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


                                 FORM 10-KSB/A-1

[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
         EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

[ ]      TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES ACT OF
         1934

               For the transition period from           to
                                              ---------    --------

                         COMMISSION FILE NUMBER 00-23527


                               eSOFT, INCORPORATED
                 (Name of Small Business Issuer in its charter)


           DELAWARE                                      84-0938960
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
incorporation or organization)

        295 INTERLOCKEN BOULEVARD, SUITE 500, BROOMFIELD, COLORADO 80021
          (Address of principal executive offices, including zip code)

                                 (303) 444-1600
                (Issuer's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:  NONE
Securities registered pursuant to Section 12(g) of the Act:  COMMON STOCK, $.01
                                                             PAR VALUE

Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]

Check if no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is contained in this form, and no disclosure will be contained,
to the best of the issuer's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. [X]

The issuer's revenues for its most recent fiscal year were:   $3,867,600

The aggregate market value of the voting stock held by non-affiliates of the
issuer was $18,222,594 as of March 16, 1999.

The number of shares of Common Stock outstanding was 7,144,368 shares as of
March 16, 1999.

Transitional Small Business Disclosure Format.     Yes [ ]     No [X]

                       DOCUMENTS INCORPORATED BY REFERENCE


               
                                      None


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                               eSOFT, INCORPORATED

                                   FORM 10-KSB

                                TABLE OF CONTENTS



<TABLE>
<CAPTION>

PART I                                                                                                     PAGE

<S>                 <C>                                                                                    <C>
         Item 1.    Description of Business..................................................................3

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

         Item 3.    Legal Proceedings.......................................................................13

         Item 4.    Submission of Matters to a Vote of Security Holders.....................................13



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..........................30

         Item 12.   Certain Relationships and Related Transactions..........................................30



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 


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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.

         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
InternetTM 100. The TEAM InternetTM 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 InternetTM 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.


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         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
InternetTM. 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 InternetTM brand name rather than the "IPAD" brand. Under
this marketing plan the Company will focus on selling the TEAM InternetTM 100
and TEAM InternetTM 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 than 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.




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         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 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 13 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.




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         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.



         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.


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         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.

         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 InternetTM 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 


                                       10

<PAGE>   11




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 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 


                                       11

<PAGE>   12



$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 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 InternetTM 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 


                                       12

<PAGE>   13




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 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.




                                       13

<PAGE>   14


         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.


                                     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



         The following discussion should be read together with the Company's
financial statements and accompanying notes included elsewhere in this Joint
Proxy Statement/Prospectus.



RESULTS OF OPERATIONS



         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
small-to-medium sized businesses 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 are 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 sized 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 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 margin in 1998 was
approximately 65% compared to 65% in 1997. The 1998 margin 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.


                                       15

<PAGE>   16




         Selling, General and Administrative, Engineering and R & D Expenses
(SG&A). 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 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
and consulting expense increased by $564,000. Engineering and technical support
expenditures increased from $56,000 in 1997 to $589,000 in 1998; 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 fundraising
activities that 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 in 1998, before income
taxes, was $3,103,000, compared to $193,000 in 1997. The increased losses are
the result of the Company's 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 that it would be realized. The Company
has $2,700,000 in net operating loss carryforwards with expirations through
2018. 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 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 and 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 placement 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 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
warrants issued to the placement agent in conjunction with the Company's March
1998 initial public offering.

         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 placement agent, subagents, and finders, who were issued
warrants to purchase 159,318 shares (10.85% of the offered 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.

         In the fourth quarter of fiscal 1998, the Company signed a letter of
intent to acquire all the outstanding equity securities of Apexx Technology,
Inc. in exchange for 2,947,368 shares of the Company's common 


                                      17

<PAGE>   18




stock. Under the terms of the letter of intent, the Company provided Apexx with
an operating line of credit of up to $500,000 that may be expanded by an
additional $500,000 upon the written consent and agreement of the board of
directors of each company. As of December 31, 1998, the Company had funded
$300,000 of this commitment, and subsequent to December 31, 1998, the Company
funded the remaining $200,000 of the operating line commitment. This commitment
to support both operations until closing may require additional fundraising
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 that 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,
capitalizable costs incurred in the development of the Company's software
products, purchase of property plant and equipment for new personnel, and an
advance on the line of credit provided 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.



