                                     F-21

<PAGE>   44


                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================

                                In the fourth quarter of 1998, the Company
                                issued 35,500 shares of its common stock at a
                                price of $1.00 per share for a total of $35,500
                                upon the exercise of options and warrants
                                previously granted.

                                Conversion of Debt

                                Prior to January 1, 1996 the Company had
                                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
                                had 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
                                is payable in full on January 2, 1999.

                                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 are
                                payable on January 2, 1999. The notes are
                                convertible into common stock, at the Company's
                                option, at the price of the Company's
                                contemplated initial public offering.

                                In the first quarter of 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.



                                     F-22

<PAGE>   45


                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================



8. LOSS PER                     The following table sets forth the computation
   SHARE                        of basic and diluted loss per share:

<TABLE>
<CAPTION>
                                Years Ended December 31,                    1998              1997    
                                ------------------------                 -----------      ----------- 
                                <S>                                      <C>              <C>         
                                Numerator -                              $(2,940,662)     $  (355,252)
                                Net loss                                                              
                                Denominator -                              5,493,276        1,536,884 
                                Denominator for basic and diluted                                     
                                earnings per share - weighted average                                 
                                shares outstanding                                                    
                                                                         -----------      ----------- 
                                Basic and diluted net loss per share     $     (0.54)     $     (0.23)
                                                                         ===========      =========== 
</TABLE>

                                For the years ended December 31, 1998 and 1997,
                                total stock options and stock   warrants of
                                1,955,418, and 762,100 were not included in the
                                computation of diluted earnings per share
                                because their effect was anti-dilutive.

9. STOCK OPTION                 In September 1998, the Board of Directors, and
   PLAN                         on December 4, 1998, the stockholders of the
                                Company, approved an 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 1,700,000 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, 1998,
                                options to purchase 1,516,500 shares of the
                                Company's common stock had been granted under
                                the Plan.

                                In September 1997, the Company granted options
                                to purchase an aggregate of 260,000 shares of
                                its common stock to employees. Terms of the
                                employee options are 200,000 shares at $1 per
                                share and $60,000 at $.50 per share which
                                expire September 2002.

                                In 1998, the Company granted options to
                                purchase 1,156,500 shares of common stock
                                ranging from $1.00 - $6.85 per share to
                                employees and directors. The shares vest over
                                various periods from 2 months to 36 months. The
                                options 


                                     F-23

<PAGE>   46
                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================

                                expire through February 2003. Of the 1,156,500
                                options, 60,000 were issued at a price below
                                fair market value at date of grant and,
                                accordingly, the Company recognized
                                compensation expense of $69,600 based on the
                                difference between the exercise price and the
                                fair market value at the grant date.

                                In 1998, the Company granted 100,000 options to
                                consultants at $1 per share, of which 65,000
                                options vest at date of grant, 35,000 options
                                vest ratably over a 36 month period, with
                                25,000 of these options being canceled in 1998.
                                The options expire through March 2002.

10.  STOCK OPTIONS              The Company applies APB 25 in accounting for
     AND WARRANTS               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,              1998                   1997      
                                ------------------------           ------------          ------------  
                                <S>                                <C>                   <C>           
                                Net loss as reported               $ (2,940,662)         $   (355,252) 
                                Net loss pro forma                   (2,962,710)             (355,969) 
                                Basic and diluted loss                                                 
                                  per share as reported                   (0.54)                (0.23) 
                                Basic and diluted loss                                                 
                                  per share pro forma                     (0.54)                (0.23) 
</TABLE>                                                         
                                                                 
<TABLE>                                                          
<CAPTION>                                                        
                                Years Ended December 31,               1998               1997          
                                ------------------------         ---------------    ------------------  
                                <S>                              <C>                <C>                 
                                Dividend yield                                 0%                    0% 
                                Expected volatility                      6 TO 14%                    0% 
                                Risk-free interest rates            4.12 TO 6.20%                    6% 
                                Expected lives in years          1.17 TO 5 YEARS    0.25 to 1.94 years  
</TABLE>


                                     F-24

<PAGE>   47
                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================


                                A summary of the status of the Company's stock
                                option plans as of December 31, 1998 and 1997
                                is presented below:

<TABLE>
<CAPTION>
                                                                                                                             
                                                                    Options                      Warrants             
                                                           ----------------------------    ------------------------   
                                                                Weighted Average               Weighted Average       
                                                                              Exercise                    Exercise    
                                                          Shares               Price         Shares          Price    
                                                          ----------      ----------      ----------      ----------  
                                <S>                      <C>             <C>             <C>             <C>          
                                Outstanding,                                                                          
                                January 1, 1997                   --      $       --              --      $       --  
                                Granted                      260,000            0.88         502,100            1.00  
                                                          ----------      ----------      ----------      ----------  
                                Outstanding,                                                                          
                                December 31, 1997            260,000            0.88         502,100            1.00  

                                Granted                    1,256,500            2.79         554,318            3.20  
                                Canceled                     (82,750)          (1.37)             --              --  
                                Exercised                   (120,500)          (0.75)       (295,000)          (1.00) 
                                                          ----------      ----------      ----------      ----------  
                                Outstanding,                                                                          
                                December 31, 1998          1,313,250            2.69         761,418            2.61  
                                                          ----------      ----------      ----------      ----------  
                                Exercisable,                                                                          
                                December 31, 1997             60,000            0.50          87,500            1.00  
                                                          ----------      ----------      ----------      ----------  
                                Exercisable,                                                                          
                                December 31, 1998            295,694      $     1.21         761,418      $     2.61  
                                                          ==========      ==========      ==========      ==========  
</TABLE>

<TABLE>
<CAPTION>
                                                                                                            
                                                                                 Options         Warrants   
                                                                                ==========      ==========  
<S>                                                                             <C>             <C>
                                Weighted average fair value of options                                      
                                and warrants granted during 1997                $     0.88      $     1.00  
                                Weighted average fair value of options                                      
                                and warrants granted during 1998                $     0.57      $     1.20  
</TABLE>



                                     F-25


<PAGE>   48
                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================



                                The following table summarizes information
                                about exercisable stock options and     
                                warrants at December 31, 1998 and 1997:

