<PAGE>
As filed with the Securities and Exchange Commission on July 10, 2000
Registration No. 333-34286
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------
AMENDMENT No. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
-----------
NETWORK ENGINES, INC.
(Exact name of registrant as specified in its charter)
Delaware 3572 04-3064173
(State or other (Primary Standard (I.R.S. Employer
jurisdiction of Industrial Identification Number)
incorporation or Classification Code
organization) Number)
25 Dan Road, Canton, Massachusetts 02021-2817
(781) 828-6767
(Address Including Zip Code, and Telephone Number Including Area Code, of
Registrant's Principal Executive Offices)
-----------
Lawrence A. Genovesi
Network Engines, Inc.
Chairman of the Board, President, Chief Executive Officer and Chief Technology
Officer
25 Dan Road, Canton, Massachusetts 02021-2817
(781) 828-6767
(Name, Address Including Zip Code and Telephone Number Including Area Code, of
Agent for Service)
-----------
Copies to:
Philip P. Rossetti, Esq. Michael A. Conza, Esq.
Hale and Dorr LLP Testa, Hurwitz & Thibeault, LLP
60 State Street, Boston, Massachusetts 125 High Street, Boston, Massachusetts
02109 02110
Telephone: (617) 526-6000 Telephone: (617) 248-7000
Telecopy: (617) 526-5000 Telecopy: (617) 248-7100
-----------
Approximate date of commencement of proposed sale to the public: As soon as
practicable after the effective date hereof.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the
same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the
same offering. [_]
If delivery of the Prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
-----------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933 or until the Registration Statement shall become
effective on such date as the Commission, acting pursuant to said Section 8(a),
may determine.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+We will amend and complete the information in this prospectus. Although we +
+are permitted by U.S. federal securities laws to offer these securities using +
+this prospectus, we may not sell them or accept your offer to buy them until +
+the documentation filed with the SEC relating to these securities has been +
+declared effective by the SEC. This prospectus is not an offer to sell these +
+securities or our solicitation of your offer to buy these securities in any +
+jurisdiction where that would not be permitted or legal. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION--July 10, 2000
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Prospectus
, 2000
[LOGO OF NETWORK ENGINES]
5,500,000 Shares of Common Stock
--------------------------------------------------------------------------------
<TABLE>
<S> <C>
Proposed Symbol & . The underwriters
Market: have an option to
purchase up to
. We have applied 825,000 additional
for quotation on shares from us to
the Nasdaq cover over-
National Market allotments.
under the symbol
"NENG."
. This is our
initial public
offering and we
anticipate that
the initial public
offering price
will be between
$13.00 and $15.00
per share.
The Offering:
. We are offering to
the public
5,500,000 shares
of our common
stock.
. Closing: ,
2000.
</TABLE>
--------------------------------------------
<TABLE>
<CAPTION>
Per
Share Total
-------------------------------------------
<S> <C> <C>
Public offering price: $ $
Underwriting fees:
Proceeds to Network Engines:
-------------------------------------------
</TABLE>
This investment involves risk. See "Risk Factors" beginning on page 5.
--------------------------------------------------------------------------------
Neither the SEC nor any state securities commission has determined whether this
prospectus is truthful or complete. Nor have they made, nor will they make, any
determination as to whether anyone should buy these securities. Any
representation to the contrary is a criminal offense.
--------------------------------------------------------------------------------
Donaldson, Lufkin & Jenrette
Dain Rauscher Wessels
Robertson Stephens
DLJdirect Inc.
<PAGE>
[The inside front cover includes a depiction of groupings of varying numbers
of our WebEngine Roadster server appliances which are connected by gold colored
lines to a gold circle. In turn, inside the gold circle is a depiction of an
Internet browser which can be used to manage the groupings of server appliances
through the Internet. In the upper right-hand corner of the graphic, the
following text appears:
Integrated Remote Management
. Lights Out Control
. Single-location, Browser-based Interface
. Rules-based Notification Levels
. Limits Need for On-site Technicians
Beneath the graphic is the following text:
Internet Server Appliances
. Powerful Web Content Servers
. Choices of Appliances to Meet Specific Customer Needs
. Clustered to Deliver High Performance
. Can be Placed in Multiple Locations to Reduce Network Delay
. Integrated Hardware and Software Management Features
Above the graphic is our logo.]
<PAGE>
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of the
prospectus or any sale of the common stock.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Prospectus Summary................. 1
Risk Factors....................... 5
Forward-Looking Statements and
Industry Data..................... 17
Assumptions that Apply to this
Prospectus........................ 17
Use of Proceeds.................... 18
Dividend Policy.................... 18
Capitalization..................... 19
Dilution........................... 20
Selected Financial Data............ 21
Management's Discussion and
Analysis of Results of Operations
and Financial Conditions.......... 24
</TABLE>
<TABLE>
<CAPTION>
Page
<S> <C>
Business......................... 35
Management....................... 49
Related Party Transactions....... 58
Principal Stockholders........... 62
Description of Capital Stock..... 64
Shares Eligible For Future Sale.. 68
Underwriting..................... 71
Legal Matters.................... 73
Experts.......................... 74
Where You Can Find Additional
Information..................... 74
Index To Financial Statements.... F-1
</TABLE>
We have applied for a trademark registration for "Network Engines," and our
trademarks, among others, include "WebEngine Roadster NT," "WebEngine Roadster
LX," "WebEngine Viper NT," "WebEngine Viper LX," "AdminEngine" and
"CommerceEngine." This prospectus also contains other trademarks, servicemarks
and tradenames that are the property of other parties.
i
<PAGE>
PROSPECTUS SUMMARY
You should read the following summary together with the more detailed
information regarding our company and the common stock we are offering and the
financial statements and related notes to those statements that appear
elsewhere in this prospectus.
Network Engines, Inc.
We develop, market and provide integrated and powerful server appliances
that enable organizations to provide information and applications over the
Internet. Server appliances are a new category of computer network
infrastructure devices that deliver specific functionality through a
combination of pre-packaged hardware and software. Unlike general-purpose
servers, our server appliances are high-powered, compact products that use
either Windows or Linux operating systems and support a range of applications
and are available with varying amounts of computing power. Our server
appliances are scalable, which means that our server appliances can be used as
standalone devices or can be easily and quickly connected in groups, or
clusters, of up to 256 units to meet different management and performance
requirements. Our server appliances are designed to meet the complex needs and
requirements of e-commerce and Internet-based organizations, including "dot
com" companies, web hosting providers, application service providers and
Internet service providers.
We offer a broad range of server appliance products that enable our
customers to create Internet content delivery systems with a wide range of
power at a reduced total cost of ownership. Our server appliances are easy to
install and configure and are designed to meet our customers' needs by
combining specific application functionality within small physical packaging.
In addition, our server appliance products contain integrated hardware and
software features that allow multiple units or groups of units to be managed
from a single location with "lights out" management. Lights out management is
the management of the appliance remotely without the assistance of any on-site
technicians.
The openness and accessibility of the Internet enable large and small
organizations to enter this competitive environment by creating Internet sites
and establishing their own network infrastructures. New and emerging
organizations hoping to grow, and well-financed organizations hoping to
increase market share, typically seek to reduce "time-to-revenue," the length
of time between developing their online ideas and the availability of their web
sites to their potential customers. The increase in Internet traffic and demand
for greater bandwidth has resulted in more utilization of remote server
facilities, including those specifically designed to house servers for
Internet-related businesses. These remote facilities are often referred to as
co-location facilities.
Traditionally, organizations have built their Internet solutions with
general-purpose servers, requiring extensive time and technical resources. To
extend the power and features of a general-purpose server, organizations must
integrate numerous discrete hardware and software elements, including operating
systems, applications, security systems, management tools and load balancers,
which are devices that direct internet traffic servers in a cluster. This
approach is not well-suited for use in remote server facilities because it
typically creates large, complex systems that require substantial facility
space. In addition, few vendors, if any, provide the ability to manage these
systems remotely without any on-site technicians. When organizations use
general-purpose servers to handle Internet traffic, they typically face a
higher total cost of ownership because equipment costs, facility costs and
operating expenses for general-purpose servers are high and time-to-revenue is
increased.
1
<PAGE>
Server appliances were developed to address the shortcomings of general-
purpose servers. International Data Corporation estimates that the worldwide
market for server appliances will grow to $8.0 billion in 2003 from
approximately $214.6 million in 1999, a compounded annual growth rate of 147%.
As market acceptance of server appliances grows, we expect that users will
increasingly demand products that meet specific functional requirements and
reduce total cost of ownership factors, including time-to-revenue, packaging
density, installation and management functionality.
We have assembled a research and development team of highly-skilled
engineers with significant experience in high-density packaging, server design,
embedded management, networking and software. We believe that this team will
allow us to build upon our current technology platforms and expand the features
and functionality of our suite of server appliances. We sell our products
through a direct sales organization and through a network of channels that
includes systems integrators, distributors and licensed manufacturers. In
fiscal 1999, we had net revenues of $6.0 million and a net loss of $5.8
million. For the six months ended March 31, 2000, we had net revenues of $10.5
million and a net loss of $5.8 million.
Our objective is to become the leading global provider of Internet server
appliances. We intend to increase market acceptance of server appliances for
Internet-based applications by providing and expanding our range of specific-
purpose server appliances that can be easily grouped to increase application
power and can be easily integrated into managed clusters.
--------------------
Our principal executive offices are located at 25 Dan Road, Canton,
Massachusetts 02021-2817 and our telephone number is (781) 828-6767. Our World
Wide Web site address is www.networkengines.com. The information on our web
site is not incorporated by reference into this prospectus.
2
<PAGE>
The Offering
<TABLE>
<C> <S>
Common stock offered................................ 5,500,000 shares
Common stock to be outstanding after this offering.. 31,923,629 shares
Use of proceeds..................................... For potential
acquisitions of
businesses, technologies
or products, additional
working capital and
general corporate
purposes. See "Use of
Proceeds."
Proposed Nasdaq National Market symbol.............. NENG
</TABLE>
The number of shares that will be outstanding after the offering is based on
the number of shares outstanding as of April 30, 2000 and excludes:
. 3,721,615 shares of common stock issuable upon exercise of stock options
outstanding as of April 30, 2000, with a weighted average exercise price
of $1.54 per share, of which options to purchase 56,505 shares were then
exercisable;
. 1,882,851 shares of common stock reserved for issuance upon exercise of
warrants outstanding as of April 30, 2000, with a weighted average
exercise price of $0.35 per share; and
. 4,506,035 shares of common stock reserved for future grant under our
stock plans.
See "Capitalization," "Management--Benefit Plans" and "Description of
Capital Stock."
3
<PAGE>
Summary Financial Data
(in thousands, except per share data)
The following summary financial data should be read in conjunction with our
financial statements and related notes and with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and other financial
data. The statement of operations data for the years ended September 30, 1998
and 1999 is derived from audited financial statements included elsewhere in
this prospectus. The statement of operations data for the three months ended
December 31, 1998, March 31, 1999, June 30, 1999, September 30, 1999, December
31, 1999 and March 31, 2000 and the balance sheet data as of March 31, 2000 are
derived from our unaudited financial statements.
Unaudited pro forma basic and diluted net loss per share have been
calculated assuming the conversion of all outstanding shares of our series A,
series B, series C and series D preferred stock into shares of common stock, as
if the shares had converted immediately upon issuance.
<TABLE>
<CAPTION>
Year Ended Three Months Ended
September 30, ---------------------------------------------------------------------
---------------- December 31, March 31, June 30, September 30, December 31, March 31,
1998 1999 1998 1999 1999 1999 1999 2000
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Net revenues............ $ 1,102 $ 6,031 $ 223 $ 893 $ 908 $ 4,007 $ 4,415 $ 6,051
Gross profit (loss)..... (489) 1,298 (162) 10 (96) 1,546 1,802 1,859
Loss from operations.... (3,625) (5,247) (1,240) (1,325) (1,757) (925) (1,616) (4,501)
Net loss................ (4,199) (5,830) (2,170) (1,000) (1,753) (907) (1,586) (4,221)
Net loss attributable to
common stockholders.... (4,199) (6,053) (2,170) (1,009) (1,763) (1,111) (2,396) (7,670)
Pro forma net loss per
common share--basic and
diluted................ $ (0.63) $ (0.16)
======= =======
Shares used in computing
pro forma basic and
diluted net loss per
common share........... 9,242 25,722
</TABLE>
The pro forma balance sheet data reflects the conversion of all outstanding
shares of redeemable convertible preferred stock into common stock upon
completion of this offering. The pro forma as adjusted balance sheet data
further adjusts the pro forma data to give effect to the sale of 5,500,000
shares of common stock offered hereby at the assumed initial public offering
price of $14.00 per share, less underwriting discounts and commissions and
estimated offering expenses.
<TABLE>
<CAPTION>
As of March 31, 2000
----------------------------
Pro Pro Forma
Actual Forma As Adjusted
<S> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and restricted cash......... $17,172 $17,172 $87,782
Working capital.................................... 20,497 20,497 91,107
Total assets....................................... 29,979 29,979 100,589
Long-term debt, less current portion............... 109 109 109
Redeemable convertible preferred stock............. 41,976 -- --
Total stockholders' equity (deficit)............... (18,898) 23,078 93,688
</TABLE>
4
<PAGE>
RISK FACTORS
An investment in our common stock involves a high degree of risk. You should
consider the following risks and the other information in this prospectus
before deciding to invest in our common stock. Our business and results of
operations could be seriously harmed by any of the following risks. The trading
price of our common stock could decline due to any of these risks, and you may
lose part or all of your investment.
Risks Related to Our Financial Results
You may have difficulty evaluating our business and operating results because
we began selling our current products in June 1999, February 2000 and the third
quarter of fiscal 2000.
We are an early-stage company in the new and rapidly evolving market for
server appliances. Because of our limited operating history in the server
appliance market, it is difficult to discern trends that may emerge and affect
our business. We did not begin shipping our current products until quite
recently. We began shipping our WebEngine Blazer and AdminEngine in June 1999
and February 2000, respectively. We began shipping our WebEngine Roadster and
WebEngine Viper products in the third quarter of fiscal 2000. Our limited
historical financial performance may make it difficult for you to evaluate the
success of our business to date and to assess its future viability.
We have a history of losses and may experience losses in the future, which
could result in the market price of our common stock declining.
Since our inception, we have incurred significant net losses, including net
losses of $4.2 million in 1998, $5.8 million in 1999 and $5.8 million for the
six months ended March 31, 2000 and we expect to have net losses in the future.
In addition, we had an accumulated deficit of $17.2 million as of March 31,
2000. We believe that our future growth depends upon the success of our new
product development and sales and marketing efforts, which will require us to
incur significant product development, sales and marketing and administrative
expenses. As a result, we will need to generate significant revenues to achieve
profitability. We cannot be certain that we will achieve profitability in the
future or, if we achieve profitability, that we will be able to sustain it. If
we do not achieve and maintain profitability, the market price for our common
stock may decline, perhaps substantially.
We anticipate that our expenses will increase substantially in the next 12
months as we:
. increase our direct sales and marketing activities;
. develop our technology, expand our existing product lines and create and
market additional server appliance products;
. make additional investments to develop our brand;
. develop strategic alliances with third-party technology vendors;
. expand our distribution and reseller channels; and
. implement additional internal systems, develop additional infrastructure
and hire additional management to keep pace with our growth.
5
<PAGE>
Any failure to significantly increase our revenues and control costs as we
implement our product and distribution strategies would also harm our ability
to achieve and maintain profitability and could negatively impact the market
price of our common stock.
We may not be able to sustain our current revenue growth rates, which could
cause our stock price to decline.
Although our revenues grew in 1998, grew rapidly in 1999 and have grown
rapidly to date in 2000, we do not believe that we will maintain this rate of
revenue growth. This is because we started from a small base of revenue and it
is difficult to achieve high percentage increases over a larger revenue base.
In addition, growing competition, the incremental manner in which customers
implement server appliances and our inexperience in selling our products could
also affect our revenue growth. Any significant decrease in our rate of revenue
growth after this offering could result in a decrease in our stock price.
We derive a substantial portion of our revenues from a small number of
customers, and our revenues may decline significantly if any major customer
cancels or delays a purchase of our products.
A relatively small number of customers accounted for a significant portion
of our net revenues. In the fiscal year ended September 30, 1999, sales to
InterVu, International Business Machines, or IBM, and Microsoft (WebTV)
accounted for 46%, 28% and 14% of net revenues, respectively. In the six months
ended March 31, 2000, sales to IBM, Microsoft (WebTV) and Tellme Networks,
accounted for 26%, 18% and 14% of net revenues, respectively. None of our
customers, including our licensed manufacturers and OEMs, is obligated to
purchase any quantity of our products in the future. If any of our large
customers stop purchasing from us or delay future purchases, our revenues and
profitability may be adversely affected, our reputation in the industry may
suffer and our ability to predict cash flow accurately may decrease. Revenues
from a relatively small number of our licensed manufacturer, OEM and direct
sales customers may account for a significant portion of our net revenues.
Accordingly, unless and until we diversify and expand our customer base, our
future success will depend upon the timing and size of future purchase orders,
if any, from our largest customers and, in particular:
. the success of our licensed manufacturer and OEM customers in marketing
our products;
. the product requirements of our direct sales customers; and
. the financial and operational success of our licensed manufacturer, OEM
and direct sales customers.
In addition, because we have a small number of customers, some of which are
significantly larger than we are, these customers may have increased bargaining
power to seek lower prices and better terms.
Our quarterly revenues and operating results may fluctuate due to a lack of
growth of the server appliance market in general or failure of our products to
achieve market acceptance.
Our quarterly revenues and operating results are difficult to predict and
may fluctuate significantly from quarter to quarter because server appliances
generally and our current products in particular are relatively new and the
future growth of the market for our products is uncertain.
6
<PAGE>
In addition, four of our current server appliance products were released in the
last year, with two released in the current fiscal quarter, and we expect to
rely on additional new products for growth in our net revenues in the future.
If the server appliance market in general fails to grow as expected or our
products fail to achieve market acceptance, our quarterly net revenues and
operating results may fall below the expectations of investors and public
market research analysts. In this event, the price of our common stock could
decline substantially.
If sales of our new or enhanced products are lower than expected, our revenues
and operating results will be adversely affected.
If our customers do not continue to purchase our new and enhanced products,
our revenues and operating results will be adversely affected. Factors that may
affect the market acceptance of our products, some of which are beyond our
control, include the following:
. the growth and changing requirements of the server appliance market;
. the performance, quality, price and total cost of ownership of our
products;
. the availability, price, quality and performance of competing products
and technologies; and
. the successful development of our relationships with licensed
manufacturers, OEMs and existing and potential channel partners.
We may not succeed in developing and marketing new types of server appliance
products, or do so in a timely manner, and our operating results may decline as
a result.
We have recently released our AdminEngine product and are developing
additional types of server appliance products. Developing new products that
meet the needs of the server appliance market requires significant additional
expense and development resources. If we fail to successfully develop and
market new products, our operating results will suffer.
If the commodification of products and competition in the server appliance
market increases, then the average unit price of our products may decrease and
our operating results may suffer.
Products in the server appliance market may be subject to potential
commodification as the industry matures and other businesses introduce
competing products. The average unit price of our products may also decrease in
response to changes in product mix, competitive pricing pressures, or new
product introductions by us or our competitors. If we are unable to offset a
decrease in our average selling prices by increasing our sales volumes, our
revenues will decline. Changes in the mix of sales of our products, including
the mix of higher margin sales of products sold in smaller quantities and
somewhat lower margin sales of products sold in larger quantities, could
adversely affect our operating results for future quarters. To maintain our
gross margins, we also must continue to reduce the manufacturing cost of our
products. Our efforts to produce higher margin products, continue to improve
our products and produce new products may make it difficult to reduce our
manufacturing cost per product. Further, our current reliance on our single
manufacturer, SCI Systems, may not allow us to reduce our cost per product.
7
<PAGE>
Risks Related to Growth of the Internet and the Server Appliance Market
If server appliances are not increasingly adopted as a means to deliver
information and conduct commerce over the Internet, the market for our products
will not grow and the market price for our common stock could decline as a
result of lower revenues or reduced investor expectations.
We expect that substantially all of our revenues will continue to come from
sales of our current and future server appliance products. As a result, we
depend on the growing use of server appliances as a means to deliver
information and conduct commerce over the Internet. The market for server
appliance products, particularly those using the Internet to deliver
information and process commercial transactions, has only recently begun to
develop and is evolving rapidly. Because this market is new, we cannot predict
its potential size or future growth rate. Our revenues may not continue to grow
and the market price for our common stock could decline if the server appliance
market does not grow rapidly.
We believe that our expectations for the growth of the server appliance
market may not be fulfilled if customers continue to use general-purpose
servers. The role of our server appliances could, for example, be limited if
general-purpose servers become better at performing functions currently being
performed by our specific-purpose server appliances or are offered at a lower
cost. This could force us to lower the prices of our products or result in
fewer sales of our products.
If the market for server appliance products does not grow because medium to
large Internet service providers and application service providers in our
target market are not receptive to them, our revenues may not grow.
Large Internet service providers and application service providers that
offer hosting services may not be as receptive to our products as other
organizations because they currently rely on, and their buying programs are
more likely to be based on, established, proprietary operating systems and
general-purpose servers. In addition, we expect that Internet service providers
that specialize in providing Internet access and non-hosting services to
consumers will not be substantial purchasers of our products. Consolidation has
recently begun to occur in the Internet service provider and application
service provider market, with many large Internet service providers and
application service providers acquiring smaller and regional companies.
Continued consolidation in this market could result in some of our customers
being absorbed into larger organizations. This consolidation may increase the
number of larger corporations that may not be as receptive to our products and,
as a result, our revenues would not grow and may even decrease.
Potential increases or changes in governmental regulation of Internet
communication and commerce could discourage the growth of the Internet, which
could decrease the demand for our products.
Due to concerns arising from the increasing use of the Internet, a number of
laws and regulations have been, and may be, adopted covering issues including
user privacy, taxation, pricing, acceptable content and quality of products and
services. Legislative changes could dampen the growth in use of the Internet
generally and decrease the acceptance of the Internet as a communications and
commercial medium. Further, due to the global nature of the Internet, it is
8
<PAGE>
possible that multiple federal, state or foreign jurisdictions might attempt to
regulate Internet transmissions or levy sales or other taxes relating to
Internet-based activities. Moreover, the applicability to the Internet of
existing laws, including laws governing property ownership, libel and personal
privacy, is uncertain. We cannot assess the possible negative impact of any
future regulation of the Internet on our business.
Risks Related to Our Product Manufacturing
Our dependence on sole source and limited source suppliers for key components
makes us susceptible to supply shortages that could prevent us from shipping
customer orders on time, if at all, and could result in lost sales or
customers.
We depend upon single source and limited source suppliers for our industry-
standard processors and power supplies and our custom-printed circuit boards,
chassis and sheet metal parts. We also depend on limited sources to supply
several other industry-standard components. We have in the past experienced,
and may in the future experience, shortages of, or difficulties in acquiring,
components needed to produce our products. In particular, there have also been
recent industry-wide shortages and delays in the production of commodities,
including high-performance processor boards, memory chips and disk drives.
Shortages have been of limited duration and have not yet caused delays in
production of our products. However, shortages in supply of these key
components for an extended time would cause delays in the production of our
products, prevent us from satisfying our contractual obligations and meeting
customer expectations, and result in lost sales or customers. If we are unable
to buy components we need or if we are unable to buy components at acceptable
prices, we will not be able to manufacture and deliver our products on a timely
or cost-effective basis to our customers.
We rely on a single contract manufacturer to produce our products and, if our
manufacturer fails to meet our requirements, we will be unable to meet customer
requirements and our customer relationships would suffer.
We do not have a written agreement with SCI Systems that guarantees
production levels or manufacturing prices and we may not be able to enter into
a written agreement with SCI Systems in the future. SCI Systems may not have
additional facilities available when we need them. Commencing volume production
or expanding production to another facility owned by SCI Systems may be
expensive and time-consuming. In addition, commencement of the manufacturing of
our products at a second SCI Systems manufacturing site or any additional sites
we may need in the future may cause transitional problems, including delays and
quality control issues, that could cause us to lose sales and impair our
ability to achieve profitability. We may need to find new outside manufacturers
to manufacture our products in higher volume and at lower costs to meet
increased demand and competition. If we are required or choose to change
outside manufacturers, we may lose sales and customer relationships may suffer.
If we do not accurately forecast our component requirements, our manufacturing
may be interrupted and delivery of products may be delayed.
We use rolling forecasts based on anticipated product orders to determine
our component requirements. Lead times for materials and components that we
order vary significantly and depend on factors including specific supplier
requirements, contract terms and current market demand for
9
<PAGE>
those components. In addition, a variety of factors, including the timing of
product releases, potential delays or cancellations of orders and the timing of
large orders, make it difficult to predict product orders. As a result, our
component requirement forecasts may not be accurate. If we overestimate our
component requirements, we may have excess inventory, which would increase our
costs. If we underestimate our component requirements, we may have inadequate
inventory, which could interrupt our manufacturing and delay delivery of our
products to our customers. Any of these occurrences would negatively impact our
business and operating results.
Risks Related to Our Marketing and Sales Efforts
We need to expand our direct sales channel and build our indirect sales channel
of system integrators and resellers to distribute our products and, if we fail
to do so, our growth could be limited.
In order to increase market awareness and sales of our products, we will
need to substantially expand our direct sales programs and build our network of
system integrators and resellers, both domestically and internationally. If we
fail in this endeavor, our growth will be limited. To date, we have relied
primarily on our direct sales force to generate demand for our products. We
have recently expanded our direct sales force and plan to hire additional sales
personnel. Competition for qualified sales people is intense, and we might not
be able to hire the quality and number of sales people we require. We have
limited experience working with systems integrators and resellers. We expect we
will need to expend significant resources to enlist systems integrators and
resellers and educate them regarding our products.
We may incur significant costs to promote our brand that may not result in the
desired brand recognition by customers or increased sales.
In the fast growing market for server appliances, we believe we need to
establish a strong brand to compete successfully. In order to attract and
retain customers, we believe that our brand must be recognized and viewed
favorably by our customers and end users. Although we intend to advertise and
promote our brand, these strategies may fail. If we are unable to design and
implement effective marketing campaigns or otherwise fail to promote and
maintain our brand, our sales could decline. Our business may also suffer if we
incur excessive expenses promoting and maintaining our brand but fail to
achieve the expected or desired increase in revenues.
If we are unable to expand our customer service and support organization, we
may not be able to retain our existing customers and attract new customers.
We currently have a small customer service and support organization and will
need to increase our staff to support new customers and the expanding needs of
our existing customers. Hiring customer service and support personnel is very
competitive in our industry due to the limited number of people available with
the necessary technical skills and understanding of server appliance products.
If we are unable to expand our customer service and support organization, we
may not be able to retain our existing customers and attract new customers. In
addition, we may be required to pay higher compensation and benefits to hire
these people than we expect. In this event, the cost of expanding our customer
service and support organization may have a negative impact on margins and
operating results.
10
<PAGE>
Risks Related to Competition Within Our Industry
If we are not able to effectively compete against providers of general-purpose
servers or specific-purpose servers, our revenues will not increase and may
decrease.
