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

                                   FORM 10-QSB

[ X ]  Quarterly Report Pursuant to Section 13 or 15(d) of the 
       Securities Exchange Act of 1934

For Period Ended               September 30, 1998
                ---------------------------------------------------------------

[   ]  Transition Report Pursuant to Section 13 or 15 (d) of the 
       Securities Exchange Act of 1934

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

Commission File Number              00-23527
                      ---------------------------------------------------------

                                   eSoft, Inc.
             ------------------------------------------------------
             (Exact name of registrant as specified in its charter)

                DELAWARE                                      84-0938960
        ------------------------                       ------------------------
        (State of Incorporation)                       (IRS Employer ID Number)

       5335 Sterling Dr., Suite C                    Boulder,  CO       80301
-----------------------------------------            --------------------------
(Address of principle executive offices)             (city)  (state) (zip code)

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


-------------------------------------------------------------------------------
              (Former name, former address and former fiscal year,
                         if changed since last report)

Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

                          YES          NO   X
                             -----        -----

Transitional Small Business Disclosure format (check one):

                          YES          NO   X
                             -----        -----

The number of shares outstanding of the Registrant's $0.01 par value common
stock on October 28, 1998 was 6,746,002.



<PAGE>   2




PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

                                   ESOFT, INC.

                                 BALANCE SHEETS


<TABLE>
<CAPTION>
                                                        DECEMBER 31,  SEPTEMBER 30,
                                                           1997           1998
                                                        ------------  -------------
                                                                       (Unaudited)
<S>                                                     <C>            <C>
                                    ASSETS

CURRENT ASSETS
     Cash                                               $   102,837    $ 4,789,665
     Receivables:
        Trade, net of allowance for doubtful accounts       199,832      2,285,031
        Subscription receivable                             200,000           --
     Inventories                                             94,607        491,193
     Prepaid expense and other                               24,799        348,253
     Note receivables                                        20,000         17,571
     Deferred income taxes                                   18,000         18,000
                                                        -----------    -----------
                           Total current assets             660,075      7,949,713

PROPERTY AND EQUIPMENT, AT COST
     Computer equipment                                     119,544        195,658
     Furniture and equipment                                143,157        220,138
                                                        -----------    -----------
                                                            262,701        415,796
     Accumulated depreciation                              (147,881)      (188,921)
                                                        -----------    -----------
         Net property and equipment                         114,820        226,875

CAPITALIZED SOFTWARE COSTS, NET OF ACCUMULATE
     AMORTIZATION                                           651,470        556,158

OTHER ASSETS
     Deferred offering costs                                280,896           --
     Other assets                                            17,539          9,724
                                                        -----------    -----------

TOTAL ASSETS                                            $ 1,724,800    $ 8,742,470
                                                        ===========    ===========
</TABLE>











    The accompanying notes are an integral part of the financial statements.

                                        2

<PAGE>   3

                                   ESOFT, INC.

                                 BALANCE SHEETS


<TABLE>
<CAPTION>
                                                        DECEMBER 31,  SEPTEMBER 30,
                                                            1997          1998
                                                        ------------  -------------
                                                                       (UNAUDITED)
<S>                                                     <C>            <C>
                      LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES
     Note Payable - bank                                $    75,757    $    51,924
     Accounts payable                                       174,754        708,822
     Deferred revenue                                        46,622        181,136
     Accrued expenses and other                              91,949        505,214
     Due to related party                                      --          100,000
     Note payable - related party - current                  20,000           --
                                                        -----------    -----------
         Total current liabilities                          409,082      1,547,096

     Deferred tax liability - net                           180,000        180,000
     Convertible notes payable - related parties            355,903           --
                                                        -----------    -----------
         Total liabilities                                  944,985      1,727,096

STOCKHOLDERS' EQUITY
     Common stock, par value $.01 per share;
      authorized 50,000,000 shares; 2,433,158 and
      6,728,002 issued and outstanding December 31,
      1997 and September 30, 1998, respectively             24,332         67,281
       Additional paid-in capital                         1,135,432      8,807,490
       Accumulated deficit                                 (379,949)    (1,859,397)
                                                        -----------    -----------
         Total stockholders' equity                         779,815      7,015,374

TOTAL LIABILITIES AND
    STOCKHOLDERS' EQUITY                                $ 1,724,800    $ 8,742,470
                                                        ===========    ===========
</TABLE>





    The accompanying notes are an integral part of the financial statements.

                                        3

<PAGE>   4
                                   ESOFT, INC.

                            STATEMENTS OF OPERATIONS
                                   (UNAUDITED)


<TABLE>
<CAPTION>
                                     FOR THE THREE MONTHS ENDED    FOR THE NINE MONTHS ENDED
                                            SEPTEMBER 30,                 SEPTEMBER 30,
                                        1997            1998           1997          1998
                                     -----------    -----------    -----------    -----------
<S>                                  <C>            <C>            <C>            <C>
REVENUES                             $   305,532    $ 1,480,199    $   787,794    $ 3,335,139

COST OF GOODS SOLD                        59,193        530,889        240,083      1,229,429
                                     -----------    -----------    -----------    -----------

GROSS PROFIT                             246,339        949,310        547,711      2,105,710

EXPENSES
  Sales and marketing expense             50,858        710,702        117,975      1,587,972
  General & administrative expense        56,535        765,554        235,349      1,564,761
  Engineering expense                      8,239        168,435         25,853        373,160
  Software amortization cost              30,690         53,220         92,070        155,313
  Research and development                  --           (2,750)          --           12,908
                                     -----------    -----------    -----------    -----------
                                         146,322      1,695,161        471,247      3,694,114