<TABLE>
<CAPTION>
                                                           Outstanding                               Exercisable          
                                                     ----------------------------------------   -----------------------   
                                                                     Weighted                                             
                                                                      Average       Weighted                   Weighted   
                                                                     Remaining      Average                    Averagee   
                                   Range of             Number      Contractual     Exercise       Number      Exercise   
                                 Exercise Prices     Outstanding       Life          Price       Exercisable     Price    
                                 ---------------     -----------       ----          -----       -----------     -----    
                                December 31, 1998                                                                         
                                -----------------                                                                         
                                <S>                  <C>              <C>           <C>           <C>           <C>       
                                OPTIONS:                                                                                  
                                   $1.00                  606,750          3.26     $    1.00       280,861     $    1.00 
                                    3.06 - 4.00           581,500          3.74          3.74         1,500          4.00 
                                    5.34 - 6.85           125,000          3.61          5.96        13,333          6.50 
                                                        ---------     ---------     ---------     ---------     --------- 
                                   $1.00 - 6.85         1,313,250          3.50     $    2.69       295,694     $    1.21 
                                                        =========     =========     =========     =========     ========= 
                                WARRANTS:                                                                                 
                                   $1.00 - 1.10           477,100          0.44     $    1.02       477,100     $    1.02 
                                    4.25 - 4.68           169,318          1.66          4.28       169,318          4.28 
                                    5.34 - 6.98           115,000          4.39          6.77       115,000          6.77 
                                                        ---------     ---------     ---------     ---------     --------- 
                                   $1.00 - 6.98           761,418          1.30     $    2.61       761,418     $    2.61 
                                                        =========     =========     =========     =========     ========= 
                                December 31, 1997                                                                         
                                -----------------                                                                         
                                OPTIONS:                                                                                  
                                   $0.50                   60,000          0.11     $    0.12        60,000     $    0.12 
                                    1.00                  200,000          3.40          0.76            --            -- 
                                                        ---------     ---------     ---------     ---------     ---------
                                   $0.50 - 1.00           260,000          3.51     $    0.88        60,000     $    0.12 
                                                        =========     =========     =========     =========     ========= 
                                WARRANTS:                                                                                 
                                   $1.00                  502,100          0.77     $    1.00        87,500     $    1.00 
                                                        =========     =========     =========     =========     ========= 
</TABLE>

                                     F-26

<PAGE>   49


                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================


                                The weighted average grant date fair value of
                                stock options granted is summarized as follows:

<TABLE>
<CAPTION>
                                Years Ended December 31,                  1998            1997 
                                ------------------------                  ----            ---- 
                                <S>                                     <C>             <C>    
                                Market value equal to exercise                                 
                                price                                   $ 0.55          $  --  
                                Market value greater than                                      
                                exercise price                            0.44             --  
                                Market value less than                                         
                                exercise price                            1.15            0.88 
</TABLE>


                                The weighted average grant date fair value of
                                warrants granted is summarized as follows:


<TABLE>
<CAPTION>
                                Years Ended December 31,                  1998          1997 
                                ------------------------                  ----          ---- 
                                <S>                                      <C>           <C>    
                                Market value equal to exercise                               
                                price                                    $  --         $ 1.00
                                Market value greater than                                    
                                exercise price                            0.11             --
                                Market value less than exercise                              
                                price                                     2.24             --
</TABLE>



                                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 1998, the Company
                                recognized approximately $108,000 of expense in
                                conjunction with the above warrants.

11.  RELATED PARTY              A director of the Company is also the President,
     TRANSACTIONS               Chief 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.



                                     F-27


<PAGE>   50
                                                            eSOFT, INCORPORATED

                                                  NOTES TO FINANCIAL STATEMENTS
===============================================================================


12. BUSINESS                    In 1998, the Company adopted SFAS No. 131,
    SEGMENTS                    "Disclosures About Segments of an Enterprise
                                and Related Information." Disclosures required
                                by SFAS No. 131 are as follows:

                                The Company is engaged in one business segment
                                - Internet Connectivity Solutions.

                                The following table presents information by
                                geographic area:

<TABLE>
<CAPTION>
                                Year Ended December 31, 1998                      Revenues(1)  Long-Lived Assets
                                ----------------------------                      -----------  -----------------
                                <S>                                               <C>            <C>             
                                United States                                     $3,187,600       $1,066,000    
                                Argentina                                            508,000               --    
                                Other foreign countries                              172,000               --    
                                                                                  ----------       ----------    
                                                                                  $3,867,600       $1,066,000    
                                                                                  ==========       ==========    
</TABLE>

                                For the year ended December 31, 1997, there
                                were no foreign sales.

                                (1) Revenues are attributed to countries based
                                on location of customer.

                                During 1998, sales to one domestic customer
                                represented $1,771,000 of the Company's total
                                sales. At December 31, 1998, accounts
                                receivable from this customer was $1,670,833.
                                During 1998, sales to one customer located in
                                Argentina represented $508,000 of the Company's
                                total sales. At December 31, 1998, accounts
                                receivable from this customer was $256,785. For
                                the year end December 31, 1997, there were no
                                such concentrations in sales or accounts
                                receivable.

                                For the years ended December 31, revenues from
                                significant customers consisted of the
                                following:

<TABLE>
<CAPTION>
                                                                           1998         1997
                                                                           ----         ----
                                <S>                                        <C>          <C> 
                                     Customer:                                              
                                         A                                  46%            -
                                         B (export sales to Argentina       13%            -
                                                                            ==            ==
</TABLE>



                                     F-28

<PAGE>   51










13.  SUBSEQUENT                 In January 1999, the Company signed a Plan of 
     EVENT                      Merger and Agreement with Apexx Technology, Inc
                                ("Apexx"). The proposed merger requires the
                                vote of the shareholders of both companies to
                                approve the merger. The transaction proposes
                                the Company issue 2,947,368 shares of its
                                common stock for all the issued and outstanding
                                shares and options of Apexx. The Company also
                                extended a line of credit to Apexx in the
                                amount of $500,000. At December 31, 1998,
                                $300,000 was outstanding and subsequent to
                                December 31, 1998, the Company extended an
                                additional $200,000.




                                     F-29


<PAGE>   52




ITEM 8.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 
         FINANCIAL DISCLOSURES

         Not applicable.