In the market for server appliances, we face significant competition from
larger companies who market general-purpose or specific-purpose servers and
have greater financial resources and name recognition than we do. Many of these
companies have larger and more established service organizations to support
these products. These and other large competitors may be able to leverage their
existing resources, including their service organizations, and provide a wider
offering of products and higher levels of support on a more cost-effective
basis than we can. In addition, competing companies may be able to undertake
more extensive promotional activities, adopt more aggressive pricing policies
and offer more attractive terms to their customers than we can. If these large
competitors provide lower cost server appliances with greater functionality or
support than our products, or if some of their products are comparable to ours
and are offered as part of a range of products that is broader than ours, our
products could become undesirable. Even if the functionality of competing
products is equivalent to ours, we face a substantial risk that a significant
number of customers would elect to pay a premium for similar functionality
rather than purchase products from a less-established vendor. Increased
competition may negatively affect our business and future operating results by
leading to price reductions, higher selling expenses or a reduction in our
market share.
Our revenues could be reduced if general-purpose server manufacturers make
acquisitions in order to join their extensive distribution capabilities with
our smaller competitors' products.
Compaq, Dell, Hewlett-Packard, IBM, Sun Microsystems and other server
manufacturers may not only develop their own server appliance solutions, but
they may also acquire or establish cooperative relationships with our other
current competitors, including smaller private companies. Because general-
purpose server manufacturers have significant financial and organizational
resources available, they may be able to quickly penetrate the server appliance
market by leveraging the technology and expertise of smaller companies and
utilizing their own extensive distribution channels. For example, Whistle, a
server appliance company, was recently acquired by IBM. We expect that the
server appliance industry will experience consolidation. It is possible that
new competitors or alliances among competitors may emerge and rapidly acquire
significant market share through consolidation.
We may sell fewer products if other vendors' products are no longer compatible
with ours or other vendors bundle their products with those of our competitors
and sell them at lower prices.
Our ability to sell our products depends in part on the compatibility of our
products with other vendors' software and hardware products. Developers of
these products may change their products so that they will no longer be
compatible with our products. These other vendors may also decide to bundle
their products with other server appliances for promotional purposes and
discount the sales price of the bundle. If that were to happen, our business
and future operating results could suffer if we were no longer able to offer
commercially viable products.
11
<PAGE>
Server appliance products are subject to rapid technological change due to
changing operating system software and network hardware and software
configurations, and our sales will suffer if our products are rendered obsolete
by new technologies.
The server appliance market is characterized by rapid technological change,
frequent new product introductions and enhancements, potentially short product
life cycles, changes in customer demands and evolving industry standards. Our
products could be rendered obsolete if products based on new technologies are
introduced or new industry standards emerge.
New products and product enhancements can require long development and
testing periods, which requires us to hire and retain increasingly scarce,
technically competent personnel. Significant delays in new product releases or
significant problems in installing or implementing new products could seriously
damage our business. We have on occasion experienced delays in the scheduled
introduction of new and enhanced products and cannot be certain that we will
avoid similar delays in the future.
Our future success depends upon our ability to enhance existing products,
develop and introduce new products, satisfy customer requirements and achieve
market acceptance. We cannot be certain that we will successfully identify new
product opportunities and develop and bring new products to market in a timely
and cost-effective manner.
Risks Related to Our Products' Dependence on Intellectual Property
and Our Use of Our Brand
Our reliance upon contractual provisions and domestic trademark laws to protect
our proprietary rights may not be sufficient to protect our intellectual
property from others who may sell similar products.
Our products are differentiated from those of our competitors by our
internally developed software and hardware and the manner in which they are
integrated into our products. If we fail to protect our intellectual property,
other vendors could sell products with features similar to ours, and this could
reduce demand for our products. We believe that the steps we have taken to
safeguard our intellectual property afford only limited protection. Others may
develop technologies that are similar or superior to our technology or design
around the copyrights and trade secrets we own. Despite the precautions we have
taken, laws and contractual restrictions may not be sufficient to prevent
misappropriation of our technology or deter others from developing similar
technologies.
In addition, the laws of the countries in which we decide to market our
services and solutions may offer little or no effective protection of our
proprietary technology. Reverse engineering, unauthorized copying or other
misappropriation of our proprietary technology could enable third-parties to
benefit from our technology without paying us for it, which would significantly
harm our business.
We have invested substantial resources in developing our products and our
brand, and our operating results would suffer if we were subject to a
protracted infringement claim or one with a significant damages award.
Substantial litigation regarding intellectual property rights and brand
names exists in our industry. We expect that server appliance products may be
increasingly subject to third-party
12
<PAGE>
infringement claims as the number of competitors in our industry segment grows
and the functionality of products in different industry segments overlaps. We
are not aware that our products employ technology that infringes any
proprietary rights of third parties. However, third parties may claim that we
infringe their intellectual property rights. Any claims, with or without merit,
could:
. be time-consuming to defend;
. result in costly litigation;
. divert our management's attention and resources;
. cause product shipment delays; or
. require us to enter into royalty or licensing agreements.
Royalty or licensing agreements may not be available on terms acceptable to
us, if at all. A successful claim of product infringement against us or our
failure or inability to license the infringed or similar technology could
adversely affect our business because we would not be able to sell the impacted
product without redeveloping it or incurring significant additional expenses.
Other Risks Related to Our Business
Failure to manage our growth successfully could lead to inefficiencies in
conducting our business, increased expenses and slower growth.
In the past year, our operations have expanded greatly. Our growth has
placed, and will continue to place, a significant strain on our management and
operating and financial systems, as well as sales and marketing and
administrative resources. As of April 30, 2000, we had a total of
141 employees, an increase from a total of 33 employees as of December 31,
1998. Additional growth will further strain these resources. If we cannot
manage our expanding operations, we may not be able to continue to grow or we
may grow at a slower rate. To manage any future growth effectively, we must
continue to improve our financial and accounting systems, inventory and
production controls, reporting and procedures, integrate new personnel and
manage expanded operations. If we fail to do so, the quality of our products
and our ability to respond to our customers' needs and retain key personnel
would cause our business to suffer. Also, we may fail to add capacity in a
cost-effective manner or allow our operating costs to escalate faster than
planned.
If we fail to recruit and retain a significant number of qualified technical
personnel and sales and marketing personnel, we may not be able to develop and
introduce our products on a timely basis.
We require the services of a substantial number of qualified technical
personnel. The market for this personnel is characterized by intense
competition, as well as a high level of employee mobility, which makes it
particularly difficult to attract and retain the qualified technical personnel
we require. We have experienced, and we expect to continue to experience,
difficulty in hiring and retaining highly-skilled employees with appropriate
technical qualifications. If we are unable to recruit and retain a sufficient
number of technical personnel, we may not be able to complete development of,
or upgrade or enhance, our products in a timely manner.
13
<PAGE>
The expansion of our sales and marketing department will also require the
hiring and retention of personnel for whom there is also a high demand. If we
are unable to recruit and retain a sufficient number of sales and marketing
personnel, we may not be able to increase market awareness of our products and
generate sales of our products as quickly as we would like. Moreover, we may
only be able to expand our staff of technical personnel and sales and marketing
personnel by providing individuals with compensation packages that are higher
than expected.
If we cannot manage and expand our international operations profitably, our
revenues may not increase and our business and results of operations would be
adversely affected.
We currently conduct limited business activity outside of North America.
However, we expect international revenue to account for a more significant
percentage of our total revenue in the future and to play an important role in
the growth of our business. We believe that we must continue to expand our
international sales and fulfillment activities in order to be successful. We
have limited experience developing and managing an international sales
operation. Also, there are risks and complexities inherent in conducting
international operations, including, for example, longer payment cycles, local
labor laws and practices and the complexity of complying with additional
regulatory requirements. As we attempt to expand our international sales, any
of these factors and our inexperience may limit our ability to expand our
international operations and, consequently, our business and results of
operations may suffer.
If we are unable to find suitable acquisition candidates, our growth could be
impeded.
A component of our business strategy is the acquisition of, or investment
in, complementary businesses, technologies or products. Our ability to identify
and invest in suitable acquisition and investment candidates on acceptable
terms is crucial to this strategy. We may not be able to identify, acquire or
make investments in promising acquisition candidates on acceptable terms.
Moreover, in pursuing acquisition and investment opportunities, we may be in
competition with other companies having similar growth and investment
strategies. Competition for these acquisitions or investment targets could
result in increased acquisition or investment prices and a diminished pool of
businesses, technologies, services or products available for acquisition or
investment. An inability to find suitable acquisition or investment candidates
at reasonable prices could slow our growth rate.
Our acquisition strategy could have an adverse effect on our existing business,
customer satisfaction and operating results.
Acquisitions involve a number of risks, including:
. adverse effects on our reported operating results due to accounting
charges associated with the acquisitions;
. difficulties in management and integration of the acquired business;
. increased expenses, including compensation expense resulting from newly-
hired employees;
. diversion of management resources and attention; and
. potential disputes with sellers of acquired businesses, technologies,
services or products.
14
<PAGE>
Our future success is dependent on the services of our founder and other key
personnel, and those persons' knowledge of our business and technical expertise
would be difficult to replace.
Our products and technologies are complex and we are substantially dependent
upon the continued service of our existing engineering personnel, and
especially Lawrence A. Genovesi, our President, Chief Executive Officer and
Chief Technology Officer. We do not have employment agreements with any of our
officers. The loss of any of our key employees could adversely affect our
business and slow our product development processes or sales and marketing
efforts. Although we maintain a key person life insurance policy on Mr.
Genovesi, the amount of this insurance may be inadequate to compensate us for
his loss.
If our products fail to perform properly and conform to our specifications, our
customers may demand refunds or assert claims for damages and our reputation
and operating results may suffer.
Because our server appliance products are complex, they could contain errors
or bugs that can be detected at any point in a product's life cycle. In the
past we have discovered errors in some of our products and have experienced
delays in the shipment of our products during the period required to correct
these errors or we have had to replace defective products that were already
shipped. These delays and replacements have principally related to new product
releases. Errors in our products may be found in the future and any of these
errors could be significant. Detection of any significant errors may result in:
. the loss of or delay in market acceptance and sales of our products;
. diversion of development resources;
. injury to our reputation; or
. increased maintenance and warranty costs.
These problems could harm our business and future operating results. Product
errors or delays could be material, including any product errors or delays
associated with the introduction of new products or the versions of our
products that support Windows or Linux operating systems. If our products fail
to conform to warranted specifications, customers could demand a refund for the
purchase price or assert claims for damages.
Moreover, because our products are used in connection with critical
distributed computing systems services, we may receive significant liability
claims if our products do not work properly. Our agreements with customers
typically contain provisions intended to limit our exposure to liability
claims. However, these limitations may not preclude all potential claims.
Liability claims could require us to spend significant time and money in
litigation or to pay significant damages. Any claims for damages, whether or
not successful, could seriously damage our reputation and our business.
We may need additional capital that may not be available to us and, if raised,
may dilute your ownership interest in us.
We may need to raise additional funds to develop or enhance our services and
solutions, to fund expansion, to respond to competitive pressures or to acquire
complementary products, businesses or technologies. Additional financing may
not be available on terms that are acceptable to us. If we raise
15
<PAGE>
additional funds through the issuance of equity or convertible debt securities,
the percentage ownership of our stockholders would be reduced and these
securities might have rights, preferences and privileges senior to those of our
current stockholders. If adequate funds are not available on acceptable terms,
our ability to fund our expansion, take advantage of unanticipated
opportunities, develop or enhance products or services, or otherwise respond to
competitive pressures would be significantly limited.
Risks Related to this Offering
Our directors, executive officers and existing stockholders will continue to
control us after this offering and could delay or prevent a change in control.
After this offering, our directors, executive officers and existing
stockholders and their affiliates will together control approximately 82.8% of
our outstanding common stock. As a result, these stockholders, if they act
together, will be able to control all matters requiring approval of a majority
of our stockholders, including the election and removal of directors and any
merger, sale of assets and other significant corporate transactions. This
control could:
. delay or prevent a change in control of Network Engines;
. deprive our stockholders of an opportunity to receive a premium for
their common stock as part of a sale of Network Engines or its assets;
and
. affect the market price of our common stock.
We have anti-takeover defenses that could delay or prevent an acquisition and
could adversely affect the price of our common stock.
After this offering, the board of directors will have the authority to issue
up to 5,000,000 shares of preferred stock and, without any further vote or
action on the part of the stockholders, will have the authority to determine
the price, rights, preferences, privileges and restrictions of the preferred
stock. This preferred stock, if issued, might have preference over the rights
of the holders of common stock and could adversely affect the price of our
common stock. The issuance of this preferred stock may make it more difficult
for a third party to acquire us or to acquire a majority of our outstanding
voting stock. We currently have no plans to issue preferred stock.
In addition, provisions of our second amended and restated certificate of
incorporation, second amended and restated by-laws and equity compensation
plans may deter an unsolicited offer to purchase Network Engines. These
provisions, coupled with the provisions of the Delaware General Corporation
Law, may delay or impede a merger, tender offer or proxy contest involving
Network Engines. For example, our board of directors will be divided into three
classes, only one of which will be elected at each annual meeting. These
factors may further delay or prevent a change of control of our business. See
"Description of Capital Stock--Delaware Law and Certain Charter and By-Law
Provisions; Anti-Takeover Effects."
Future sales by existing stockholders could depress the market price of our
common stock.
Sales of a substantial number of shares of our common stock in the public
market after this offering could depress the market price of our common stock
and could impair our ability to raise capital through the sale of additional
equity securities. See "Shares Eligible for Future Sale."
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<PAGE>
FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA
This prospectus contains forward-looking statements that involve substantial
risks and uncertainties. In some cases you can identify these statements by
forward-looking words including "anticipate," "believe," "could," "estimate,"
"expect," "intend," "may," "should," "will," and "would" or similar words. You
should read statements that contain these words carefully because they discuss
our future expectations, contain projections of our future results of
operations or of our financial position or state other "forward-looking"
information. We believe that it is important to communicate our future
expectations to our investors. However, there may be events in the future that
we are not able to accurately predict or control. The factors listed above in
the section captioned "Risk Factors," as well as any cautionary language in
this prospectus, provide examples of risks, uncertainties and events that may
cause our actual results to differ materially from the expectations we describe
in our forward-looking statements. Before you invest in our common stock, you
should be aware that the occurrence of the events described in these risk
factors and elsewhere in this prospectus could have an adverse effect on our
business, results of operations and financial position.
This prospectus contains industry data related to our business and the
server appliance industry, which we believe is reasonable. This industry data
includes projections that are based on a number of assumptions. If these
assumptions turn out to be incorrect, actual results may differ from the
projections based on these assumptions. The failure of the server appliance
market to grow at these projected rates may have a material adverse effect on
our business, results of operations and financial condition, and the market
price of our common stock.
ASSUMPTIONS THAT APPLY TO THIS PROSPECTUS
Unless we indicate otherwise, all information in this prospectus is based on
the following:
. conversion of all outstanding shares of preferred stock into shares of
common stock effective upon the closing of this offering;
. no exercise by the underwriters of their over-allotment option; and
. a 2.5-for-1 stock split which was effected prior to this offering.
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<PAGE>
USE OF PROCEEDS
We expect the net proceeds from our sale of 5,500,000 shares of common stock
will be approximately $70.6 million, at an assumed initial public offering
price of $14.00 per share less underwriting discounts and commissions and
estimated offering expenses. If the underwriters' over-allotment option is
exercised in full, we estimate that our net proceeds will be approximately
$81.4 million.
The principal purposes of this offering are to establish a public market for
our common stock, increase visibility in the marketplace, facilitate our future
access to public capital markets, provide liquidity to existing stockholders
and obtain additional working capital.
We have no current specific plan for the proceeds of this offering. The
amounts and timing of our actual expenditures will depend on numerous factors,
including the status of our technology development efforts, sales and marketing
activities, the amount of cash generated or used by our operations and the
activities of our competition. We may find it necessary or advisable to use
portions of the proceeds for other purposes, including potential acquisitions
of businesses, technologies or products, and we will have broad discretion in
the application of the net proceeds. No specific acquisitions are currently
planned and no portion of the net proceeds has been allocated for any
acquisition. Pending our use of the net proceeds, we intend to invest the net
proceeds in investment grade, interest-bearing securities.
DIVIDEND POLICY
We have never paid or declared any cash dividends on our common stock or
other securities and do not anticipate paying cash dividends in the foreseeable
future. We currently intend to retain all of our future earnings, if any, for
use in the operation and expansion of our business.
Under the terms of our existing credit agreement, we are prohibited from
paying any cash dividends without the prior written consent of our lender.
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<PAGE>
CAPITALIZATION
The following table sets forth our cash position and total capitalization
as of March 31, 2000
. on an actual basis;
. on a pro forma basis to give effect to the conversion of all outstanding
shares of our preferred stock into shares of common stock upon the
closing of this offering; and
. on a pro forma as adjusted basis to reflect the sale in this offering of
5,500,000 shares of common stock at an assumed initial public offering
price of $14.00 per share, less underwriting discounts and commissions
and estimated offering expenses payable by us.
This table should be read in conjunction with our financial statements and
notes thereto, which can be found at the end of this prospectus.
<TABLE>
<CAPTION>
As of March 31, 2000
-----------------------------
Pro Pro Forma
Actual Forma As Adjusted
(in thousands)
<S> <C> <C> <C>
Cash, cash equivalents and restricted cash....... $17,172 $17,172 $87,782
======= ======= =======
Current portion of long-term debt................ $ 66 $ 66 $ 66
======= ======= =======
Long-term debt, less current portion............. $ 109 $ 109 $ 109
Redeemable convertible preferred stock:
Series D Convertible Preferred Stock, $.01 par
value; 3,581,554 shares, no shares and no
shares authorized, issued and outstanding,
actual, pro forma and pro forma as adjusted,
respectively.................................. 28,152 -- --
Series C Convertible Preferred Stock, $.01 par
value; 1,123,549 shares, no shares and no
shares authorized, issued and outstanding,
actual, pro forma and pro forma as adjusted,
respectively.................................. 9,949 -- --
Series B Convertible Preferred Stock, $.01 par
value; 357,142 shares, no shares and no shares
authorized, issued and outstanding, actual,
pro forma and pro forma as adjusted,
respectively.................................. 2,750 -- --
Series A Convertible Preferred Stock, $.01 par
value; 185,250 shares, no shares and no shares
authorized, issued and outstanding, actual,
pro forma and pro forma as adjusted,
respectively.................................. 1,125 -- --
------- ------- -------
Total redeemable convertible preferred
stock....................................... 41,976 -- --
Stockholders' equity (deficit):
Common stock, $.01 par value; 60,000,000 shares
authorized and 4,902,035 shares issued and
outstanding, actual; 60,000,000 shares
authorized and 26,350,477 shares issued and
outstanding, pro forma; 100,000,000 shares
authorized and 31,850,477 shares issued and
outstanding pro forma as adjusted............. 49 264 319
Additional paid-in capital..................... 11,104 52,865 123,420
Accumulated deficit............................ (17,241) (17,241) (17,241)
Note receivable from stockholder............... (92) (92) (92)
Deferred stock compensation.................... (12,718) (12,718) (12,718)
------- ------- -------
Total stockholders' equity (deficit)......... (18,898) 23,078 93,688
------- ------- -------
Total capitalization....................... $23,187 $23,187 $93,797
======= ======= =======
</TABLE>
This information excludes 3,501,017 shares of common stock issuable upon
exercise of options outstanding as of March 31, 2000 at a weighted average
exercise price of $0.99 per share, 1,882,851 shares of common stock issuable
upon exercise of warrants outstanding as of March 31, 2000 at a weighted
average exercise price of $0.35 per share, 3,549,785 shares of common stock
reserved for future grant under our 1999 stock incentive plan, 750,000 shares
of common stock reserved for issuance under our 2000 employee stock purchase
plan and 500,000 shares of common stock reserved for issuance under our 2000
director stock option plan.
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<PAGE>
DILUTION
Our pro forma net tangible book value as of March 31, 2000, was $23.1
million, or approximately $0.88 per share. Pro forma net tangible book value
per share represents the pro forma stockholders' equity divided by the pro
forma number of shares of common stock outstanding, giving effect to the
conversion of all outstanding shares of preferred stock. After giving effect to
the sale of the 5,500,000 shares of common stock being offered at an assumed
initial public offering price of $14.00 per share less underwriting discounts
and commissions and estimated offering expenses payable by us, our pro forma
net tangible book value at March 31, 2000, would have been $93.7 million, or
approximately $2.94 per share. This represents an immediate increase in pro
forma net tangible book value of $2.06 per share to existing stockholders and
an immediate dilution in net tangible book value of $11.06 per share to new
investors in common stock in this offering. The following table illustrates
this dilution on a per share basis:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................... $14.00
Pro forma net tangible book value per shares as of March 31,
2000........................................................... $0.88
Increase attributable to new investors.......................... 2.06
Pro forma net tangible book value per share after offering........ 2.94
------
Dilution per share to new investors............................... $11.06
======
</TABLE>
The following table sets forth, on a pro forma basis as of March 31, 2000,
the differences between the number of shares of common stock purchased, the
total consideration paid and the average price per share paid by existing
stockholders and by the new investors purchasing shares of common stock in this
offering, before deducting underwriting discounts and commissions and estimated
offering expenses payable by us, at the assumed initial public offering price
of $14.00 per share.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average
------------------ -------------------- Price Per
Number Percent Amount Percent Share
<S> <C> <C> <C> <C> <C>
Existing stockholders......... 26,350,477 83% $ 38,380,000 33% $ 1.46
New public investors.......... 5,500,000 17 77,000,000 67 14.00
---------- --- ------------ ---
Total....................... 31,850,477 100% $115,380,000 100%
========== === ============ ===
</TABLE>
The foregoing discussion excludes any shares to be issued in connection with
the over-allotment option and excludes any shares of common stock issuable upon
the exercise of options or warrants. As of March 31, 2000, there were 3,501,017
shares of common stock issuable upon exercise of options outstanding at a
weighted average exercise price of $0.99 per share, 1,882,851 shares of common
stock issuable upon exercise of warrants outstanding at a weighted average
exercise price of $0.35 per share, 3,549,785 shares of common stock reserved
for future grant under our 1999 stock incentive plan, 750,000 shares of common
stock reserved for issuance under our 2000 employee stock purchase plan and
500,000 shares of common stock reserved for issuance under our 2000 director
stock option plan. To the extent that any shares are issued upon exercise of
options or warrants that were outstanding at March 31, 2000 or granted after
that date, or reserved for future issuance under our stock plans, there may be
further dilution to new investors.
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<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our financial statements and related notes included elsewhere
in this prospectus. The statement of operations data for the fiscal years ended
September 30, 1997, 1998 and 1999 and the balance sheet data as of September
30, 1998 and 1999 are derived from our financial statements audited by
PricewaterhouseCoopers LLP, independent accountants, included elsewhere in this
prospectus. The statement of operations data for the years ended September 30,
1995 and 1996 and the balance sheet data as of September 30, 1995, 1996 and
1997 are derived from our audited financial statements not included elsewhere
in this prospectus. The statement of operations data for the three months ended
December 31, 1998, March 31, 1999, June 30, 1999, September 30, 1999, December
31, 1999 and March 31, 2000, the statement of operations data for the six
months ended March 31, 1999 and 2000 and the balance sheet data as of March 31,
2000 are derived from our unaudited financial statements. The unaudited
financial statements have been prepared on the same basis as our audited
financial statements and, in our opinion, include all adjustments, consisting
only of normal recurring adjustments, which we consider necessary for a fair
presentation of our results of operations and financial position for these
periods. These historical results are not necessarily indicative of results to
be expected for any future period.
Unaudited pro forma basic and diluted net loss per share have been
calculated assuming the conversion of all outstanding shares of preferred stock
into shares of common stock, as if the shares had converted immediately upon
issuance. Accordingly, accretion of preferred stock to redemption value has not
been included in the calculation of unaudited pro forma basic and diluted net
loss per share.