OTHER INCOME (EXPENSE)
  Interest income                          1,247         95,199          1,915        115,095
  Interest expense                        (7,204)          (876)       (23,922)        (6,139)
                                     -----------    -----------    -----------    -----------
                                          (5,957)        94,323        (22,007)       108,956

NET INCOME (LOSS)                    $    94,060    $  (651,528)   $    54,457    $(1,479,448)
                                     ===========    ===========    ===========    ===========

NET INCOME (LOSS) PER COMMON SHARE
     Basic                           $      0.06    $     (0.10)   $      0.04    $     (0.29)
     Diluted                         $      0.05    $     (0.10)   $      0.03    $     (0.29)

Basic weighted average shares
      outstanding                      1,512,573      6,679,415      1,347,570      5,061,780
                                     ===========    ===========    ===========    ===========
Diluted weighted average shares
     outstanding                       1,868,476      6,679,415      1,703,473      5,061,780
                                     ===========    ===========    ===========    ===========
</TABLE>




    The accompanying notes are an integral part of the financial statements.

                                        4

<PAGE>   5

                                   ESOFT, INC.

                       STATEMENTS OF STOCKHOLDERS' EQUITY
                                   (UNAUDITED)


<TABLE>
<CAPTION>
                                                      COMMON STOCK           ADDITIONAL                     TOTAL
                                                                              PAID-IN      ACCUMULATED   STOCKHOLDERS'
                                                  SHARES        AMOUNT        CAPITAL        DEFICIT        EQUITY
                                                ---------------------------------------------------------------------
<S>                                             <C>           <C>           <C>            <C>            <C>
BALANCE, December 31, 1997                        2,433,158   $    24,332   $ 1,135,432    ($  379,949)   $   779,815

Issuance of warrants pursuant to                       --            --             438           --              438
  private placement, January 1998
Issuance of stock pursuant to
  private placement net, of offering costs,
  February 1998                                     290,000         2,900       184,082           --          186,982
Issuance of stock pursuant to option
  conversion February 1998                           60,000           600        29,400           --           30,000
Issuance of stock pursuant to stock
  grant February 1998                                90,000           900          (900)          --             --
Issuance of stock pursuant to IPO
  net of offering costs, March 1998               1,550,000        15,500       993,650           --        1,009,150
Issuance of stock for IPO fee shares,
  March 1998                                        110,000         1,100        (1,100)          --             --
Issuance of stock for note conversion,
  March 1998                                        355,903         3,560       352,343           --          355,903
Issuance of stock pursuant to private
  placement, March 1998                              50,000           500        49,500           --           50,000
Issuance of stock pursuant to exercise
  of agents' warrants, April 1998                   250,000         2,500       247,500           --          250,000
Issuance of compensatory options,
  April 1998                                           --            --          69,600           --           69,600
Issuance of stock pursuant to private
  placement, net of offering costs, June 1998     1,468,941        14,689     5,459,704           --        5,474,393
Issuance of stock pursuant to stock
  options and warrant exercised July -
  September 1998                                     70,000           700        69,300         70,000
Issuance of warrants for services,
    July - September 1998                           218,541       218,541
Net loss for the nine months ended September
30, 1998                                               --            --            --       (1,479,448)    (1,479,448)
                                                -----------   -----------   -----------    -----------    -----------
BALANCE, September 30, 1998                       6,728,002   $    67,281   $ 8,807,490    ($1,859,397)   $ 7,015,374
                                                ===========   ===========   ===========    ===========    ===========
</TABLE>



    The accompanying notes are an integral part of the financial statements.

                                        5

<PAGE>   6


                                   ESOFT, INC.

                            STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                  FOR THE NINE MONTHS ENDED
                                                                                         SEPTEMBER 30,

                                                                                     1997           1998
                                                                                  -----------    -----------
<S>                                                                               <C>            <C>
CASH FLOW FROM OPERATING ACTIVITIES
  Net Income (loss) from operations                                               $    54,457    $(1,479,448)
  Adjustments to reconcile net cash provided by (used in) operating activities:
      Depreciation & software amortization                                            113,283        196,246
      Provision for losses on accounts receivables                                       --          177,930
      Provision for inventory obsolescence                                               --           18,000
      Amortization of warrants                                                           --           52,521
      Issuance of compensatory options                                                   --           46,400

  Changes in operating assets and liabilities: (increase) decrease in:
      Accounts receivable - trade                                                     (36,455)    (2,262,199)
      Inventories                                                                     (17,314)      (414,586)
      Other assets                                                                       --            7,815
      Prepaid expenses                                                               (125,034)      (134,434)

  Increase (decrease) in:
      Accounts payable                                                                 46,584        534,068
      Accrued expenses                                                                  1,532        413,265
      Deposits                                                                         42,788           --
      Deferred revenue                                                                (44,734)       134,514
                                                                                  -----------    -----------
Net cash provided by (used in) operating activities                                    35,107     (2,709,908)

CASH FLOW FROM INVESTING ACTIVITIES
      Purchase of equipment                                                            (3,277)      (153,095)
      Capitalized software costs                                                     (196,878)       (60,000)
      Notes receivable - related parties                                                 --            1,806
                                                                                  -----------    -----------
Net cash used in investing activities                                                (200,155)      (211,289)

