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NETWORK ENGINES INC
10-K, 2000-12-21
PREPACKAGED SOFTWARE

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x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2000

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from  to

Delaware		04-3064173
(State or other jurisdiction of incorporation)		(I.R.S. Employer Identification No.)

25 Dan Road, Canton, MA		02021
(Address of principal executive offices)		(Zip Code)

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				Page
PART I
ITEM 1.		BUSINESS		1
ITEM 2.		PROPERTIES		13
ITEM 3.		LEGAL PROCEEDINGS		13
ITEM 4.		SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS		14
PART II
ITEM 5.		MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS		17
ITEM 6.		SELECTED CONSOLIDATED FINANCIAL DATA		18
ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		19
ITEM 7A.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		39
ITEM 8.		FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA		40
ITEM 9.		CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE		63
PART III
ITEM 10.		DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT		63
ITEM 11.		EXECUTIVE COMPENSATION		63
ITEM 12.		SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT		63
ITEM 13.		CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS		63
PART IV
ITEM 14.		EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K		64
SIGNATURES				65

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pre-packaged functionality to reduce or eliminate the need for custom integration by the end user;

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high-density physical packaging that provides high-performance server hardware in small, rack-mounted devices to minimize the costs of co-location space rental;

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an integrated management system that enables administrators to extensively control their server appliances remotely, even in the case of system failure; and

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built-in clustering capability that enables users to easily scale the power and functionality of their solution as user demand grows and evolves.

Ÿ

it is a complete, integrated, standalone specific-purpose server appliance;

Ÿ

it can be easily installed, requiring simple configuration information to be entered through the front-panel liquid crystal display or an Internet browser;

Ÿ

it can be grouped in a load-balanced cluster with additional server appliances to increase the power of the solution;

Ÿ

it includes hardware and software that enable centralized management and allow the addition of the appliance to a cluster; and

Ÿ

its management functionality can be extended by the addition of our management appliance, AdminEngine, to its cluster.

Ÿ

the NT products incorporate Microsoft Windows NT Server version 4.0, Microsoft Internet Information Server, our customized management software, Microsoft Index Server and Microsoft Management Console; and

Ÿ

the LX products incorporate Linux software, including Red Hat version 6.1, the Apache web server version 1.3.9, our customized management software, and software for file transfer protocol access, a domain name server and a variety of e-mail servers.

Ÿ

substantial management capability of our server appliances in each appliance independently or using our AdminEngine to manage a cluster of appliances;

Ÿ

support for both Windows and Linux operating systems; and

Ÿ

an intuitive user interface for ease of installation, configuration and management.

Ÿ

Internet browser interface.    AdminEngine utilizes any standard browser software for presentation of its Java-based user interface. The AdminEngine interface was designed for easy navigation from screen to screen and the ability to present an easy-to-understand top-level interface that can also present detailed technical information to the more experienced administrator.

Ÿ

Rules-based decision-making.    AdminEngine enables users to develop a set of rules for management actions based on the information reported to AdminEngine from other appliances in the cluster. Rules may be based on error or performance conditions, and actions can range from simple notification to a complex series of management responses.

Ÿ

Cluster management bus control.    AdminEngine manages the connections between appliances grouped in a cluster using a cluster management bus, which does not rely on a normal network connection. This device automatically recognizes new appliances when they are first connected and assigns addresses for future reference. It subsequently uses the cluster management bus software and associated application logic to communicate with appliances if they are no longer responding on the network.

Ÿ

to plan and build an integrated program addressing both internal and external audiences, including prospects, customers, business and trade press, industry analysts and investors;

Ÿ

to position us as a leader in providing a wide range of server appliances for the Internet;

Ÿ

to design and implement media and tactical programs that communicate effectively with our target audiences; and

Ÿ

to clearly and consistently communicate our positioning in our marketing programs.

Ÿ

reduce our capital expenditures;

Ÿ

conserve the working capital that would be required to fund inventory;

Ÿ

adjust manufacturing volumes more quickly to meet changes in demand; and

Ÿ

operate with reduced space dedicated to manufacturing operations.