                                   PART III

ITEM 9.  DIRECTORS AND EXECUTIVE OFFICERS; COMPLIANCE WITH SECTION 16(a) OF THE
         EXCHANGE ACT

         The directors and executive officers of the Company are listed below.
Directors are elected to hold office until the next annual meeting of
shareholders and until their respective successors have been elected and
qualified. 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                      40        President, Chief Executive Officer and Director

             Jason M. Rollings                 37        Vice President of Operations

             Thomas Tennessen                  39        Chief Financial Officer, Secretary, and Treasurer

             Robert C. Hartman                 38        Vice President of Engineering

             James R. Bell                     44        Vice President of Business Development

             Jane Merikel                      35        Vice President of Marketing

             Richard Rice                      47        Director

</TABLE>

BIOGRAPHICAL INFORMATION

         Philip L. Becker - Mr. Becker, is the Company's 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 eSoft 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 the Company's 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 



                                     -23-
<PAGE>   53


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.

         Thomas Tennessen - Mr. Tennessen, has been the Company's Chief
Financial Officer, Secretary, and Treasurer since April 9, 1998. Mr. Tennessen
was a financial consultant from March 1997 to April 1998 and was the Chief
Financial Officer of Topro, Inc., a publicly-held system integrator, from
September 1994 to March 1997.

         Robert C. Hartman - Mr. Hartman, has been the Company's 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.

         James R. Bell - Mr. Bell, is the Vice-President, Business Development
of the Company since December 1998. Mr. Bell has been employed by the Company
since April 1998; From January 1990 to April 1998 he was employed as Senior
V.P.-Operations for Phoenix Network, Inc.

         Jane Merickel - Ms. Merickel, has been the Company's 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.

         Richard Rice - Mr. Rice has been a director of the Company 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.

Compliance with Section 16 (a) of the Exchange Act

         Section 16 (a) of the Securities Exchange Act of 1934 ( the "Exchange
Act") requires the Company's directors and officers and persons who own more
than ten percent of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
(the "SEC"). Directors, officers and greater than ten-percent shareholders are
required by SEC regulation to furnish the Company with copies of all Section 16
(a) reports filed.

         Based solely on its review of the copies of the reports it received
from persons required to file, the Company believes that during the period from
January 1, 1998 through December 31, 1998, all filing requirements applicable
to its officers, directors and greater than ten-percent shareholders were
complied with.


                                     -24-
<PAGE>   54




ITEM 10. EXECUTIVE COMPENSATION

           The following table sets forth information regarding compensation
paid during the past three fiscal years to the Company's Chief Executive
Officer and to any of the Company's four most highly compensated executive
officers who received total salary and bonus in excess of $100,000 per annum
during the fiscal year ended December 31, 1998:

                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                                                 Long Term
                                                                                            Compensation Payouts
                        Annual Compensation                        Awards
                  --------------------------------   ------------------------------------   ---------------------
        (a)            (b)       (c)         (d)       (e)         (f)           (g)            (h)          (i)
                                                                            Securities  
                                                     Other   Restricted     Underyling               
Name and Principal                                   Annual     Stock      Option/SAR's     LTIP       All Other    
Position             Year   Salary ($)   Bonus ($)  Comp ($)  Awards ($)       (#)        Payouts     Compensation  
                            ----------   ---------  --------  ----------   ------------   -------     ------------ 
<S>                  <C>   <C>           <C>        <C>       <C>          <C>            <C>         <C>
Philip Becker        1998  $115,833         $0         $0         $0             $0            $0            $0

Chairman and CTO     1997  $100,000         $0         $0         $0             $0            $0            $0

                     1996  $60,000          $0         $0         $0             $0            $0            $0

Jeffrey Finn(1)      1998  $25,909          $0         $0         $0             $0            $0            $0

President and CEO    1997  $0               $0         $0         $0             $0            $0            $0

                     1996  $0               $0         $0         $0             $0            $0            $0

Jason Rollings(2)    1998  $90,000        $35,973      $0         $0             $0            $0            $0

Vice President of    1997  $24,204          $0         $0         $0             $0            $0            $0

Operations           1996  $0               $0         $0         $0             $0            $0            $0

Regis Frank(3)       1998  $120,000         $0         $0         $0             $0            $0            $0

Former President and 1997  $0               $0         $0         $0             $0            $0            $0

  COO                1996  $0               $0         $0         $0             $0            $0            $0
</TABLE>

-------
(1) Mr. Finn joined the Company in November 1998.

(2) Mr. Rollins joined the Company in October 1997.

(3) Mr. Frank served as the Company's President and Chief Operating
    Officer from November 1997 to November 1998. Mr. Frank received a salary of
    $10,000 per month while serving as President and Chief Operating Officer.
    Pursuant to the severance arrangement described under the heading "Certain
    Relationships and Related Transactions of the Company -- Severance
    Arrangement," the Company is required to pay Mr. Franks's salary through
    May 31, 1999.

                     OPTION/SAR GRANTS IN LAST FISCAL YEAR

        Prior to the adoption of the Stock Option Plan described below, no
stock options were ever granted to or exercised by executive officers of the
Company.

        In September 1998, the Board of Directors and on December 4, 1998 the
stockholders of the Company approved an 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 1,700,000
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 February 15, 1999, options to
purchase 1,254,500 shares of the Company's common stock had been granted under
the Plan.



                                     -25-
<PAGE>   55



         In the fiscal year ending December 31, 1998, stock options were
granted as follows:


                     OPTION/SAR GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>

                                                         % OF TOTAL 
                                    NUMBER OF          OPTIONS GRANTED      
                                SHARES UNDERLYING      TO EMPLOYEES IN           EXERCISE             EXPIRATION
        NAME                     OPTIONS GRANTED         FISCAL YEAR              PRICE                  DATE
        ----                     ---------------         -----------              -----                  ----
<S>                             <C>                    <C>                    <C>                     <C>                   
     Jeffrey Finn                  418,000(1)                33%               $ 4.00/share            11/5/02
     Regis Frank                   128,000(2)                10%               $ 1.00/share            1/7/2003(2)
     Jason Rollings                 30,000(3)                 2%               $ 1.00/share            1/7/2002(3)
</TABLE>

---------------

(1) Includes 18,000 options granted in consideration of Mr. Finn's services as
    a director of the Company. 750 options vested for the fiscal year ended
    December 31, 1998. Options granted in consideration of services as a
    director vest at a rate of 1/24 each month for two years. The remaining
    options held by Mr. Finn vest as follows: 77,777 shares vest on June 1999
    and 11,111 shares a month vest thereafter until fully vested.