YEAR 2000 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 versions 2.03 and higher of the IPAD 1200, IPAD
2500 and the IPAD 5000 are Y2K compliant.

         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 February 1999 an IPAD software upgrade was
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 product 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 that 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 second 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 has
found them to be 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 Y2K 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:


                                       20

<PAGE>   21




         In June 1998 FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
market value. Gains or losses resulting from changes in the values of those
derivatives are accounted for depending on the use of the derivative and whether
it qualifies for hedge accounting. The key criterion for hedge accounting is
that the hedging relationship must be highly effective in achieving offsetting
changes in fair value or cash flows. SFAS No. 133 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," which 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



<TABLE>

<S>                                                                                                         <C>
         Report of Independent Certified Public Accountants...................................................F-2

         Balance Sheet at December 31, 1998...................................................................F-3

         Statements of Operations for the Years ended December 31, 1998 and 1997..............................F-5

         Statements of Stockholders' Equity for the Years ended December 31, 1997 and 1998....................F-6

         Statements of Cash Flows for the Years ended December 31, 1998 and 1997..............................F-7

         Summary of Accounting Policies.......................................................................F-9

         Notes to Financial Statements........................................................................F-15

</TABLE>







                                       22

<PAGE>   23


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 the Company since November 1998. Formerly Senior Vice
President of Sales and Marketing Strategy from July 1996 to October 1998 at
Evolving Systems, Inc., a company specializing in software solutions for the
telecommunications industry, Mr. Finn from April 1990 to March 1996 was a
founder of Prairie Systems, where he designed and launched a number of
innovative telecommunications software products and services.


                                       23

<PAGE>   24




         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
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"). 


                                       24

<PAGE>   25


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.




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, to
the two executive officers who received total salary and bonus in excess of
$100,000 during the fiscal year ended December 31, 1998, and to one former
executive officer who received total salary in excess of $100,000 during the
fiscal year ended December 31, 1998. The Company did not make any long-term
compensation awards to any of the named executive officers during the periods
indicated.



                           SUMMARY COMPENSATION TABLE




<TABLE>
<CAPTION>
                                                                    ANNUAL COMPENSATION                  AWARDS
                                                      -------------------------------------------      ----------

                                                                                                       SECURITIES
                                                                                      OTHER ANNUAL     UNDERLYING
NAME AND PRINCIPAL POSITION                           YEAR      SALARY        BONUS   COMPENSATION      OPTIONS

<S>                                                   <C>      <C>           <C>       <C>            <C>   
Philip Becker                                         1998     $115,833         --         --             --  
Chairman and Chief Technical Officer                  1997     $100,000         --         --          218,000
                                                      1996     $ 60,000         --         --             --  
                                                                                                              
Jeffrey Finn(1)                                       1998     $ 25,909         --         --          418,000
President and Chief Executive Officer                 1997         --           --         --             --  
                                                      1996         --           --         --             --  
                                                                                                              
Jason Rollings(2)                                     1998     $ 90,000     $ 35,973       --             --  
Vice President of Operations                          1997     $ 24,204         --         --           30,000
                                                      1996         --           --         --             --  
                                                                                                              
Regis Frank(3)                                        1998     $120,000         --         --             --  
Former President and Chief Operating                  1997         --           --         --          128,000
Officer                                               1996         --           --         --             --  
</TABLE>


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

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

(3)   Mr. Frank served as the Company's President and Chief Operating Officer
      from November 1997 to October 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 in Item 12., the Company is
      required to pay Mr. Frank's salary through May 31, 1999.




                                       25


<PAGE>   26



                      OPTION/SAR GRANTS IN LAST FISCAL YEAR



         Prior to the adoption of the equity incentive plan described below
under the heading "-- Stock Option Plan," no stock options were ever granted to
or exercised by executive officers of the Company. In the fiscal year ending
December 31, 1998, stock options were granted to the executive officers named in
the Summary Compensation Table as follows:




<TABLE>
<CAPTION>
                                                   % OF TOTAL OPTIONS                                                    
                                                         GRANTED                                                         

                               NUMBER OF            TO DIRECTORS AND                                                     
                                                      EMPLOYEES IN              EXERCISE               EXPIRATION
                           SHARES UNDERLYING     
NAME                        OPTIONS GRANTED            FISCAL YEAR               PRICE                    DATE

<S>                        <C>                         <C>                    <C>                     <C> 
Jeffrey Finn(1)                  418,000                   33%                 $4.00/share              11/5/2002
</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.