CASH FLOW FROM FINANCING ACTIVITIES
      Principal (payments) on borrowings                                              (19,174)       (23,833)
      Proceeds from subscription receivable                                           116,000        200,000
      Due to related party                                                               --          100,000
      Deferred offering costs                                                         (45,484)          --
      Proceeds (payment) from related party borrowings                                 20,000        (20,000)
      Proceeds from issuance of promissory notes                                      100,000           --
      Net proceeds sale of stock, warrants and options                                347,354      7,351,858
                                                                                  -----------    -----------
  Net cash provided by financing activities                                           518,696      7,608,025

INCREASE (DECREASE) IN CASH                                                           353,648      4,686,828

CASH: BEGINNING OF PERIOD                                                              20,750        102,837
                                                                                  -----------    -----------

CASH: END OF PERIOD                                                               $   374,398    $ 4,789,665
                                                                                  ===========    ===========
</TABLE>




    The accompanying notes are an integral part of the financial statements.

                                        6

<PAGE>   7
                                   ESOFT, INC.

                          NOTES TO FINANCIAL STATEMENTS

     1.  INTERIM FINANCIAL INFORMATION

         In the opinion of management, the accompanying unaudited financial
         statements contain all adjustments necessary to present fairly the
         financial position as of September 30, 1998 and the results of
         operations and statement of cash flows for the periods presented. The
         results of operations for the nine month periods ending September 30,
         1998 and 1997 are not necessarily indicative of results to be expected
         for the full year.

     2.  TRADE RECEIVABLES

         The following information summarizes trade receivables:

<TABLE>
<CAPTION>
                                                             DECEMBER 31,          SEPTEMBER 30,
                                                                 1997                  1998
                                                               --------             ----------
<S>                                                            <C>                   <C>
  Accounts Receivable                                           247,832              2,510,031
    Less allowance for doubtful accounts                        (48,000)              (225,000)
                                                               --------             ----------
                                                               $199,832             $2,360,031
                                                               ========             ==========
</TABLE>


         The Company has ten distributors and/or telecommunication companies
         (telecos) which accounted for 57% of the Company's sales through the
         nine months ending September 30, 1998 and 87% of the third quarter
         sales. Sales for the third quarter were composed of 62% for
         international destinations and 38% for the domestic market. Sales
         composition through nine months ending September 1998 include 50% for
         international destinations and 50% for the domestic market. The ten
         distributors that make up the majority of the Company's nine months
         sales represent 49% of the total accounts receivable, with one customer
         representing 28% of our total accounts receivable on September 30,
         1998.

         The Company has three distributors and/or telcos which each comprise
         10% or more of the sales through the nine months ending June 30, 1998.
         The three distributors and/or telcos represent 21%, 15% and 14%
         respectively of the nine months sales revenue.

         The Company, with regard to its foreign sales, does not take the risk
         of foreign currency fluctuation. All sales are designated as payment in
         U.S. denominated funds at the time of sale.


                                        7

<PAGE>   8
                                   ESOFT, INC.

                          NOTES TO FINANCIAL STATEMENTS

     3.  NOTES PAYABLES:

<TABLE>
<CAPTION>
                                                                                        DECEMBER 31,          SEPTEMBER 30,
                                                                                            1997                  1998
                                                                                         ----------           -----------
<S>                                                                                      <C>                  <C>
Notes Payables

On January 3, 1997, the Company borrowed $100,000 from a bank, bearing interest
at 12% per annum and was payable with monthly installments of $3,325 with the
balance due on April 3, 1998. On April 5, 1998, the loan was extended to October
5, 1998 with monthly installment payments of $3,325 and a final payment of
$51,924 due October 5, 1998. The loan is collateralized by all assets of the
Company. Subsequent to September
98 the loan was paid in full.                                                            $   75,757           $    51,924
                                                                                         ==========           ===========
Related Party:

Two notes payable on demand to an officer, director and stockholder of the
Company, interest payable monthly at 7% per annum, the note was paid in full in
May 1998.                                                                                $   20,000           $       -
                                                                                         ==========           ===========
</TABLE>
 

     4.  NET INCOME (LOSS) PER SHARE

         Basic earnings (loss) per share is calculated by dividing the net
         income(loss) by the weighted average common shares outstanding during
         the period. For purposes of computing diluted earnings per share,
         dilutive securities are not included when the effect is anti-dilutive.

<TABLE>
<CAPTION>
                                                    FOR THE THREE MONTHS ENDED            FOR THE NINE MONTHS ENDED
                                                          SEPTEMBER 30,                         SEPTEMBER 30,
                                                     1997                1998              1997               1998
                                                   ---------          ---------         ---------          ---------
<S>                                                <C>                <C>               <C>                <C>
Basic weighted average common shares
     outstanding                                   1,512,573          6,679,415         1,347,570          5,061,780
     Convertible debt                                355,903          -                   355,903          -
                                                   ---------          ---------         ---------          ---------
Diluted weighted average common shares and
     assumed conversions outstanding               1,868,476          6,679,415         1,703,473          5,061,780
                                                   =========          =========         =========          =========
</TABLE>

         Options and warrants to purchase 1,596,418 shares of common stock were
         not included in the computation of diluted earnings per share because
         their effect was anti-dilutive for the period ending September 30,
         1998. Options and warrants to purchase 674,600 shares of common stock
         of which 60,000 shares were exercisable were not included in the 
         computation of diluted earnings per share based the treasury method 
         calculations for the period ending September 30,1997.