(2) Includes 18,000 options granted in consideration of Mr. Frank's services
    as a director of the Company. Pursuant to the severance arrangement
    described below, Mr. Frank will be entitled to exercise 62,500 shares on or
    before March 31, 1999 per the original vesting schedule. The remaining
    options terminate on March 31, 1999.

(3) 10,000 options vested for the fiscal year ended December 31, 1998. The
    options held by Mr. Rollings vest as follows: 1,111 shares a month until
    fully vested.

            AGGREGATED OPTION/SAR EXERCISES FY-END OPTION/SAR VALUES
<TABLE>
<CAPTION>

           (a)                  (b)            (c)                      (d)                             (e)
                                                                                               Value of Unexercised
                               Shares                     Number of Securities Underlying      In-the Money Options/
                            Acquired on       Value         Unexercised Options/SARs at         SARs at FY-End (#)
Name                          Exercise       Realized   FY-End(#) Exercisable/Unexercisable  Exercisable/Unexercisable(1)
----                          --------       --------   -----------------------------------  -------------------------
<S>                         <C>              <C>        <C>                                  <C>
Philip Becker
         Chairman & CTO
         Unexercisable          -0-            -0-                   120,111(2)                      $563,321
         Exercisable                                                  97,889                         $459,099

Jeffrey Finn
         President & CEO        -0-            -0-
         Unexercisable                                               417,250(3)                      $705,152
         Exercisable                                                     750                            1,268
Jason Rollings
         Vice President
          of Operations         -0-            -0-                    30,000(4)                      $140,700
         Unexercisable                                                10,000                           46,900
         Exercisable  
Regis Frank
         Former President
          and COO
         Unexercisable          -0-            -0-                   128,000(5)                      $600,320
         Exercisable                                                  57,500                          269,675
</TABLE>

---------

(1)  The year-end value represents the difference between the option exercise
     prices (ranging from $1.00 to $4.00 per share) and the $5.69 market value
     of the Company's common stock on December 31, 1998, multiplied by the
     number of shares under option. Market value represents the closing price
     reported by the Nasdaq SmallCap Market on December 31, 1998.

(2)  Includes 18,000 options granted in consideration of Mr. Becker's services
     as a director of the Company. Options granted in consideration of services
     as a director vest at a rate of 1/24 each month for two years. The
     remaining options held by Mr. Becker vest as follows: 7/36 of these shares
     vested in April 1998 and 1/36 of these shares vest each month thereafter
     until fully vested.

(3)  Includes 18,000 options granted in consideration of Mr. Finn's services as
     a director of the Company. Options granted in consideration of services as
     a director vest at a rate of 1/24 each month for two years. The remaining
     options held by Mr. Finn vest as follows: options to purchase 77,777
     shares are exercisable on June 1999 and options to purchase 11,111 shares
     vest each month thereafter until fully vested.

(4)  The options held by Mr. Rollings vest as follows: 7/36 of these shares
     vested in August 1998 and 1/36 of these shares vest each month thereafter
     until fully vested.



                                     -26-
<PAGE>   56



(5)  Includes 18,000 options granted in consideration of Mr. Frank's services
     as a director of the Company. Options granted in consideration of services
     as a director vest at a rate of 1/24 each month for two years. Options
     granted in consideration of services that vested immediately total 20,000
     shares. The remaining options 90,000 held by Mr. Frank vest as follows:
     7/36 of these shares vested in August 1998 and 1/36 of these shares vest
     each month thereafter until fully vested.

         Compensation of Directors. The directors of the Company are not
currently compensated for serving as directors, each director has been granted
an option to purchase 18,000 shares of Common Stock at $1.00 per share. Outside
director's travel expenses are reimbursed by the Company, Mr. Becker and Mr.
Finn also receive compensation as officers.

    EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
                                 ARRANGEMENTS.

Philip Becker

         On September 2, 1997 the Company and Philip Becker, the Chairman,
Chief Technical Officer and a director of the Company, entered into an
employment agreement (the "Becker Agreement") that extends for a thirty six
month period commencing on September 1, 1997. Under the terms of the Becker
Agreement, the Company is obligated to pay to Mr. Becker the sum of $10,000 per
month. In addition, Mr. Becker was granted incentive stock options to acquire
200,000 shares of the Company's 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.

         Mr. Becker is also eligible to receive 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 Mr. Becker's gross annual
salary, the bonus will be capped at the amount of Mr. Becker's salary for the
quarter.

         The Becker Agreement includes non-competition and confidentiality
provisions that extend for 12 months and five years following the termination
of Mr. Becker's employment with the Company, respectively. The Becker Agreement
may be terminated by either the Company or Becker on 30 days notice without
cause. If Mr. Becker's employment is terminated by the Company without cause,
the Company must pay Mr. Becker one month's salary for each year of employment
since 1992.

Jeffrey Finn

         On November 6, 1998 the Company and Jeffrey Finn, the President and
Chief Executive Officer and a director of the Company, entered into an
employment agreement that extends for a thirty-six month period commencing on
November 9, 1998. Under the terms of the agreement, the Company will pay to
Finn the sum of $15,000 per month. In addition, Mr. Finn was granted incentive
stock options to acquire 400,000 shares of the Company's common stock at a
price of $4.00 per share for a period of four years. The options vest over a
thirty-six 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.

         Mr. Finn is also eligible to receive incentive pay equal to 50% of his
annual salary paid quarterly based on objectives agreed by Mr. Finn 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.

Jason Rollings

         On October 7, 1997, the Company provided a letter (the "Rollings
Letter") to Jason M. Rollings, the Company's Vice President of Operations,
outlining the terms of his employment with the Company. Under the terms of the
Rollings Letter, the Company will pay to Mr. Rollings the sum of $7,500 per
month. In addition, Mr. Rollings was granted incentive stock options to acquire
30,000 shares of the Company's 



                                     -27-
<PAGE>   57



common stock at a price of $1.00 per share for a period of four years from the
date of issuance, January 8, 1998. The options vest over a 36 month period as
follows: 7/36 of the options vested in August 1998 and 1/36 of the options will
vest on the first day of each month thereafter. Mr. Rollings is also eligible
to receive a quarterly performance bonus, based equally on Mr. Rollings
performance and the Company's performance, not to exceed $7,500 per quarter.