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<PAGE>
Selected Financial Data
(in thousands, except per share data)
<TABLE>
<CAPTION>
Six Months Ended
Fiscal Year Ended September 30, March 31,
----------------------------------------- -----------------
1995 1996 1997 1998 1999 1999 2000
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Net revenues............ $ 661 $1,515 $ 609 $ 1,102 $ 6,031 $ 1,116 $ 10,466
Cost of revenues........ 335 718 465 1,591 4,733 1,268 6,805
------ ------ ------- ------- ------- ------- --------
Gross profit (loss).... 326 797 144 (489) 1,298 (152) 3,661
Operating expenses:
Research and
development........... 92 169 395 923 2,564 867 3,084
Sales and marketing.... 98 233 477 1,593 2,920 1,147 4,627
General and
administrative........ 257 268 396 620 934 389 1,191
Stock compensation..... -- -- -- -- 127 10 876
------ ------ ------- ------- ------- ------- --------
Total operating
expenses............ 447 670 1,268 3,136 6,545 2,413 9,778
Income (loss) from
operations............. (121) 127 (1,124) (3,625) (5,247) (2,565) (6,117)
Interest income
(expense), net......... (27) (69) (33) (574) (897) (919) 310
------ ------ ------- ------- ------- ------- --------
Income (loss) before
extraordinary item..... (148) 58 (1,157) (4,199) (6,144) (3,484) (5,807)
Extraordinary gain on
extinguishment of
debt................... -- -- -- -- 314 314 --
------ ------ ------- ------- ------- ------- --------
Net income (loss)....... (148) 58 (1,157) (4,199) (5,830) (3,170) (5,807)
Accretion of redeemable
convertible preferred
stock.................. -- -- -- -- (223) -- (4,259)
------ ------ ------- ------- ------- ------- --------
Net income (loss)
attributable to common
stockholders........... $ (148) $ 58 $(1,157) $(4,199) $(6,053) $(3,170) $(10,066)
====== ====== ======= ======= ======= ======= ========
Income (loss) per common
share before
extraordinary item--
basic and diluted...... $(0.06) $ 0.02 $ (0.36) $ (1.31) $ (1.92) $ (0.96) $ (2.86)
Extraordinary item per
common share--basic and
diluted................ -- -- -- -- 0.09 -- --
------ ------ ------- ------- ------- ------- --------
Net income (loss) per
common share--basic and
diluted................ $(0.06) $ 0.02 $ (0.36) $ (1.31) $ (1.83) $ (0.96) $ (2.86)
====== ====== ======= ======= ======= ======= ========
Shares used in computing
basic and diluted net
income (loss) per
common share........... 2,675 3,025 3,177 3,200 3,312 3,285 3,525
Pro forma net loss per
common share--basic and
diluted (unaudited).... $ (0.63) $ (0.28)
======= ========
Shares used in computing
basic and diluted pro
forma net loss per
common share
(unaudited)............ 9,242 21,011
</TABLE>
<TABLE>
<CAPTION>
As of September 30, As of
----------------------------------- March 31,
1995 1996 1997 1998 1999 2000
<S> <C> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and
restricted cash............... $ 11 $ 32 $ 16 $ 113 $ 1,535 $ 17,172
Working capital (deficit)...... (8) 205 (97) (3,937) 1,897 20,497
Total assets................... 313 804 699 1,730 5,864 29,979
Long-term debt, less current
portion....................... 61 82 58 69 158 109
Redeemable convertible
preferred stock............... -- -- 1,000 1,000 12,467 41,976
Total stockholders' equity
(deficit)..................... (45) 227 (953) (4,554) (9,897) (18,898)
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
-----------------------------------------------------------------------
December 31, March 31, June 30, September 30, December 31, March 31,
1998 1999 1999 1999 1999 2000
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
Net revenues............ $ 223 $ 893 $ 908 $4,007 $ 4,415 $ 6,051
Cost of revenues........ 385 883 1,004 2,461 2,613 4,192
------- ------- ------- ------ ------- -------
Gross profit (loss).... (162) 10 (96) 1,546 1,802 1,859
Operating expenses:
Research and
development........... 317 550 640 1,057 1,174 1,910
Sales and marketing.... 558 589 778 995 1,615 3,012
General and
administrative........ 203 186 206 339 432 759
Stock compensation..... -- 10 37 80 197 679
------- ------- ------- ------ ------- -------
Total operating
expenses............ 1,078 1,335 1,661 2,471 3,418 6,360
Loss from operations.... (1,240) (1,325) (1,757) (925) (1,616) (4,501)
Interest income
(expense), net......... (930) 11 4 18 30 280
------- ------- ------- ------ ------- -------
Loss before
extraordinary item..... (2,170) (1,314) (1,753) (907) (1,586) (4,221)
Extraordinary gain on
extinguishment of
debt................... -- 314 -- -- -- --
------- ------- ------- ------ ------- -------
Net loss................ $(2,170) $(1,000) $(1,753) $ (907) $(1,586) $(4,221)
======= ======= ======= ====== ======= =======
As a Percentage of Net
Revenues:
Net revenues............ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of revenues........ 172.6 98.9 110.6 61.4 59.2 69.3
------- ------- ------- ------ ------- -------
Gross profit (loss).... (72.6) 1.1 (10.6) 38.6 40.8 30.7
Operating expenses:
Research and
development........... 142.2 61.6 70.5 26.4 26.6 31.6
Sales and marketing.... 250.2 66.0 85.7 24.8 36.6 49.8
General and
administrative........ 91.0 20.8 22.7 8.5 9.8 12.5
Stock compensation..... -- 1.1 4.0 2.0 4.4 11.2
------- ------- ------- ------ ------- -------
Total operating
expenses............ 483.4 149.5 182.9 61.7 77.4 105.1
------- ------- ------- ------ ------- -------
Loss from operations.... (556.0) (148.4) (193.5) (23.1) (36.6) (74.4)
Interest income
(expense), net......... (417.1) 1.2 0.4 0.5 0.7 4.6
------- ------- ------- ------ ------- -------
Loss before
extraordinary item..... (973.1) (147.2) (193.1) (22.6) (35.9) (69.8)
Extraordinary gain on
extinguishment of
debt................... -- 35.2 -- -- -- --
------- ------- ------- ------ ------- -------
Net loss................ (973.1)% (112.0)% (193.1)% (22.6)% (35.9)% (69.8)%
======= ======= ======= ====== ======= =======
</TABLE>
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITIONS
You should read the following discussion and analysis of our financial
condition and results of operations in conjunction with our financial
statements and related notes included elsewhere in this prospectus.
Overview
We develop, market and provide integrated and powerful server appliances
that enable organizations to provide information and applications over the
Internet. We were incorporated in 1989 as PowerStation Technologies, Inc. to
provide systems integration and consulting services. In fiscal 1994, we
transitioned our business by becoming a developer of fault-tolerant high-
density general-purpose computers, our P6000 product line. In September 1997,
we changed our name to Network Engines, Inc. and began expending substantial
research and development efforts to leverage our legacy general-purpose
computer technology into server appliance products. Research and development
expenses increased significantly from $395,000 to $923,000 to $2.6 million in
fiscal 1997, 1998 and 1999, respectively.
In June 1999, we introduced our WebEngine Blazer product, which is our first
generation of server appliances. Since July 1999, substantially all of our
revenue has been attributable to the WebEngine Blazer product as we
discontinued development and sales of the P6000 product line upon the
introduction of our server appliances. Additionally, we introduced our
AdminEngine server appliance in February 2000 and our WebEngine Roadster and
WebEngine Viper server appliances in the third quarter of fiscal 2000 and
expect to introduce our CommerceEngine server appliance in the fourth quarter
of fiscal 2000.
Since we began focusing on server appliances in 1998, we have incurred
substantial costs to develop our technology and products, to recruit and train
personnel for our engineering, sales and marketing and technical support
departments, and to establish an administrative organization. As a result, we
had an accumulated deficit of $17.2 million as of March 31, 2000. We anticipate
that our operating expenses will increase substantially in the future as we
increase our sales and marketing operations, develop new channels, fund greater
levels of research and development, expand our technical support and improve
our operational and financial systems. Accordingly, we will need to generate
significant revenues to achieve profitability. In addition, our limited
operating history in the server appliance market makes it difficult for us to
predict future operating results, and, accordingly, there can be no assurances
that we will sustain revenue growth or achieve profitability in future
quarters.
We derive revenues from the sale of our products to customers and from
license fees. License fees are generated by granting customers a right to
manufacture specific configurations of our product and to distribute that
product under their name. For direct sales and sales to resellers, we recognize
revenues upon delivery, provided evidence of an arrangement has been received,
no obligations remain outstanding and collectibility is reasonably assured. For
the license agreements, we recognize license revenues upon sell through to the
licensee's customers.
24
<PAGE>
We have strategic agreements with IBM, Infolibria and Micronpc.com that
allow them to manufacture our WebEngine Blazer hardware design. Until IBM and
Micronpc.com were able to manufacture the licensed product for themselves, we
were manufacturing the product for them and charging them a higher unit sales
price for this service than we would have received in license fees had they
manufactured the product. As of March 31, 2000, we expect that substantially
all future revenues from IBM and Micronpc.com will be license revenues.
Accordingly, the revenue per unit for these customers will decrease. However,
since these licensees will be manufacturing the units, we will not incur any
substantial cost of revenues and our gross profit as a percentage of revenue
will be high for license revenues. There are no minimum license fee commitments
under any of these agreements.
We sell our products through a direct sales force, through systems
integrators acting as resellers, and to OEMs and licensed manufacturers.
Substantially all of our sales to date have been to customers in the United
States. We intend to expand our reseller channel in the United States and to
establish an international indirect channel.
Gross profit represents net revenues recognized less the cost of revenues.
Cost of revenues includes cost of materials, manufacturing costs, manufacturing
personnel expenses, obsolescence charges, packaging, license fees and shipping
and warranty costs. Our gross profit will be affected primarily by the mix of
product revenues versus license revenues, the timing and size of customer
orders, and new product introductions by us and our competitors.
Research and development expenses consist primarily of salaries and related
expenses for personnel engaged in research and development, fees paid to
consultants and outside service providers, material costs for prototype and
test units and other expenses related to the design, development, testing and
enhancements of our products. We expense all of our research and development
costs as they are incurred. We believe that a significant level of investment
in product research and development is required to remain competitive.
Accordingly, we expect to continue to devote substantial resources to product
research and development. As a result, we expect research and development
expenses will increase in absolute dollars but will continue to fluctuate as a
percentage of net revenues.
Sales and marketing expenses consist primarily of salaries, commissions and
related expenses for personnel engaged in sales, marketing and customer support
functions, as well as costs associated with trade shows, public relations and
marketing materials. We intend to expand our sales and marketing operations and
efforts substantially, both domestically and internationally, in order to
increase market awareness and to generate sales of our products. Accordingly,
we expect our sales and marketing expenses to increase in absolute dollars but
continue to fluctuate as a percentage of net revenues.
General and administrative expenses consist primarily of salaries and other
related costs for executive, finance, accounting, information technology,
facilities and human resources personnel, as well as accounting, legal, other
professional fees and allowance for doubtful accounts. We expect these expenses
to increase in absolute dollars but continue to fluctuate as a percentage of
net revenues as we add administrative personnel and incur additional costs
related to the growth of our business, expansion of our information
infrastructure and our operation as a public company.
25
<PAGE>
As of March 31, 2000, we recorded deferred stock compensation on our balance
sheet of $13.8 million in connection with stock option and restricted stock
grants to our employees and directors that were granted between February 1,
1999 and March 31, 2000. This amount represents the difference between the
exercise price and the deemed fair value of our common stock for financial
reporting purposes at the date of grant. We will amortize this stock
compensation over the vesting period of the related options. During the six
months ended March 31, 2000, we amortized $876,000 of stock compensation.
During the remainder of fiscal 2000 and 2001, we expect to amortize stock
compensation of:
<TABLE>
<CAPTION>
Expected Amortization of
Fiscal Quarter Ending Stock Compensation
--------------------- ------------------------
(in thousands)
<S> <C>
June 30, 2000.......................................... $1,031
September 30, 2000..................................... 1,009
December 31, 2000...................................... 1,009
March 31, 2001......................................... 997
June 30, 2001.......................................... 938
September 30, 2001..................................... 938
</TABLE>
We then expect aggregate per quarter stock compensation amortization of
approximately $918,000 during fiscal 2002, between $835,000 and $916,000 in
fiscal 2003 and between $34,000 and $746,000 during fiscal 2004. The amount of
stock compensation expense to be recorded in future periods could decrease if
options for accrued but unvested compensation are forfeited.
As of March 31, 2000, we had net operating loss carryforwards for both
federal and state income tax purposes of approximately $8.9 million available
to offset future taxable income. These net operating loss carryforwards expire
beginning in 2019 and 2004, respectively. We have not recognized any benefit
from the future use of loss carryforwards for these periods because of the
uncertainty surrounding their realization.
Our net loss attributable to common stockholders includes accretion charges
to increase the carrying amount of our redeemable convertible preferred stock
to the amount we would be required to pay if the preferred stock were to be
redeemed. All preferred stock will automatically convert to common stock as a
result of this offering. As a result, there will not be any accretion charges
in the future related to our currently outstanding redeemable convertible
preferred stock.
We had 141 employees as of April 30, 2000, a substantial increase from 48 as
of September 30, 1999 and 33 as of December 31, 1998. This rapid growth has
placed significant demands on our management and operational resources. In
order to manage our growth effectively, we must implement and improve our
operational systems, procedures and controls on a timely basis. If our total
revenues do not increase relative to our operating expenses, our management
systems do not expand to meet increasing demands, we fail to attract,
assimilate and retain qualified personnel or our management otherwise fails to
manage our expansion effectively, we could experience a decline in our revenues
and operating results.
26
<PAGE>
Results of Operations
In light of the significant change in our business related to the
introduction of our server appliance products, we have presented a comparison
of results for (1) the three months ended March 31, 2000 versus the three
months ended December 31, 1999; (2) the three months ended December 31, 1999
versus the three months ended September 30, 1999 and (3) the three months ended
September 30, 1999 versus the three months ended June 30, 1999. We have also
presented a comparison of results for each of the fiscal years ended September
30, 1997, 1998 and 1999.
Three Months Ended March 31, 2000 and Three Months Ended December 31, 1999
Net Revenues
Net revenues increased to $6.1 million for the three months ended March 31,
2000 from $4.4 million for the three months ended December 31, 1999. Of this
increase, approximately 64% was due to increased sales volumes of our WebEngine
Blazer product and approximately 36% was due to an increased average sales
price of the WebEngine Blazer attributable to the sale of configurations with
faster processing power and more memory.
Gross Profit
Gross profit increased to $1.9 million for the three months ended March 31,
2000 from $1.8 million for the three months ended December 31, 1999. Gross
profit as a percentage of net revenues decreased to 30.7% for the three months
ended March 31, 2000 from 40.8% for the three months ended December 31, 1999.
The decrease in gross profit was primarily due to a decrease in product sales
to IBM that was only partially offset by license revenue from IBM. For the
three months ended December 31, 1999, product sales to IBM accounted for 53% of
net revenues versus license revenue from IBM accounting for less than 10% of
net revenues for the three months ended March 31, 2000.
Operating Expenses
Research and Development. Research and development expenses increased to
$1.9 million for the three months ended March 31, 2000 from $1.2 million for
the three months ended December 31, 1999. This increase in research and
development expenses was due primarily to an increase in compensation costs as
research and development personnel increased during the period from 35
employees to 42 employees and, to a lesser extent, to higher expenses related
to prototype and test units and consultant expenses.
Sales and Marketing. Sales and marketing expenses increased to $3.0 million
for the three months ended March 31, 2000 from $1.6 million for the three
months ended December 31, 1999. This increase in sales and marketing expenses
was due primarily to an increase in compensation costs as sales, marketing and
customer support personnel during the period increased from 33 employees to 48
employees, increased commission expense attributable to higher net revenues
and, to a lesser extent, due to increased spending on marketing programs,
increased travel expenses associated with increased sales personnel and higher
costs attributable to evaluation units.
27
<PAGE>
General and Administrative. General and administrative expense increased to
$759,000 for the three months ended March 31, 2000 from $432,000 for the three
months ended December 31, 1999. This increase in general and administrative
expenses was due primarily to an increase in compensation costs as general and
administrative personnel during the period increased from ten employees to 17
employees, increased legal fees and higher corporate recruiting costs.
Stock Compensation. For the three months ended March 31, 2000, we recorded
deferred stock compensation of $9.0 million relating to stock options and
restricted stock granted to employees and directors versus $3.2 million
recorded for the three months ended December 31, 1999. These amounts are being
amortized over the vesting periods of the granted options. Stock-based
compensation increased to $679,000 for the three months ended March 31, 2000
from $197,000 for the three months ended December 31, 1999.
Three Months Ended December 31, 1999 and Three Months Ended September 30, 1999
Net Revenues
Net revenues increased to $4.4 million for the three months ended December
31, 1999 from $4.0 million for the three months ended September 30, 1999. The
increase was primarily due to increased sales volumes of our WebEngine Blazer
product.
Gross Profit
Gross profit increased to $1.8 million for the three months ended December
31, 1999 from $1.5 million for the three months ended September 30, 1999. Gross
profit as a percentage of net revenues increased to 40.8% for the three months
ended December 31, 1999 from 38.6% for the three months ended September 30,
1999. The increase in gross profit was primarily due to increased sales volume
of our WebEngine Blazer product.
Operating Expenses
Research and Development. Research and development expenses increased to
$1.2 million for the three months ended December 31, 1999 from $1.1 million for
the three months ended September 30, 1999. The increase in research and
development expenses was primarily due to an increase in compensation and
recruiting costs as research and development personnel during the period
increased from 16 employees to 35 employees. This increase was partially offset
by a decrease in consultant expenses and a decrease in costs related to
prototype and test units.
Sales and Marketing. Sales and marketing expenses increased to $1.6 million
for the three months ended December 31, 1999 from $1.0 million for the three
months ended September 30, 1999. The increase in sales and marketing expenses
was primarily due to an increase in compensation and recruiting costs related
to an increase in sales, marketing and customer support personnel during the
period from 18 employees to 33 employees.
General and Administrative. General and administrative expense increased to
$432,000 for the three months ended December 31, 1999 from $339,000 for the
three months ended September 30,
28
<PAGE>
1999. The increase in general and administrative expenses was primarily due to
an increase in compensation and recruiting costs related to an increase in
general and administrative personnel during the period from seven employees to
ten employees.
Stock Compensation. For the three months ended December 31, 1999, we
recorded deferred stock compensation of $3.2 million relating to stock options
and restricted stock granted to employees and directors versus $708,000
recorded for the three months ended September 30, 1999. These amounts are being
amortized over the vesting periods of the granted options. Stock-based
compensation increased to $197,000 for the three months ended December 31, 1999
from $80,000 for the three months ended September 30, 1999.
Three Months Ended September 30, 1999 and Three Months Ended June 30, 1999
Net Revenues
Net revenues increased to $4.0 million for the three months ended September
30, 1999 from $908,000 for the three months ended June 30, 1999. The increase
in net revenues was primarily due to the June introduction of our WebEngine
Blazer product that accounted for substantially all of the net revenues for the
three months ended September 30, 1999.
Gross Profit (Loss)
Gross profit (loss) increased to $1.5 million for the three months ended
September 30, 1999 from ($96,000) for the three months ended June 30, 1999.
Gross profit (loss) as a percentage of net revenues increased to 38.6% for the
three months ended September 30, 1999 from (10.6%) for the three months ended
June 30, 1999. The increase in gross profit was primarily due to increased
sales related to the introduction of our WebEngine Blazer product.
Operating Expenses
Research and Development. Research and development expenses increased to
$1.1 million for the three months ended September 30, 1999 from $640,000 for
the three months ended June 30, 1999. This increase in research and development
expenses was due to an increase in compensation and recruiting expenses related
to an increase in research and development personnel during the period from
nine employees to 15 employees, increased prototype and test unit costs and an
increase in consultant expenses.
Sales and Marketing. Sales and marketing expenses increased to $1.0 million
for the three months ended September 30, 1999 from $778,000 for the three
months ended June 30, 1999. This increase in sales and marketing expenses was
due to an increase in sales commissions associated with our increased net
revenues and increased compensation costs attributable to an increase in sales,
marketing and customer support personnel during the period from 14 employees to
18 employees.
General and Administrative. General and administrative expense increased to
$339,000 for the three months ended September 30, 1999 from $206,000 for the
three months ended June 30, 1999.
29
<PAGE>
This increase in general and administrative expenses was due primarily to
increased legal and accounting fees and, to a lesser extent, due to increased
facilities costs and increased costs related to the expansion of our
information systems infrastructure.
Stock Compensation. For the three months ended September 30, 1999, we
recorded deferred stock compensation of $708,000 relating to stock options
granted to employees versus $368,000 recorded for the three months ended June
30, 1999. These amounts are being amortized over the vesting periods of the
granted options. Stock-based compensation increased to $80,000 for the three
months ended September 30, 1999 from $37,000 for the three months ended June
30, 1999.
Fiscal 1997, 1998 and 1999
Net Revenues
Net revenues increased from $609,000 in fiscal 1997 to $1.1 million in
fiscal 1998 and to $6.0 million in fiscal 1999. The increase in net revenues
from fiscal 1997 to 1998 was primarily due to both increased unit sales of our
P6000 product and an increase in the average unit sales price attributable to
units shipping with a greater number of processors in fiscal 1998. The increase
in net revenues from fiscal 1998 to 1999 was primarily due to the June 1999
introduction of our WebEngine Blazer server appliance.
Gross Profit (Loss)
Gross profit (loss) decreased from a $144,000 gross profit in fiscal 1997 to
($489,000) in fiscal 1998 and then increased to a $1.3 million gross profit in
fiscal 1999. Gross profit (loss) as a percentage of net revenues decreased from
23.6% in fiscal 1997 to (44.4%) in fiscal 1998 and then increased to 21.5% in
fiscal 1999. The decrease in gross profit from fiscal 1997 to 1998 was
primarily due to higher discounting on P6000 sales, increased obsolescence
charges related to the P6000 product line and increased manufacturing
compensation costs. The increase in gross profit from fiscal 1998 to 1999 was
primarily due to increased sales volume related to the June 1999 introduction
of our WebEngine Blazer that was partially offset by increased obsolescence
charges related to the P6000 product line and increased manufacturing
compensation costs.
Operating Expenses
Research and Development. Research and development expenses were $395,000,
$923,000 and $2.6 million in fiscal 1997, 1998 and 1999, respectively,
representing 64.9%, 83.8% and 42.5% of net revenues in the respective periods.
The dollar increases for each of the periods were primarily due to increases in
personnel, consultants and material costs for prototype and test units and were
attributable to development efforts related to our server appliances.
Sales and Marketing. Sales and marketing expenses were $477,000, $1.6
million and $2.9 million in fiscal 1997, 1998 and 1999, respectively,
representing 78.3%, 144.6% and 48.4% of net revenues in the respective periods.
The dollar increases for each of the periods were primarily due to increased
personnel in our direct sales and marketing organization, higher sales
commissions associated with increased net revenues and increased marketing
activities.
30
<PAGE>
General and Administrative. General and administrative expenses were
$396,000, $620,000 and $934,000 in fiscal 1997, 1998 and 1999, respectively,
representing 65.0%, 56.3% and 15.5% of net revenues in the respective periods.
The dollar increases for each of the periods were primarily due to increases in
personnel, professional fees and increases in our allowance for doubtful
accounts associated with increased revenues.
Stock Compensation. During fiscal 1999 we recorded deferred stock-based
compensation of $1.6 million related to stock options granted to employees and
directors. We had no deferred stock-based compensation relating to stock option
grants in fiscal 1997 and 1998. We recorded $127,000 of stock-based
compensation expense in operating expenses in fiscal 1999. There was no stock-
based compensation expense recorded in operating expenses during fiscal 1997
and 1998.
Extraordinary Gain
The extraordinary gain on extinguishment of debt realized in fiscal 1999 was
due to the forgiveness of all interest expense on the notes payable upon the
conversion of that debt into series B and series C redeemable convertible
preferred stock.
As a result of our limited history with our server appliance products, we
cannot forecast operating expenses based on historical results. Accordingly, we
may incur expenses, in part, based on future revenue projections. Most of our
expenses are fixed in nature, and we may not be able to quickly reduce spending
if revenues are lower than we have projected. Our ability to forecast our
quarterly sales accurately is limited, which makes it difficult to predict the
quarterly revenues that we will recognize. We expect that our business,
operating results and financial condition would be harmed if revenues did not
meet projections. Investors should not rely on the results of one quarter as an
indication of future performance.
We expect that our revenues and operating results may vary significantly
from quarter to quarter, and we anticipate that our expenses will increase
substantially for at least the next two fiscal years as we:
. increase our sales and marketing activities, including expanding our
North American direct sales force, establish an international presence
and commence our initial advertising campaign;
. expand our indirect channels, both domestically and internationally;
. develop our technology, expand our product lines and create and market
new products; and
. pursue strategic relationships and acquisitions.
31
<PAGE>
Liquidity and Capital Resources
Since our fiscal 1997, we have financed our operations primarily through the
sale of equity securities, borrowings and the sale of our products. As of March
31, 2000, we have raised approximately $37.3 million, net of offering costs,
from the issuance of preferred stock. As of March 31, 2000, we had $16.8
million in cash and cash equivalents.
In April 2000, we amended an equipment line of credit agreement to provide
for an additional $2.0 million of equipment financing and a $4.0 million
working capital revolving line of credit. The additional equipment financing is
separated into two consecutive six-month borrowing periods of $1.0 million
beginning on the date of the amendment. Interest at the rate of prime plus
1.25% is payable monthly. Any outstanding balances at the end of each of the
two borrowing periods will be repaid in 36 equal monthly installments. The
revolving line of credit matures in April 2001 and bears interest at prime plus
1%.
Cash used in operating activities was $768,000, $3.4 million, $5.1 million
and $7.6 million in fiscal 1997, 1998, 1999 and for the six months ended March
31, 2000, respectively. Cash used in fiscal 1997 was primarily due to a net
loss of $1.2 million and an increase in inventories, offset in part by decrease
in accounts receivable and increases in accrued expenses and depreciation,
inventory reserves and provision for doubtful accounts expenses. Cash used in
fiscal 1998 was primarily due to a net loss of $4.2 million and increases in
accounts receivable and inventories, offset in part by increases in accounts
payable and accrued expenses and charges for depreciation, inventory reserves
and amortization of discount on notes payable. Cash used in fiscal 1999 was
primarily due to a net loss of $5.8 million and increases in accounts
receivable and inventories, offset in part by increases in accounts payable and
accrued expenses and charges for depreciation, inventory reserves and
amortization of discount on notes payable. Cash used for the six months ended
March 31, 2000 was primarily due to a net loss of $5.8 million and increases in
accounts receivable, inventories and prepaid expenses, offset in part by an
increases in accounts payable, accrued expenses and deferred revenue and
charges for depreciation, inventory reserves and stock-based compensation.
Cash used in investing activities was $185,000, $343,000, $723,000 and $2.4
million in fiscal 1997, 1998, 1999 and for the six months ended March 31, 2000,
respectively. Cash used in investing activities was primarily for purchases of
property and equipment and, for the six months ended March 31, 2000, providing
a $279,000 letter of credit as a security deposit on our new leased facilities
in Canton, Massachusetts and the use of $276,000 as we commenced leasehold
improvements in the new Canton facility. As of this date, we expect to spend
approximately $1.3 million on additional leasehold improvements and
approximately $1.0 million on furniture and equipment related to our new Canton
facility.
Cash provided by financing activities was $937,000, $3.8 million, $7.2
million and $25.4 million in fiscal 1997, 1998, 1999 and for the six months
ended March 31, 2000, respectively. Cash provided by financing activities
consisted primarily of proceeds from private sales of preferred stock and
bridge loans from stockholders and, for the six months ended March 31, 2000,
the exercise of stock options and warrants. These bridge loans were subsequent
to our sale of series A preferred stock in fiscal 1997 and eventually converted
into a combination of series B and series C preferred stock in fiscal 1999.
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We intend to continue to invest heavily in the development of new products
and enhancements to our existing products. Our future liquidity and capital
requirements will depend upon numerous factors, including:
. the costs and timing of expansion of sales and marketing activities;
. the costs and timing of expansion of product development efforts and the
success of these development efforts;
. the extent to which our existing and new products gain market
acceptance;
. the level and timing of license revenues;
. the costs involved in maintaining and enforcing intellectual property
rights;
. market developments;
. the costs and timing of expanding and improving our facilities;
. available borrowings under line of credit arrangements; and
. other factors.
We believe that the net proceeds from this offering, together with cash we
expect to generate from sales of our products and licensing of our technology,
cash on hand, cash equivalents and cash from borrowings, will be sufficient to
meet our debt service, operating and capital requirements for at least the next
12 months. After that, we may need to raise additional funds. We may seek to
raise additional funds through additional borrowings, public or private equity
financings or from other sources. There can be no assurance that additional
financing will be available at all or, if available, will be on terms
acceptable to us. If additional financing is needed and is not available on
acceptable terms, we would need to reduce our planned rate of growth and reduce
our operating expenses.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standard Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
SFAS 133, as amended by Statement of Financial Accounting Standards No. 137,
"Accounting for Derivative Instruments and Hedging Activities--Deferral of the
Effective Date of FASB Statement No. 133," is effective for fiscal years
beginning after June 15, 2000. SFAS 133 will be effective for our fiscal year
ended September 30, 2001. We believe the adoption of this statement will not
have a significant impact on our financial position, results of operations or
cash flows.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB 101"). This bulletin summarizes certain views of the staff of the
Securities and Exchange Commission on applying generally accepted accounting
principles to revenue recognition in financial statements. The staff of the
Securities and Exchange Commission believes that revenue is realized or
realizable and earned when all of the following criteria are met: persuasive
evidence of an arrangement exists; delivery has occurred or services have been
rendered; the seller's price to the buyer is fixed or determinable; and
collectibility is reasonably assured. We do not expect the application of SAB
101 to have a material impact on our financial position or results of
operations.