        AGGREGATED OPTION/SAR EXERCISES FISCAL YEAR-END OPTION/SAR VALUES




<TABLE>
<CAPTION>
                                                                                          VALUE OF UNEXERCISED
                          SHARES                   NUMBER OF SECURITIES UNDERLYING  
                                        VALUE                                          IN-THE MONEY OPTIONS/SARS AT
                       ACQUIRED ON                   UNEXERCISED OPTIONS/SARS AT    
NAME                     EXERCISE     REALIZED             FISCAL YEAR-END                 FISCAL YEAR-END(1)
<S>                   <C>             <C>           <C>                                 <C>         

Philip Becker(2)                                                                                                               
  Unexercisable             0          $    0                  120,111                         $   563,321 
  Exercisable               0          $    0                   97,889                         $   459,099 
                                                                                                           
Jeffrey Finn(3)                                                                                            
  Unexercisable             0          $    0                  417,250                         $   705,152 
  Exercisable               0          $    0                      750                         $     1,268 
                                                                                                           
Jason Rollings(4)                                                                                          
  Unexercisable             0          $    0                   20,000                         $    93,800 
  Exercisable               0          $    0                   10,000                         $    46,900 
                                                                                                           
Regis Frank(5)                                                                                             
  Unexercisable             0          $    0                   65,500                         $   307,195 
  Exercisable               0          $    0                   62,500                         $   293,125 
</TABLE>



                                       26

<PAGE>   27


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

(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 in 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.

(5)  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 had the option to exercise up to 62,500 shares on or
     before March 31, 1999. All unexercised options terminated on March 31,
     1999.



         DIRECTOR COMPENSATION



         The Company's directors do not currently receive cash compensation for
serving as directors. Other than Mr. Eyestone, who was granted options to
purchase 25,000 shares of the Company's common stock, each director has been
granted options to purchase 18,000 shares of the Company's common stock. These
options were granted at an exercise price equal to the fair market value of the
Company's common stock at the date of grant. Each director's travel expenses are
reimbursed by the Company. Options granted in consideration of services as a
director vest at a rate of 1/24 each month for two years.



         EMPLOYMENT AGREEMENTS



         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 


                                       27

<PAGE>   28




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 Mr. 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 Mr.
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 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.

         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 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 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 thirty-six 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 




                                       28

<PAGE>   29


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 $8,250 per month. The employment agreements provide for either a quarterly
performance-based bonus ranging from $5,000 to $10,000, or a 1% commission on
net sales revenues, paid on a quarterly basis. In addition to monthly
compensation and quarterly bonuses, executives under these agreements have
received incentive stock options to purchase between 40,000 and 60,000 shares of
the Company's common stock at exercise prices ranging from $1.00 to $6.50 per
share. These executive employment agreements also contain twelve month
noncompetition and confidentiality provisions, and provide for severance
payments following a termination of the executive without cause.



         STOCK OPTION PLAN



         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.



                                       29

<PAGE>   30




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
                                                                          OWNERSHIP
            NAME AND ADDRESS OF BENEFICIAL OWNER                                                     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 ARRANGEMENT



     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 


                                       30

<PAGE>   31




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's common stock until March 31, 1999, the remaining options
will terminate on March 31, 1999.



           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.



                                     PART IV



ITEM 13.   EXHIBITS AND REPORTS ON FORM 8-K



           EXHIBITS

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




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. (filed with Registration Statement on Form S-4 on
          March 19, 1999 and incorporated herein by reference).
2.2       Form of Stockholders' Agreement to be executed by Apexx Technology,
          Inc. stockholders in connection with the merger (filed with
          Registration Statement on Form S-4 on March 19, 1999 and incorporated
          herein by reference).
2.3       Form of Optionholders' Agreement to be executed by Apexx Technology,
          Inc. optionholders in connection with the merger (filed with
          Registration Statement on Form S-4 on March 19, 1999 and incorporated
          herein by reference).
2.4       Form of Escrow Agreement to be executed by eSoft, Inc. Thomas
          Loutzenheiser and The Trust Company of The Bank of Montreal (filed
          with Registration Statement on Form S-4 on March 19, 1999 and
          incorporated herein by reference).
2.5       Source Code Escrow Agreement among eSoft, Inc., Apex Technology, Inc.
          and DSI (filed with Registration Statement on Form S-4 on March 19,
          1999 and incorporated herein by reference).
2.6       Employment Agreement by and between eSoft, Inc. and Thomas
          Loutzenheiser (filed with Registration Statement on Form S-4 on March
          19, 1999 and incorporated herein by reference).
2.7       Employment Agreement by and between eSoft, Inc. and Albert Youngwerth
          (filed with Registration Statement on Form S-4 on March 19, 1999 and
          incorporated herein by reference).
2.8       Employment Agreement by and between eSoft, Inc. and Ray Jenks (filed
          with Registration Statement on Form S-4 on March 19, 1999 and
          incorporated herein by reference).
2.9       Employment Agreement by and between eSoft, Inc. and John Hanousek
          (filed with Registration Statement on Form S-4 on March 19, 1999 and
          incorporated herein by reference).