Name		Age		Position
Lawrence A. Genovesi		42		Chairman of the Board of Directors, President, Chief Executive Officer and Chief Technology Officer
Douglas G. Bryant		43		Vice President of Administration, Chief Financial Officer, Treasurer and Secretary
Timothy J. Dalton		49		Vice President of Manufacturing
William B. Elliott		56		Vice President of Marketing
Rene E. Thibault		49		Vice President of Sales
Gregory A. Baryza		53		Vice President of Engineering
Robert F. Wambach		40		Vice President of Strategic Technology Relationships

		High		Low
Fourth Quarter (from July 13, 2000)		$45.375		$24.875

		Year ended September 30,
		1996			1997			1998			1999			2000
Net product revenues		$1,515			$    609			$  1,102			$  6,031			$  38,216
Net license revenues		—			—			—			—			4,858
Total net revenues		1,515			609			1,102			6,031			43,074
Cost of product revenues		718			465			1,591			4,733			26,695
Cost of license revenues		—			—			—			—			34
Total cost of revenues		718			465			1,591			4,733			26,729
Gross profit (loss)		797			144			(489	)		1,298			16,345
Operating expenses:
Research and development		169			395			923			2,564			8,219
Selling and marketing		233			477			1,593			2,920			15,760
General and administrative		268			396			620			934			3,963
Stock compensation		—			—			—			127			2,921
Total operating expenses		670			1,268			3,136			6,545			30,863
Income (loss) from operations		127			(1,124	)		(3,625	)		(5,247	)		(14,518	)
Other income (expense), net		(69	)		(33	)		(574	)		(897	)		2,037
Income (loss) before extraordinary item		58			(1,157	)		(4,199	)		(6,144	)		(12,481	)
Extraordinary gain on extinguishment of debt		—			—			—			314			—
Net income (loss)		58			(1,157	)		(4,199	)		(5,830	)		(12,481	)
Accretion of redeemable convertible preferred stock		—			—			—			(223	)		(8,103	)
Net income (loss) attributable to common stockholders		$    58			$(1,157	)		$(4,199	)		$(6,053	)		$(20,584	)
Income (loss) per common share before extraordinary item—basic and      diluted		$  0.02			$  (0.36	)		$  (1.31	)		$  (1.92	)		$    (1.99	)
Extraordinary item per common share—basic and diluted		—			—			—			0.09			—
Net income (loss) per common share—basic and diluted		$  0.02			$  (0.36	)		$  (1.31	)		$  (1.83	)		$    (1.99	)
Shares used in computing basic and diluted net income (loss) per common      share		3,025			3,177			3,200			3,312			10,344
Pro forma net income (loss) per common share—basic and diluted      (unaudited)		0.02			(0.30	)		(0.92	)		(0.63	)		(0.50	)
Shares used in computing basic and diluted pro forma net loss per common      share (unaudited)		3,025			3,818			4,589			9,242			25,129
		September 30,
		1996			1997			1998			1999			2000
Balance Sheet Data:
Cash, cash equivalents and restricted cash		$    32			$      16			$    113			$  1,535			$112,429
Working capital (deficit)		205			(97	)		(3,937	)		1,897			128,332
Total assets		804			699			1,730			5,864			146,212
Long-term debt, less current portion		82			58			69			158			90
Redeemable convertible preferred stock		—			1,000			1,000			12,467			—
Total stockholders’ equity (deficit)		227			(953	)		(4,554	)		(9,897	)		135,476

Fiscal Quarter Ending		Expected Amortization of Stock Compensation
		(in thousands)
December 31, 2000		$1,007
March 31, 2001		995
June 30, 2001		936
September 30, 2001		936