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In March 2000, the Financial Accounting Standard Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation--an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 and among other issues
clarifies the following: the definition of an employee for purposes of applying
APB Opinion No. 25; the criteria for determining whether a plan qualifies as a
noncompensatory plan; the accounting consequence of various modifications to
the terms of previously fixed stock options or awards; and the accounting for
an exchange of stock compensation awards in a business combination. FIN 44 will
become effective July 1, 2000, but certain conclusions in FIN 44 cover specific
events that occurred after either December 15, 1998 or January 12, 2000. We do
not expect the application of FIN 44 to have a material impact on our financial
position or results of operations.
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BUSINESS
Overview
We develop, market and provide integrated and powerful server appliances
that allow organizations to provide information and applications over the
Internet. Server appliances are a new category of computer network
infrastructure devices that deliver specific functionality through a
combination of pre-packaged hardware and software. Unlike general-purpose
servers, our server appliances are high-powered, compact products that can be
used with either Windows or Linux operating systems and a range of
applications and computing power. Our customers may select the number and type
of each server that they need, utilize them separately or combine them into
groups, or clusters, and locate them geographically as needed. Our servers can
be managed from a single location without the support of on-site technicians.
Our server appliances are designed to meet the complex needs and requirements
of e-commerce and Internet-based organizations, including dot com companies,
web hosting providers, application service providers and Internet service
providers. Our server appliances are easy to install and configure and are
designed to meet our customers' needs by combining specific application
functionality within small physical packaging.
Industry Background
The emergence of the Internet as a global communications medium for e-
commerce and information delivery is now well-accepted. The openness and
accessibility of the Internet enable large and small organizations, either new
or established, to enter this competitive environment by creating Internet
sites and establishing their own network infrastructures. New and emerging
organizations hoping to grow, and well-financed organizations hoping to
increase market share, typically seek to reduce time-to-revenue.
Organizations seek to appeal to a wide range of users and to generate large
volumes of activity at their web sites, resulting in significant Internet
traffic. The growth and complexity in Internet use and functionality,
including streaming media, dynamic content and e-commerce transactions, have
led to increased demand for greater bandwidth and processing power. The
increase in Internet traffic and demand for greater bandwidth has resulted in
more utilization of remote server facilities, which house servers for
Internet-related businesses. These facilities, often known as co-location
facilities, provide strategically located secure data center space with high-
speed network connections to the Internet, can improve network performance to
end users by reducing the distance between end users and Internet servers.
Traditionally, organizations have built their Internet solutions with
general-purpose servers. This method requires extensive time and technical
resources and capabilities which increases overall cost of ownership,
including time and cost of implementation. To extend the power and features of
a general-purpose server, organizations must integrate numerous discrete
hardware and software elements, including operating systems, applications,
security systems, load balancers and management tools, which increases overall
costs and time-to-revenue. This approach is not well-suited for use in remote
server facilities because it typically creates large, complex systems that
require substantial facility space. In addition, most vendors' offerings
include limited management and few vendors, if any, provide remote lights out
management capabilities, which increases the need
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for dedicated attention of on-site information technology professionals. When
organizations use general-purpose servers to handle Internet traffic, they
typically face a higher total cost of ownership since equipment, facility costs
and operating expenses are high and time-to-revenue is increased.
To address the shortcomings of general-purpose servers, many organizations
are seeking well-designed solutions for Internet applications that meet a
common set of requirements. These organizations include e-commerce and
Internet-based businesses, including dot com companies, web hosting providers,
application service providers and Internet service providers. Their
requirements include:
. pre-packaged functionality to reduce or eliminate the need for custom
integration by the end user;
. high-density physical packaging that provides high-performance server
hardware in small, rack-mounted devices to minimize the costs of co-
location space rental;
. an integrated management system that enables administrators to
extensively control their server appliances remotely, even in the case
of system failure; and
. built-in clustering capability that enables users to easily scale the
power and functionality of their solution as user demand grows and
evolves.
The server appliance, which is a combination of computing hardware and
software that is designed to deliver a single application function, was
developed to address the shortcomings of general-purpose servers. International
Data Corporation estimates that the worldwide market for server appliances will
grow to $8.0 billion in 2003 from approximately $214.6 million in 1999, a
compounded annual growth rate of 147%. As market acceptance of server
appliances grows, we expect that users will increasingly demand products that
meet specific functional requirements and reduce total cost of ownership,
including time-to-revenue, packaging density, installation and management
functionality. In addition, specific customer preferences for operating
systems, applications and computing power play important roles in customer
selection of server appliances. Therefore, server appliance vendors who offer a
choice in these areas will have a broader market opportunity.
The Network Engines Solution
We develop, market and provide a selection of server appliances that enable
organizations to provide information and applications over the Internet to meet
the requirements of e-commerce and Internet-based organizations. Our server
appliances are high-powered, compact products with a choice of operating
systems, applications and computing power. Key elements of our solution
include:
High Performance in a Small Package. Our products integrate high performance
components in a small package enabling our customers to minimize hosting or co-
location costs for servers. All of our products today are 1.75 inches in
height, also known as one rack unit, which is typically one-half to one-third
the height of the leading, currently available general-purpose servers with the
same processing power. This is important because our customers typically use
multiple server appliances
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and must pay for the amount of rack space the servers require. Our server
appliances minimize the space requirements for our customers without loss of
computing power, thereby reducing the rental costs for rack space at co-
location facilities.
Ease of Installation and Use. Each of our server appliances is pre-
configured and is capable of performing its assigned application when it is
unpacked and connected. The typical installation consists of the user entering
one or sometimes a few configuration parameters, including the network address,
either through the front-panel liquid crystal display or an Internet browser.
Customers do not need to integrate other hardware, operating systems,
applications or management software. Each appliance has built-in management for
installation, configuration and error reporting, as well as application
management capabilities specific to the appliance type. With these features, we
believe our servers enable our customers to decrease time-to-revenue and lower
cost of ownership.
Integrated Remote Management. Our server appliances contain integrated
hardware and software components that allow lights out management capable of
monitoring and operating our server appliances even if a server's operating
system is not functioning. Each of our server appliances is designed with a
dedicated embedded processor and extensive, embedded software for system
management and communications. Customers can monitor and control our appliances
in dispersed, remote locations using an Internet connection and an Internet
browser. In addition, our management system enables customers to develop rules-
based decision-making, whereby errors or performance conditions in a remote
cluster can trigger actions ranging from simple notification to a complex
series of automatic responses. This remote management capability enables
customers to customize and centralize system administration and scale their
Internet solutions without hiring a proportionate number of technicians.
Dynamic Scalability. Our solution is scalable because our customers can
increase the power and capacity of their server clusters simply by adding more
servers. Our server appliances can be easily connected to form a group, or
cluster, or to augment an existing cluster, to meet both varied and rapidly
changing management and performance requirements, thereby reducing costs. The
scalability of our solution is dynamic because the performance of individual
networking applications operating on our servers can be increased rapidly and
without interruption by increasing the number of server appliances in a cluster
of our servers devoted to that application. Our proprietary connection
technology automatically recognizes new Network Engines' appliances and assigns
addresses without interruption, instantly establishing communication with, and
control of, any of our server appliances that are added to a working cluster.
Selection of Operating Systems, Applications and Computing Power. We offer
customers appliances with a choice of operating systems, a range of
applications and varying degrees of computing power and functionality. Our
customers have differing requirements for operating systems, either Windows or
Linux, applications and computing power. By offering these choices, our
products appeal to a broad range of customers.
The Network Engines Strategy
Our objective is to become a leading global provider of Internet server
appliances for medium- to large-sized organizations that use Internet-based
applications. The key elements of our strategy include:
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Broaden Our Server Appliance Product Line. We believe that each medium- to
large-scale Internet server appliance customer has specific application and
appliance requirements that result in the need for a variety of server
appliances. To increase our appeal to the server appliance market, we are
seeking to broaden our product line beyond our current web content and e-
commerce appliances to include products designed specifically for streaming
content, storage, database management, system security and other purposes. In
addition, we intend to continue to meet the evolving needs of our customers by
offering a product line with varying levels of performance and a choice of
operating systems.
Continue Hardware and Software Innovation. With our technology expertise, we
seek to continue to develop hardware and software innovations for the server
appliance market. Utilizing our software expertise, we intend to ensure that
our products have intuitive user interfaces and that they may be easily
installed, configured and remotely managed. We also intend to continue to
enhance the performance of our hardware platforms and their remote
manageability, while maintaining our leadership in compact packaging. In
addition, we intend to continue to enhance the combinations of hardware and
software in our server appliances to address the evolving needs of the
Internet.
Expand Research and Development. We will continue our research and
development efforts, including the hiring of qualified technical personnel, in
an effort to enhance existing products and develop new products. In order to
offer our customers the best possible products and to accommodate their future
software and hardware choices and their legacy technology equipment, we will
also seek to continue to develop relationships with key technology vendors that
enhance our total product offerings. With our expanded research and development
capabilities, we intend either to integrate new technologies into our products
or to enhance the management and interoperability of our products within our
customers' installations.
Build Multi-tier Distribution Capability. We sell our products through a
direct sales force, through systems integrators acting as resellers, and to
OEMs and licensed manufacturers. We intend to expand and utilize a direct sales
organization to build our relationships with large end-user customers and to
maintain a good understanding of their changing and expanding market
requirements. In addition, we intend to continue building relationships with
network systems integrators to provide our products more effectively to this
and other market segments. We are expanding our distribution network to include
several international equipment distributors and an Internet-based channel
fulfillment program. A key element of our distribution strategy is to continue
to license our technology and sell our products to significant licensed
manufacturers and OEMs and to seek additional licensed manufacturer and OEM
relationships. For example, we have licensing relationships with IBM,
Infolibria and Micronpc.com and an OEM relationship with VA Linux. We believe
these relationships will assist us in establishing market presence and
increasing our product sales.
Establish Strong Brand Identity. We seek to establish company name
recognition and identification in our targeted market to enhance our sales
efforts. We intend to employ an aggressive public relations campaign and
creative marketing strategies to build market awareness of our products. We
intend to continue to incorporate innovative hardware designs with easy-to-use,
stylish web management interfaces to reinforce our brand name and establish a
strong competitive advantage.
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Invest in Businesses, Products and Technologies. We intend to pursue
strategic acquisitions of, or investments in, businesses, products and
technologies that will provide us with additional industry expertise, enhance
our range of product offerings, expand our development and production capacity,
broaden our client base and expand our geographical presence.
Products
Network Engines' Internet Appliance Architecture is our approach to building
high-performance, high-density appliances for use by e-commerce and Internet-
based organizations, including dot com companies, web hosting providers,
application service providers and Internet service providers. This architecture
enables us to combine the hardware and software needed to install, manage,
optimize and expand our customers' Internet-based applications.
Inherent in our architecture is the concept that simple, comprehensive
management of customer installations is as important as ease of set up. All of
our products can be managed from any location using a standard web browser,
enabling network managers to operate more efficiently without sacrificing site
performance and availability. All of our products are designed within this
Internet Appliance Architecture framework. Each of our server appliances has
the following common characteristics:
. it is a complete, integrated, standalone specific-purpose server
appliance;
. it can be easily installed, requiring simple configuration information
to be entered through the front-panel liquid crystal display or an
Internet browser;
. it can be grouped in a load-balanced cluster with additional appliances
of its own type to increase the power of the solution;
. it includes hardware and software that enable centralized management and
allow the addition of the appliance to a cluster; and
. its management functionality can be extended by the addition of our
management appliance, AdminEngine, to its cluster.
We currently offer WebEngine, CommerceEngine and AdminEngine server
appliances.
WebEngine Product Offerings
The WebEngine family of products includes the WebEngine Roadster NT,
WebEngine Roadster LX, WebEngine Viper NT, WebEngine Viper LX and WebEngine
Blazer. Each WebEngine server appliance may be easily and rapidly deployed to
handle Internet-based information. Each member of the WebEngine family has
distinct features developed to provide a customized solution for the range of
organizations that provide information over the Internet, from entry-level
home-based businesses to large-scale, rapid-growth Internet businesses.
We have committed significant research and development resources to offer
our WebEngine products with either Windows or Linux operating systems in the NT
and LX versions of the Roadster and Viper. This choice accommodates customer
preferences for operating systems and applications. The software in each of the
NT and LX products is as follows:
. 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
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. 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.
WebEngine Roadster and WebEngine Viper. The WebEngine Roadster and Viper
products incorporate Intel processing components in a rack mountable device
that is one rack unit in height. The Roadster and Viper products can be used as
standalone servers, if a customer needs to dedicate an affordable server
appliance to individual web sites or end users. These products can also be
grouped into a cluster of servers containing up to 256 of our appliances. Setup
is easy and management of the Roadsters and Vipers can be handled through the
front-panel liquid crystal display or an Internet browser.
The WebEngine Roadster NT and LX products are our entry-priced server
appliances. The WebEngine Viper NT and LX products have either one or two Intel
Pentium III processors, allowing for higher performance and speed. We commenced
commercial shipment of the WebEngine Roadster and the WebEngine Viper in the
third quarter of fiscal 2000. We charge between $2,000 and $5,000 per unit for
our WebEngine Roadster appliances and between $4,000 and $15,000 per unit for
our WebEngine Viper appliances, depending upon specific product configurations.
WebEngine Blazer. The WebEngine Blazer uses the same hardware platform as
the Viper products. Blazers are available without an operating system to allow
for complete customer configuration or they may be ordered with Windows or
Linux operating systems already installed. Like our other products, the Blazer
includes a backup management network connection and an industry-standard
network connection to give our customers a powerful hardware platform with our
standard management features that can be easily expanded. We commenced
commercial shipment of the WebEngine Blazer in June 1999. We charge between
$4,000 and $15,000 per unit for our WebEngine Blazer appliances, depending upon
specific product configurations.
AdminEngine
The AdminEngine enables the management of up to 256 Network Engines
appliances that are grouped in a cluster, from any location, through any
standard web browser or standards-based network management application.
AdminEngine enables a customer to quickly and easily solve a variety of
problems that otherwise would require a technician to travel to the customer's
server room, which is often located in a remote facility. Using an Internet
browser, customers can restart any Network Engines server from a network drive,
reset it for a local restart, and power it up or down. AdminEngine also allows
our customers to closely monitor performance of their appliances and to
establish rules that will enable our servers to notify the customer of unusual
events. We commenced commercial shipment of the AdminEngine in February 2000.
We charge approximately $5,000 per unit for our AdminEngine, depending upon
specific product configurations.
CommerceEngine
We expect to commence commercial shipment of the CommerceEngine in the
fourth quarter of fiscal 2000. The CommerceEngine is our server appliance that
customers can use to increase their ability to process secure Internet
commercial transactions. The CommerceEngine incorporates a
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hardware-based secure transaction processor in a rack-mountable device that is
one rack unit in height and includes specialized secure transaction processing
software. CommerceEngine is based on industry standards and is compatible with
a wide variety of encryption tools, as well as communications and security
protocols. CommerceEngine gives our customers the performance benefits of
hardware-based secure transaction processing, without complicated installation
and configuration and it can be scaled by adding additional CommerceEngines and
WebEngine appliances. The manageability of the CommerceEngine can be increased
by grouping multiple units in a cluster with our AdminEngine. We expect to
charge between $4,000 and $18,000 per unit for our CommerceEngine, depending
upon specific product configurations.
Technology
A key benefit of our server appliances is the integration of hardware and
software technologies to provide a complete solution for our users. Our server
appliance hardware and software technology is integrated with many industry-
standard technologies to create server appliance solutions.
Hardware Platforms
We have made significant investments in the development of hardware
platforms that combine very high-density packaging of industry-standard
components with management features for clustered server appliances.
High-density packaging. We believe that we have been a leader in the
development of server hardware utilizing standard Intel Pentium III processors
in a rack mountable device that is one rack unit in height. We have developed
significant expertise in cooling and monitoring temperatures to maintain
operating conditions within specifications for the included components.
Management. The processing board of each of our server appliances contains
hardware and software dedicated to the management of that particular appliance
and contributes to our ability to achieve lights out management. This
management section of the processing board is connected to our management
appliance by a network connection, as well as a backup management connection,
known as a cluster management bus. Although our management appliance normally
uses the principal network connection to communicate with each of our
appliances, it is able to switch to the cluster management bus when
communications through the network connection are not available.
Software
We have made significant investments in the development of our software
applications that are integrated with our hardware platforms to provide:
. substantial management capability of our server appliances in each
appliance independently or using our AdminEngine to manage a cluster of
appliances;
. support for both Windows and Linux operating systems; and
. an intuitive user interface for ease of installation, configuration and
management.
Our software is incorporated at three levels: standard appliance management
software in all of our WebEngine and CommerceEngine products; specific
appliance management software in each of our WebEngine and CommerceEngine
products; and AdminEngine software in our AdminEngine management server
appliance.
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Standard Appliance Management. Each of our WebEngine and CommerceEngine
products includes software that allows the appliance to be managed as a
standalone device. In addition, each of these server appliances includes
software to enable enhanced management communications using our AdminEngine if
that appliance is added to a cluster of our appliances that are managed
together. This built-in software reports on hardware conditions, including
temperatures, voltage measurements, fan rotation and similar operating
conditions. It also provides performance statistics, including numbers of
transactions, processor utilization, disk and memory utilization and related
measurements. This software reports on the presence and working condition of
application and system software components. Each server appliance incorporates
software that can execute management instructions. For example, the software
can restart the operating system or reset the power supply.
Specific Appliance Management. Management software is also included in each
appliance for normal application management functions, depending on the level
of management provided by the application builder. For example, Roadster NT and
Viper NT provide a simple interface to the management features of Microsoft's
Internet Information Server. Roadster LX and Viper LX include proprietary
software for the creation and management of web site partitions--functionality
that is not included with the Apache application.
AdminEngine Application. Our AdminEngine appliance application incorporates
several key items of technology:
. 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.
. 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.
. 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.
. External appliance interface. AdminEngine provides a standard point of
control for products developed by our third-party technology providers
to be managed as part of a cluster of our appliances.
Customers
Our customers include companies with e-commerce web sites and high-traffic
Internet web sites, as well as web hosting providers, including application
service providers and Internet service providers. These customers include
providers of streaming video service, web content services, television-based
web services, e-commerce, web portals and emerging web technologies. Customers
also include OEMs and parties that are licensed to build products based on our
product designs. In
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the fiscal year ended September 30, 1999, sales to InterVu, IBM and Microsoft
(WebTV) accounted for 46%, 28% and 14% of net revenues, respectively. For the
six months ended March 31, 2000, sales to each of IBM, Microsoft (WebTV) and
Tellme Networks accounted for 26%, 18% and 14% of our net revenues,
respectively.
Our customers include:
<TABLE>
<S> <C> <C>
Akamba Infobank Computer NetScaler
Arlan & Associates InfoLibria Network Storage Solutions
Audiotalk Networks Information Technology NovaWiz
BeVocal Systems Rearden Steel
Bluedog.com Intertainer Register.com
Comet Systems Intervu Responsys.com
CyberIQ Systems iVillage.com Revit Technology
Data Transit IVion Network Screaming Media
International Lucent Technologies Tellme Networks
Digital Impact Mi8 Ticketmaster Online-City
e-Media Microsoft (WebTV) Search
Enosus Systems Mission Critical TssiMicrosage
FastForward Networks Motorola Visualize Video
iBEAM Broadcasting Natex Communications VocaLoca
IBM NetCreations
</TABLE>
Sales
We sell our products through a direct sales organization and through a
network of channels that includes systems integrators, distributors and
licensed manufacturers. We are continuing to expand our relationships with
channel partners and establish an Internet channel. As of April 30, 2000, we
employed 38 people in sales.
Direct Sales
Our direct sales organization sells to large users of Internet-based
applications and dot com companies and focuses on organizations who require
multiple numbers of our server appliances to meet the demands of their
applications. We have regional sales managers and technical sales engineers
that are located in and serve strategic metropolitan areas, including Atlanta,
Boston, Dallas, Los Angeles, New York, Philadelphia, San Francisco and
Washington D.C. Our sales managers and sales engineers work in teams to analyze
our prospective customers' requirements and propose solutions that meet their
needs. Our sales teams maintain close relationships with our customers after
our products have been installed to ensure our customers remain satisfied. Our
sales managers are compensated with a base salary and commissions which are
based on their attainment of sales quotas. In addition to a base salary, our
sales engineers receive bonus payments based on the sales revenues generated by
their assigned customers.
Channel Sales
Our indirect sales efforts in the United States are primarily focused on
enhancing our network of domestic systems integrators and resellers with
significant experience with networking applications. We are also focusing on
developing additional indirect sales channels as we initiate sales activities
outside the United States, primarily in Europe and Asia.
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Licensing and OEM Relationships
We have entered into strategic OEM and licensed manufacturer agreements
under which our products, manufactured either by us or another company, are
branded and sold under another company's label. Our current OEM and licensed
manufacturers include IBM, Infolibria, Micronpc.com and VA Linux. While we
expect sales to these OEM and licensed manufacturers to continue, none of them
has any obligation to purchase any quantity of our products in the future. We
will continue to seek to license our technology to broaden our sales capacity.
We entered into an agreement with IBM in July 1999 that permits IBM to
manufacture products using our design and technology and sell them under IBM's
own label. We receive a royalty payment based on the number of units sold by
IBM. This agreement expires in January 2002, but may be terminated by IBM at
any time.
Marketing
Our marketing objectives include building market awareness and acceptance
of Network Engines and our products, as well as generating qualified customer
leads. We attend trade shows, send out direct mail, and provide information
about our company and our products on our web site. We also conduct public
relations activities utilizing the services of Beaupre & Co., a division of
Brodeur Worldwide. Our executives speak at industry events and provide
briefings to industry analysts and trade press. We have begun advertising in
local and trade publications to promote our products to our target markets.
Our marketing goals include the following:
. to plan and build an integrated program addressing both internal and
external audiences, including prospects, customers, business and trade
press, industry analysts and investors;
. to position us as a leader in providing a wide range of server
appliances for the Internet;
. to design and implement media and tactical programs that communicate
effectively with our target audiences; and
. to clearly and consistently communicate our positioning in our marketing
programs.
As of April 30, 2000, we employed 11 people in marketing.
Support Services
We believe that our ability to consistently provide high-quality customer
service and support will be a key factor in attracting and retaining
customers. We provide support for our products through technical sales
engineers who are located in our sales offices and through our customer
support staff based in our Canton, Massachusetts facility. Our support
activities include direct support to our customers through our web site, which
offers technical information designed to assist in answering frequently asked
questions and in problem diagnosis and resolution. We also provide telephone
support via a help desk, e-mail support, and remote control support that
provides direct access from our support personnel to our customers' systems
for diagnosis and problem resolution. We have also recently engaged the
services of IBM as a subcontractor to provide on-site support in U.S.
locations where we do not have our own service personnel. Our service
arrangement with IBM, which provides next-day, on-site customer support visits
and after-hours phone-in help desk support, is expected to be operational by
the second half of fiscal 2000.
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We provide a warranty program for all of our products, which is typically
one year in duration for all parts replacement. Our standard terms and
conditions provide that a customer may return a defective product for repair or
replacement during the warranty period. In addition, during the warranty
period, it has been our practice to send our customers a replacement unit in
advance of their returning a unit experiencing problems. The customer then
swaps units, returning the damaged unit to our depot repair facility in Canton,
Massachusetts. We plan to add additional repair facilities as we build our
distribution capability to be able to provide this level of service on a
worldwide basis. As of April 30, 2000, we employed five people in support
services.
Manufacturing
We use contract manufacturers to produce most of our products. We also have
our own manufacturing employees and manufacturing facilities to build
prototypes and initial units of our new server appliance hardware products. Our
in-house capability is also currently used to perform final assembly, testing
and quality assurance processes, although many of these activities will be
transferred to our manufacturer, SCI Systems. SCI Systems currently utilizes
two of their facilities to build our server appliances--one in Hookset, New
Hampshire and the other in Augusta, Maine.
Some of our sub-assemblies, including chassis, central processing unit
motherboards, and power supplies, are manufactured to our specifications while
other sub-assemblies, for example disk drives, are commodity items. This
approach allows us to maintain design control in areas where we add significant
value and to benefit from market economies with respect to commodity items.
Our contract manufacturing strategy allows us to:
. reduce our capital expenditures;
. conserve the working capital that would be required to fund inventory;
. adjust manufacturing volumes more quickly to meet changes in demand; and
. operate with reduced space dedicated to manufacturing operations.
Research & Development
We believe that our future success depends on our ability to build upon our
current technology platforms, expand the features and functionality of our
suite of server appliances, and develop additional products that maintain our
technological advantages. We have assembled a team of highly skilled engineers
with significant industry experience in high-density packaging, server design,
embedded management, networking, software, quality assurance and technical
documentation. As of April 30, 2000, we employed 46 people in this group.
We will continue to integrate our own hardware and software designs with
industry-standard components, including operating systems and processor
technologies. We also intend to combine technology from other industry sources
into our server appliances where appropriate in order to meet functionality and
time-to-market objectives. We currently have new server appliances and new
hardware platforms under development that are intended to increase the choices
of server appliances we offer to our customers. Included in this development
activity are server appliances for network attached storage, for Internet
caching, for load balancing and for streaming video. These research and
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<PAGE>
development activities for our server appliances range from feasibility studies
to active development efforts. It is possible that we may choose to abandon any
or all of these activities without bringing them to market.
Our product development expenses for fiscal 1998, 1999 and the six months
ended March 31, 2000, were $923,000, $2.6 million and $3.1 million,
respectively. We expect our product development expenses to increase as we hire
additional research and development personnel to develop new products and
enhance our existing products.
Strategic Relationships
We have developed, and will continue to seek to develop, relationships with
key technology vendors that enhance our product offerings. We believe the use
of industry standard technologies, wherever possible, can reduce the cost of
our development activities and the cost of our products to our customers. We
also believe that the integration of non-standard technologies from these key
vendors can allow us to bring products to market more quickly and to reduce the
costs that would result from developing the capability ourselves. In addition,
we believe that extending the management capabilities of our products to
provide management of some of these key vendors products will assist us in
meeting the needs of our customers to manage their Internet systems that
include products from other vendors.
Competition
Our markets are new, rapidly evolving and highly competitive, and we expect
this competition to persist and intensify in the future. We face competition
primarily from server vendors that provide solutions for network computing
systems.
Our principal competitors are general-purpose server manufacturers,
including Compaq, Dell, Hewlett-Packard, IBM and Sun Microsystems. These
competitors have begun manufacturing special versions of their general-purpose
server products for sale as server appliances. We also compete with server
appliance vendors such as Cobalt, Network Appliance and CacheFlow. These other
competitors are expanding their product lines to include several types of
server appliances. In addition, we compete with computer companies that
specialize in building very compact rack-mounted server products, but who do
not typically include software in their offerings. Examples of these
competitors are TruSolutions, Penguin Computing and Qsol.com.
We believe that we compete favorably on factors that are important to our
target market, including packaging density, ease of installation and
configuration, clustering capability to build large configurations of our
server appliances, management capabilities for co-located servers and a wide
range of appliance choices.
We expect competition in the server appliance market to increase
significantly as more companies enter the market and current competitors expand
their product lines. Many of these potential competitors may have significant
competitive advantages, including greater name recognition, more resources to
apply to the development, marketing and sales of their products, and more
established sales channels.