                                       31

<PAGE>   32






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. (filed with
          Registration Statement on Form S-4 on March 19, 1999 and incorporated
          herein by reference).
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 (filed with Registration Statement
          on Form S-4 on March 19, 1999 and incorporated herein by reference).
9.2       Voting Agreement by and between eSoft, Inc and Albert Youngwerth,
          Heather Youngwerth, Lawrence Lynch, George Minow, Chris Minow, William
          Rivers, Ray Jenks (filed with Registration Statement on Form S-4 on
          March 19, 1999 and incorporated herein by reference).
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).
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).


                                       32

<PAGE>   33





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).
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).


                                       33

<PAGE>   34




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 (filed with
          Registration Statement on Form S-4 on March 19, 1999 and incorporated
          herein by reference).
10.37     Loan agreement entered into by and between eSoft, Inc. and Apexx
          Technology, Inc. dated December 2, 1998 (filed with Registration
          Statement on Form S-4 on March 19, 1999 and incorporated herein by
          reference).
10.38     Secured promissory note entered into by Apexx Technology, Inc. and
          eSoft, Inc. dated December 2, 1998 (filed with Registration Statement
          on Form S-4 on March 19, 1999 and incorporated herein by reference).
10.39     Security agreement entered into by Apexx Technology, Inc. pledging
          assets to secure loan agreement entered into dated December 2, 1998
          (filed with Registration Statement on Form S-4 on March 19, 1999 and
          incorporated herein by reference).
10.40     Stock Pledge Agreement entered into by Thomas Loutzenheiser and eSoft,
          Inc. dated December 2, 1998 (filed with Registration Statement on Form
          S-4 on March 19, 1999 and incorporated herein by reference).
10.41     Guaranty Agreement entered into by Thomas Loutzenheiser and eSoft,
          Inc. dated December 2, 1998 (filed with Registration Statement on Form
          S-4 on March 19, 1999 and incorporated herein by reference).
10.42     Employment Agreement between Jane Merickel and eSoft (filed with
          Registration Statement on Form S-4 on March 19, 1999 and incorporated
          herein by reference).


                                       34

<PAGE>   35




           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".



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



                                       35

<PAGE>   36

                              FINANCIAL STATEMENTS

                                    CONTENTS


<TABLE>
<CAPTION>
                                                                                                    PAGE

<S>                                                                                                 <C>
Report of Independent Certified Public Accountants...................................................F-2
Balance Sheet at December 31, 1998...................................................................F-3
Statements of Operations for the Years ended December 31, 1998 and 1997..............................F-5
Statements of Stockholders' Equity for the Years ended December 31, 1997 and 1998....................F-6
Statements of Cash Flows for the Years ended December 31, 1998 and 1997..............................F-7
Summary of Accounting Policies.......................................................................F-9
Notes to Financial Statements........................................................................F-15
</TABLE>


                                      F-1
<PAGE>   37

               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-2
<PAGE>   38

                                                             eSOFT, INCORPORATED

                                                                   BALANCE SHEET
================================================================================


<TABLE>
<CAPTION>
December 31,                                                                       1998
------------                                                                    -----------
<S>                                                                             <C>
ASSETS
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
                                                                                -----------
                                                                                $ 7,417,451
                                                                                ===========
</TABLE>

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


                                      F-3
<PAGE>   39

                                                            eSOFT, INCORPORATED

                                                       BALANCE SHEET (CONTINUED)
================================================================================


<TABLE>
<CAPTION>
December 31,                                                                       1998
------------                                                                    -----------
<S>                                                                             <C>
LIABILITIES AND STOCKHOLDERS' EQUITY