                                        8

<PAGE>   9

                                   ESOFT, INC.

                          NOTES TO FINANCIAL STATEMENTS

     5.  DUE TO  - RELATED PARTY

         The Company accepted subscription agreements for the private placement
         of 150,000 shares of the Company's common stock at $1.00 per share in
         March 1998. From the total private placement Philip Becker, the CEO &
         CTO of the Company, subscribed to purchase 100,000 shares of the
         Company's common stock. All private placement require the Company to
         seek the approval of the Vancouver Stock Exchange which may or may not
         permit such transactions. Due to the ownership level of the shareholder
         increasing to 20% of the outstanding shares in March 1998 the issuance
         of the common stock was subsequently restricted by the Vancouver Stock
         Exchange in May 1998. The Vancouver Stock Exchange authorized the
         Company to issue the shares, subject to shareholder approval of the
         private placement to Philip Becker. If shareholder approval is not
         received, the funds are required to be remitted to the subscriber
         immediately. The Company has scheduled a shareholders' meeting,
         December 4, 1998, to seek approval for the above referenced
         transaction.

     6.  REVENUE RECOGNITION

         The Company recognizes revenue at the time products are shipped to its
         customers. Provision is made currently for estimated product returns
         which may occur under programs the Company has with its customers.
         Revenue from support and update service agreements is deferred at the
         time the agreement is executed and recognized ratably over the
         contractual period. The Company recognizes revenues from customer
         training and consulting services when such services are provided. All
         costs associated with licensing of software products, support and
         update services and training and consulting services are expensed as
         incurred.

     7.  IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

         See Item 2 - Management's Discussion and Analysis of Financial
         Condition and Results of Operations page 16 for recently issued
         accounting standards.


                                        9

<PAGE>   10
                           FORWARD-LOOKING STATEMENTS

              Statements made in this Form 10-QSB that are not historical or
         current facts are "forward-looking statements" made pursuant to the
         safe harbor provisions of Section 27A of the Securities Act of 1933
         ("The 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,"
         "approximate" or "continue," or the negative thereof. The Company
         intends that such forward-looking statements be subject to the safe
         harbors for such statements. The Company wishes to caution readers not
         to place undue reliance on any such forward-looking statements, which
         speak only as of the date made. Any forward-looking statements
         represent management's best judgment as to what may occur in the
         future. However, forward- looking statements are subject to risks,
         uncertainties and important factors beyond the control of the Company
         that could cause actual results and events to differ materially from
         historical results of operations and events and those presently
         anticipated or projected. These factors include adverse economic
         conditions, entry of new and stronger competitors, inadequate capital,
         unexpected costs, failure to gain product approval in foreign countries
         and failure to capitalize upon access to new markets. Additional risks
         and uncertainties which may affect forward-looking statements about the
         Company's IPAD business and prospects include the possibility that a
         competitor will develop a more comprehensive or less expensive IPAD
         solution, delays in market awareness of eSoft and its products,
         possible delays in eSoft's marketing strategy, which could have an
         immediate and material adverse effect by placing eSoft behind its
         competitors. The Company disclaims any obligation subsequently to
         revise any forward-looking statements to reflect events or
         circumstances after the date of such statement or to reflect the
         occurrence of anticipated or unanticipated events.

     ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 
              AND RESULTS OF OPERATIONS

              The primary market being pursued by the Company consists of
         small-to-medium size businesses (SMB) that wish to initiate or expand
         their connection and presence on the Internet. The Company believes
         that the SMB market is not only expanding exponentially into the
         Internet arena, but also requires a solution that is more cost
         effective and easier to install and maintain than systems typically
         available for the Fortune 1000 companies. The Company further believes
         that, for reasons of internal control and additional cost reduction,
         the SMB segment finds it beneficial to host their own hardware and
         software systems rather than rely upon a remote Internet service
         provider. For the higher end IPAD model 5000, a secondary target market
         includes Internet service providers, enterprise level operations and
         special applications. The Company believes that a significant portion
         of the expansion of Internet usage--now doubling every 100 days with an
         estimated 62,000,000 U.S. Internet users at the end of 1997--is from
         the SMB segment that comprises the largest portion of the installed
         local area networks and increasingly recognizes the importance of the
         Internet to grow their business and improve productivity. Up until the
         introduction of the Company's IPAD products, the only alternatives for
         Internet connection and presence were either complete reliance on a
         remote Internet service provider, or the installation and support of a
         complex, expensive in-house system configuration. With the IPAD system
         and advancements in the telecommunications and Internet technologies,
         businesses can now assume most of the responsibilities and functions
         which heretofore have been provided on their behalf by Internet service
         providers. Most importantly for the SMB market, the IPAD system is a
         complete, plug-and-play solution that can be installed and maintained
         by non-technical personnel and at a fraction of the cost of the typical
         large system solution. The IPAD functionality includes an integrated
         router, firewall, domain name server, worldwide web server, remote
         access server and e-mail server for the Intranet and Internet. The
         Company's primary distribution strategy is the classical two-tier
         distribution channel, but with a concentration on those distributors,
         VARs and resellers that focus on the network and telecommunications
         segments.