		1996			1997			1998			1999			2000
As a Percentage of Net Revenues:
Net product revenues		100	%		100	%		100	%		100	%		89	%
Net license revenues		—			—			—			—			11
Total net revenues		100			100			100			100			100
Cost of product revenues		47			76			144			78			62
Cost of license revenues		—			—			—			—			—
Total cost of revenues		47			76			144			78			62
Gross profit (loss)		53			24			(44	)		22			38
Operating expenses:
Research and development		11			65			84			43			19
Selling and marketing		15			79			145			48			37
General and administrative		18			65			56			15			9
Stock compensation		—			—			—			2			7
Total operating expenses		44			209			285			108			72
Income (loss) from operations		9			(185	)		(329	)		(86	)		(34	)
Other income (expense), net		(5	)		(5	)		(52	)		(15	)		5
Income (loss) before extraordinary item		4			(190	)		(381	)		(101	)		(29	)
Extraordinary gain on extinguishment of debt		—			—			—			5			—
Net Income (loss)		4	%		(190	)%		(381	)%		(96	)%		(29	)%

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the costs and timing of expansion of sales and marketing activities;

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the costs and timing of expansion of product development efforts and the success of these development efforts;

Ÿ

the extent to which our existing and new products gain market acceptance;

Ÿ

the level and timing of license revenues;

Ÿ

the costs involved in maintaining and enforcing intellectual property rights;

Ÿ

market developments;

Ÿ

the costs and timing of expanding and improving our facilities;

Ÿ

available borrowings under line of credit arrangements; and

Ÿ

other factors.

Ÿ

increase our direct sales and marketing activities;

Ÿ

develop our technology, expand our existing product lines and create and market additional server appliance products;

Ÿ

make additional investments to develop our brand;

Ÿ

develop strategic alliances with third-party technology vendors;

Ÿ

expand our distribution and reseller channels; and

Ÿ

implement additional internal systems, develop additional infrastructure and hire additional management to keep pace with our growth.

Ÿ

the growth and changing requirements of the server appliance market;

Ÿ

the performance, quality, price and total cost of ownership of our products;

Ÿ

the availability, price, quality and performance of competing products and technologies; and

Ÿ

the successful development of our relationships with licensed manufacturers, OEMs and existing and potential channel partners.

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be time-consuming to defend;

Ÿ

result in costly litigation;

Ÿ

divert our management’s attention and resources;

Ÿ

cause product shipment delays; or

Ÿ

require us to enter into royalty or licensing agreements.

Ÿ

adverse effects on our reported operating results due to accounting charges associated with the acquisitions;

Ÿ

difficulties in management and integration of the acquired business;

Ÿ

increased expenses, including compensation expense resulting from newly-hired employees;

Ÿ

diversion of management resources and attention; and

Ÿ

potential disputes with sellers of acquired businesses, technologies, services or products.

Ÿ

the loss of or delay in market acceptance and sales of our products;

Ÿ

diversion of development resources;

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injury to our reputation; or

Ÿ

increased maintenance and warranty costs.

		Page
REPORT OF INDEPENDENT ACCOUNTANTS		41
CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 1999 AND 2000		42
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEARS ENDED SEPTEMBER 30,      1998, 1999 AND 2000		43
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (DEFICIT) FOR THE YEARS      ENDED SEPTEMBER 30,1998, 1999 AND 2000		44
CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED SEPTEMBER 30,      1998, 1999 AND 2000		45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS		46