         Pursuant to the Rollings Letter, the Company also lent Mr. Rollings
$20,000. The loan is to be forgiven over a two-year period; $10,000 of such
loan was forgiven after one year of Mr. Rollings' service and the remainder
will be forgiven when Mr. Rollings has completed his second year of employment
with the Company. If Mr. Rollings chooses to leave the Company before
completing two years of employment with the Company, he is obligated to repay
any portion of the loan still outstanding. If the Company terminates Mr.
Rollings' employment for any reason, other than cause, any outstanding loan
balance will be immediately forgiven and Mr. Rollings will be entitled to three
months severance.

         On March 17, 1998, the Company lent Mr. Rollings an additional
$15,000. This loan is to be repaid by Mr. Rollings from any quarterly bonus he
receives. If Mr. Rollings chooses to leave the Company before any such loan has
been repaid, Mr. Rollings is obligated to repay any outstanding balance related
hereto. If the Company terminates Mr. Rollings for any reason, other than
cause, any outstanding loan balance will be forgiven. At December 31, 1998, the
balance outstanding on this loan was $5,250.

Other Employment Agreements

         The Company has entered into employment agreements with three other
executive officers with a range of salary levels and benefits. The term of
these employment agreements is thirty-six months, at salary levels ranging from
$7,500 to $11,000 per month. The employment agreements provide for either a
quarterly performance-based bonus ranging from $5,000 to $12,500, 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 20,000 and 60,000 shares
of the Company's common stock at exercise prices ranging from $1.00 to $6.15
per share. Certain of the executive employment agreements also contain twelve
month non-competition and confidentiality provisions, and certain agreements
provide for severance payments to continue for three months following a
termination of the executive without cause.




                                     -28-
<PAGE>   58





Item 11.   Security Ownership of Certain Beneficial Owners and Management

           The following table sets forth, as of February 22, 1999 the number
of shares of the Company's Common Stock beneficially owned by (a) owners of
more than five percent of the Company's outstanding Common Stock who are known
to the Company and (b) the Directors of the Company, individually, and the
Executive Officers and Directors of the Company as a group, and (c) the
percentage of ownership of the outstanding Common Stock represented by such
shares. The security holders listed below are deemed to be the beneficial
owners of shares of Common Stock underlying options and warrants which are
exercisable within 60 days from the above date.

<TABLE>
<CAPTION>

                                                                 AMOUNT AND NATURE    
                                                                  OF BENEFICIAL 
            NAME AND ADDRESS OF BENEFICIAL OWNER                     OWNERSHIP            PERCENT OF CLASS
-------------------------------------------------------------   --------------------      ----------------    

<S>                                                             <C>                       <C>   
Philip L. Becker, Chairman of the Board and Chief Technical     
Officer, and a Director ......................................        1,150,111(1)            16.27%
5335 Sterling Drive, Suite C
Boulder, CO 80304

Jeffrey Finn, President and Chief Executive Officer                   
and a Director ...............................................            9,500(2)             0.14%

Jason M. Rollins, Vice President of Operations ...............           13,333(3)             0.19%

Richard B. Rice, Director ....................................           17,500(4)             0.25%

Regis Frank, Former Chief Operating Officer ..................           62,500(5)              0.9%

All Directors and Executive Officers as a group ..............        1,259,948(6)            17.64%
</TABLE>

---------
(1) Includes 123,111 options exercisable presently or within 60 days. 

(2) Includes 4,500 options exercisable presently or within 60 days. 

(3) Includes 13,333 options exercisable presently or within 60 days. 

(4) Includes 10,500 options exercisable presently or within 60 days.

(5) Includes 62,500 options exercisable presently.  Mr. Frank left the Company
    in November 1997.

(6) Includes 209,778 options exercisable presently or within 60 days.

ITEM 12.   CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

           The Company has entered into transactions with its officers and
directors, and with principal shareholders listed in Item 11 or affiliated
entities as described below.

SEVERANCE AGREEMENT

           On November 10, 1998 the Company served Regis Frank, the Company's
then President and Chief Operating Officer, with notice of termination of
services pursuant to his employment agreement. Mr. Frank's employment agreement
required the Company to provide Mr. Frank with ninety days prior notice of his
termination. In addition, Mr. Frank's employment agreement required the Company
to pay Mr. Frank three months salary and to allow Mr. Frank to participate in
the Company's employee benefits program for three months as severance following
Mr. Frank's termination. Mr. Frank agreed to resign as an officer and director
effective November 10, 1998, and the Company agreed to pay to Mr. Frank $10,000
per month, as provided by his employment agreement, through February 28, 1999,
and to provide Mr. Frank with severance pay and benefits for three months
beginning on March 1, 1999. As part of his severance arrangement, Mr. Frank
also has the right to exercise options to purchase 62,500 shares of the Company
common stock until March 31, 1999, the remaining options will terminate on
March 31, 1999.



                                     -29-
<PAGE>   59



RELATED CUSTOMER

           Richard Rice, a director of the Company, is also the President,
Chief 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 products in 1998.





                                     -30-
<PAGE>   60




                                    PART IV

ITEM 13.   EXHIBITS AND REPORTS ON FORM 8-K

           (a) EXHIBITS. The following Exhibits are filed herewith or have been
previously filed with the Securities and Exchange Commission and are
incorporated by reference herein:

EXHIBIT
NUMBER                      DESCRIPTION OF EXHIBITS

2.1*       Amended and Restated Agreement and Plan Merger dated January 25,
           1999 between eSoft, Inc., eSoft Acquisition Corporation and Apexx
           Technology, Inc.

2.2*       Form of Stockholders' Agreement to be executed by Apexx Technology,
           Inc. stockholders in connection with the merger

2.3*       Form of Optionholders' Agreement to be executed by Apexx Technology,
           Inc. optionholders in connection with the merger

2.4*       Form of Escrow Agreement to be executed by eSoft, Inc. Thomas
           Loutzenheiser and The Trust Company of The Bank of Montreal

2.5*       Source Code Escrow Agreement among eSoft, Inc., Apex Technology,
           Inc. and DSI

2.6*       Employment Agreement by and between eSoft, Inc. and Thomas
           Loutzenheiser

2.7*       Employment Agreement by and between eSoft, Inc. and Albert
           Youngwerth

2.8*       Employment Agreement by and between eSoft, Inc. and Ray Jenks

2.9*       Employment Agreement by and between eSoft, Inc. and John Hanousek

3.1        Articles of Incorporation (filed with Registration Statement on Form
           10-SB on December 22, 1997 and incorporated herein by reference).