                                       10

<PAGE>   11

              During the third quarter, the Company anticipated signing
         agreements with three additional distributors. Subsequently to
         September 30th the Company signed a distribution agreement with CHS
         Electronics. Domestically, the Company fell short of its goal and only
         signed one regional distributor, SED International and anticipates
         signing a third distributor in the fourth quarter. SED, located in
         Tucker, Georgia, with sales revenues of $646 million in distribution of
         microcomputer products, has eight sales and warehouse offices located
         across the US. SED International has a total database of 50,000
         customers with approximately 15,000 active customers with approximately
         40% - 50% of the customers in the networking arena. 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 some Japanese distribution opportunities and
         the Company expects continued progress in the fourth quarter. While the
         Company is encouraged by initial IPAD evaluations by a European cable
         company, management was disappointed in its overall efforts to expand
         its European sales through its original distributor, Telindus SA. As a
         result, the Company is exploring other avenues for distribution and
         refocusing its efforts on telecommunication and cable companies in the
         European market.

              In August, the Company consummated a contract with Telecom
         Soluciones, one of two Argentinian telephone companies. 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 IPAD system delivery in
         excess of $500,000. Additionally, progress was made with potential for
         fourth quarter sales to other telecommunications companies in Peru and
         Chile. The Company expects to continue the discussions in these
         countries through the fourth quarter, as well as restart activities in
         Brazil and Mexico.

              The Company completed negotiations, in the third quarter of its
         eStar alliance program, with the respective parties, anticipating early
         fourth quarter completion of contracts. The program combines the
         strengths of a national leasing company, a national systems integrator
         and Internet access providers to enable telecommunication companies to
         deliver a complete Internet package to their SMB market.

              The Company continues to add Channel Development Representatives
         (CDRs) and in the third quarter hired, trained and deployed CDRs in
         Washington DC area, Chicago, Denver, Dallas, and San Antonio, and is in
         discussions with a company with manufacturer's representatives in the
         large Canadian cities. The purpose of the CDRs and manufacturer's reps
         is to assist our distributors with lead generation and market
         pull-through of our products in channel to VARs and system integrators.
         In its third quarter, the Company added a total of seven distribution
         sales personnel plus a sales representative in the eStar
         telecommunications program. In the fourth quarter, the Company will
         make a concerted and aggressive effort, through the use of its
         distributor databases and CDRs to grow market awareness of eSoft and
         its family of IPAD products. The Company will conduct a minimum of ten
         seminars with the assistance of its distributors to introduce eSoft
         products to VARs and end users and to educate the market about the all-
         in-one appliance alternatives for the SMB. The Company anticipates
         adding an additional sales representative for the eStar program and
         seven more CDRs in the fourth quarter.

              In the third quarter, the Company recruited Frankie Benning as
         director of channel sales with responsibilities for all distribution in
         the United States and Canada. Ms. Benning comes to eSoft from Netscape
         Communications Corp. where she was distribution sales manager. Ms.
         Benning has 10 years experience building channel development programs
         for companies such as Intel and Hewlett Packard.

              The Company completed the quarter ended September 30, 1998 with
         revenues of $1,480,000 or 384% growth over the comparable quarter in
         1997. The average quarter-on-quarter growth rate over the last six (6)
         quarters has been 40%. The Company has year-to-date sold into the
         channel in excess of 1,000 units.

                                       11

<PAGE>   12
         To continue this steep growth ramp, the Company must continue through
         1998 to expand the distribution channels with the addition of other
         large and regional distributors. In order for the Company to maintain
         the continued growth the distributor channel must deliver sell through
         and the all-in-one appliance must continue to be accepted as an
         alternative to current technology for connection to the Internet. The
         Company will significantly increase its sales and marketing
         expenditures to support the channel expansion and telecommunications
         marketing strategies. Sales efforts in the fourth quarter will focus on
         developing increased market pull-through of product in the channel. The
         Company will also continue to explore and develop the international
         marketplace. The Company will explore product line unbundling and
         expansion with commensurate increases in engineering staff, as well as
         expanding its customer support organization. With the increase in
         headquarters staff, the Company will begin to plan a relocation to a
         larger facility in early 1999.

              Management believes its aggressive pursuit of distribution
         channels will have both short-term and long-term effects on its
         operations. Cash flow from operations is anticipated to be utilized for
         the continued expansion of its sales and marketing efforts, as well as
         supporting its extended receivable terms to new distributors. Some
         personnel additions are also anticipated in the technical support and
         engineering departments. In addition to these near-term effects, the
         Company expects that these efforts will expand its installed base of
         IPADs and continue its growth path. However, with the aggressive market
         expansion, the Company anticipates consuming working capital to meet
         this continued growth curve for the near term. Additionally, the
         Company anticipates future losses as a result of expenses incurred in
         support of the aggressive expansion of the sales force to accomplish
         the proposed growth curve. The Company anticipates turning profitable
         in 1999.

              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 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.

     LIQUIDITY AND CAPITAL RESOURCES

              During the first quarter, the Company completed a $340,000 private
         placement in February and March 1998 of 340,000 shares of the Company's
         common stock, at a price of $1.00 per share to officers, directors, key
         employees and consultants of the Company including a subscription for
         50,000 shares, included in above at a price of $1.00 which was
         collected in April 1998.