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
     and outstanding                                                                 68,635
   Additional paid in capital                                                     9,032,480
   Accumulated deficit                                                           (3,320,611)
                                                                                -----------
Total stockholders' equity                                                        5,780,504
                                                                                -----------
                                                                                $ 7,417,451
                                                                                ===========
</TABLE>

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


                                      F-4
<PAGE>   40

                                                             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-5
<PAGE>   41

                                                             eSOFT, INCORPORATED

                                              STATEMENTS OF STOCKHOLDERS' EQUITY
================================================================================

<TABLE>
<CAPTION>
                                                                              
                                                        Common Stock          Additional                         Total
Years Ended December 31,                          ------------------------      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             820,000          8,200        320,959            --           329,159
     private placements, net of offering
     costs of $80,841 (Note 7)
   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-6
<PAGE>   42

                                                             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
     receivable - employee                                    (15,000)           (20,000)
   Payments received from non-operating
     notes receivable - employee                               20,443               --
   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>

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


                                      F-7
<PAGE>   43

                                                             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-8
<PAGE>   44

                                                             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 held-to-maturity,
SECURITIES      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-9
<PAGE>   45

                                                             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. Depreciation is
EQUIPMENT        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 products for
SOFTWARE COSTS   resale are charged to expense until technological feasibility
                 has been established upon completion of a detail program
                 design. Thereafter, all software development costs are
                 capitalized until the point that the product is ready for sale
                 and subsequently reported at the lower of amortized cost or net
                 realizable value.                                            

                 In accordance with Statement of Financial Accounting Standard
                 ("SFAS") No. 86, the Company recognizes the greater amount of
                 annual amortization of capitalized software costs under 1) the
                 ratio of current year revenues by product, to the product's
                 total estimated revenues method or 2) over the products
                 estimated economic useful life by the straight-line method.

LONG-TERM        The Company applies SFAS No. 121, "Accounting for the        
ASSETS           Impairment of Long-Lived Assets." Under SFAS No. 121,        
                 long-lived assets and certain intangibles are evaluated for   
                 impairment when events or changes in circumstances indicate   
                 that the carrying value of the assets may not be recoverable  
                 through the estimated undiscounted future cash flows resulting
                 from the use of these assets. When any such impairment exists,
                 the related assets will be written down to fair value.        

REVENUE          The Company recognizes certain revenue at the time products are
RECOGNITION      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-10
<PAGE>   46

                                                             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. 128, "Earnings
PER SHARE          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             The preparation of financial statements in conformity with
ESTIMATES          generally accepted accounting principles requires management
                   to make estimates and assumptions


                                      F-11
<PAGE>   47

                                                             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 OF  Credit risk represents the accounting loss that would be
CREDIT RISK        recognized at the reporting date if counterparties failed to
                   completely perform as contracted. Concentrations of credit
                   risk, whether on or off the balance sheet, that arise from
                   financial instruments exist for groups of customers or groups
                   of counterparties when they have similar economic
                   characteristics that would cause their ability to meet
                   contractual obligations to be similarly effected by changes
                   in economic or other conditions.

                   Concentrations of credit risk with respect to trade accounts
                   receivable are generally limited due to customers are
                   dispersed across geographic areas. Ongoing 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 believes the book
FINANCIAL          value of financial instruments approximates their fair value.
INSTRUMENTS        

STOCK OPTIONS      The Company applies Accounting Principles Board Opinion
AND WARRANTS       ("APB") 25, "Accounting for Stock Issued to Employees," and
                   related Interpretations in accounting for all stock option
                   plans. Under APB 25, compensation cost is recognized for
                   stock options granted at prices below the market price of the
                   underlying common stock on the date of grant.

                   SFAS No. 123, "Accounting for Stock-Based Compensation,"
                   requires the Company to provide pro forma information
                   regarding net income as if compensation cost for the
                   Company's stock option plans had been determined in
                   accordance with the fair value based method prescribed in
                   SFAS No. 123. 

COMPREHENSIVE      The Company has adopted SFAS No. 130, "Reporting
INCOME             Comprehensive Income." Comprehensive income is comprised of
                   net income and all changes to the statements of stockholders'
                   equity, except those due to investment by stockholders,
                   changes in paid in capital and distributions to stockholders.
                   The adoption of SFAS No. 130 does not impact the Company's
                   financial statements for 1998 and 1997.