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Intellectual Property
We have invested significantly in the development of proprietary technology
for our products and our operations frequently incorporate proprietary and
confidential information. We rely upon a combination of copyright and trademark
laws and non-disclosure and other intellectual property contractual
arrangements to protect our proprietary rights. We protect our software,
documentation and other written materials under trade secret and copyright
laws, which only provide limited protection. We do not hold any patents and
currently have no patent applications pending. We also enter into
confidentiality or license agreements with our employees, consultants and
corporate partners, and control access to and distribution of our software,
documentation and other proprietary information.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy or otherwise obtain and use our products or technology.
Monitoring unauthorized use of our products is difficult, and we cannot be
certain that the steps we have taken will prevent misappropriation of our
technology, particularly in foreign countries where the laws may not protect
our proprietary rights as fully as in the United States. In addition, our
competitors might independently develop similar technology or duplicate our
product or circumvent any patents or our other intellectual property rights.
Due to rapid technological change in our market, we believe the various legal
protections available for our intellectual property are of limited value.
Instead, we seek to establish and maintain a technology leadership position by
leveraging technological and creative skills of our personnel, new product
developments and enhancements to existing products.
Employees
Our success in recruiting, hiring and training large numbers of full-time
and skilled employees and, if the need arises, obtaining large numbers of
temporary employees during periods of increased product demand, is critical to
our ability to produce high quality products on a timely basis. As of April 30,
2000, we had 141 employees. In addition, we may hire temporary employees during
the year depending on market acceptance of our products. We believe that the
demographics surrounding our headquarters, and our reputation and compensation
package, should allow us to continue to attract and retain qualified employees.
We are committed to training our employees and we believe that we maintain
good employee relations.
Facilities
We recently moved our corporate headquarters to a facility in Canton,
Massachusetts, consisting of approximately 52,000 square feet of manufacturing
and office space. In August 2000, we plan to expand our corporate headquarters
into an additional 23,000 square feet located at the Canton facility. We
believe that the Canton facility and additional or alternative available spaces
will be adequate to meet our requirements for the foreseeable future. In
addition, we have regional sales office facilities in the following strategic
metropolitan areas: Los Angeles, New York, San Francisco and Washington, D.C.
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Legal Proceedings
On December 29, 1999, a former employee, George Flate, commenced a lawsuit
against us, a current officer and director and a former officer and director in
Suffolk Superior Court, a Massachusetts state court. Mr. Flate alleges that he
was unlawfully terminated as Vice President of OEM Sales in an effort to
deprive him of commission payments. He is seeking undisclosed damages based on
two contractual claims relating to his employment, although we anticipate he
will claim damages in the multi-million dollar range. Specifically, he is
alleging a breach of the implied covenant of good faith and fair dealing
against Network Engines and a claim of intentional interference with
contractual relations against the current and former officers of the company
named in the lawsuit. Both of these claims are based on Mr. Flate's allegations
that he is entitled to commissions from several transactions that were
negotiated after Mr. Flate was no longer with the company. Mr. Flate was
employed by Network Engines for approximately one year. Currently, the matter
is in the early stages of discovery. Although we believe these claims are
without merit and we intend to vigorously defend against each claim asserted in
the complaint, an adverse resolution of either of these claims could require
the payment of substantial monetary damages. Moreover, our defense against
these claims might result in the expenditure of significant financial and
managerial resources.
We are, from time to time, a party to other litigation arising in the normal
course of our business. Management believes that none of these other actions,
individually or in the aggregate, will have a material adverse effect on our
financial position or results of operations.
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<PAGE>
MANAGEMENT
Executive Officers and Directors
Our executive officers and directors, and their ages and positions as of
April 30, 2000, are as follows:
<TABLE>
<CAPTION>
Name Age Position
<C> <C> <S>
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.......... 48 Vice President of Manufacturing
William B. Elliott......... 55 Vice President of Marketing
Rene E. Thibault........... 49 Vice President of Sales
Robert F. Wambach.......... 39 Vice President of Engineering
John A. Blaeser(2)......... 58 Director
Lawrence Kernan(1)(2)...... 46 Director
Dennis A. Kirshy(1)........ 57 Director
Frank M. Polestra.......... 74 Director
Michael H. Shanahan(1)(2).. 43 Director
Robert M. Wadsworth(1)(2).. 40 Director
</TABLE>
---------------------
(1) Member of the compensation committee
(2) Member of the audit committee
Set forth below is certain information regarding the professional experience
for each of the above-named persons.
Lawrence A. Genovesi is our founder and has served as our Chairman of the
Board, President, Chief Executive Officer and Chief Technology Officer since
October 1989. Mr. Genovesi also founded and served as Chief Executive Officer
of New England Interconnection Devices, Inc., a contract manufacturer, from May
1985 to July 1988. From October 1982 to January 1983, Mr. Genovesi served as
Vice President of Engineering for Microsystems International, Inc., a computer
manufacturer. From June 1981 to December 1982, Mr. Genovesi served as Director
of Engineering for CPU Systems Corp., a computer manufacturer and reseller.
Douglas G. Bryant has served as our Secretary and Vice President of
Administration since March 2000, our Treasurer since January 1998 and our Chief
Financial Officer since September 1997. Prior to joining Network Engines, Mr.
Bryant served as Chief Financial Officer of CrossComm Corporation, a
manufacturer of internetworking products including routers and switches, from
July 1996 to June 1997, and as Corporate Controller from September 1989 to June
1996.
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<PAGE>
Timothy J. Dalton has served as Vice President of Manufacturing since
November 1997. From November 1996 to November 1997, Mr. Dalton served as
Operations Manager of Axil Computer Corporation, a privately-held designer and
manufacturer of eight-way SMP servers. From January 1994 to July 1996, Mr.
Dalton served as Director of Manufacturing Engineering of Concurrent Computer
Corporation, a designer and manufacturer of Real Time Fault Tolerant servers
for the financial and telecommunications industries.
William B. Elliott has served as Vice President of Marketing since December
1997. Previously, Mr. Elliott served as Vice President of Operations for
Dynaflo, Inc. from May 1997 to December 1997. From October 1996 to May 1997,
Mr. Elliott served as Vice President of Sales and Marketing for Anysoft, Inc.,
a producer of utility software that enhances the interchange of information
between legacy and modern Windows-based applications. Mr. Elliott served as
Vice President of Telecommunications at Stratus Computer from November 1993 to
April 1996, and as Vice President of International Sales for Stratus'
telecommunications division from October 1990 to November 1993.
Rene E. Thibault has been Vice President of Sales since July 1999. Prior to
joining Network Engines, Mr. Thibault served as Vice President of Sales and
Marketing for Voice Request Corporation, a developer of speech-enabled call
routing systems, from January 1997 to June 1999. From October 1995 to December
1996, Mr. Thibault served as Vice President of Sales for Centigram
Communications Corporation, a manufacturer of multimedia messaging and personal
assistant servers. Mr. Thibault also served as Director of Sales for Centigram
from September 1990 to September 1995.
Robert F. Wambach has served as Vice President of Engineering since May
1999. Prior to joining Network Engines, Mr. Wambach served as Senior Director
of VPN Programs at Shiva Corporation, a manufacturer of hardware and software
to enable the connectivity of enterprise networks, which was ultimately
acquired by a subsidiary of Intel and renamed Intel Network Systems, from
February 1999 to May 1999, Senior Director of Platform Engineering from June
1998 to February 1999, and Director of Hardware Engineering from June 1997 to
June 1998. Mr. Wambach held various engineering management positions with
Fujitsu-Nexion (formerly Nexion) from May 1993 to June 1997.
John A. Blaeser has been a director of Network Engines since October 1999.
Since January 1996, Mr. Blaeser has served as President, Chief Executive
Officer and Chairman of the Board of Concord Communications Inc., a maker of e-
business management solutions. Mr. Blaeser served as Managing General Partner
of EG&G Venture Partners from January 1990 to December 1995.
Lawrence Kernan has served as a Director of Network Engines since October
1999. Mr. Kernan has been a Principal of MDT Advisers, Inc., an investment and
venture capital firm, since December 1991. Mr. Kernan has also served as a
director of Keurig, Inc., a manufacturer of coffee brewing equipment, as
Chairman of the Board of Directors, since April 1995. Mr. Kernan has previously
served as a director at First American Financial Corporation, ADS Technologies,
Inc., Cobotyx, Inc. and Visage, Inc.
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<PAGE>
Dennis A. Kirshy has served as a Director of Network Engines since July
1997. Mr. Kirshy is a private investor and has advised and invested in small
technology companies in the networking, internetworking and computer industries
since February 1993. Mr. Kirshy is also a director of several privately-held
companies in the networking and computer peripherals arena.
Frank M. Polestra has served as a Director of Network Engines since May
1997. Mr. Polestra has been Managing Director of Ascent Venture Management,
Inc., a manager of venture funds and investor in early-stage companies in the
Northeastern United States, since March 1999. Mr. Polestra is a Managing Member
or General Partner of each of the general partners of Ascent Venture Partners,
L.P., Ascent Venture Partners II, L.P. and Ascent Venture Partners III, L.P.
Mr. Polestra is also a partner of Le Serre. Prior to his position with Ascent
Venture Management, Mr. Polestra was President, Director and General Partner of
Pioneer Capital Corporation, a venture capital management firm, from 1981 to
1999. Mr. Polestra is also a director of several privately-held companies.
Michael H. Shanahan has served as a Director of Network Engines since
January 1999. Mr. Shanahan has served as General Partner of Egan-Managed
Capital, L.P., a venture capital firm managing a portfolio of investments in
technology companies, since co-founding that firm in February 1997. From April
1982 to February 1997, Mr. Shanahan was a Partner with Eastech Management
Company, a manager of venture capital funds with investments in technology
companies. Mr. Shanahan is also a director of several privately-held companies.
Robert M. Wadsworth has served as a Director of Network Engines since
December 1999. He has been a Managing Director of HarbourVest Partners, LLC, a
global private equity firm investing in Internet and information technology
companies on a worldwide basis, since January 1997. Mr. Wadsworth has also been
a General Partner of Hancock Venture Partners, the predecessor organization to
HarbourVest, since December 1988. Mr. Wadsworth is also a member of the board
of directors of the following companies: Banyan Systems, Inc., Blue Sky
Software Corporation, Cardiff Software, Inc., Communication Systems Technology,
Inc., Concord Communications, Inc., Nuera Communications, Inc., Oasis
Technology Ltd., Outsourcing Services Group, Polaris Service, Inc.,
Switchboard.com, Inc., Tally Systems Corporation and Trintech Group Limited.
Election of Directors
Upon the closing of this offering, the board of directors will be divided
into three classes, each of whose members will serve for a staggered three-year
term. Dennis A. Kirshy and Michael H. Shanahan will serve in the class whose
term expires in 2001; Lawrence Kernan and Frank M. Polestra will serve in the
class whose term expires in 2002; and Lawrence A. Genovesi, John A. Blaeser and
Robert M. Wadsworth will serve in the class whose term expires in 2003. Upon
the expiration of the term of a class of directors, directors for that class
will be elected for three-year terms at the annual meeting of stockholders.
Each officer serves at the discretion of the board of directors and holds
office until his or her successor is elected and qualified or until his or her
earlier resignation or removal. A voting agreement among us and several of our
stockholders provides for the nomination and election of directors by certain
of our 5% stockholders. Messrs. Genovesi, Blaeser, Kernan, Kirshy, Polestra,
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Shanahan and Wadsworth were elected to the board of directors pursuant to the
voting agreement. The voting agreement terminates upon the closing of this
offering.
Compensation of Directors
We intend to grant stock options on an annual basis under our director plan
and may grant other equity awards from time-to-time to our non-employee
directors pursuant to our 1999 plan or director plan.
Board Committees
The board of directors has established a compensation committee and an audit
committee. The compensation committee, which consists of Messrs. Kernan,
Kirshy, Shanahan and Wadsworth, reviews executive salaries, administers any
bonus, incentive compensation and stock option plans, and approves the salaries
and other benefits of our executive officers. In addition, the compensation
committee consults with our management regarding pension and other benefit
plans and our compensation policies and practices. The audit committee, which
consists of Messrs. Blaeser, Kernan, Shanahan and Wadsworth, reviews the
professional services provided by our independent accountants, the independence
of our accountants from our management, our annual financial statements and our
system of internal accounting controls. The audit committee also reviews other
matters related to our accounting, auditing and financial reporting practices
and procedures that the committee find appropriate or may be brought to its
attention.
Compensation Committee Interlocks and Insider Participation
Prior to the formation of a compensation committee, the board of directors
as a whole made decisions concerning the compensation of executive officers.
Mr. Genovesi, an executive officer, was a member of our board of directors when
it performed the functions generally performed by a compensation committee,
including determining the compensation of executive officers. However, Mr.
Genovesi did not participate in any discussions regarding his compensation. For
a description of transactions between us and certain of our directors, Messrs.
Genovesi, Kernan, Kirshy, Polestra, Shanahan and Wadsworth, and entities
affiliated with our directors, see "Related Party Transactions" below.
Executive Compensation
The following table sets forth, for the fiscal year ended September 30,
1999, the cash compensation paid and shares underlying options granted to our:
. Chief Executive Officer; and
. five other most highly compensated executive officers who received, or
would have received, annual compensation in excess of $100,000, referred
to collectively as the named executive officers.
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<PAGE>
Summary Compensation Table
<TABLE>
<CAPTION>
Long-term
Compensation
Awards
------------
Annual
Compensation (1) Shares
---------------- Underlying
Name and Principal Position Salary Bonus Options (2)
<S> <C> <C> <C>
Lawrence A. Genovesi........................... $146,154 -- --
Chief Executive Officer
Douglas G. Bryant.............................. 111,538 -- 149,850
Chief Financial Officer
William B. Elliott............................. 111,538 -- 127,500
Vice President of Marketing
Timothy J. Dalton.............................. 111,538 -- 121,500
Vice President of Manufacturing
Rene E. Thibault............................... 34,039 $18,750(4) 348,000
Vice President of Sales (3)
Robert F. Wambach.............................. 43,269 -- 261,000
Vice President of Engineering (5)
</TABLE>
---------------------
(1) In accordance with the rules of the Securities and Exchange Commission,
the compensation set forth in the table does not include medical, group
life or other benefits which are available to all of our salaried
employees, and certain perquisites and other benefits, securities or
property which do not exceed the lesser of $50,000 or 10% of the person's
salary and bonus shown in the table.
(2) We did not award any stock appreciation rights or make any long-term
incentive payments during fiscal 1999 to the named executive officers.
Options granted to the named executive officers were granted at fair
market value as determined by the board of directors based on all factors
available to the board of directors on the grant date.
(3) Mr. Thibault joined us in July 1999. On an annualized basis, Mr. Thibault
would have earned a salary of $150,000 and an incentive-based compensation
target of $75,000.
(4) Comprised of commissions paid based on revenue generated.
(5) Mr. Wambach joined us in April 1999. On an annualized basis, Mr. Wambach
would have earned a salary of $125,000.
In the table above, columns required by the regulations of the Securities
and Exchange Commission have been omitted where no information was required to
be disclosed under those columns.
Option Grants in the Last Fiscal Year
The following table sets forth grants of stock options made under our 1999
stock incentive plan for the year ended September 30, 1999 to each individual
named in the Summary Compensation Table. We have never granted any stock
appreciation rights.
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<PAGE>
The amounts shown as potential realizable value represent hypothetical gains
that could be achieved for the respective options if exercised at the end of
the option term. These amounts represent certain assumed rates of appreciation
in the value of our common stock. The 5% and 10% assumed annual rates of
compounded stock price appreciation are mandated by rules by the Securities and
Exchange Commission. These estimates do not represent our estimate or
projection of the future price of our common stock and may not necessarily be
achieved. The potential realizable value is calculated based on the ten year
term of the option at its time of grant on the assumption that the share value
appreciates from the assumed initial public offering price of $14.00 at the
indicated compounded annual rate and that the option is exercised and sold on
the last day of its term for the appreciated stock price. Actual gains, if any,
on stock option exercises depend on the future performance of our common stock.
The percentage of total options granted to our employees in the last fiscal
year is based on options to purchase an aggregate of 1,593,975 shares of common
stock granted during fiscal 1999.
<TABLE>
<CAPTION>
Individual Grants
-------------------------------------------
Potential Realizable
Value at Assumed
Annual Rates of
Number of % of Total Stock Price
Securities Options Exercise Appreciation for
Underlying Granted To of Base Option Term
Options Employees in Price Expiration ----------------------
Name Granted Fiscal Year ($/Sh) Date 5% 10%
<S> <C> <C> <C> <C> <C> <C>
Lawrence A. Genovesi.... -- -- % $ -- -- $ -- $ --
Douglas G. Bryant....... 149,850 9.4 0.133 2/24/09 3,397,328 5,421,482
William B. Elliott...... 127,500 8.0 0.133 2/24/09 2,890,619 4,612,873
Timothy J. Dalton....... 121,500 7.6 0.133 2/24/09 2,754,590 4,411,955
Rene E. Thibault........ 348,000 21.8 0.133 7/22/09 7,889,691 12,590,429
Robert F. Wambach....... 261,000 16.4 0.133 5/26/09 5,917,267 9,442,822
</TABLE>
Fiscal Year-End Option Values
The following table sets forth information for each of the named executive
officers with respect to the value of options outstanding as of September 30,
1999. There was no public trading market for our common stock as of September
30, 1999. Accordingly, these values have been calculated based on the assumed
initial public offering price of $14.00, less the aggregate exercise price.
<TABLE>
<CAPTION>
Number of Securities
Underlying Value of Unexercised
Shares Unexercised Options In-The-Money Options
Acquired at September 30, 1999 at September 30, 1999
on Value --------------------- ---------------------
Name Exercise Realized Vested Unvested Vested Unvested
<S> <C> <C> <C> <C> <C> <C>
Lawrence A. Genovesi.... -- -- -- -- $ -- $ --
Douglas G. Bryant....... -- -- 48,628 212,372 677,226 2,948,643
William B. Elliott...... -- -- 39,375 178,125 548,363 2,473,038
Timothy J. Dalton....... -- -- 22,968 151,032 319,868 2,096,082
Rene E. Thibault........ -- -- -- 348,000 -- 4,825,600
Robert F. Wambach....... -- -- -- 261,000 -- 3,619,200
</TABLE>
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<PAGE>
Benefit Plans
1999 Stock Incentive Plan. Our 1999 stock incentive plan, as amended, was
originally adopted by our board of directors in October 1999 and approved by
our stockholders in November 1999. Up to 8,047,902 shares of our common stock
currently may be issued pursuant to options or awards granted under the 1999
plan. The number of shares that may be issued pursuant to the 1999 plan will be
increased annually beginning on October 1, 2000 by the lesser of:
. 4,000,000 shares;
. 5% of the outstanding shares on the date of the increase; or
. a lesser amount determined by the board of directors.
Share increases may not exceed an aggregate of 12,000,000 shares during the
term of the 1999 plan.
The 1999 plan provides for the grant of incentive stock options intended to
qualify under Section 422 of the Internal Revenue Code, nonstatutory stock
options, restricted stock awards and other stock-based awards. Our officers,
employees, directors, consultants and advisors are eligible to receive awards
under the 1999 plan. The granting of awards under the 1999 plan is
discretionary. Under present law, however, incentive stock options may be
granted only to employees. Under the 1999 plan, no participant may receive any
award for more than 1,250,000 shares in any calendar year.
We may grant options at an exercise price less than, equal to or greater
than the fair market value of our common stock on the date of grant. Under
present law, incentive stock options and options intended to qualify as
performance-based compensation under Section 162(m) of the Internal Revenue
Code may not be granted at an exercise price less than the fair market value of
the common stock on the date of grant or less than 110% of the fair market
value in the case of incentive stock options granted to optionees holding more
than 10% of the voting power of Network Engines. The 1999 plan permits our
board of directors to determine how optionees may pay the exercise price of
their options, including by cash, check or, in connection with a "cashless
exercise," through a broker, by surrender to us of shares of common stock, by
delivery to us of a promissory note, or by any combination of the permitted
forms of payments.
Our board of directors administers the 1999 plan. Our board of directors has
the authority to adopt, amend and repeal the administrative rules, guidelines
and practices relating to the plan and to interpret its provisions. It may
delegate authority under the 1999 plan to one or more committees of the board
of directors and, subject to certain limitations, to one or more of our
executive officers. Subject to any applicable limitations contained in the 1999
plan, our board of directors or a committee of the board of directors or
executive officer to whom our board of directors delegates authority, as the
case may be, selects the recipients of awards and determines:
. the number of shares of common stock covered by options and the dates
when the options become exercisable;
. the exercise price of options;
. the duration of options; and
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<PAGE>
. the number of shares of common stock subject to any restricted stock or
other stock-based awards and the terms and conditions of the awards,
including the conditions for repurchase, issue price and repurchase
price.
Typically, for each option granted, 25% of the shares become exercisable on
the first anniversary of the option grant and the remainder become exercisable
in 12 equal installments at the rate of 6.25% of the shares each three-month
period following the first anniversary of the option grant.
The plan provides that in the event of a merger, liquidation or other
acquisition event, each outstanding option or restricted stock award shall be
assumed or an equivalent option or award substituted by the successor
corporation, as determined by our board of directors, unless the successor
corporation refuses to assume or substitute for the option or award, in which
case those options or awards shall become fully vested and free of restrictions
prior to the consummation of the acquisition event.
No award may be granted under the 1999 plan after October 21, 2009, but the
vesting and effectiveness of options and awards previously granted may extend
beyond that date. As of April 30, 2000, we granted awards of and options
exercisable for 4,915,875 shares of common stock, excluding awards and options
that have been cancelled. Our board of directors may at any time amend, suspend
or terminate the 1999 plan, except that no award granted after an amendment of
the 1999 plan and designated as subject to Section 162(m) of the Internal
Revenue Code by our board of directors shall become exercisable, realizable or
vested, to the extent the amendment was required to grant the award, unless and
until the amendment is approved by our stockholders.
2000 Employee Stock Purchase Plan. Our 2000 employee stock purchase plan was
adopted by the board of directors in March 2000 and will be approved by the
stockholders in May 2000. The employee stock purchase plan authorizes the
issuance of up to a total of 750,000 shares of common stock to participating
employees.
All of our employees, including our employee-directors, who are customarily
employed by us for more than 20 hours a week and who are customarily employed
by us for at least five months in a calendar year are eligible to participate
in the employee stock purchase plan. Employees who would immediately after the
grant own 5% or more of the total combined voting power or value of our stock
or any subsidiary are not eligible to participate.
The employee stock purchase plan permits eligible employees to purchase
common stock through payroll deductions, which may not exceed 15% of an
employee's compensation, subject to certain limitations. On the first day of a
designated payroll deduction period, referred to as the offering period, we
will grant to each eligible employee who has elected to participate in the
employee stock purchase plan an option to purchase shares of common stock. On
the last day of the offering period, the employee is deemed to have exercised
the option, at the option exercise price, to the extent of accumulated payroll
deductions. Under the terms of the employee stock purchase plan, the option
price is an amount equal to 85% of the fair market value per share of the
common stock on either the first day or the last day of the offering period,
whichever is lower. The first offering period under the employee stock purchase
plan will commence on the first date that we have filed
56
<PAGE>
with the Securities and Exchange Commission an effective registration statement
on Form S-8 for purposes of registering under the Securities Act of 1933, or
the Securities Act, all shares of our common stock issuable under the employee
stock purchase plan, and shall end on December 31, 2000. The compensation
committee may, in its discretion, choose an offering period of 12 months or
less for each of the offerings and choose a different offering period for each
offering.
If an employee is not a participant on the last day of the offering period,
the employee is not entitled to exercise any option, and the amount of the
employee's accumulated payroll deductions will be refunded. An employee's
rights under the employee stock purchase plan terminate upon voluntary
withdrawal from the employee stock purchase plan at any time, or when the
employee ceases employment for any reason, except that upon termination of
employment because of death, the employee's beneficiary has a right to the
accumulated payroll deductions in the participant's account.
2000 Director Stock Option Plan. Our 2000 director stock option plan was
adopted by our board of directors in March 2000 and will be approved by our
stockholders in May 2000. Under the director plan, our directors who are not
employees of Network Engines or a subsidiary of Network Engines receive non-
statutory options to purchase shares of common stock. A total of 500,000 shares
of common stock may be issued upon the exercise of options granted under the
director plan.
Pursuant to the director plan, each non-employee director who first becomes
a non-employee director after the closing of this offering will be granted an
option to purchase 50,000 shares of common stock on the date of his or her
initial election to our board of directors, which will vest ratably over four
years on each anniversary of the date of grant. In addition, each non-employee
director will receive an option to purchase 15,000 shares of common stock on
the date of each annual meeting of stockholders commencing with the 2001 annual
meeting of stockholders (other than a director who was initially elected to the
board of directors at any annual meeting or, if previously, at any time after
the prior year's annual meeting). The options granted annually vest upon the
earlier of one year from the date of grant or the date immediately preceding
the next annual meeting of stockholders, so long as the optionee remains our
director. The exercise price per share of all options granted to directors
under the director plan will be the fair market value of a share of common
stock on the date of grant.
Employee Savings and Retirement Plan. We have an employment savings and
retirement plan. The plan covers all of our full-time employees. Under the
plan, participants may elect to defer a portion of their eligible compensation,
subject to certain limitations. We do not match employee contributions to the
plan.
Management Incentive Plan. The compensation committee adopted a management
incentive plan in February 2000. Under this plan, commencing with the quarterly
period ending June 30, 2000, we will pay on a quarterly basis to each of our
vice presidents and our president a percentage of their respective annual base
salaries if we achieve our net revenue targets for that quarter. For the
quarters ending June 30, 2000 and September 30, 2000, the compensation
committee determined that the executives will receive 12.5% of their respective
annual base salaries if targets for those periods are met.
57
<PAGE>
RELATED PARTY TRANSACTIONS
Transfer of P6000 Product Line
In April 2000, we sold all of our inventory and test equipment related to
the P6000 product line to Copernicus Systems, Inc., which is wholly-owned by
Cheryl H. Smith. Ms. Smith, the wife of Mr. Genovesi, is a co-founder,
stockholder and former director and officer of Network Engines. Our production
and development of the P6000 product line has been discontinued and we have
fully reserved for these assets on our balance sheet. In exchange for these
assets, Copernicus Systems, Inc. agreed to pay to us royalties on future sales
of the inventory and agreed to support P6000 units for which we have
obligations under warranty or service contracts.
Loan and Guarantee from Lawrence A. Genovesi and Cheryl H. Smith
In April 1993, Mr. Genovesi and Ms. Smith loaned us $26,175 in exchange for
a promissory note bearing interest at 10% annually made in their favor. In
January 1996, Ms. Smith also loaned us $4,300 in exchange for a promissory note
bearing interest at 12% annually in her favor. The interest rate on each note
was reduced by one-half in January 1999. These notes were paid in full and
canceled in August 1999.
In order to receive a Small Business Administration guarantee of 90% of a
$100,000 note obtained in May 1994, Mr. Genovesi and Ms. Smith granted a second
mortgage on their personal residence to the Small Business Administration. We
repaid the loan in fiscal 1999.