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

              In March 1998, the Company completed its initial public offering
         in Canada of 1,550,000 shares of the Company's common stock at an
         offering price of $1.00 per share. Additionally, the Agent was issued
         110,000 shares of the Company's common stock in the Canadian Offering
         along with warrants to purchase 250,000 shares of the Company's common
         stock at a price of $1.00 for the first 12 months and at a price of
         $1.15 for the next 12 months. The Agent, subsequent to March 31, 1998,
         exercised its right to purchase

                                       12

<PAGE>   13

         250,000 shares of common stock. The net cash proceeds to the Company
         from the IPO was approximately $906,000 after payment of expenses of
         approximately $644,000.

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

              On June 15, 1998, eSoft 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 $5,474,000 after payment
         of expenses of the offering, estimated at $261,000, and payment of
         $507,825 (8.13% of the offering price) commissions to the Agent,
         SubAgents, and Finders who were issued warrants to purchase 159,318
         (10.85% of the offered shares) shares of the Company's common stock at
         a price of US $4.25 in the first year and US $4.90 in the second year.

              In the third quarter, eSoft 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.

              The Company's cash position on September 30, 1998 was $4,790,000,
         a decrease of $1,157,000 from the previous quarter. The Company's
         working capital at September 30, 1998 was $ 6,403,000, a decrease of
         $391,000 from the second quarter. To support the hiring of new
         employees in the period with office equipment and demo units, the
         Company has expended $153,000 year to date in capital expenditures with
         $35,000 in equipment purchased this quarter. Management anticipates
         continuing losses in support of the growth, and thus its cash position
         will continue to decrease. Additionally, in the near term, with new
         distributors being added to continue market development, the Company
         anticipates its accounts receivable to increase. The Company is
         increasing efforts to reduce the present Accounts Receivable balance
         through more stringent collection efforts of the current customer base
         in an attempt to reduce days outstanding. Inventories grew
         significantly consuming cash and at the end of the quarter inventories
         was $509,000. The increase is associated with the inability to
         presently forecast feed mixes installed in the IPAD. The Company had
         $196,000 or 38% of the total inventory in modem, ISDN and ISDN-Europe
         modems in stock at the end of the quarter. Management believes that its
         current cash position and the anticipated receipts will be sufficient
         to meet its working capital needs for the foreseeable future.

     Cash Flow

              During the nine months ended September 30,1998, cash increased by
         $4,687,000. Adjustments to reconcile net loss ($1,480,000) resulted in
         adjustments of the use of funds of $491,000 from depreciation,
         amortization of software costs, provision for loss on accounts
         receivables and issuance of compensatory options and warrants for
         services. Funds used in operating activities were ($2,710,000). Funds
         of $1,090,000 were provided from operating activities from an increase
         of $534,000 in accounts payable, $413,000 from an increase in accrued
         expenses, an increase in deferred revenue of $135,000 and an increase
         of 8,000 in other assets. Operating funds of ($2,811,000) were used to
         finance the ($2,262,000) increase in accounts receivable, ($415,000)
         increases in inventories and ($134,000) increase in prepaids.
         Investment activities came from investments in capital equipment of
         ($153,000), capitalized software development costs ($60,000) and an
         increase in notes receivable of $1,800 for a total use of funds for
         investment activities of ($211,000). Financing activities provided net
         $7,608,000 of cash proceeds from conversion of debt, stock offerings,
         option and warrant conversion, and debt increases and repayments. Net
         cash in the amount of $1,597,000 was received during the period from
         the Company's IPO, private placements and warrant and option conversion
         of 2,380,000 shares of the Company's common stock and $5,474,000 from
         the June private placement. $200,000 from the collection of
         subscription receivable and

                                       13

<PAGE>   14




         $100,000 from a stock subscription agreement was accepted but
         restricted as explained in related party transaction Note 5. Principal
         payments and debt repayments of ($44,000). A deferred offering costs
         from the completion of the Company's fund raising from financing
         activities and compensatory warrant compensation totaling $281,000. Non
         cash items of debt conversion of $356,000 on the Company's indebtedness
         reduced.

              The Company anticipates expending an additional $175,000 for
         capital expenditures this fiscal year. eSoft will continue to
         capitalize software development costs consistent with its strategy of
         the development of IPAD software for the marketplace.

         RESULTS OF OPERATIONS FOR THREE MONTHS ENDED SEPTEMBER 30, 1998
              COMPARED TO THE THREE MONTHS ENDED SEPTEMBER 30, 1998

              Quarterly revenues totaled $1,480,000 versus revenue of $306,000
         for the comparable quarter in 1997. This represents an increase of
         $1,175,000 or 384% over the comparable quarter in 1997. The increase is
         associated with the continued expansion of the Company's sales effort
         of IPAD products both domestically and in the international market. The
         Company in the quarter added one domestic distributor and two
         international distributor for a total of 540 revenue units shipped in
         the quarter into the channel. Of this 237 revenue units were shipped
         domestically and 303 revenue units were shipped for international
         distribution. This broadened product line over 1997, along with the
         expanded sales and marketing efforts both domestically and abroad,
         resulted in the Company posting significant sales growth. The Company,
         has experienced an average growth rate of 40% per quarter since the
         release of the IPAD 1200 and 2500. For the quarter ending September
         1998 the Company experienced sales growth of $387,000 or 32% revenue
         growth over the second quarter results.

              Gross profit margin in the current quarter was 64% of revenue
         ($949,000) compared to 62% ($696,000) for the three months ended June
         30, 1997. The increase is associated with transition to delivery of
         more IPAD 2500 in the quarter versus pervious quarters. Gross profits
         would have been higher, however an $18,000 reserve was taken for TBBS
         inventories and the transition to the new IPAD box. It is anticipated
         that the margins will be maintained at this level through the remainder
         of the fiscal year with the present distribution strategy.