/s/    PRICEWATERHOUSE COOPERS LLP

PricewaterhouseCoopers LLP

		September 30,
		1999			2000
ASSETS
Current assets:
Cash and cash equivalents		$    1,435			$112,382
Restricted cash		100			47
Accounts receivable, net of allowance for doubtful accounts of $227 and $370 at September 30, 1999 and             2000, respectively		2,025			11,805
Inventories		1,251			6,600
Prepaid expenses and other current assets		222			1,031
Due from contract manufacturer		—			7,113
Total current assets		5,033			138,978
Property and equipment, net		831			7,098
Other assets		—			136
Total assets		$    5,864			$146,212
LIABILITIES , REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT )
Current liabilities:
Accounts payable		$    2,354			$    6,906
Accrued compensation and other related benefits		98			1,773
Other accrued expenses		516			1,077
Deferred revenue		105			827
Current portion of capital lease obligations and notes payable		63			63
Total current liabilities		3,136			10,646
Capital lease obligations and notes payable, net of current portion		158			90
Commitments and contingencies (Note 10)
Redeemable convertible preferred stock:
Series C redeemable convertible preferred stock, $.01 par value, 1,123,549 shares authorized, issued and             outstanding at September 30, 1999 and no shares authorized, issued and outstanding at September 30,             2000		8,705			—
Series B redeemable convertible preferred stock, $.01 par value, 360,000 authorized and 357,142 shares issued             and outstanding at September 30, 1999 and no shares authorized, issued and outstanding at September 30,             2000		2,750			—
Series A redeemable convertible preferred stock, $.01 par value, 185,250 shares authorized, issued and             outstanding at September 30, 1999 and no shares authorized, issued and outstanding at September 30,             2000		1,012			—
Total redeemable convertible preferred stock		12,467			—
Stockholders’ equity (deficit):
Preferred stock, $.01 par value, no shares authorized, issued and outstanding at September 30, 1999 and             5,000,000 authorized, no shares issued and outstanding at September 30, 2000		—			—
Common stock, $.01 par value, 60,000,000 and 100,000,000 shares authorized; 3,429,862 and 34,218,585             shares issued and outstanding at September 30, 1999 and 2000, respectively		34			342
Additional paid-in capital		2,942			171,314
Accumulated deficit		(11,434	)		(23,915	)
Note receivable from stockholder		—			(94	)
Deferred stock compensation		(1,439	)		(12,171	)
Total stockholders’ equity (deficit)		(9,897	)		135,476
Total liabilities, redeemable convertible preferred stock and stockholders’ equity (deficit)		$    5,864			$146,212

		Year ended September 30,
		1998			1999			2000
Net product revenues		$  1,102			$  6,031			$  38,216
Net license revenues		—			—			4,858
Total net revenues		1,102			6,031			43,074
Cost of product revenues (excluding stock compensation of $16 and $254 for      the years ended September 30, 1999 and 2000, respectively)		1,591			4,733			26,695
Cost of license revenues		—			—			34
Total cost of revenues		1,591			4,733			26,729
Gross profit (loss)		(489	)		1,298			16,345
Operating expenses:
Research and development (excluding stock compensation of $37 and $430                for the years ended September 30, 1999 and 2000, respectively)		923			2,564			8,219
Selling and marketing (excluding stock compensation of $53 and $1,217                for the years ended September 30, 1999 and 2000, respectively)		1,593			2,920			15,760
General and administrative (excluding stock compensation of $25 and                $1,020 for the years ended September 30, 1999 and 2000,                respectively)		620			934			3,963
Stock compensation		—			127			2,921
Total operating expenses		3,136			6,545			30,863
Loss from operations		(3,625	)		(5,247	)		(14,518	)
Interest income		18			52			2,197
Interest expense		(592	)		(949	)		(60	)
Loss on disposal of property and equipment		—			—			(100	)
Loss before extraordinary item		(4,199	)		(6,144	)		(12,481	)
Extraordinary gain on extinguishment of debt		—			314			—
Net loss		(4,199	)		(5,830	)		(12,481	)
Accretion of redeemable convertible preferred stock		—			(223	)		(8,103	)
Net loss attributable to common stockholders		$(4,199	)		$(6,053	)		$(20,584	)
Loss per common share before extraordinary item—basic and diluted		$  (1.31	)		$  (1.92	)		$    (1.99	)
Extraordinary item per common share—basic and diluted		—			0.09			—
Net loss per common share—basic and diluted		$  (1.31	)		$  (1.83	)		$    (1.99	)
Shares used in computing basic and diluted net loss per common share		3,200			3,312			10,344
Pro forma net loss per common share—basic and diluted (unaudited)		$  (0.92	)		$  (0.63	)		$    (0.50	)
Shares used in computing basic and diluted pro forma net loss per common      share (unaudited)		4,589			9,242			25,129