Severance Arrangements with Cheryl H. Smith
In January 1998, we and Ms. Smith executed a Severance Agreement and
Release, pursuant to which we paid Ms. Smith approximately $72,000 and engaged
Copernicus & Co., which is wholly-owned by Ms. Smith, as a consultant for one
month at a fee of $300 per day. We and Ms. Smith released each other from most
claims related to her employment by us.
Issuances of Preferred Stock to Directors and 5% Holders
We have issued four series of preferred stock. Each series A, series B and
series C preferred share is convertible upon the completion of this offering
into 7.5 shares of our common stock. Each series D preferred share is
convertible upon the completion of this offering into 2.5 shares of our common
stock. We issued the following number of shares of each series of preferred
stock on the following dates:
. On April 9, 1997, we issued an aggregate of 185,250 shares of series A
preferred stock at $5.40 per share, or 1,389,375 shares of common stock
at $0.72 per share on an as-converted basis;
. On January 13, 1999, we issued an aggregate of 357,142 shares of series
B preferred stock at $7.70 per share, or 2,678,565 shares of common
stock at $1.03 per share on an as-converted basis;
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<PAGE>
. On January 13 and June 30, 1999, we issued an aggregate of 1,123,549
shares of series C preferred stock at $7.70 per share, or 8,426,617
shares of common stock at $1.03 per share on an as-converted basis; and
. On December 20, 1999, we issued an aggregate of 3,581,554 shares of
series D preferred stock at $7.05 per share, or 8,953,885 shares of
common stock at $2.82 per share on an as-converted basis.
The following directors and 5% holders of our common stock and entities
controlled by them were issued the following number of shares of each series of
preferred stock in exchange for cash or the cancellation of bridge notes:
<TABLE>
<CAPTION>
Series A Series B Series C Series D
Preferred Preferred Preferred Preferred
Stock Stock Stock Stock
<S> <C> <C> <C> <C>
5% Holders
Ascent Venture Partners, L.P., Ascent
Venture Partners II, L.P. and Ascent
Venture Partners III, L.P.
(affiliated entities)(1)............ 185,250 357,142 139,122 283,688
MD Co................................ -- -- 388,941 141,894
Egan-Managed Capital, L.P............ -- -- 291,698 106,383
HarbourVest VI-Direct Fund, L.P...... -- -- -- 1,985,816
Canaan Equity Partners II, LLC....... -- -- -- 709,220
Directors
Dennis A. Kirshy..................... -- -- 6,493 2,056
Lawrence Kernan(2)................... -- -- 1,298 --
Frank M. Polestra(3)................. -- -- 9,740 --
</TABLE>
---------------------
(1) Ascent Venture Partners, L.P. and Ascent Venture Partners II, L.P.
acquired all of their series A preferred stock and series B preferred
stock and 19,480 and 77,922 shares of their series C preferred stock from
Pioneer Ventures Limited Partnership and Pioneer Ventures Limited
Partnership II, respectively.
(2) Mr. Kernan may be deemed to beneficially own shares purchased by MD Co.,
which purchased 388,941 shares of series C preferred stock and 141,844
shares of series D preferred stock.
(3) Mr. Polestra may be deemed to beneficially own shares held by each of
Ascent Venture Partners, L.P., which purchased 37,050, 71,428, and 27,824
shares of series A preferred stock, series B preferred stock and series C
preferred stock, respectively, Ascent Venture Partners II, L.P., which
purchased 148,200, 285,714 and 111,298 shares of series A preferred stock,
series B preferred stock and series C preferred stock, respectively,
Ascent Venture Partners III, L.P., which purchased 283,688 shares of
series D preferred stock, and Le Serre, which purchased 4,544 shares of
series C preferred stock.
Issuances of Common Stock and Options to Purchase Common Stock to Directors and
5% Holders of our Common Stock
On March 16, 2000, our board of directors approved the sale of 12,500 shares
of common stock to Mr. Shanahan at $6.00 per share. Pursuant to a stock
restriction agreement these shares vest on the earlier of one year after the
date of grant or on the day prior to our next annual stockholders' meeting
after the end of fiscal 2000.
59
<PAGE>
On March 16, 2000, we granted options to purchase 12,500 shares of our
common stock at $6.00 per share to each of Messrs. Kernan, Polestra and
Wadsworth.
On November 18, 1999, we sold 375,000 shares of common stock to Mr. Genovesi
for $0.24 per share in exchange for a $90,000 full recourse promissory note.
The note from Mr. Genovesi is due on demand or on November 18, 2004 and accrues
interest at 6.08% compounded annually. Pursuant to a stock restriction
agreement, these 375,000 shares vest on a quarterly basis beginning on December
31, 1999 and ending on September 30, 2002. Each quarter, the amount that vests
is determined based on the attainment of net revenue and net profit objectives
set by the board of directors. Mr. Genovesi must forfeit any shares that have
not vested by November 18, 2006.
We sold 225,000 shares of common stock to Mr. Kirshy for $0.07 per share on
January 7, 1998. Pursuant to a stock restriction agreement, these 225,000
shares vest over three years, one-third on June 30, 1998 and 8.375% of the
remainder each quarter until June 30, 2000. We sold 75,000 shares of common
stock to Mr. Kirshy for $0.24 per share on November 18, 1999. Pursuant to a
stock restriction agreement, one-half of these 75,000 shares vest one year
after the sale and 12.5% of the remainder vest each quarter thereafter.
We sold 187,500 shares of common stock to Mr. Blaeser for $0.24 per share on
November 18, 1999. Pursuant to a stock restriction agreement, these 187,500
shares vest over four years, 25% upon the expiration of one year and 6.25% at
the end of each quarter thereafter.
Issuance of Promissory Notes
We have issued the following subordinated promissory notes, bearing interest
at 10% per annum, to 5% holders of our common stock and entities controlled by
them, all of which were cancelled in exchange for series B or series C
preferred stock:
<TABLE>
<CAPTION>
Name Dates of Issuance Aggregate Amount
<S> <C> <C>
Ascent Venture Partners, L.P. and
Ascent Venture Partners II, L.P.
(affiliated entities)(1)........... 10/16/1997-11/2/1998 $3,400,000
MD Co............................... 12/8/1998 428,571(2)
Egan-Managed Capital, L.P........... 12/8/1998 321,429(2)
Frank Polestra(3)................... 8/12/1998 75,000(4)
</TABLE>
---------------------
(1) The notes held by Ascent Venture Partners, L.P. and Ascent Venture
Partners II, L.P. were originally acquired by Pioneer Ventures Limited
Partnership and Pioneer Ventures Limited Partnership II, respectively.
(2) Bore interest at a rate of 15% per annum.
(3) Mr. Polestra is a Managing Member or President of each of the general
partners which control Ascent Venture Partners, L.P., Ascent Venture
Partners II, L.P. and Ascent Venture Partners III, L.P.
(4) Mr. Polestra could have been deemed to beneficially own $680,000 in
promissory notes issued to Ascent Venture Partners, L.P., $2,720,000 in
promissory notes issued to Ascent Venture Partners II, L.P., and a $25,000
promissory note issued to Le Serre, but those notes have not been included
as held by Mr. Polestra in the table.
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<PAGE>
Issuance of Warrants to Purchase Common Stock
Between October 16, 1997 and January 13, 1999, in connection with the sale
of promissory notes or series C preferred stock, we issued warrants to purchase
an aggregate of 1,705,500 shares of our common stock at an exercise price of
$0.36667 per share with a ten year term to the following holders of 5% or more
of our common stock on a fully converted basis and a director.
<TABLE>
<CAPTION>
Original Revised
Number of Number of
Shares of Shares of
Common Stock Common Stock
Underlying Underlying
Name (1) Warrants Warrants (2) Dates of Issuance
<S> <C> <C> <C>
Ascent Venture Partners,
L.P., and Ascent Venture
Partners II, L.P.
(affiliated entities)(3).. 472,267 901,875 10/16/1997-11/2/1998
MD Co...................... 546,427 NA 12/8/1998 and 1/13/1999
Egan-Managed Capital,
L.P....................... 409,822 NA 12/8/1998 and 1/13/1999
Frank Polestra............. 10,410(4) 20,812(5) 11/2/1998
--------- ---------
Total..................... 1,438,926 1,878,936
========= =========
</TABLE>
---------------------
(1) See Notes to Table of Beneficial Ownership in "Principal Stockholders" for
information relating to the beneficial ownership of the referenced shares.
(2) Reflects modification of the number of shares underlying bridge warrants
issued on October 16, 1997, January 30, 1998, May 21, 1998, June 4, 1998,
August 12, 1998, by agreements dated December 8, 1998 by and among Network
Engines, Pioneer Ventures Limited Partnership, Pioneer Ventures Limited
Partnership II, Mr. Polestra, Le Serre and other investors who received
warrants on those dates.
(3) The warrants held by each of Ascent Venture Partners, L.P. and Ascent
Venture Partners II, L.P. were originally issued to Pioneer Ventures
Limited Partnership and Pioneer Ventures Limited Partnership II,
respectively.
(4) Mr. Polestra may be deemed to beneficially own warrants to purchase 94,455
shares of common stock issued to Ascent Venture Partners, L.P., warrants to
purchase 377,812 shares of common stock issued to Ascent Venture Partners,
II, L.P., and a warrant to purchase 3,465 shares of common stock issued to
Le Serre.
(5) Mr. Polestra may be deemed to beneficially own warrants to purchase 180,375
shares of common stock issued to Ascent Venture Partners, L.P., warrants to
purchase 721,500 shares of common stock issued to Ascent Venture Partners
II, L.P. and a warrant to purchase 6,937 shares of common stock issued to
Le Serre.
Issuance of Options to Purchase Common Stock
We have granted options to our directors and executive officers, and we
intend to grant additional options to our directors and executive officers in
the future. See "Management--Option Grants in Last Fiscal Year," "--Benefit
Plans" and "--Director Compensation."
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information regarding beneficial
ownership of our common stock as of April 30, 2000 and as adjusted to reflect
the sale of the shares in this offering by:
. each person who is known by us to own beneficially more than 5% of the
outstanding shares of common stock;
. each of our directors and named executive officers; and
. all our directors and executive officers as a group.
<TABLE>
<CAPTION>
Number of Shares
Beneficially
Owned Prior to
and After
the Offering(1) Percentage of Shares(1)
------------------------------------------
Name and Address of Beneficial Before After
Owner the Offering the Offering
<S> <C> <C> <C>
Ascent Venture Partners, L.P.,
Ascent Venture Partners II, L.P.
and Ascent Venture Partners III,
L.P. (affiliated entities)(2) ... 6,722,450 25.4% 21.1%
255 State Street
Boston, Massachusetts 02109
HarbourVest Partners VI--Direct
Fund, L.P........................ 4,964,540 18.8 15.6
c/o HarbourVest Partners, LLC
One Financial Center, 44th Floor
Boston, Massachusetts 02111
MD Co............................. 3,818,095 14.4 12.0
125 Cambridge Park Drive
Cambridge, Massachusetts 02140-
2314
Egan-Managed Capital, L.P......... 2,863,515 10.8 9.0
Thirty Federal Street
Boston, Massachusetts 02110
Canaan Equity Partners II,
LLC(3)........................... 1,773,050 6.7 5.6
105 Rowayton Avenue
Rowayton, Connecticut 06853-1436
Directors and Executive Officers
Lawrence A. Genovesi(4)........... 2,625,000 9.9 8.2
Douglas G. Bryant(5).............. 116,295 * *
Timothy J. Dalton(6).............. 70,780 * *
William B. Elliott(7)............. 96,092 * *
Rene E. Thibault.................. 65,250 * *
Robert F. Wambach(8).............. 65,250 * *
John A. Blaeser................... 187,500 * *
Lawrence Kernan(9)................ 3,827,830 14.5 12.0
Dennis A. Kirshy(10).............. 338,837 1.3 1.1
Frank M. Polestra(11)............. 6,857,330 26.0 21.5
Michael H. Shanahan(12)........... 2,876,015 10.9 9.0
Robert M. Wadsworth(13)........... 4,964,540 18.8 15.6
All directors and executive
officers as a group
(12 persons)(14)................. 22,090,719 83.3% 69.0%
</TABLE>
---------------------
* Less than 1% of the outstanding common stock.
62
<PAGE>
---------------------
(1) The number of shares of common stock deemed outstanding prior to this
offering includes: (i) 26,423,629 shares of common stock outstanding as of
April 30, 2000; and (ii) any shares issuable pursuant to options and
warrants held by the respective person which may be exercised within 60
days after April 30, 2000 as set forth in the additional footnotes below.
The number of shares of common stock deemed outstanding after this
offering includes the 5,500,000 shares that we are offering for sale in
this offering. Beneficial ownership is determined in accordance with the
rules of the Securities and Exchange Commission, and includes voting and
investment power with respect to shares. Unless otherwise indicated below,
to our knowledge, all persons named in the table have sole voting and
investment power with respect to their shares of common stock, except to
the extent authority is shared by spouses under applicable law. The fact
that we have included these "beneficially owned" shares, however, does not
constitute an admission that the named stockholder is a direct or indirect
beneficial owner of the shares. Unless otherwise indicated, the address of
each person listed is c/o Network Engines, Inc., 25 Dan Road, Canton,
Massachusetts 02021.
(2) Includes 1,202,640 shares owned by Ascent Venture Partners, L.P.,
4,810,590 shares owned by Ascent Venture Partners II, L.P. and 709,220
shares owned by Ascent Venture Partners III, L.P.
(3) Includes 1,161,350 shares owned by Caanan Equity II L.P., 92,197 shares
owned by Caanan Equity II Entrepeneurs LLC, and 519,502 shares owned by
Caanan Equity II L.P. (QP).
(4) Includes 750,000 shares of common stock owned by Cheryl H. Smith, the wife
of Mr. Genovesi. Mr. Genovesi disclaims beneficial ownership of all shares
owned by Ms. Smith.
(5) Includes 16,312 shares subject to options exercisable within 60 days
following April 30, 2000.
(6) Includes 10,875 shares subject to options exercisable within 60 days
following April 30, 2000.
(7) Includes 13,592 shares subject to options exercisable within 60 days
following April 30, 2000.
(8) Consists of 65,250 shares subject to options exercisable within 60 days
following April 30, 2000.
(9) Includes 3,818,095 shares owned by MD Co. Mr. Kernan may be deemed to have
or share voting or investment power with respect to these shares. He is a
Principal of MDT Advisers, Inc., which controls MD Co. Mr. Kernan
disclaims beneficial ownership of these shares except to the extent of his
pecuniary interest in the shares.
(10) Includes 7,500 shares of common stock held by Mr. Kirshy's son, Wade G.
Kirshy. Mr. Kirshy disclaims beneficial ownership of the 7,500 shares
held by Wade G. Kirshy.
(11) Includes 41,017 shares owned by Le Serre, 1,202,640 shares owned by
Ascent Venture Partners, L.P., 4,810,590 shares owned by Ascent Venture
Partners II, L.P. and 709,220 shares owned by Ascent Venture Partners
III, L.P. Mr. Polestra may be deemed to have or share voting or
investment power with respect to these shares. Mr. Polestra is a Managing
Member or General Partner of each of the general partners which control
Ascent Venture Partners, L.P., Ascent Venture Partners II, L.P. and
Ascent Venture Partners III, L.P. Mr. Polestra disclaims beneficial
ownership of these shares except to the extent of his pecuniary interest
in the shares.
(12) Includes 2,863,515 shares owned by Egan-Managed Capital, L.P. Mr.
Shanahan may be deemed to have or share voting or investment power with
respect to these shares. He is a General Partner of Egan-Managed Capital,
L.P. Mr. Shanahan disclaims beneficial ownership of these shares except
to the extent of his pecuniary interest in the shares.
(13) Consists of 4,964,540 shares owned by HarbourVest Partners VI--Direct
Fund, L.P. Mr. Wadsworth may be deemed to have or share voting or
investment with respect to these shares. He is a Managing Director of
HarbourVest Partners, LLC, which controls HarbourVest Partners VI-Direct
Fund, L.P. Mr. Wadsworth disclaims beneficial ownership of these shares
except to the extent of his pecuniary interest in the shares.
(14) Includes 106,030 shares subject to options exercisable within 60 days
following April 30, 2000.
63
<PAGE>
DESCRIPTION OF CAPITAL STOCK
The following is a description of all of the material terms of our capital
stock contained in our second amended and restated certificate of
incorporation. Because this is a summary description, we refer you to the
provisions of Delaware corporate law and of our second amended and restated
certificate of incorporation and our second amended and restated by-laws, which
you can access using the EDGAR database at www.sec.gov/edgarhp.htm.
Effective upon the closing of this offering, our authorized capital stock
will consist of 100,000,000 shares of common stock, $.01 par value per share.
As of April 30, 2000, we had outstanding:
. 4,975,187 shares of common stock held by 52 stockholders of record;
. 5,247,495 shares of preferred stock held by 43 stockholders of record;
. options to purchase 3,721,615 shares of common stock; and
. warrants to purchase 1,882,851 shares of common stock.
Upon the closing of this offering, all outstanding shares of preferred stock
will automatically convert into 21,448,442 shares of common stock. The options
and warrants will remain outstanding.
Common Stock
Based upon the number of shares outstanding as of April 30, 2000, giving
effect to the conversion of all shares of preferred stock into 21,448,442
shares of common stock upon the closing of this offering, and giving effect to
the issuance of the shares of common stock offered by us in this offering,
there will be 31,923,629 shares of common stock outstanding upon the closing of
this offering. In addition, as of April 30, 2000, there were outstanding
options for the purchase of a total of 3,721,615 shares of common stock and
warrants for the purchase of 1,882,851 shares of common stock.
Holders of common stock are entitled to one vote for each share held on all
matters submitted to a vote of stockholders at the annual meeting of
stockholders and do not have cumulative voting rights. Directors are elected by
a plurality of the votes of the shares present in person or by proxy at the
meeting and entitled to vote in elections of directors. Holders of common stock
are entitled to receive ratably any dividends that are declared by the board of
directors out of funds legally available therefor, subject to any preferential
dividend rights of outstanding preferred stock. Upon the liquidation,
dissolution or winding up of Network Engines, the holders of common stock are
entitled to receive ratably our net assets available after the payment of all
our debts and other liabilities, subject to the prior rights of any outstanding
preferred stock. Holders of our common stock have no preemptive, subscription,
redemption or conversion rights, nor are they entitled to the benefit of any
sinking fund. The rights, powers, preferences and privileges of holders of
common stock are subject to, and may be adversely affected by, the rights of
the holders of shares of any series of preferred stock that our board of
directors may designate and issue in the future.
64
<PAGE>
Preferred Stock
Our board of directors will be authorized, subject to any limitations
prescribed by law, without further stockholder approval, to issue from time to
time up to an aggregate of 5,000,000 shares of preferred stock, in one or more
series. Each series of preferred stock that may be authorized shall have the
number of shares, designations, preferences, voting powers, qualifications and
special or relative rights or privileges as shall be determined by our board of
directors, which may include, among others, dividend rights, voting rights,
redemption provisions, liquidation preferences, conversion rights and
preemptive rights.
Our stockholders have granted the board of directors authority to issue the
preferred stock and to determine its rights and preferences in order to
eliminate delays associated with a stockholder vote on specific issuances. The
rights of the holders of common stock will be subject to the rights of holders
of any preferred stock issued in the future. The issuance of preferred stock,
while providing desirable flexibility in connection with possible acquisitions
and other corporate purposes, could adversely affect the voting power or other
rights of the holders of common stock, and could make it more difficult for a
third party to acquire, or discourage a third party from attempting to acquire,
a majority of our outstanding voting stock.
Registration Rights
According to the terms of an investor rights agreement, beginning six months
following the date of the closing of this offering, the holders of 21,886,014
shares of common stock and 1,852,851 shares of common stock issuable upon
conversion of warrants, including Ascent Venture Partners II, L.P., HarborVest
VI-Direct Fund, L.P., MD Co., Egan-Managed Capital, L.P. and Canaan Equity
Partners II LLC, may require us to file a registration statement under the
Securities Act. To demand registration, stockholders holding an aggregate of
8,308,603 of those shares must request that we file a registration statement to
register the resale of their shares. Those stockholders must also request
registration of enough shares so that the offering would have an anticipated
aggregate offering price of $5.0 million. We are only required to effect up to
two of these demand registrations.
Additionally, these holders of 23,738,865 shares of common stock and shares
of common stock issuable upon exercise of warrants will have incidental
registration rights with respect to the future registration of our shares of
common stock under the Securities Act; these holders are entitled to notice of
any future registration and to include their shares in any future registration.
At any time we become eligible to file a registration statement on Form S-3
under the Securities Act, upon the request of holders of not less than 474,778
shares of common stock, we must effect a registration on Form S-3. However, the
registration must have a minimum anticipated aggregate offering price of $1.0
million.
These registration rights are subject to conditions and limitations,
including, in the case of an underwritten public offering, the right of the
managing underwriter to limit the number of shares of common stock to be
included in the registration. We are generally required to bear all the
expenses of registrations under the investor rights agreement, except
underwriting discounts and commissions. The investor rights agreement also
contains our commitment to indemnify the holders of registration
65
<PAGE>
rights for certain losses they might incur in connection with registrations
under the agreement. Registration of any of the shares of common stock held by
stockholders with registration rights would result in those shares becoming
freely tradeable without restriction under the Securities Act.
Warrants
As of April 30, 2000, the following warrants to purchase a total of
1,882,851 shares of our common stock were outstanding:
<TABLE>
<CAPTION>
Number of
Shares of
Common Stock Exercise Price Expiration Date
<S> <C> <C>
52,500 $0.5333 July 31, 2002
136,987 0.0733 August 31, 2002
30,000 0.3667 February 23, 2003
277,500 0.3667 October 15, 2007
208,125 0.3667 January 29, 2008
55,500 0.3667 May 20, 2008
222,000 0.3667 June 3, 2008
291,375 0.3667 August 12, 2008
13,875 0.3667 September 8, 2008
48,562 0.3667 November 2, 2008
428,572 0.3667 December 8, 2008
117,855 0.3667 January 13, 2009
</TABLE>
Delaware Law and Certain Charter and By-Law Provisions; Anti-Takeover Effects
We are subject to the provisions of Section 203 of the General Corporation
Law of Delaware. Section 203 prohibits a publicly-held Delaware corporation
from engaging in a "business combination" with an "interested stockholder" for
a period of three years after the date of the transaction in which the person
became an interested stockholder, unless the business combination is approved
in a prescribed manner. A "business combination" includes mergers, asset sales
and other transactions resulting in a financial benefit to the interested
stockholder. Subject to certain exceptions, an "interested stockholder" is a
person who, together with affiliates and associates, owns, or within three
years did own, 15% or more of the corporation's voting stock.
Our second amended and restated certificate of incorporation and second
amended and restated by-laws provide for the division of the board of directors
into three classes, as nearly equal in size as possible, with staggered three-
year terms. See "Management--Election of Directors." Under our second amended
and restated certificate of incorporation and second amended and restated by-
laws any vacancy on the board of directors, however occurring, including a
vacancy resulting from an enlargement of the board, may only be filled by vote
of a majority of the directors then in office. The classification of the board
of directors and the limitations on the removal of directors and filling of
vacancies could have the effect of making it more difficult for a third party
to acquire, or of discouraging a third party from acquiring, control of Network
Engines.
66
<PAGE>
Our second amended and restated certificate of incorporation and second
amended and restated by-laws also provide that, after the closing of this
offering, any action required or permitted to be taken by our stockholders at
an annual meeting or special meeting of stockholders may only be taken if it is
properly brought before a meeting of stockholders and may not be taken by
written action in lieu of a meeting. Our second amended and restated
certificate of incorporation and second amended and restated by-laws further
provide that special meetings of the stockholders may only be called by the
Chairman of the board of directors, the Chief Executive Officer, the President,
or by the board of directors. Under the second amended and restated by-laws, in
order for any matter to be considered "properly brought" before a meeting, a
stockholder must comply with certain requirements regarding advance notice to
us. The foregoing provisions could have the effect of delaying until the next
stockholders' meeting stockholder actions which are favored by the holders of a
majority of our outstanding voting securities. These provisions may also
discourage another person or entity from making a tender offer for our common
stock, because a person or an entity, even if that person or entity acquired a
majority of our outstanding voting securities, would be able to take action as
a stockholder (e.g., to elect new directors or approve a merger) only at a duly
called stockholders meeting, and not by written consent.
The General Corporation Law of Delaware provides generally that the
affirmative vote of a majority of the shares entitled to vote on any matter is
required to amend a corporation's certificate of incorporation or by-laws,
unless a corporation's certificate of incorporation or by-laws, as the case may
be, requires a greater percentage. Our second amended and restated by-laws may
be amended or repealed by a majority vote of the board of directors or the
holders of a majority of the shares of our capital stock issued and outstanding
and entitled to vote, subject to any limitations set forth in the restated by-
laws. The stockholder vote would be in addition to any separate class vote that
might in the future be required pursuant to the terms of any series of
preferred stock that might be outstanding at the time any amendments are
submitted to stockholders for approval.
Limitation of Liability and Indemnification
Our second amended and restated certificate of incorporation provides that
our directors and officers shall be indemnified by us to the fullest extent
authorized by Delaware law, as it now exists or may in the future be amended,
against all expenses and liabilities reasonably incurred in connection with the
service for or on our behalf. In addition, our second amended and restated
certificate of incorporation provides that our directors will not be personally
liable for monetary damages to us for breaches of their fiduciary duty as
directors, unless they violated their duty of loyalty to us or our
stockholders, acted in bad faith, knowingly or intentionally violated the law,
authorized illegal dividends or redemptions or derived an improper personal
benefit from their action as directors.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is EquiServe Trust
Company.
Nasdaq National Market Listing
We have applied for quotation of our common stock on the Nasdaq National
Market under the trading symbol "NENG."
67
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering (assuming no exercise of the underwriters'
over-allotment option), we will have outstanding an aggregate of 31,923,629
shares of common stock, assuming no exercise of outstanding options or
warrants. Of the total outstanding shares, the 5,500,000 shares sold in this
offering will be freely tradeable without restriction or further registration
under the Securities Act, except that any shares held by our affiliates, as
that term is defined under the Securities Act, may generally only be sold in
compliance with the limitations of Rule 144 as described below.
Sales of Restricted Shares
The remaining 26,423,629 shares of common stock held by existing
stockholders are "restricted shares," which means they were issued and sold by
us in reliance on, and are subject to, exemptions from the registration
requirements of the Securities Act, including Rule 144, Rule 144(k) and Rule
701. These restricted shares are also subject to "lock-up" agreements with the
underwriters and will become eligible for sale in the public market during or
after the period covered by the lock-up agreements.
Rule 144. In general, under Rule 144 as currently in effect, beginning 90
days after the date of this prospectus, a person who has beneficially owned
shares of our common stock for at least one year would be entitled to sell
within any three-month period a number of shares that does not exceed the
greater of
. 1% of the number of shares of common stock then outstanding, which will
equal approximately 319,236 shares immediately after the offering, or
. the average weekly trading volume of the common stock on the Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to such sale.