3.2        Certificate of Incorporation of New eSoft, Inc. (filed with
           Amendment No. 1 to Registration Statement on Form 10-SB on February
           18, 1998 and incorporated herein by reference).

3.3        Certificate of Merger of eSoft, Inc. into New eSoft, Inc. (filed
           with Amendment No. 1 to Registration Statement on Form 10-SB on
           February 18, 1998 and incorporated herein by reference).

3.4*       Amendment to Certificate of Incorporation of eSoft, Inc.

3.5        Bylaws of eSoft (filed with Registration Statement on Form 10-SB on
           December 22, 1997 and incorporated herein by reference).

3.6        Bylaws of New eSoft, Inc. (filed with Registration Statement on Form
           10-SB on December 22, 1997 and incorporated herein by reference).

9.1*       Voting Agreement by and between eSoft, Inc and Tom Loutzenheiser,
           Gayle Loutzenheiser and David Dahms

9.2*       Voting Agreement by and between eSoft, Inc and Albert Youngwerth,
           Heather Youngwerth, Lawrence Lynch, George Minow, Chris Minow,
           William Rivers, Ray Jenks

10.1       Severance Agreement and Mutual Release dated December 19, 1997
           between eSoft and Wayne Farlow (filed with Registration Statement on
           Form 10-SB on December 22, 1997 and incorporated herein by
           reference).

10.2       Agency Agreement with C.M. Oliver Capital (filed with Amendment No.
           1 to Registration Statement on Form SB-2, filed March 24, 1998 and
           incorporated herein by reference).

10.3       Agent's Warrant (filed with Amendment No. 1 to Registration
           Statement on Form SB-2, filed March 24, 1998 and incorporated herein
           by reference).

10.4       Lease Agreement dated September 18, 1997 between eSoft and Aspen
           Industrial Park Partnership (filed with Registration Statement on
           Form SB-2 on December 24, 1997 and incorporated herein by
           reference).





                                     -31-
<PAGE>   61




10.5       Voting Agreement dated September 2, 1997 between Philip Becker,
           Pantheon Capital Ltd. And Transition Partners, Ltd. (filed with
           Registration Statement on Form 10-SB on December 22, 1997 and
           incorporated herein by reference).

10.6       Termination Agreement (filed with Amendment No. 1 to Registration
           Statement on Form 10-SB on February 18, 1998 and incorporated herein
           by reference).

10.7       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).

10.8       Agreement dated May 6, 1997 between Transition Partners, Ltd. and
           eSoft (filed with Registration Statement on Form 10-SB on December
           22, 1997 and incorporated herein by reference).

10.9       Agreement dated October 14, 1996 between Transition Partners, Ltd.
           and eSoft (filed with Registration Statement on Form 10-SB on
           December 22, 1997 and incorporated herein by reference).

10.10      Amendment to Agreement dated August 22, 1997 between Transition
           Partners, Ltd. and eSoft (filed with Registration Statement on Form
           10-SB on December 22, 1997 and incorporated herein by reference).

10.11      Second Amendment to Agreement dated November 11, 1997 between
           Transition Partners, Ltd. and eSoft (filed with Registration
           Statement on Form 10-SB on December 22, 1997 and incorporated herein
           by reference).

10.12      Stock Option Agreement dated November 11, 1997 between Transition
           Partners, Ltd. and eSoft (filed with Registration Statement on Form
           10-SB on December 22, 1997 and incorporated herein by reference).

10.13      Amended Stock Warrant Agreement dated January 29, 1998 (filed with
           Amendment No. 1 to Registration Statement on Form 10-SB on February
           18, 1998 and incorporated herein by reference).

10.14      Consulting Agreement dated August 1, 1997 between eSoft and Kent
           Nuzum (filed with Registration Statement on Form 10-SB on December
           22, 1997 and incorporated herein by reference).

10.15      Consulting Agreement dated August 22, 1997 between Pantheon Capital
           Ltd. and eSoft (filed with Registration Statement on Form 10-SB on
           December 22, 1997 and incorporated herein by reference).

10.16      Amendment to Consulting Agreement dated August 22, 1997 between
           Pantheon Capital Ltd. and eSoft (filed with Registration Statement
           on Form 10-SB on December 22, 1997 and incorporated herein by
           reference).

10.17      Stock Option Agreement dated November 11, 1997 between Pantheon
           Capital Ltd. and eSoft (filed with Registration Statement on Form
           10-SB on December 22, 1997 and incorporated herein by reference).

10.18      Amended Stock Warrant Agreement dated January 29, 1998 (filed with
           Amendment No. 1 to Registration Statement on Form 10-SB on February
           18, 1998 and incorporated herein by reference).

10.19      Stock Option Agreement dated November 11, 1997 between Copeland
           Consulting Group, Inc. and eSoft (filed with Registration Statement
           on Form 10-SB on December 22, 1997 and incorporated herein by
           reference).

10.20      Amended Stock Warrant Agreement dated January 29, 1998 (filed with
           Amendment No. 1 to Registration Statement on Form 10-SB on February
           18, 1998 and incorporated herein by reference).

10.21      Employment Agreement dated September 2, 1997 between Philip Becker
           and eSoft (filed with Registration Statement on Form 10-SB on
           December 22, 1997 and incorporated herein by reference).



                                     -32-
<PAGE>   62




10.22      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).

10.23      Termination Agreement terminating Software Development and
           Consulting Agreements (filed with Amendment No. 1 to Registration
           Statement on Form 10-SB on February 18, 1998 and incorporated herein
           by reference).

10.24      Promissory Note to First National Bank of Arvada, Colorado (filed
           with Amendment No. 1 to Registration Statement on Form 10-SB on
           February 18, 1998 and incorporated herein by reference).

10.25      Proposal for financing arrangement from Colorado National Bank
           (filed with Amendment No. 1 to Registration Statement on Form 10-SB
           on February 18, 1998 and incorporated herein by reference).

10.26      Employment Agreement dated March 6, 1998 between Regis Frank and
           eSoft (filed with Amendment No. 1 to Registration Statement on Form
           SB-2, filed March 24, 1998 and incorporated herein by reference).

10.27      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).

10.28      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).

10.29      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).