		Common Stock				Additional Paid-in Capital			Accumulated Deficit			Note Receivable from Stockholder			Deferred Stock Compensation			Total Stockholders’ Equity (Deficit)
		Shares		Amount
Balance, September 30, 1997		3,182,250		$  32		$      420			$  (1,405	)		$—			$        —			$      (953	)
Issuance of restricted common stock		225,000		2		15												17
Issuance of common stock warrants in     connection with bridge loans						581												581
Net loss									(4,199	)								(4,199	)
Balance, September 30, 1998		3,407,250		34		1,016			(5,604	)		—			—			(4,554	)
Issuance costs associated with Series C     redeemable convertible preferred     stock						(188	)											(188	)
Issuance of common stock upon stock     option exercise		22,612		—		2												2
Issuance of common stock warrants in     connection with bridge loans						608												608
Issuance of common stock warrants in     connection with Series C redeemable     convertible preferred stock						157												157
Issuance of common stock options to     consultants and compensation     expense for stock option     modifications						4												4
Deferred stock compensation related to     grants of stock options						1,566									(1,566	)		—
Amortization of deferred stock     compensation to expense															127			127
Accretion of redeemable convertible     preferred stock to redemption     value						(223	)											(223	)
Net loss									(5,830	)								(5,830	)
Balance, September 30, 1999		3,429,862		34		2,942			(11,434	)		—			(1,439	)		(9,897	)
Issuance of restricted common stock		650,000		6		221						(90	)					137
Issuance costs associated with Series D     redeemable convertible preferred     stock						(82	)											(82	)
Issuance of common stock upon initial     public offering, net of issuance     costs		7,475,000		75		116,809												116,884
Conversion of redeemable convertible     preferred stock to common stock in     connection with the initial public     offering		21,448,442		214		45,606												45,820
Issuance of common stock upon stock     option exercises		650,577		7		66												73
Issuance of common stock upon     warrant exercises		564,704		6		202												208
Interest on note receivable from     stockholder												(4	)					(4	)
Deferred stock compensation related to     grants of stock options						13,916									(13,916	)		—
Amortization of deferred stock     compensation to expense															2,921			2,921
Deferred compensation related to     cancellation of stock options for     terminated employees						(263	)								263			—
Accretion of redeemable convertible     preferred stock to redemption     value						(8,103	)											(8,103	)
Net loss									(12,481	)								(12,481	)
Balance, September 30, 2000		34,218,585		$342		$171,314			$(23,915	)		$(94	)		$(12,171	)		$135,476

		Year ended September 30,
		1998			1999			2000
Cash flows from operating activities:
Net loss		$(4,199	)		$(5,830	)		$(12,481	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		194			361			1,353
Provision for inventory reserve		350			663			1,036
Amortization of discount on notes payable		348			841			—
Provision for doubtful accounts		50			120			176
Gain on extinguishment of debt		—			(314	)		—
Compensation expense related to common stock options		—			127			2,921
Interest on note receivable from stockholder		—			—			(4	)
Loss on disposal of property and equipment		—			—			100
Changes in operating assets and liabilities:
Accounts receivable		(427	)		(1,653	)		(9,956	)
Inventories		(587	)		(1,327	)		(6,385	)
Prepaid expenses and other current assets		(71	)		(136	)		(809	)
Due from contract manufacturer		—			—			(7,113	)
Accounts payable		447			1,602			4,552
Accrued compensation and related benefits and other accrued expenses		458			329			2,236
Deferred revenue		29			76			722
Net cash used in operating activities		(3,408	)		(5,141	)		(23,652	)
Cash flows from investing activities:
Purchase of property and equipment		(343	)		(623	)		(7,727	)
Proceeds from sale of property and equipment		—			—			7
Change in restricted cash		—			(100	)		53
Increase in other assets		—			—			(136	)
Net cash used in investing activities		(343	)		(723	)		(7,803	)
Cash flows from financing activities:
Proceeds from bridge loans		3,950			1,100			—
Proceeds from notes payable		4			56			2,205
Payments on capital lease obligations and notes payable		(123	)		(128	)		(2,273	)
Proceeds from issuance of common stock, net of issuance costs		17			2			117,302
Proceeds from issuance of redeemable convertible preferred stock, net of issuance              costs		—			6,156			25,168
Net cash provided by financing activities		3,848			7,186			142,402
Net increase in cash and cash equivalents		97			1,322			110,947
Cash and cash equivalents, beginning of year		16			113			1,435
Cash and cash equivalents, end of year		$    113			$  1,435			$112,382
Supplemental cash flow information:
Interest paid		$      29			$      36			$        55
Non-cash transactions:
Acquisition of property and equipment under capital leases		$    101			$    117			$        —
Bridge loans and accrued interest converted to Series B and C redeemable convertible              preferred stock		$      —			$  5,057			$        —
Restricted common stock issued in exchange for note receivable from stockholder		$      —			$      —			$        90
Redeemable convertible preferred stock converted to common stock		$      —			$      —			$  45,820