Sales under Rule 144 are also subject to specific manner-of-sale provisions,
notice requirements and the availability of current public information about
us.
Rule 144(k). Under Rule 144(k), a person who is not one of our affiliates at
any time during the 90 days preceding a sale and who has beneficially owned the
shares proposed to be sold for at least two years, including the holding period
of any prior owner other than an affiliate, is entitled to sell such shares
without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144. Therefore, unless otherwise
restricted, "144(k)" shares may be sold immediately upon completion of this
offering.
Lock-up Agreements. All of the restricted shares are subject to lock-up
agreements providing that the stockholders will not offer, sell or otherwise
dispose of any shares owned by them for a period of 180 days after the date of
this offering. However, holders of restricted shares who have not been
executive officers or directors of our company on or since the date of this
prospectus may offer, sell or otherwise dispose of 25% of those shares on the
later of 90 days after the date of this offering or on the second trading day
after the first public release of our quarterly results, if the last recorded
sale price on the Nasdaq National Market for 20 of the 30 trading days ending
on the 90th day is at least twice the price per share in the initial public
offering. These stockholders may also offer, sell or
68
<PAGE>
otherwise dispose of an additional 25% of those shares 135 days after the date
of this offering if the price per share of common stock has achieved the same
target level for the 30 trading day period ending on the 135th day. However,
Donaldson, Lufkin & Jenrette Securities Corporation, may in its sole
discretion, at any time without notice, release all or any portion of the
shares subject to lock-up agreements. Upon expiration of the lock-up
agreements, 466,125 additional shares will become eligible for sale pursuant to
Rule 144(k), 14,744,548 additional shares will become eligible for sale under
the other provisions of Rule 144 and 827,112 additional shares will become
eligible for sale under Rule 701.
Eligibility of Restricted Shares for Sale in the Public Market
Under Rules 144 and 701
(Listed by date upon which shares become saleable)
<TABLE>
<CAPTION>
Number of
Date Shares
---- ----------
<S> <C>
Later of 90 days after the effective date or second trading day
following first public release of quarterly earnings(1)........... 277,423
135 days after the effective date(1)............................... 277,449
180 days after the effective date (expiration of lockup)........... 16,037,785
</TABLE>
------------
(1)The number of shares listed may be offered, sold or traded provided that the
last recorded sale price per share for 20 of the 30 trading days ending on
the applicable date is at least twice the initial public offering price per
share.
Options and Employee Compensation Shares
Rule 701 provides that currently outstanding shares of common stock acquired
under our employee compensation plans may be resold beginning 90 days after the
date of this prospectus by:
. persons, other than our affiliates, subject only to the manner of sale
provisions of Rule 144; and
. our affiliates under Rule 144 without compliance with its one-year
minimum holding period, subject to certain limitations.
At April 30, 2000, approximately 56,505 shares of common stock were issuable
pursuant to vested options under our 1999 plan, all of which are subject to
lock-up agreements with the underwriters and will be eligible for sale in the
public market in accordance with Rule 701 under the Securities Act beginning 90
days after the date of this prospectus.
We intend to file one or more registration statements on Form S-8 under the
Securities Act following the date of this prospectus, to register up to
8,227,650 shares of common stock underlying outstanding stock options or other
rights granted or to be granted pursuant to our 1999 plan, employee stock
purchase plan and director plan, including the 56,505 shares of common stock
subject to options vested as of April 30, 2000, and 4,506,035 shares of common
stock reserved for options or awards to be granted under our 1999 plan,
employee stock purchase plan and director plan. The registration statements for
the plans are expected to become effective upon filing.
69
<PAGE>
Registration Rights
Six months after this offering, the holders of 23,738,865 shares of common
stock and shares of common stock issuable upon conversion of warrants will
be entitled to certain rights with respect to the registration of their shares
under the Securities Act. After any required registration of shares, the
registered shares will be freely tradeable without restriction under the
Securities Act. These sales could cause the market price of our common stock to
decline. See "Description of Capital Stock--Registration Rights."
Pricing of the Offering
Prior to this offering, there has been no public market for our common
stock, and no predictions can be made as to the effect, if any, that market
sales of shares of common stock from time to time, or the availability of
shares for future sale, may have on the market price for the common stock.
Sales of substantial amounts of common stock, or the perception that
substantial sales could occur, could adversely affect prevailing market prices
for the common stock and could impair our future ability to obtain capital
through an offering of equity securities.
70
<PAGE>
UNDERWRITING
Subject to the terms and conditions contained in an underwriting agreement
dated , 2000, the underwriters named below, who are represented
by Donaldson, Lufkin & Jenrette Securities Corporation, Dain Rauscher
Incorporated, FleetBoston Robertson Stephens Inc., and DLJdirect Inc., have
severally agreed to purchase from us the number of shares of common stock set
forth opposite their names below:
<TABLE>
<CAPTION>
Number
Underwriters of Shares
<S> <C>
Donaldson, Lufkin & Jenrette Securities Corporation.................
Dain Rauscher Incorporated..........................................
FleetBoston Robertson Stephens Inc..................................
DLJdirect Inc.......................................................
---------
Total............................................................. 5,500,000
=========
</TABLE>
The underwriting agreement provides that the obligations of the underwriters
to purchase and accept delivery of the shares of common stock offered by this
prospectus are subject to approval by their counsel of legal matters concerning
the offering and to conditions that must be satisfied by us. The underwriters
are obligated to purchase and accept delivery of all of the shares of common
stock offered by this prospectus, other than those shares covered by the over-
allotment option described below, if any are purchased.
The underwriters initially propose to offer the shares of common stock in
part directly to the public at the initial public offering price set forth on
the cover page of this prospectus and in part to dealers, including the
underwriters, at the initial public offering price less a concession not in
excess of $ per share. The underwriters may allow, and dealers may re-
allow, to other dealers a concession not in excess of $ per share.
After the initial offering of the common stock, the public offering price and
other selling terms may be changed by the representatives at any time without
notice. The underwriters do not intend to confirm sales to any accounts over
which they exercise discretionary authority.
An electronic prospectus will be available on the web site maintained by
DLJdirect Inc., an affiliate of Donaldson, Lufkin & Jenrette Securities
Corporation.
We have granted to the underwriters an option, exercisable for 30 days after
the date of this prospectus, to purchase, from time to time, in whole or in
part, up to an aggregate of additional shares of common stock at
the initial public offering price less underwriting discounts and commissions.
The underwriters may exercise the option solely to cover over-allotments, if
any, made in connection with the offering. To the extent that the underwriters
exercise the option, each
71
<PAGE>
underwriter will become obligated, subject to conditions contained in the
underwriting agreement, to purchase its pro rata portion of the additional
shares based on the underwriter's percentage underwriting commitment.
We have agreed to indemnify the underwriters against liabilities which may
arise in connection with the offering, including liabilities under the
Securities Act, or to contribute to payments that the underwriters may be
required to make.
Each of Network Engines, our executive officers, directors and stockholders
have agreed to lock-up agreements which provide, subject to certain exceptions,
that Network Engines, our officers, directors and stockholders will not (i)
offer, pledge, sell, contract to sell, sell any option or contract to purchase,
purchase any option or contract to sell, grant any option, right or warrant to
purchase or otherwise transfer or dispose of, directly or indirectly, any
shares of common stock or any securities convertible into or exercisable or
exchangeable for common stock or (ii) enter into any swap or other arrangement
that transfers all or a portion of the economic consequences associated with
the ownership of any common stock (regardless of whether any of the
transactions described in clause (i) or (ii) is to be settled by the delivery
of common stock, other securities, in cash or otherwise) for a period of 180
days after the date of this prospectus without the prior written consent of
Donaldson, Lufkin & Jenrette Securities Corporation. However, up to 50% of the
shares of common stock held by our stockholders, subject to the restrictions
described above (other than shares owned by directors and executive officers),
will be released from these restrictions under the conditions described under
the caption "Shares Eligible for Future Sale--Sales of Restricted Shares."
In addition, during the 180-day period after the date of this prospectus, we
have also agreed not to file any registration statement with respect to the
registration of any shares of common stock or any securities convertible into
or exercisable or exchangeable for common stock without the prior written
consent of Donaldson, Lufkin & Jenrette Securities Corporation. However, we are
permitted to file a registration statement on Form S-8 with respect to shares
of common stock issuable under our existing benefit plans, all of which shares
are subject to the lock-up agreements with Donaldson, Lufkin & Jenrette
Securities Corporation. Furthermore, none of our stockholders have registration
rights, which have not been waived, that may be exercised during the 180-day
period.
Prior to the offering, there has been no established trading market for the
common stock. The initial public offering price of the shares of common stock
offered by this prospectus will be determined by negotiation among us and the
underwriters. The factors to be considered in determining the initial public
offering price include:
. the history of and the prospects for the industry in which we compete;
. our past and present operations;
. the historical results of operations;
. our prospects for future earnings;
. the recent market prices of securities of generally comparable
companies; and
. the general condition of the securities markets at the time of the
offering.
72
<PAGE>
The underwriters have reserved up to 357,500 shares of the common stock to
be sold in this offering for sale to some of our employees and associates of
our employees and directors, and to other individuals or companies who have
commercial arrangements or personal relationships with us. Through this
directed share program, we intend to ensure that those individuals and
companies that have supported us, or who are in a position to support us in the
future, have the opportunity to purchase our common stock at the same price
that we are offering our shares to the general public. Prospective participants
will not receive any investment materials other than a copy of this prospectus,
and will be permitted to participate in this offering at the initial public
price presented on the cover page of this prospectus. No commitment to purchase
shares by any participant in the directed share program will be accepted until
after the registration statement, of which this prospectus is a part, is
effective and an initial public offering price has been established. The number
of shares available for sale to the general public will be reduced by the
number of shares sold through the directed share program. Any shares reserved
for the directed share program which are not so purchased will be offered by
the underwriters to the general public on the same basis as the other shares
offered hereby.
Other than in the United States, no action has been taken by us or the
underwriters that would permit a public offering of the shares of common stock
offered in any jurisdiction where action for that purpose is required. The
shares of common stock offered may not be offered or sold, directly or
indirectly, nor may this prospectus or any other offering materials or
advertisements in connection with the offer and sale of any shares of common
stock be distributed or published in any jurisdiction, except under
circumstances that will result in compliance with the applicable rules and
regulations of the applicable jurisdiction. Persons into whose possession this
prospectus comes are advised to inform themselves about and observe any
restrictions relating to the offering and the distribution of this prospectus.
This prospectus does not constitute an offer to sell or a solicitation of an
offer to buy any shares of common stock offered in any jurisdiction in which
the offer or a solicitation of shares made by this prospectus is unlawful.
In connection with the offering, the underwriters may engage in transactions
that stabilize, maintain or otherwise affect the price of the common stock.
Specifically, the underwriters may over-allot the offering, creating a
syndicate short position. The underwriters may bid for and stabilize the price
of the common stock. In addition, the underwriting syndicate may reclaim
selling concessions from syndicate members and selected dealers if they
repurchase previously distributed common stock in syndicate covering
transactions, in stabilizing transactions or otherwise. These activities may
stabilize or maintain the market price of the common stock above independent
market levels. The underwriters are not required to engage in these activities,
and may end any of these activities at any time.
LEGAL MATTERS
The validity of the shares of common stock we are offering will be passed
upon for us by Hale and Dorr LLP, Boston, Massachusetts and for the
underwriters by Testa, Hurwitz & Thibeault, LLP, Boston, Massachusetts.
73
<PAGE>
EXPERTS
Our financial statements as of September 30, 1999 and 1998 and for each of
the three years in the period ended September 30, 1999 included in this
prospectus have been so included in reliance upon the report of
PricewaterhouseCoopers LLP, independent accountants, given upon the authority
of said firm as experts in auditing and accounting.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 to register with the Commission the shares of our common
stock described in this prospectus. This prospectus is part of that
registration statement, and provides you with a general description of the
common stock being registered and offered, but does not include all of the
information you can find in the registration statement or the exhibits to the
registration statement. You should refer to the registration statement and its
exhibits for more information about our business and the shares of common stock
being registered.
You may read and copy all or any portion of the registration statement or
any reports, statements or other information we file with the Commission at the
Commission's public reference room at 450 Fifth Street, N.W., Judiciary Plaza,
Room 1024, Washington, D.C. 20549, and at the Commission's regional offices
located at Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661-2511 and 7 World Trade Center, Suite 1300, New York, New York
10048. You may obtain information on the operation of the Public Reference Room
by calling the SEC at 1-800-SEC-0330. Copies of the registration statement or
any reports, statements or other information we file with the Commission can
also be obtained at prescribed rates by mail from the Public Reference Section
of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. In
addition, the Commission maintains a web site (http://www.sec.gov) that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission.
74
<PAGE>
NETWORK ENGINES, INC.
Index to Financial Statements
<TABLE>
<CAPTION>
Page
<S> <C>
Report of Independent Accountants........................................ F-2
Balance Sheets as of September 30, 1998 and 1999 and as of March 31, 2000
(unaudited)............................................................. F-3
Statement of Operations for the years ended September 30, 1997, 1998 and
1999 and the six months ended March 31, 1999 and 2000 (unaudited)....... F-4
Statement of Stockholders' Equity (Deficit) for the years ended September
30, 1997, 1998 and 1999 and the six months ended March 31, 2000
(unaudited)............................................................. F-5
Statement of Cash Flows for the years ended September 30, 1997, 1998 and
1999 and the six months ended March 31, 1999 and 2000 (unaudited)....... F-6
Notes to Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Network Engines, Inc.:
In our opinion, the accompanying balance sheets and the related statements
of operations, of stockholders' equity (deficit) and of cash flows present
fairly, in all material respects, the financial position of Network Engines,
Inc. at September 30, 1999 and 1998, and the results of its operations and its
cash flows for each of the three years in the period ended September 30, 1999
in conformity with accounting principles generally accepted in the United
States. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States,
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Boston, Massachusetts
November 22, 1999, except as to
Note 13 for which the date is May 17, 2000
F-2
<PAGE>
NETWORK ENGINES, INC.
BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
As of As of
September 30, March 31, 2000
---------------- -------------------
1998 1999 Actual Pro Forma
(unaudited)
(Note 2)
Assets
<S> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents.............. $ 113 $ 1,435 $ 16,793 $ 16,793
Restricted cash........................ -- 100 379 379
Accounts receivable, less allowance for
doubtful accounts of $107, $227 and
$287 at September 30, 1998, 1999 and
March 31, 2000 (unaudited),
respectively.......................... 492 2,025 5,211 5,211
Inventories............................ 587 1,251 3,949 3,949
Prepaid expenses and other current
assets................................ 86 222 957 957
------- ------- -------- --------
Total current assets................... 1,278 5,033 27,289 27,289
Property and equipment, net............. 452 831 2,056 2,056
Other assets............................ -- -- 634 634
------- ------- -------- --------
Total assets.......................... $ 1,730 $ 5,864 $ 29,979 $ 29,979
======= ======= ======== ========
<CAPTION>
Liabilities, Redeemable Preferred Stock
and Stockholders' Equity (Deficit)
<S> <C> <C> <C> <C>
Current liabilities:
Bridge loans........................... $ 3,717 $ -- $ -- $ --
Accounts payable....................... 752 2,354 5,047 5,047
Accrued interest....................... 247 -- -- --
Accrued expenses....................... 363 614 1,059 1,059
Deferred revenue....................... 29 105 620 620
Current portion of capital lease
obligations........................... 21 48 66 66
Notes payable.......................... 86 15 -- --
------- ------- -------- --------
Total current liabilities.............. 5,215 3,136 6,792 6,792
Capital lease obligations, net of
current portion........................ 69 132 109 109
Notes payable........................... -- 26 -- --
------- ------- -------- --------
Total liabilities...................... 5,284 3,294 6,901 6,901
Commitments and contingencies (Note 10)
Redeemable convertible preferred stock:
Series D redeemable convertible
preferred stock, $.01 par value,
3,581,554 shares authorized; 3,581,554
and no shares issued and outstanding
at March 31, 2000 (unaudited) and pro
forma March 31, 2000 (unaudited)
(liquidation preference of $25,250 at
March 31, 2000 (unaudited))........... -- -- 28,152 --
Series C redeemable convertible
preferred stock, $.01 par value,
1,123,549 shares authorized;
1,123,549, 1,123,549 and no shares
issued and outstanding at September
30, 1999, March 31, 2000 (unaudited)
and pro forma March 31, 2000
(unaudited) (liquidation preference of
$8,651 at March 31, 2000
(unaudited)).......................... -- 8,705 9,949 --
Series B redeemable convertible
preferred stock, $.01 par value,
360,000 shares authorized; 357,142,
357,142 and no shares issued and
outstanding at September 30, 1999,
March 31, 2000 (unaudited) and pro
forma March 31, 2000 (unaudited)
(stated at liquidation preference).... -- 2,750 2,750 --
Series A redeemable convertible
preferred stock, $.01 par value,
185,250 shares authorized; 185,250,
185,250, 185,250 and no shares issued
and outstanding at September 30, 1998,
1999, March 31, 2000 (unaudited) and
pro forma March 31, 2000 (unaudited)
(liquidation preference of $1,000 at
March 31, 2000 (unaudited))........... 1,000 1,012 1,125 --
------- ------- -------- --------
Total redeemable convertible preferred
stock................................. 1,000 12,467 41,976 --
Stockholders' equity (deficit):
Common stock, $.01 par value,
60,000,000 shares authorized;
3,407,250, 3,429,862, 4,902,035 and
26,350,477 shares issued and
outstanding at September 30, 1998,
1999, March 31, 2000 (unaudited) and
pro forma March 31, 2000 (unaudited).. 34 34 49 264
Additional paid-in capital............. 1,016 2,942 11,104 52,865
Accumulated deficit.................... (5,604) (11,434) (17,241) (17,241)
Note receivable from stockholder....... -- -- (92) (92)
Deferred stock compensation............ -- (1,439) (12,718) (12,718)
------- ------- -------- --------
Total stockholders' equity (deficit)... (4,554) (9,897) (18,898) 23,078
------- ------- -------- --------
Total liabilities, redeemable
convertible preferred stock and
stockholders' equity (deficit)....... $ 1,730 $ 5,864 $ 29,979 $ 29,979
======= ======= ======== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-3
<PAGE>
NETWORK ENGINES, INC.
STATEMENT OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended Six Months Ended
September 30, March 31,
------------------------- -----------------
1997 1998 1999 1999 2000
<S> <C> <C> <C> <C> <C>
Net revenues..................... $ 609 $ 1,102 $ 6,031 $ 1,116 $ 10,466
Cost of revenues (excluding stock
compensation of $16 and $62 for
the year ended September 30,
1999 and the six months ended
March 31, 2000 (unaudited),
respectively)................... 465 1,591 4,733 1,268 6,805
------- ------- ------- ------- --------
Gross profit (loss)............. 144 (489) 1,298 (152) 3,661
Operating expenses:
Research and development
(excluding stock compensation
of $37 and $202 for the year
ended September 30, 1999 and
the six months ended March 31,
2000 (unaudited),
respectively).................. 395 923 2,564 867 3,084
Selling and marketing (excluding
stock compensation of $53 and
$311 for the year ended
September 30, 1999 and the six
months ended March 31, 2000
(unaudited), respectively)..... 477 1,593 2,920 1,147 4,627
General and administrative
(excluding stock compensation
of $21, $10 and $301 for the
year ended September 30, 1999
and the six months ended March
31, 1999 and 2000 (unaudited),
respectively).................. 396 620 934 389 1,191
Stock compensation.............. -- -- 127 10 876
------- ------- ------- ------- --------
Total operating expenses........ 1,268 3,136 6,545 2,413 9,778
------- ------- ------- ------- --------
Loss from operations............. (1,124) (3,625) (5,247) (2,565) (6,117)
Interest income.................. 12 18 52 19 340
Interest expense................. (45) (592) (949) (938) (30)
------- ------- ------- ------- --------
Loss before extraordinary item... (1,157) (4,199) (6,144) (3,484) (5,807)
Extraordinary gain on
extinguishment of debt.......... -- -- 314 314 --
------- ------- ------- ------- --------
Net loss......................... (1,157) (4,199) (5,830) (3,170) (5,807)
Accretion of redeemable
convertible preferred stock..... -- -- (223) -- (4,259)
------- ------- ------- ------- --------
Net loss attributable to common
stockholders.................... $(1,157) $(4,199) $(6,053) $(3,170) $(10,066)
======= ======= ======= ======= ========
Loss per common share before
extraordinary item--basic and
diluted......................... $ (0.36) $ (1.31) $ (1.92) $ (0.96) $ (2.86)
Extraordinary item per common
share--basic and diluted........ -- -- 0.09 -- --
------- ------- ------- ------- --------
Net loss per common share--basic
and diluted..................... $ (0.36) $ (1.31) $ (1.83) $ (0.96) $ (2.86)
======= ======= ======= ======= ========
Shares used in computing basic
and diluted net loss per common
share........................... 3,177 3,200 3,312 3,285 3,525
Pro forma net loss per common
share--basic and diluted
(unaudited)..................... $ (0.63) $ (0.28)
======= ========
Shares used in computing basic
and diluted pro forma net loss
per common share (unaudited).... 9,242 21,011
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-4
<PAGE>
NETWORK ENGINES, INC.
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
(in thousands, except share data)
<TABLE>
<CAPTION>
Note Total
Common Stock Additional Receivable Deferred Stockholders'
---------------- Paid-in Accumulated from Stock Equity
Shares Amount Capital Deficit Stockholder Compensation (Deficit)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, September 30,
1996................... 3,144,750 $31 $ 444 $ (248) $-- $ -- $ 227
Issuance of common
stock.................. 37,500 1 24 -- -- -- 25
Issuance costs
associated with Series
A redeemable
convertible preferred
stock.................. -- -- (48) -- -- -- (48)
Net loss................ -- -- -- (1,157) -- -- (1,157)
--------- --- ------- -------- ---- -------- --------
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 common stock
upon stock option and
warrant exercises
(unaudited)............ 834,673 8 202 -- -- -- 210
Issuance of restricted
common stock
(unaudited)............ 637,500 7 146 -- (90) -- 63
Issuance costs
associated with Series
D redeemable
convertible preferred
stock (unaudited)...... -- -- (82) -- -- -- (82)
Interest on note
receivable from
stockholder
(unaudited)............ -- -- -- -- (2) -- (2)
Deferred stock
compensation related to
grants of stock options
(unaudited)............ -- -- 12,212 -- -- (12,212) --
Amortization of deferred
stock compensation to
expense (unaudited).... -- -- -- -- -- 876 876
Deferred compensation
related to cancellation
of stock options for
terminated employees
(unaudited)............ -- -- (57) -- -- 57 --
Accretion of redeemable
convertible preferred
stock to redemption
value (unaudited)...... -- -- (4,259) -- -- -- (4,259)
Net loss (unaudited).... -- -- -- (5,807) -- -- (5,807)
--------- --- ------- -------- ---- -------- --------
Balance, March 31, 2000
(unaudited)............ 4,902,035 $49 $11,104 $(17,241) $(92) $(12,718) $(18,898)
========= === ======= ======== ==== ======== ========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-5
<PAGE>
NETWORK ENGINES, INC.
STATEMENT OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six Months
Year Ended September Ended
30, March 31,
------------------------- ----------------
1997 1998 1999 1999 2000
(unaudited)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net loss......................... $(1,157) $(4,199) $(5,830) $(3,170) $(5,807)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Depreciation and amortization.... 88 194 361 135 289
Provision for inventory
reserves........................ 35 350 663 166 214
Amortization of discount on note
payable......................... -- 348 841 841 --
Provision for doubtful
accounts........................ 37 50 120 60 60
Gain on extinguishment of debt
................................ -- -- (314) -- --
Compensation expense related to
common stock options............ -- -- 131 -- 876
Interest on note receivable from
stockholder..................... -- -- -- -- (2)
Changes in operating assets and
liabilities:
Accounts receivable............. 435 (427) (1,653) 274 (3,246)
Inventories..................... (307) (587) (1,327) (197) (2,912)
Prepaid expenses and other
current assets................. (14) (71) (136) (97) (735)
Accounts payable................ (11) 447 1,602 (232) 2,693
Accrued interest and expenses... 126 458 325 (303) 445
Deferred revenue................ -- 29 76 (11) 515
------- ------- ------- ------- -------
Net cash used in operating
activities.................... (768) (3,408) (5,141) (2,534) (7,610)
Cash flows used in investing
activities:
Purchase of property and
equipment....................... (185) (343) (623) (151) (1,514)
Deposit of restricted cash....... -- -- (100) -- (279)
Increase in other assets......... -- -- -- (22) (634)
------- ------- ------- ------- -------
Net cash used in investing
activities.................... (185) (343) (723) (173) (2,427)
Cash flows from financing
activities:
Proceeds from bridge loans....... -- 3,950 1,100 1,100 --
Proceeds from notes payable...... -- 4 56 56 2,205
Payments on notes payable........ (40) (112) (101) (73) (2,246)
Payments on capital lease
obligations..................... -- (11) (27) -- (5)
Proceeds from issuance of common
stock........................... 25 17 2 -- 273
Proceeds from issuance of
redeemable convertible preferred
stock, net...................... 952 -- 6,156 3,070 25,168
------- ------- ------- ------- -------
Net cash provided by financing
activities.................... 937 3,848 7,186 4,153 25,395
------- ------- ------- ------- -------
Net increase (decrease) in cash
and cash equivalents............. (16) 97 1,322 1,446 15,358
Cash and cash equivalents,
beginning of period.............. 32 16 113 113 1,435
------- ------- ------- ------- -------
Cash and cash equivalents, end of
period........................... $ 16 $ 113 $ 1,435 $ 1,559 $16,793
======= ======= ======= ======= =======
Supplemental cash flow
information:
Interest paid.................... $ 29 $ 29 $ 36 $ 32 $ 29
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 $ 5,057 $ --
Restricted common stock issued in
exchange for note receivable
from stockholder................ $ -- $ -- $ -- $ -- $ 90
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-6
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS
1. NATURE OF BUSINESS
Business
Network Engines, Inc. (the "Company") develops, markets and provides
integrated and scalable server appliances that enable organizations to provide
information and applications over the Internet. The Company markets its
products principally in North America through a direct sales organization, as
well as through indirect channels consisting of original equipment
manufacturers, resellers and systems integrators. The Company reports results
in one operating segment.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
The Company recognizes product revenue upon delivery, provided evidence of
an arrangement has been received, no obligations remain outstanding and
collectibility is reasonably assured. The Company recognizes license revenue
upon sell through to the licensees' end users. License revenue was immaterial
for all periods presented in these financial statements. The Company accrues
for anticipated returns and warranty costs upon product delivery. Revenue from
support contracts is recognized ratably over the term of the agreement.
Unaudited Interim Financial Data
The interim financial data as of March 31, 2000 and for the six months
ended March 31, 1999 and 2000 have been derived from unaudited financial
statements of the Company. Management believes these unaudited financial
statements have been prepared on the same basis as the audited financial
statements and include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the financial position and
results of operations for such periods. Results for the six months ended March
31, 1999 and 2000 have not been audited and are not necessarily indicative of
results to be expected for the full fiscal year.