10.30      Employment Agreement between Thomas R. Tennessen and eSoft (filed
           with Amendment No. 2 to Registration Statement on Form SB-2, filed
           April 17, 1998 and incorporated herein by reference).

10.31      Employment Agreement between Thomas R. Tennessen and eSoft (filed
           with Registration Statement on Form SB-2 on August 19, 1998 and
           incorporated herein by reference).

10.32      Employment Agreement between James R. Bell and eSoft (filed with
           Registration Statement on Form SB-2 on August 19, 1998 and
           incorporated herein by reference).

10.33      Employment Letter between James M. Love and eSoft (filed with
           Registration Statement on Form SB-2 on August 19, 1998 and
           incorporated herein by reference).

10.34      Consulting Retainer Agreement (filed with Registration Statement on
           Form SB-2 on August 19, 1998 and incorporated herein by reference).

10.35      Form of Distributor Agreement (filed with Registration Statement on
           Form SB-2 on August 19, 1998 and incorporated herein by reference).

10.36*     Employment Agreement between Jeffrey Finn and eSoft

10.37*     Loan agreement entered into by and between eSoft, Inc. and Apexx
           Technology, Inc. dated December 2, 1998

10.38*     Secured promissory note entered into by Apexx Technology, Inc. and
           eSoft, Inc. dated December 2, 1998

10.39*     Security agreement entered into by Apexx Technology, Inc. pledging
           assets to secure loan agreement entered into dated December 2, 1998

10.40*     Stock Pledge Agreement entered into by Thomas Loutzenheiser and
           eSoft, Inc. dated December 2, 1998 10.41* Guaranty Agreement entered
           into by Thomas Loutzenheiser and eSoft, Inc. dated December 2, 1998

10.42*     Employment Agreement between Jane Merickel and eSoft dated _________.

*          Filed with Registration Statement on Form S-4 on March 18, 1999.




                                     -33-
<PAGE>   63




         (b)Reports on Form 8-K. During the last quarter of the period covered
         by this report, the Company filed reports on Form 8-K as listed below.
         No financial statements were filed with these reports. The following
         report on Form 8-K reported information pursuant to "Item 5 -Other
         Events".

          i. Form 8-K dated December 8, 1998, filed December 8, 1998.




                                     -34-
<PAGE>   64




                                   SIGNATURES

         Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

                                         the Company, Incorporated

Date: March 24, 1999                     By: /s/ Jeffrey Finn 
----------------------------                ----------------------------------
                                             Jeffrey Finn
                                             President and CEO


Date: March 24, 1999                     By: /s/ Thomas Tennessen 
----------------------------                 ---------------------------------
                                             Principal Financial and
                                             Chief Accounting Officer

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

<TABLE>
<CAPTION>

         Signatures                                  Title                                    Date
         ----------                                  -----                                    ----
<S>                                            <C>                                       <C>
/s/ Philip Becker                              Chairman, CTO and a                        March 24, 1999
------------------------                            Director  
Philip Becker                                        


/s/ Jeffrey Finn                               President CEO and a                        March 24, 1999
------------------------                             Director  
Jeffrey Finn                                         


/s/ Thomas Tennessen                           Secretary, Treasurer, and                  March 24, 1999
------------------------                        Chief Financial Officer 
Thomas Tennessen                                

/s/ Richard Rice                                     Director                             March 24, 1999
------------------------
Richard Rice
</TABLE>




                                     -35-





<PAGE>   65

                                 EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                      DESCRIPTION OF EXHIBITS
<S>        <C>
2.1*       Amended and Restated Agreement and Plan Merger dated January 25,
           1999 between eSoft, Inc., eSoft Acquisition Corporation and Apexx
           Technology, Inc.

2.2*       Form of Stockholders' Agreement to be executed by Apexx Technology,
           Inc. stockholders in connection with the merger

2.3*       Form of Optionholders' Agreement to be executed by Apexx Technology,
           Inc. optionholders in connection with the merger

2.4*       Form of Escrow Agreement to be executed by eSoft, Inc. Thomas
           Loutzenheiser and The Trust Company of The Bank of Montreal

2.5*       Source Code Escrow Agreement among eSoft, Inc., Apex Technology,
           Inc. and DSI

2.6*       Employment Agreement by and between eSoft, Inc. and Thomas
           Loutzenheiser

2.7*       Employment Agreement by and between eSoft, Inc. and Albert
           Youngwerth

2.8*       Employment Agreement by and between eSoft, Inc. and Ray Jenks

2.9*       Employment Agreement by and between eSoft, Inc. and John Hanousek

3.1        Articles of Incorporation (filed with Registration Statement on Form
           10-SB on December 22, 1997 and incorporated herein by reference).

3.2        Certificate of Incorporation of New eSoft, Inc. (filed with
           Amendment No. 1 to Registration Statement on Form 10-SB on February
           18, 1998 and incorporated herein by reference).

3.3        Certificate of Merger of eSoft, Inc. into New eSoft, Inc. (filed
           with Amendment No. 1 to Registration Statement on Form 10-SB on
           February 18, 1998 and incorporated herein by reference).

3.4*       Amendment to Certificate of Incorporation of eSoft, Inc.

3.5        Bylaws of eSoft (filed with Registration Statement on Form 10-SB on
           December 22, 1997 and incorporated herein by reference).

3.6        Bylaws of New eSoft, Inc. (filed with Registration Statement on Form
           10-SB on December 22, 1997 and incorporated herein by reference).

9.1*       Voting Agreement by and between eSoft, Inc and Tom Loutzenheiser,
           Gayle Loutzenheiser and David Dahms

9.2*       Voting Agreement by and between eSoft, Inc and Albert Youngwerth,
           Heather Youngwerth, Lawrence Lynch, George Minow, Chris Minow,
           William Rivers, Ray Jenks

10.1       Severance Agreement and Mutual Release dated December 19, 1997
           between eSoft and Wayne Farlow (filed with Registration Statement on
           Form 10-SB on December 22, 1997 and incorporated herein by
           reference).

10.2       Agency Agreement with C.M. Oliver Capital (filed with Amendment No.
           1 to Registration Statement on Form SB-2, filed March 24, 1998 and
           incorporated herein by reference).

10.3       Agent's Warrant (filed with Amendment No. 1 to Registration
           Statement on Form SB-2, filed March 24, 1998 and incorporated herein
           by reference).