		As of September 30,
		1998		1999		2000
Options to purchase common stock		608		1,937		4,381
Warrants to purchase common stock		1,895		2,350		1,786
Unvested restricted common stock		132		57		556
		2,635		4,344		6,723

		September 30,
		1999		2000
Raw materials		$  845		$3,524
Work in process		120		847
Finished goods		286		2,229
		$1,251		$6,600

				September 30,
		Useful Life		1999		2000
Office furniture and equipment		5 years		$  351		$1,465
Engineering and production equipment		3 years		404		1,755
Computer equipment and software		3 years		642		2,879
Leasehold improvements		Lesser of 3 years or lease term		210		2,118
Demonstration equipment		1.5—3 years		—		978
				1,607		9,195
Less: accumulated depreciation and amortization				776		2,097
				$  831		$7,098

Year ended September 30,
2001		$  76
2002		63
2003		14
Total payments		153
Less amounts representing interest		21
Present value of future minimum payments		132
Less amount due within one year		63
Long-term portion		$  69

		Redeemable Convertible Preferred Stock
		Shares			Amount
Balance, September 30, 1997 and 1998		185,250			$    1,000
January 1999 issuance of Series B redeemable convertible      preferred stock upon conversion of bridge loans		357,142			2,750
January 1999 issuance of Series C redeemable convertible      preferred stock upon conversion of bridge loans		299,631			2,307
June 1999 issuance of Series C redeemable convertible      preferred stock for cash		401,816			3,094
Accretion of redeemable convertible preferred stock to      redemption value		—			223
Balance, September 30, 1999		1,665,941			12,467
December 1999 issuance of Series D redeemable convertible      preferred stock for cash		3,581,554			25,250
Accretion of redeemable convertible preferred stock to      redemption value		—			8,103
Conversion of Series A, B, C and D redeemable convertible      preferred stock into common stock upon initial public      offering		(5,247,495	)		(45,820	)
Balance, September 30, 2000		—			$        —

		Number of Options			Weighted Average Exercise Price
Outstanding, October 1, 1997		—			$  —
Granted		882,150			0.07
Exercised		(225,000	)		0.07
Cancelled		(48,750	)		0.07
Outstanding, September 30, 1998		608,400			0.07
Granted		1,593,975			0.14
Exercised		(22,612	)		0.07
Cancelled		(242,610	)		0.08
Outstanding, September 30, 1999		1,937,153			0.13
Granted		3,323,299			6.20
Exercised		(650,577	)		0.11
Cancelled		(229,287	)		2.28
Outstanding, September 30, 2000		4,380,588			$4.62

		Options Outstanding						Options Exercisable
Exercise Price Range		Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)		Number of Options		Weighted Average Exercise Price
$0.07—$0.24		1,912,539		$  0.17		8.70		107,057		$0.14
$1.20—$2.00		1,016,374		$  1.78		9.29		—		$  —
$4.00—$6.00		261,125		$  4.93		9.41		—		$  —
$8.00—$14.50		1,073,550		$11.96		9.69		—		$  —
$26.38—$45.38		117,000		$33.93		9.92		—		$  —
		4,380,588						107,057