              Selling, General and Administrative, Engineering and R & D
         Expenses (SG&A) increased $1,549,000 or 1,058% from $146,000 in 1997 to
         $1,695,000 for the quarter ending September 1998. Sales and marketing
         expenses increased $660,000 from $51,000 in 1997 to $711,000 in 1998.
         The significant increases in expenditures are attributed to the
         addition of sales and marketing personnel, consultants and outside
         services, travel expenses, commission and marketing programs required
         to accomplish the ramp of the Company's anticipated sales growth rates.
         These expenditures represent 53% or $373,000 of the total quarterly
         sales and marketing expenditures. The Company, in the quarter, added
         two (2) new hires in the Marketing department and seven (7) new hires
         in the Sales department. The hiring of new Channel Development Reps is
         anticipated to continue through the end of the fiscal year end. The
         sales department continues to utilize outside consultants to develop
         the international markets which is a significant portion of the sales
         expenditures. General and administrative expense increased $709,000 or
         1,254%, from $57,000 in the 1997 period compared to expenditures of
         $766,000 for the current quarter. One of the significant increases is
         associated with a $150,000 increase in bad debt expense in the quarter
         representing 20% of the total G& A expense. Engineering and tech
         support expenses increased to $168,000 for the three months ending
         September 1998 with the majority of work being performed on system
         sales support training and engineering upgrades and updates to the IPAD
         system. The Company sales growth rate was 32% over the second quarter
         while expenditures in the SG & A areas increased 36% over the previous
         quarter. The

                                       14

<PAGE>   15


         SG&A will continue to grow with the anticipated addition of new hires
         to augment the Company in all departments. Amortized software
         development costs total $53,000 for the period.

              Interest expense decreased $6,300 in the three months ended
         September 30,1998 from $7,200 in 1997 to $900 in 1998. This decrease in
         interest expense is attributed to the conversion of a significant
         portion of debt to equity in the first quarter and the continued pay
         down of the bank loan in 1998. The bank loan was paid in full
         subsequent to September 30, 1998. Interest income increased $94,000 in
         the quarter. This increase is associated with completion of the private
         placement at the end of the second quarter. The significant increase
         relates to funds held in escrow with all interest being paid to the
         Company in July when the escrow closed and reported all earnings.

              Net Losses from operations was ($651,000) for the three months
         ended September 30,1998, compared to $94,000 profit for the same period
         in 1997, an increase in the loss of ($746,000) over the same period.
         The net losses are associated with the increased SG&A necessary to
         maintain a continued quarterly sales growth rate in expanding into this
         market. Losses are anticipated to continue through the current fiscal
         year due to expenditures leading sales growth rates and the addition of
         new hires.

         RESULTS OF OPERATIONS FOR NINE MONTHS ENDED SEPTEMBER 30, 1998
              COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 1997

              Revenues for nine months of operations totaled $3,335,000 compared
         to revenues of $788,000 for the same period in 1997. This represents an
         increase of $2,547,000 or 323% over the comparable nine month period in
         1997. The increase is associated with the continued expansion of the
         Company's sales effort of IPAD product both domestically and in the
         international marketplace. The Company added three domestic
         distributors and five international distributors, VARs and/or telcos in
         the nine months of the year contributing $2,750,000 or 86% of the total
         sales for the year.

              Gross profit margin was 63% of revenue ($2,106,000) compared to
         62% ($1,156,000) for the six months ended June 30, 1998. The slight
         increase in gross profit margin is associated with no shipments of raw
         material to Europe in the third quarter. In addition the product mix
         changed to predominantly IPAD 2500 versus IPAD 1200 in which margin is
         lower. Raw materials have been shipped from the U.S. to Europe
         resulting in additional duties and freight costs in the first half of
         the year. It is anticipated that the margins will be maintained at this
         level through the remainder of the fiscal year with the current
         two-tier distribution approach.

              Selling, General and Administrative, Engineering and R & D
         Expenses (SG&A) increased $3,223,000 or 684% from $471,000 for the nine
         months in 1997 to $3,694,000 for the same nine months in the 1998
         period. Sales and marketing expenses increased $1,470,000 from $118,000
         in 1997 to $1,588,000 in 1998. The increases in expenditures are
         attributed to the addition of sales and marketing personnel,
         consultants and outside services, travel expenses, commission and
         marketing programs required to meet the ramp of the Company's
         anticipated sales growth rates. The Company has added twelve (12) sales
         and sales support staff and five (5) marketing staff in 1998 in
         addition to utilizing 5 sales agents to develop international markets.
         The afore-mentioned expenditures represented 57% of the total year to
         date expenditures for sales and marketing. General and administrative
         expense increased $1,329,000 from $236,000 in the 1997 period compared
         to total expenses of $1,565,000 year to date. Engineering tech support
         expenses increased to $373,000 for the nine months ending September
         1998 with the majority of work being performed on system sales support
         training and engineering upgrades and updates to the IPAD system. The
         Company has maintained an average of 40% quarter-on-quarter sales
         growth rate over the last six quarters. To

                                       15

<PAGE>   16

         accomplish this sales ramp, the Company's SG & A increased an average
         of 59% quarter-on-quarter over the last six quarters. Amortized
         software development costs total $155,000 for the period.