                                      F-12
<PAGE>   48

                                                             eSOFT, INCORPORATED

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


PENSIONS AND            The Company has adopted SFAS No. 132, "Employers'
OTHER POST              Disclosure About Pensions and Other Post Retirement
RETIREMENT BENEFITS     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 Instruments
ISSUED ACCOUNTING       and Hedging Activities" requires companies to record
PRONOUNCEMENTS          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-13
<PAGE>   49

                                                             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-14


<PAGE>   50


                                                             eSOFT, INCORPORATED

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

1.   INVESTMENT            A summary of the amortized cost and estimated market
     SECURITIES            value of investment securities which mature in six  
                           months is as follows:                               


<TABLE>
<CAPTION>
                                                 Gross          Gross         Estimated
                                              Unrealized     Unrealized        Market
December 31, 1998         Amortized Cost         Gains         Losses          Value
---------------------- --------------------- -------------  ------------- ---------------
<S>                         <C>               <C>             <C>           <C>       
HELD TO MATURITY:

   Short-term zero          
      coupon notes          $1,991,541        $   --          $   --        $1,991,541
                            ==========        =========       =========     ==========
</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 1997,
     DEVELOPMENT           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-15

<PAGE>   51



                                                             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
------------------------                           -------------         -----------
<S>                                                <C>                   <C>        
DEFERRED EXPENSE (BENEFIT):
Federal                                            $    (148,000)        $   148,000
State                                                    (14,000)             14,000
                                                   -------------         -----------
                                                   $    (162,000)        $   162,000
                                                   =============         ===========
</TABLE>


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


                                      F-16

<PAGE>   52



                                                             eSOFT, INCORPORATED

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



<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                                               
  termination                                                  --         243,000
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>


                           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.



                                      F-17
<PAGE>   53



                                                             eSOFT, INCORPORATED

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



                           At December 31, 1998, the Company had net operating
                           loss carryforwards of approximately $2,700,000 with
                           expirations through 2018. 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-18
<PAGE>   54



                                                             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



                                      F-19
<PAGE>   55



                                                             eSOFT, INCORPORATED

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


                           paid $195,000 to nationalize the interface of the
                           IPAD for the Japanese marketplace.

                           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%



                                      F-20
<PAGE>   56


                                                             eSOFT, INCORPORATED

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


                           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.

                           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.



                                      F-21
<PAGE>   57



                                                             eSOFT, INCORPORATED

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


                           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.

                           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.


                                      F-22
<PAGE>   58



                                                             eSOFT, INCORPORATED

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


                           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.

                           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.



                                      F-23
<PAGE>   59



                                                             eSOFT, INCORPORATED

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


                           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.

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

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




                                      F-24
<PAGE>   60


                                                             eSOFT, INCORPORATED

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


                           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 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 stock
     AND WARRANTS          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>






                                      F-25
<PAGE>   61


                                                             eSOFT, INCORPORATED

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



<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>

                           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-26
<PAGE>   62


                                                             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                    Average
   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-27
<PAGE>   63



                                                             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-28
<PAGE>   64


                                                             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-29
<PAGE>   65


                                                             eSOFT, INCORPORATED

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


13.  SUBSEQUENT            In January 1999, the Company signed a Plan of Merger
       EVENT               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-30


<PAGE>   66



                                   SIGNATURES



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



                                             eSOFT, INC.


                                             By:   /s/ Jeffrey Finn
                                                  -----------------------------
                                                  Name: Jeffrey Finn

                                                  Title: President and Chief 
                                                         Executive Officer



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



<TABLE>
<CAPTION>

        Signatures                                        Title                                            Date
        ----------                                        -----                                            ----
<S>                                     <C>                                                            <C>    
/s/ Philip Becker
------------------------------
Philip Becker                           Chairman of the Board, Chief Technical Officer                  April 16, 1999


/s/ Jeffrey Finn
------------------------------
Jeffrey Finn                            Director, President and Chief Executive Officer                 April 16, 1999
                                        (Principal Executive Officer and Acting Principal
                                        Financial Officer)
/s/ Richard Eyestone
------------------------------
Richard Eyestone                        Director                                                        April 16, 1999


/s/ Richard Rice
------------------------------
Richard Rice                            Director                                                        April 16, 1999


</TABLE>