		1998						1999						2000
		Net loss attributable to common stockholders			Net loss per common share			Net loss attributable to common stockholders			Net loss per common share			Net loss attributable to common stockholders			Net loss per common share
		(in thousands, except per share data)
As reported		$(4,199	)		$(1.31	)		$(6,053	)		$(1.83	)		$(20,584	)		$(1.99	)
Pro forma		$(4,201	)		$(1.31	)		$(6,066	)		$(1.83	)		$(21,990	)		$(2.13	)

		Common Stock Warrants
		Shares			Exercise Price		Expiration Date
Outstanding, October 1, 1997		249,487			$0.07—$0.53		August 2002—February 2003
Issuance of warrants in connection with                issuance of bridge loans (“1998 bridge                loans”)		1,645,732			$0.37		October 2007—September 2008
Outstanding, September 30, 1998		1,895,219			$0.07—$0.53		August 2002—September 2008
Issuance of warrants in connection with                issuance of bridge loans		798,562			$0.37		November 2008—December 2008
Cancellation of warrants in connection                with conversion of bridge loans into                preferred stock		(549,607	)		$0.37
Issuance of warrants in connection with                issuance of Series C redeemable                convertible preferred stock		206,250			$0.37		January 2009
Outstanding, September 30, 1999		2,350,424			$0.07—$0.53		August 2002—January 2009
Exercise of warrants		(564,704	)		$0.37
Outstanding September 30, 2000		1,785,720			$0.07—$0.53		August 2002—January 2009

Year Ending September 30,
2001		$  887
2002		848
2003		892
2004		916
2005		356
Total		$3,899

		1998			1999			2000
At U.S. federal statutory rate		$(1,428	)		$(1,781	)		$(4,243	)
State taxes, net of federal effect		(261	)		(381	)		(673	)
Research and development credits		(20	)		(92	)		(220	)
Non-deductible stock option compensation charge		—			43			948
Non-deductible expenses and other charges		132			(103	)		(56	)
Effect of change in valuation allowance		1,577			2,314			4,244
Provision for income taxes		$      —			$      —			$      —

		1999			2000
Net operating losses		$2,690			$5,110
Tax credit carryforwards		238			568
Capitalized research and engineering		1,227			1,129
Temporary differences		338			1,931
Total deferred tax asset		4,493			8,738
Valuation allowance		(4,493	)		(8,738	)
Net deferred tax asset		$    —			$    —

		1998		1999		2000
United States		$1,102		$6,031		$41,803
Foreign countries		—		—		1,271
		$1,102		$6,031		$43,074

		Page
Report of Independent Accountants		41
Consolidated Balance Sheet as of September 30, 1999 and 2000		42
Consolidated Statement of Operations for the years ended September 30, 1998, 1999 and 2000		43
Consolidated Statement of Stockholders’ Equity (Deficit) for the years ended September 30, 1998, 1999      and 2000.		44
Consolidated Statement of Cash Flows for the years ended September 30, 1998, 1999 and 2000		45
Notes to Consolidated Financial Statements.		46

NETWORK ENGINES, INC

/S /    LAWRENCE A. GENOVESI

By:

Lawrence A. Genovesi

Chairman of the Board, President, Chief Executive Officer and Chief Technology Officer

Name		Title
/s/    LAWRENCE A. GENOVESI                                                                                                                                     Lawrence A. Genovesi		Chairman of the Board, President, Chief Executive Officer and Chief Technology Officer (Principal Executive Officer)
/s/    DOUGLAS G. BRYANT                                                                                                                                     Douglas G. Bryant		Vice President of Administration, Chief Financial Officer, Treasurer and Secretary (Principal Financial Officer and Principal Accounting Officer)
/s/    JOHN A. BLAESER                                                                                                                                     John A. Blaeser		Director
/s/    LAWRENCE KERNAN                                                                                                                                     Lawrence Kernan		Director
/s/    DENNIS A. KIRSHY                                                                                                                                     Dennis A. Kirshy		Director
/s/    FRANK M. POLESTRA                                                                                                                                     Frank M. Polestra		Director
/s/    MICHAEL H. SHANAHAN                                                                                                                                     Michael H. Shanahan		Director
/s/    ROBERT M. WADSWORTH                                                                                                                                     Robert M. Wadsworth		Director