              Interest expense for the nine months ending September 1998
         decreased $18,000 from $24,00 in 1997 to $6,000 in 1998. This decrease
         in interest expense is attributed to the conversion of a significant
         portion of debt to equity in the first quarter of 1998. The Company
         additionally continues to pay down its term loan with the bank,
         reducing interest expense. Interest income increased $113,000 for the
         year to date period for a total of $115,000 for the nine months ended
         September 1998. This increase is associated with completion of the
         private placement at the end of the second quarter. The significant
         increase relates to funds held in escrow, with all interest being paid
         to the Company in July when the escrow closed.

              Net losses from operations totaled ($1,479,000) for the nine
         months ended September 30,1998, compared to $55,000 profit for the same
         period in 1997, an increase in the loss of ($1,534,000) over the same
         period. The net loss is associated with the increased SG&A necessary to
         ramp quarterly sales growth rates. Losses are anticipated to continue
         through the current fiscal year due to expenditures leading sales
         growth rates.

     YEAR 2000 EFFECT

              The Company's TBBS product line has one deficiency associated with
         year 2000 for which a correction is scheduled for a revision release in
         October 1998. Older versions of the IPAD hardware have a BIOS
         deficiency and this deficiency will be corrected in the product release
         schedule for this fiscal year. The current IPAD product line has no
         known susceptibility to year 2000 issues. The cost of the revision to
         the TBBS and IPAD product is not expected to be material. The Company
         has no present knowledge of any other internal systems having a year
         2000 compliant problem. Other year 2000 items are not anticipated to be
         material.

     IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

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

              In June 1997, the Financial Accounting Standards Board issued
         Statement of Financial Accounting Standards No.130, Reporting
         Comprehensive Income (SFAS 130), which establishes standards for
         reporting and display of comprehensive income, its components and
         accumulated balances. Comprehensive income is defined to include all
         changes in equity except those resulting from investments by owners and
         distributions to owners. Among other disclosures, SFAS 130 requires
         that all items that are required to be recognized under current
         accounting standards as components of comprehensive income be reported
         in a financial statement that is displayed with the same prominence as
         other financial statements. SFAS 130 has been adopted and there was no
         affect on the financial statements.

              Also, in June 1997, FASB issued SFAS No. 131, "Disclosures about
         Segments of an Enterprise and Related Information" which supersedes
         SFAS No. 14, "Financial Reporting for Segments of a Business
         Enterprise." SFAS No. 131 establishes standards for the way that public
         companies report information about operating segments in annual
         financial statements and requires reporting of selected information
         about operating segments in interim financial statements issued to the
         public. It also establishes standards for disclosures regarding
         products and services, geographic areas and major customers. SFAS No.
         131 defines operating segments as components of a company about which
         separate financial information is available that is evaluated regularly
         by the chief operating decision maker in deciding how to allocate
         resources and in assessing performance. SFAS 131 is effective for
         financial statements for periods beginning after December 15, 1997 and
         requires comparative information for earlier years to be restated.
         Because of the recent issuance of the standard, management has been
         unable to fully evaluate the impact,

                                       16

<PAGE>   17


         if any, the standards may have on future financial statement
         disclosures. Results of operations and financial position, however,
         will be unaffected by implementation of this standard.

              In October 1997, Statement of Position 97-2, Software Revenue
         Recognition (SOP 97-2) was issued. The SOP provides guidance on when
         revenue should be recognized and in what amounts licensing, selling,
         leasing, or otherwise marketing computer software. SOP 97-2 is
         effective for transactions entered into in fiscal years after December
         15, 1997. In March 1998, SOP 98-4 was issued to defer for one year the
         application of certain provisions of SOP 97-2. Because of the recent
         issuance of these SOP's, management has been unable to fully evaluate
         the impact, if any, these SOP's may have on future financial statement
         disclosure.

              In February 1998, the FASB issued SFAS No. 132, "Employer's
         Disclosures about Pensions and Other Postretirement Benefits" which
         standardizes the disclosure requirements for pensions and other
         postretirement benefits and requires additional information on changes
         in the benefit obligations and fair values of plan assets that will
         facilitate financial analysis. SFAS No. 132 is effective for years
         beginning after December 15, 1997 and requires comparative information
         for earlier years to be restated, unless such information is not
         readily available. Management believes the adoption of this statement
         will have no material impact on the Company's financial statements.

                                       17

<PAGE>   18




PART II - OTHER INFORMATION

     Item 1.  Legal Proceedings

              Not applicable

     Item 2.  Changes in Securities

              Not applicable

     Item 3.  Defaults Upon Senior Securities

              Not applicable

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

              Not applicable

     Item 5.  Other Information

              Not applicable

     Item 6.  Exhibits and Reports on Form 8-K

              a)  Exhibits

                  27       Financial Data Schedule.

              b) Reports on Form 8-K.

                  none


                                       18

<PAGE>   19




                                   SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                       eSoft, Inc.
                                       (Registrant)



Date: October 28,1998                  /s/ Philip Becker
     -----------------------           -------------------------------------
                                       Philip Becker
                                       Chairman, CEO


Date: October 28,1998                   /s/ Thomas Tennessen
     -----------------------           -------------------------------------
                                       Thomas Tennessen
                                       Chief Financial Officer and Principal
                                       Financial and Accounting Officer


                                       19

<PAGE>   20
                                 EXHIBIT INDEX


Exhibit No.                       Description
-----------                       -----------
    27                      Financial Data Schedule.