10.4       Lease Agreement dated September 18, 1997 between eSoft and Aspen
           Industrial Park Partnership (filed with Registration Statement on
           Form SB-2 on December 24, 1997 and incorporated herein by
           reference).
</TABLE>






<PAGE>   66



<TABLE>
<S>        <C>
10.5       Voting Agreement dated September 2, 1997 between Philip Becker,
           Pantheon Capital Ltd. And Transition Partners, Ltd. (filed with
           Registration Statement on Form 10-SB on December 22, 1997 and
           incorporated herein by reference).

10.6       Termination Agreement (filed with Amendment No. 1 to Registration
           Statement on Form 10-SB on February 18, 1998 and incorporated herein
           by reference).

10.7       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).

10.8       Agreement dated May 6, 1997 between Transition Partners, Ltd. and
           eSoft (filed with Registration Statement on Form 10-SB on December
           22, 1997 and incorporated herein by reference).

10.9       Agreement dated October 14, 1996 between Transition Partners, Ltd.
           and eSoft (filed with Registration Statement on Form 10-SB on
           December 22, 1997 and incorporated herein by reference).

10.10      Amendment to Agreement dated August 22, 1997 between Transition
           Partners, Ltd. and eSoft (filed with Registration Statement on Form
           10-SB on December 22, 1997 and incorporated herein by reference).

10.11      Second Amendment to Agreement dated November 11, 1997 between
           Transition Partners, Ltd. and eSoft (filed with Registration
           Statement on Form 10-SB on December 22, 1997 and incorporated herein
           by reference).

10.12      Stock Option Agreement dated November 11, 1997 between Transition
           Partners, Ltd. and eSoft (filed with Registration Statement on Form
           10-SB on December 22, 1997 and incorporated herein by reference).

10.13      Amended Stock Warrant Agreement dated January 29, 1998 (filed with
           Amendment No. 1 to Registration Statement on Form 10-SB on February
           18, 1998 and incorporated herein by reference).

10.14      Consulting Agreement dated August 1, 1997 between eSoft and Kent
           Nuzum (filed with Registration Statement on Form 10-SB on December
           22, 1997 and incorporated herein by reference).

10.15      Consulting Agreement dated August 22, 1997 between Pantheon Capital
           Ltd. and eSoft (filed with Registration Statement on Form 10-SB on
           December 22, 1997 and incorporated herein by reference).

10.16      Amendment to Consulting Agreement dated August 22, 1997 between
           Pantheon Capital Ltd. and eSoft (filed with Registration Statement
           on Form 10-SB on December 22, 1997 and incorporated herein by
           reference).

10.17      Stock Option Agreement dated November 11, 1997 between Pantheon
           Capital Ltd. and eSoft (filed with Registration Statement on Form
           10-SB on December 22, 1997 and incorporated herein by reference).

10.18      Amended Stock Warrant Agreement dated January 29, 1998 (filed with
           Amendment No. 1 to Registration Statement on Form 10-SB on February
           18, 1998 and incorporated herein by reference).

10.19      Stock Option Agreement dated November 11, 1997 between Copeland
           Consulting Group, Inc. and eSoft (filed with Registration Statement
           on Form 10-SB on December 22, 1997 and incorporated herein by
           reference).

10.20      Amended Stock Warrant Agreement dated January 29, 1998 (filed with
           Amendment No. 1 to Registration Statement on Form 10-SB on February
           18, 1998 and incorporated herein by reference).

10.21      Employment Agreement dated September 2, 1997 between Philip Becker
           and eSoft (filed with Registration Statement on Form 10-SB on
           December 22, 1997 and incorporated herein by reference).
</TABLE>




<PAGE>   67



<TABLE>
<S>        <C>
10.22      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).

10.23      Termination Agreement terminating Software Development and
           Consulting Agreements (filed with Amendment No. 1 to Registration
           Statement on Form 10-SB on February 18, 1998 and incorporated herein
           by reference).

10.24      Promissory Note to First National Bank of Arvada, Colorado (filed
           with Amendment No. 1 to Registration Statement on Form 10-SB on
           February 18, 1998 and incorporated herein by reference).

10.25      Proposal for financing arrangement from Colorado National Bank
           (filed with Amendment No. 1 to Registration Statement on Form 10-SB
           on February 18, 1998 and incorporated herein by reference).

10.26      Employment Agreement dated March 6, 1998 between Regis Frank and
           eSoft (filed with Amendment No. 1 to Registration Statement on Form
           SB-2, filed March 24, 1998 and incorporated herein by reference).

10.27      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).

10.28      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).

10.29      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).

10.30      Employment Agreement between Thomas R. Tennessen and eSoft (filed
           with Amendment No. 2 to Registration Statement on Form SB-2, filed
           April 17, 1998 and incorporated herein by reference).

10.31      Employment Agreement between Thomas R. Tennessen and eSoft (filed
           with Registration Statement on Form SB-2 on August 19, 1998 and
           incorporated herein by reference).

10.32      Employment Agreement between James R. Bell and eSoft (filed with
           Registration Statement on Form SB-2 on August 19, 1998 and
           incorporated herein by reference).

10.33      Employment Letter between James M. Love and eSoft (filed with
           Registration Statement on Form SB-2 on August 19, 1998 and
           incorporated herein by reference).

10.34      Consulting Retainer Agreement (filed with Registration Statement on
           Form SB-2 on August 19, 1998 and incorporated herein by reference).

10.35      Form of Distributor Agreement (filed with Registration Statement on
           Form SB-2 on August 19, 1998 and incorporated herein by reference).

10.36*     Employment Agreement between Jeffrey Finn and eSoft

10.37*     Loan agreement entered into by and between eSoft, Inc. and Apexx
           Technology, Inc. dated December 2, 1998

10.38*     Secured promissory note entered into by Apexx Technology, Inc. and
           eSoft, Inc. dated December 2, 1998

10.39*     Security agreement entered into by Apexx Technology, Inc. pledging
           assets to secure loan agreement entered into dated December 2, 1998

10.40*     Stock Pledge Agreement entered into by Thomas Loutzenheiser and
           eSoft, Inc. dated December 2, 1998 10.41* Guaranty Agreement entered
           into by Thomas Loutzenheiser and eSoft, Inc. dated December 2, 1998
           10.42* Employment Agreement between Jane Merickel and eSoft dated !.

*          Filed with Registration Statement on Form S-4 on March 18, 1999.
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