/s/    PRICEWATERHOUSE COOPERS LLP

PricewaterhouseCoopers LLP

						Additions
Fiscal Year		Description		Balance at Beginning of Period		Charged to Expense		Charged to Revenue		Deductions		Balance at End of Period
1998:		ALLOWANCE FOR DOUBTFUL ACCOUNTS		57		50		—		—		107
1999:		ALLOWANCE FOR DOUBTFUL ACCOUNTS		107		120		—		—		227
2000:		ALLOWANCE FOR DOUBTFUL ACCOUNTS		227		176		—		33		370

Exhibit No.		Exhibit
3.1		Second Amended and Restated Certificate of Incorporation of the Registrant.
3.2		Second Amended and Restated By-laws of the Registrant
*4.1		Specimen common stock certificate
4.2		Agreement and Plan of Merger dated November 7, 2000, among Network Engines, Inc., IPP Acquisition Co. and IP Performance, Inc.
*10.1		Lease dated October 19, 1999 with New Boston Batterymarch, LP for 25 Dan Road, Canton, Massachusetts
*10.2		The Registrant’s 1999 Stock Incentive Plan
*10.3		Form of Incentive Stock Option Agreement under the Registrant’s 1999 Stock Incentive Plan
*10.4		The Registrant’s 2000 Employee Stock Purchase Plan
*10.5		The Registrant’s 2000 Director Stock Option Plan
*10.6		Investor Rights Agreement Investor Rights Agreement, dated December 20, 1999, among the Registrant and certain investors in our preferred stock and warrants.
*10.7		Restricted Stock Agreement with Lawrence Genovesi, dated November 18, 1999, under the 1999 Stock Incentive Plan.
†10.8		Manufacturing and Purchase Agreement, dated August 4, 2000, between the Registrant and SCI Systems, Inc.
*10.9		Restricted Stock Agreement with Dennis Kirshy, dated January 7, 1998, under the 1997 Stock Incentive Plan
*10.10		Restricted Stock Agreement with Dennis Kirshy, dated November 18, 1999, under the 1999 Stock Incentive Plan
*10.11		Restricted Stock Agreement with John Blaeser, dated November 18, 1999, under the 1999 Stock Incentive Plan
*10.12		P6000 Asset Purchase Agreement between the Registrant and Copernicus Systems, Inc. dated April 13, 2000
*10.13		Loan Modification Agreement, dated as of April 5, 2000, between the Registrant and Silicon Valley Bank
*10.14		Restricted Stock Agreement with Michael H. Shanahan, dated April 3, 2000, under the 1999 Stock Incentive Plan
*10.15		Form of option granted to each of Frank M. Polestra, Robert M. Wadsworth and Lawrence Kernan on March 16, 2000
*10.16		Form of First Amendment to the Registrant’s 1999 Stock Incentive Plan
*10.17		License Agreement between the Registrant and International Business Machines Corporation, dated July 19, 1999
*10.18		First Amendment dated February 1, 2000 and Second Amendment dated June 1, 2000 to Lease for 25 Dan Road, Canton, Massachusetts
21.1		Subsidiaries of the Registrant
23.1		Consent of PricewaterhouseCoopers LLP
27.1		Financial Data Schedule

*	Incorporated by reference from exhibits filed with the Company’s registration statement (File No. 333-34286) on Form S-1, as amended, filed under the Securities and Exchange Act of 1933, as amended.

†	Confidential treatment requested as to certain portions, which portions are omitted and filed separately with the Securities and Exchange Commission pursuant to a Confidential Treatment Request.