Concentrations of Risk
Credit. Financial instruments, which potentially subject the Company to
concentrations of credit risk, consist principally of cash, cash equivalents,
restricted cash and trade receivables. The Company invests primarily in money
market funds of major financial institutions. The Company provides credit to
customers in the normal course of business and does not require collateral
from its customers but routinely assesses their financial strength. The
Company maintains reserves for potential credit losses and such losses have
been within management's expectations.
Customers. Revenue of approximately $207,000 (34%), $140,000 (23%) and
$128,000 (21%) was attributable to three customers during the year ended
September 30, 1997. Revenue of approximately $562,000 (51%) and $132,000 (12%)
was attributable to two customers during the year ended September 30, 1998.
Revenue of approximately $2,774,000 (46%), $1,689,000 (28%) and $844,000 (14%)
was attributable to three customers during the year ended September 30, 1999.
F-7
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Revenue of approximately $408,000 (37%) and $126,000 (11%) was attributable to
two customers during the six months ended March 31, 1999 (unaudited) and
revenue of approximately $2,774,000 (26%), $1,832,000 (18%) and $1,486,000
(14%) was attributable to three customers during the six months ended March 31,
2000 (unaudited).
One customer accounted for approximately $491,000 (82%) of accounts
receivable at September 30, 1998, three customers accounted for approximately
$1,809,000 (80%) of accounts receivable as of September 30, 1999 and three
customers accounted for approximately $3,444,000 (63%) of accounts receivable
at March 31, 2000 (unaudited).
Suppliers. Although the Company generally uses standard parts and components
for its products, certain processor board components are currently available
only from a single source. Other components and subassemblies are available
only from limited sources. Although the Company believes that these components
and subassemblies are sufficiently available from alternate sources in a
reasonable amount of time, the reduction or interruption of supply, a
significant price increase or engineering changes required by the use of
alternate components and subassemblies could adversely affect the Company's
operating results.
Fair Value of Financial Instruments
Financial instruments, including cash, cash equivalents, restricted cash,
accounts receivable, accounts payable and redeemable convertible preferred
stock, are carried in the financial statements at amortized cost which
approximated fair value as of September 30, 1997, 1998 and 1999 and March 31,
2000 (unaudited).
Cash, Cash Equivalents and Restricted Cash
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents. At September 30,
1999, the Company's cash equivalents of $1,372,000 consisted of investments in
money market funds. These investments are stated at cost, which approximated
fair value. At September 30, 1998, the Company had no cash equivalents. At
September 30, 1999, $100,000 of cash was restricted and pledged as collateral
to the Company's primary contract manufacturer. At March 31, 2000, $379,000 of
cash was restricted and pledged as collateral to the Company's primary contract
manufacturer and its facility landlord (unaudited).
Inventories
Inventories are valued at the lower of cost or market, with cost determined
using the first-in, first-out method.
Property and Equipment
Property and equipment are recorded at cost and depreciated using the
straight-line method over their estimated useful lives. Property and equipment
held under capital leases are stated at the present
F-8
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
value of the minimum lease payments at the inception of the lease and are
amortized using the straight-line method over the lesser of the life of the
related asset or the term of the lease. Upon retirement or sale, the cost of
the assets disposed of and related accumulated depreciation are removed from
the accounts and any resulting gain or loss is included in the determination of
net income or loss. Repairs and maintenance are charged to expense as incurred.
Research and Development
Research and development costs, except for certain software development
costs, are expensed as incurred. Software development costs incurred after
technological feasibility has been achieved and until the products are
available for general release are capitalized and amortized as the greater of
the ratio of current revenues to total expected revenues from the product or
straight-line method over the remaining estimated economic life of the product.
Costs of internally developed software which qualify for capitalization have
not been material to date.
Accounting for Stock-Based Compensation
Stock options and restricted stock issued to employees and members of the
Company's Board of Directors are accounted for in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees,"
and related interpretations ("APB 25"); accordingly, compensation expense is
recorded for options and restricted stock awarded to employees and directors to
the extent that the exercise or purchase prices are less than the common
stock's fair market value on the date of grant, where the number of shares and
exercise or purchase price are fixed. The difference between the fair value of
the Company's common stock and the exercise or purchase price of the stock
option or restricted stock award is recorded as deferred stock compensation.
Deferred stock compensation is amortized to compensation expense over the
vesting period of the underlying stock option or restricted stock. The Company
follows the disclosure requirements of Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") (see
Note 8). Stock-based awards to non-employees are accounted for under provisions
of SFAS 123.
Income Taxes
Deferred tax assets and liabilities are determined based on the difference
between the financial statement and the tax bases of assets and liabilities
using enacted tax rates in effect in the years in which the differences are
expected to reverse. A valuation reserve against deferred tax assets is
recorded, if based upon weighted available evidence, it is more likely than not
that some or all of the deferred tax assets will not be realized.
F-9
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Comprehensive Income (Loss)
Comprehensive income (loss) is comprised of two components, net income (loss)
and other comprehensive income (loss). Comprehensive loss is equal to net loss
for the years ended September 30, 1997, 1998 and 1999 and the six month periods
ended March 31, 1999 and 2000 (unaudited).
Net Loss Per Common Share--Historical
Basic net loss per common share is computed by dividing net loss
attributable to common stockholders by the weighted average number of common
shares outstanding. Restricted common shares that are vested at the end of each
reporting period have been included as common shares outstanding for the basic
net loss per share calculation during that period; unvested restricted shares
have not been included in the basic net loss per common share calculation.
There is no difference between basic and diluted net loss per share since
potential common shares from the conversion of redeemable convertible preferred
stock and the exercises of options and warrants are dilutive for all periods
presented. The calculations of diluted net loss per common share for the years
ended September 30, 1997, 1998 and 1999 and the six months ended March 31, 1999
and 2000 do not include 1,638,862, 3,892,995, 16,782,135, 16,103,107
(unaudited) and 26,832,312 (unaudited) potential shares of common stock
equivalents, including common stock options and warrants and redeemable
convertible preferred stock, respectively.
Net Loss Per Common Share--Pro Forma
The unaudited pro forma net loss per common share for the year ended
September 30, 1999 and the six months ended March 31, 2000 is calculated
assuming the automatic conversion of all preferred stock outstanding had
occurred as of the beginning of the period or as of the date of issuance of the
preferred stock, if later. Therefore, accretion of the redeemable convertible
preferred stock is excluded from the calculation of pro forma net loss per
common share. The redeemable convertible preferred stock automatically converts
into 21,448,442 shares of common stock upon the completion of the Company's
initial public offering. The calculations of pro forma diluted net loss per
common share for the year ended September 30, 1999 and the six months ended
March 31, 2000 do not include 4,287,577 and 5,383,870 (unaudited) potential
shares of common stock equivalents as their inclusion would be dilutive,
respectively.
Unaudited Pro Forma Balance Sheet
Under the terms of the Company's redeemable convertible preferred stock, all
shares of such preferred stock will automatically convert into common stock
upon completion of the Company's initial public offering of common stock. The
unaudited pro forma balance sheet reflects the conversion of the outstanding
shares of redeemable convertible preferred stock into 21,448,442 shares of
common stock, as if the conversions had occurred on March 31, 2000.
F-10
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of financial
statements and the reported amounts of revenue and expenses during the period.
Actual results could differ from those estimates and would impact future
results of operations and cash flows.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standard Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
SFAS 133, as amended by Statement of Financial Accounting Standards No. 137,
"Accounting for Derivative Instruments and Hedging Activities--Deferral of the
Effective Date of FASB Statement No. 133," is effective for fiscal years
beginning after June 15, 2000. Because the Company does not currently hold any
derivative instruments and does not currently engage in hedging activities, the
adoption of SFAS 133 is not expected to have a material impact on its financial
position or operating results.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB 101"). This bulletin summarizes certain views of the staff of the
Securities and Exchange Commission (the "Staff") on applying generally accepted
accounting principals to revenue recognition in financial statements. The Staff
believes that revenue is realized or realizable and earned when all of the
following criteria are met: persuasive evidence of an arrangement exists;
delivery has occurred or services have been rendered; the seller's price to the
buyer is fixed or determinable; and collectibility is reasonably assured. The
Company does not expect the application of SAB 101 to have a material impact on
the Company's financial position or results of operations.
In March 2000, the Financial Accounting Standard Board issued FASB
Interpretation No. 44, "Accounting for Certain Transactions Involving Stock
Compensation--an interpretation of APB Opinion No. 25" ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 and among other issues
clarifies the following: the definition of an employee for purposes of applying
APB Opinion No. 25; the criteria for determining whether a plan qualifies as a
noncompensatory plan; the accounting consequence of various modifications to
the terms of previously fixed stock options or awards; and the accounting for
an exchange of stock compensation awards in a business combination. FIN 44 will
become effective July 1, 2000, but certain conclusions in FIN 44 cover specific
events that occurred after either December 15, 1998 or January 12, 2000. The
Company does not expect the application of FIN 44 to have a material impact on
the Company's financial position or results of operations.
F-11
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
3. INVENTORIES
Inventories consisted of the following at September 30, 1998, 1999 and March
31, 2000 (unaudited) (in thousands):
<TABLE>
<CAPTION>
September 30,
------------- March 31,
1998 1999 2000
<S> <C> <C> <C>
Raw materials........................................... $ 293 $ 845 $2,924
Work in process......................................... 121 120 66
Finished goods.......................................... 173 286 959
----- ------- ------
$ 587 $ 1,251 $3,949
===== ======= ======
</TABLE>
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at September 30, 1998 and
1999 (in thousands):
<TABLE>
<CAPTION>
Useful Life 1998 1999
<S> <C> <C> <C>
Office furniture and
equipment 5 years $163 $351
Engineering and production
equipment 3 years 173 404
Computer equipment and
software 3 years 335 642
Leasehold improvements Lesser of 3 years or lease term 210 210
---- -----
881 1,607
Less: accumulated
depreciation and
amortization 429 776
---- -----
$452 $831
==== =====
</TABLE>
As of September 30, 1998 and 1999, the Company had approximately $89,000 and
$165,000 (net of approximately $11,000 and $53,000 of accumulated amortization)
of office furniture, computer software and equipment under capital leases,
respectively.
Depreciation and amortization expense was approximately $88,000, $194,000
and $361,000 for the years ended September 30, 1997, 1998 and 1999,
respectively.
5. BRIDGE LOANS
During the year ended September 30, 1998, the Company issued a series of
uncollateralized subordinated promissory notes totaling $3,950,000 that were
payable on demand with an interest rate of 10% per annum. As of September 30,
1998, no principal or interest had been paid. In connection with these
promissory notes, the Company granted warrants to purchase 1,645,732 shares of
common stock at an exercise price of $0.37 per share. These warrants were
immediately exercisable on the date of issue and expire after ten years. The
fair value of the warrants on the date of issue of approximately $581,000 was
recorded in stockholders' equity (deficit) and as a discount on the related
notes payable. The discount was amortized as interest expense over the
estimated life of the notes and resulted in additional interest expense of
$348,000 and $233,000 during the years ended September 30, 1998 and 1999,
respectively.
F-12
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
During the year ended September 30, 1999, the Company issued a series of
uncollateralized subordinated promissory notes totaling $1,100,000 that were
payable on demand with interest rates of 10% and 15%. In connection with these
notes, the Company granted warrants to purchase 798,562 shares of the Company's
common stock at an exercise price of $0.37 per share. The fair value of the
warrants on the date of issue of approximately $608,000 was recorded in
stockholders' equity (deficit) and as a discount on the related notes payable.
The discount was amortized as interest expense during the year ended September
30, 1999.
On January 13, 1999, the Company converted approximately $2,750,000 of the
subordinated promissory notes into 357,142 shares of Series B redeemable
convertible preferred stock ("Series B Preferred") and approximately $2,300,000
of the subordinated promissory notes plus approximately $7,000 of accrued
interest into 299,631 shares of Series C redeemable convertible preferred stock
("Series C Preferred"). The note holders forgave $263,245 of accrued interest
upon the conversion of the subordinated promissory notes. The interest
forgiveness has been recorded as an extraordinary gain on extinguishment of
debt.
6. NOTES PAYABLE
Notes payable consisted of the following at September 30, 1998 and 1999 (in
thousands):
<TABLE>
<CAPTION>
1998 1999
<S> <C> <C>
Equipment line of credit....................................... $ -- $41
Note payable................................................... 17 --
Credit card debt............................................... 44 --
10% note payable to officer and stockholders................... 21 --
12% note payable to former officer and stockholder............. 4 --
----- ---
Total notes payable............................................ 86 41
Less current portion........................................... 86 15
----- ---
Long-term notes payable........................................ $ -- $26
===== ===
</TABLE>
In May 1994, the Company issued a $100,000 note payable to a bank with 60-
monthly payments of principal and interest through May 1999. The interest rate
on the note was determined monthly as prime plus 2.25%. In accordance with the
note's terms, this note was paid in full as of May 1999.
In March 1996, the Company obtained a credit card with a maximum limit of
$50,000. The interest rate on the credit card is prime plus 6.75% (14.75%, 15%
and 15.25% at September 30, 1999, 1998 and 1997, respectively).
At September 30, 1998, the Company had an uncollateralized 10% interest
bearing note payable of approximately $21,000 with two stockholders. The
original maturity of this note payable was April 30, 1996 and the Company had
been charged a late payment fee of 3% per month since the maturity date. At
September 30, 1998, the Company had an additional uncollateralized 12% interest
bearing note payable of approximately $4,000 with a former officer and
stockholder. No interest or
F-13
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
late fees had been paid on either note as of September 30, 1998. During the
year ended September 30, 1999, the Company entered into an agreement with the
holders of the related party notes whereby the interest rate on each note was
halved, no further interest accrued after January 13, 1999 and all late fees
were waived. In total, approximately $51,000 of interest and late fees were
forgiven during the year ended September 30, 1999. Both notes and the remaining
accrued interest were paid in full in August 1999. The interest forgiveness and
waiver of late fees have been recorded as an extraordinary gain on
extinguishment of debt.
In November 1998, the Company entered into a line of credit for the purchase
of equipment with a maximum limit of $60,000. The interest rate on the line is
determined on the average daily balance of prime plus 1.0% (9.0% at September
30, 1999). Under the terms of the agreement, any equipment advances that were
outstanding on November 30, 1998 (approximately $56,000) were payable in 34
equal monthly installments of principal, plus accrued interest, commencing
December 31, 1998. Equipment advances, once repaid, may not be re-borrowed. The
line of credit is collateralized by substantially all of the assets of the
Company.
The aggregate amounts of notes payable due as of September 30, 1999 were as
follows (in thousands):
<TABLE>
<S> <C>
Year ended September 30,
2000.................................................................. $22
2001.................................................................. 21
2002.................................................................. 2
---
Total payments........................................................ 45
Less amounts representing interest.................................... 4
---
41
Less amounts due within one year...................................... 15
---
Long-term portion..................................................... $26
===
</TABLE>
On September 28, 1998, the Company entered into an Accounts Receivable
Purchase Agreement (the "Agreement") with a bank. Under the terms of the
Agreement, the bank agreed to pay the Company 85% of approved receivables and
hold the remaining 15% in reserve until collected by the bank. The total of all
receivables purchased may not exceed $1,000,000 at any time. The Company is
charged a finance fee of 1% per month on outstanding Purchased Receivables and
a one-time administrative fee for each Purchased Receivable of .25% of the
receivable. Receivables purchased are collateralized by all of the assets of
the Company. The term of this Agreement is for one year and from year to year
thereafter unless terminated by either party. No amounts were outstanding under
this Agreement at September 30, 1998 or 1999.
F-14
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
7. STOCKHOLDERS' EQUITY (DEFICIT)
Redeemable Convertible Preferred Stock
The following table summarizes redeemable convertible preferred stock
activity (in thousands, except share data):
<TABLE>
<CAPTION>
Redeemable
Convertible
Preferred Stock
-----------------
Shares Amount
<S> <C> <C>
April 1997 issuance of Series A redeemable convertible
preferred stock....................................... 185,250 $ 1,000
--------- -------
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
January 1999 issuance of Series C redeemable
convertible preferred stock for cash.................. 422,102 3,093
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 (unaudited)...... 3,581,554 25,250
Accretion of redeemable convertible preferred stock to
redemption value (unaudited).......................... -- 4,259
--------- -------
Balance, March 31, 2000 (unaudited).................... 5,247,495 $41,976
========= =======
</TABLE>
As of September 30, 1999, the Company had three series of redeemable
convertible preferred stock: Series A preferred stock ("Series A Preferred"),
Series B Preferred and Series C Preferred (collectively, the "Preferred Stock")
and had reserved 12,494,557 shares of its common stock for the conversion of
all Preferred Stock.
The Preferred Stock is convertible into common stock at any time, at the
option of the holder, based on specified formulas, subject to anti-dilution
adjustments, as defined. At September 30, 1999, each share of Preferred Stock
was convertible into 7.5 shares of common stock. Each share of Series B
Preferred and Series C Preferred will automatically convert into common stock
upon an initial public offering of common stock at a price per share of at
least $3.08 and proceeds to the Company of at least $30,000,000. Each share of
Series A Preferred will automatically convert into common stock upon an initial
public offering of common stock at a price per share of at least $2.16 and
proceeds to the Company of at least $10,000,000. Additionally, at the election
of 75% of the
F-15
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
holders of Series A Preferred or Series B Preferred, all shares of Series A
Preferred or Series B Preferred, respectively, will automatically convert into
shares of common stock.
Holders of the Preferred Stock are entitled to votes equaling the number of
shares of common stock into which their shares may be converted. The holders of
Preferred Stock are entitled to annual, cumulative dividends of $0.432 for
Series A Preferred and $0.693 for Series B Preferred and Series C Preferred
when and if declared by the Company's Board of Directors. If the Company pays
dividends of less than the total amount of unpaid dividends, such payments will
be made first to the holders of Series C Preferred until paid in full, then to
the holders of Series B Preferred until paid in full and then to the holders of
Series A Preferred. No dividends may be paid to the holders of common stock
until all unpaid dividends on the Preferred Stock have been paid.
In the event of liquidation, dissolution or winding up of the Company, the
holders of Series C Preferred are entitled to a liquidation preference of $7.70
per share plus all declared and unpaid dividends thereon, prior to any
distributions to holders of the Series A Preferred, Series B Preferred or
common stock. Upon satisfaction of the Series C Preferred liquidation
preference, the holders of Series B Preferred are entitled to a liquidation
preference of $7.70 per share plus all declared and unpaid dividends thereon,
prior to any distributions to holders of the Series A Preferred or common
stock. Upon the satisfaction of the Series C Preferred and Series B Preferred
liquidation preferences, the holders of Series A Preferred are entitled to a
liquidation preference of $5.40 per share plus all declared and unpaid
dividends thereon, prior to any distributions to holders of common stock.
However, to the extent any net assets available for distribution to
shareholders exceeds $125 million, the entire amount of such assets would be
distributed ratably among the holders of shares of common stock and Preferred
Stock as if converted into shares of common stock.
The Company, upon written notice from the holders of at least two-thirds of
the Series C Preferred, is obligated to redeem all or any portion (but not less
than one-third of the shares of the holders electing to redeem) of the
Preferred Stock after January 2003. The redemption price per share for the
Series C Preferred would be the sum of the liquidation value per share and the
amount calculated as the current valuation of the Company less the aggregate
liquidation value for all shares of Preferred Stock divided by the fully
diluted number of outstanding shares of common stock. If based on the then
current valuation of the Company, the net assets available for distribution to
shareholders exceeds $125 million, then the redemption price for each share of
Series C Preferred would be the amount payable if the entire net assets of the
Company were distributed ratably among the holders of shares of common stock
and Preferred Stock as if converted into shares of common stock. The redemption
price per share for Series B Preferred would be the liquidation value per
share. The redemption price per share for holders of Series A Preferred would
be the greater of the liquidation value per share or the current fair market
value per share that factors in aggregate consideration received upon the
assumed exercise of all derivative securities. If the Company does not have
sufficient funds for all requested redemptions, payment will be made first to
the holders of Series C Preferred until paid in full, then to the holders of
Series B Preferred until paid in full and then to the holders of Series A
Preferred. The Company has the option to redeem shares for cash or
F-16
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
in the form of an 18-month pre-payable note bearing interest at prime plus 2%,
secured by the available assets of the Company.
Common Stock
On November 12, 1999, the Company completed a three-for-one split of the
Company's common stock, which was effected through a stock dividend (the "1999
Stock Split"). All common stock share and per share amounts that appear in the
financial statements and the notes thereto have been restated to reflect the
1999 Stock Split.
On January 7, 1998, the Company issued 225,000 shares of restricted stock at
$0.07 per share to a director of the Company. In accordance with the restricted
stock agreement, the Company has the right to buy back any unvested shares at
the same purchase price if the director ceases to be affiliated with the
Company. Shares vest 33% as of June 30, 1998 and 8.375% per quarter thereafter.
As of September 30, 1999, 56,532 shares remained unvested.
Unaudited. In November 1999, the Company issued 637,500 shares of restricted
stock at $0.24 per share to certain officers and directors of the Company. Of
these shares, 75,000 shares vest 50% on November 18, 2000 and 12.5% per quarter
thereafter and 187,500 shares vest 25% on November 18, 2000 and 6.25% per
quarter thereafter. The remaining 375,000 shares vest quarterly upon the
achievement of certain financial targets or in December 2004, whichever is
earlier. As of March 31, 2000, the Company had achieved two quarterly financial
targets and, accordingly, 62,500 shares had vested. Unvested restricted shares
are subject to forfeiture in the event that an employee ceases to be employed
by the Company or a director ceases to be a director of the Company. The
Company recorded deferred stock compensation of approximately $1,206,000, which
represents the excess of the fair value of the restricted shares at the date of
issue over the purchase price. Compensation expense will be recognized ratably
over the vesting period of the restricted stock. For the six months ended
March 31, 2000, the Company recognized approximately $115,000 of related stock
compensation expense.
In connection with the November 1999 restricted stock grants, the Company
accepted a recourse note payable from an officer of the Company in the amount
of $90,000. This note has an interest rate of 6.08% and is payable on the
earlier of demand by the Company or November 18, 2004.
8. STOCK INCENTIVE PLAN
Options and awards to purchase shares of the Company's common stock have
been granted to employees and directors under the Company's 1997 Stock
Incentive Plan (the "1997 Plan"), which was adopted by the Board of Directors
in November 1997. On October 21, 1999 the 1997 Plan was terminated and all
outstanding options became options under the 1999 Stock Incentive Plan.
On October 21, 1999, the Company's Board of Directors approved, subject to
shareholder approval, the Company's 1999 Stock Incentive Plan (the "1999
Plan"). Under the 1999 Plan, stock option and restricted stock or other stock-
based awards for up to 4,747,902 shares of common stock
F-17
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
may be issued to employees, officers, directors, consultants and advisors of
the Company (see Note 13). Options are granted for terms of up to ten years and
vest over varying periods, generally 25% on the first anniversary of the grant
date and thereafter in equal quarterly installments over the next three years.
The option price per share is determined by the Board of Directors.
Stock option activity for the 1997 Plan and 1999 Plan (the "Plans"), since
October 1, 1997 was as follows:
<TABLE>
<CAPTION>
Weighted
Average
Number of Exercise
Options Price
<S> <C> <C>
Outstanding, October 1, 1997.......................... -- $ --
Granted............................................. 882,150 0.07
Exercised........................................... (225,000) 0.07
Canceled............................................ (48,750) 0.07
---------
Outstanding, September 30, 1998....................... 608,400 0.07
Granted............................................. 1,593,975 0.14
Exercised........................................... (22,612) 0.07
Canceled............................................ (242,610) 0.08
---------
Outstanding, September 30, 1999....................... 1,937,153 0.13
Granted (unaudited)................................. 2,080,750 1.58
Exercised (unaudited)............................... (367,100) 0.10
Canceled (unaudited)................................ (149,786) 0.18
---------
Outstanding, March 31, 2000 (unaudited)............... 3,501,017 0.99
========= =====
</TABLE>
As of September 30, 1999 and March 31, 2000 (unaudited), options to purchase
199,915 and 92,242 shares of common stock, respectively, were exercisable with
a weighted-average exercise price of $0.08 and $0.10, respectively. No options
were exercisable at September 30, 1998. The weighted average fair value of
options granted during the year ended September 30, 1998 was $0.02 per share;
all options were granted with an exercise price equal to fair market value. For
financial reporting purposes, the weighted average fair values of options
granted during the year ended September 30, 1999 with exercise prices equal to
the fair market value and with exercise prices at below fair market value were
$0.02 (31,875 options) and $1.05 (1,562,100 options) per share, respectively.
As of September 30, 1999 and March 31, 2000 (unaudited), 201,735 and 3,549,785
shares, respectively, were available for future grants under the Plans (see
Note 13).
F-18
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The following table summarizes the stock options outstanding at March 31,
2000 (unaudited):
<TABLE>
<CAPTION>
Number of Remaining Number of
Exercise Options Contractual Options
Price Outstanding Life (in years) Exercisable
<S> <C> <C> <C>
$0.07 240,820 7.82 51,555
0.13 1,119,352 9.11 40,687
0.24 860,845 9.60 --
1.20 278,250 9.75 --
2.00 740,625 9.83 --
4.00 139,250 9.88 --
6.00 121,875 9.96 --
--------- ------
3,501,017 92,242
========= ======
</TABLE>
During the year ended September 30, 1999 and the six months ended March 31,
2000 (unaudited), the Company recorded deferred compensation for restricted
stock and stock options granted to employees at prices deemed to be below fair
market value for financial reporting purposes of approximately $1,566,000 and
$12,212,000 respectively. The Company is recognizing the compensation expense
over the vesting period. The Company recognized compensation expense relating
to deferred compensation of approximately $127,000 and $876,000 for the year
ended September 30, 1999 and the six months ended March 31, 2000 (unaudited),
respectively.
Had compensation expense for the Company's Plans been determined based on
the fair value at the date of grant for awards made since the Plans' adoption,
consistent with the provisions of SFAS 123, the Company's net loss
attributable to common stockholders and net loss per common share for the
years ended September 30, 1998 and 1999 would have increased to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
1998 1999
-------------------- --------------------
Net Net
Net loss loss Net loss loss
attributable per attributable per
to common common to common common
stockholders share stockholders share
(in thousands, except per share data)
<S> <C> <C> <C> <C>
As reported..................... $(4,199) $(1.31) $(6,053) $(1.83)
Pro forma....................... (4,201) (1.31) (6,066) (1.83)
</TABLE>
For this purpose, the fair value of options at the date of grant were
estimated using the minimum value method with the following assumptions: risk-
free interest rate of 6.0% and 5.5% for 1998 and 1999, respectively; no
dividend yield; no volatility factor; and a weighted-average expected life of
the options of five years. However, because the determination of the fair
value of all options granted after the Company becomes a publicly-traded
entity will include an expected volatility factor, because most options vest
over periods of up to four years and because additional option grants are
expected to be made subsequent to September 30, 1999, the pro forma effects of
applying the fair value method may be materially different in future years.
F-19
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
9. STOCK WARRANTS
During the years ended September 30, 1998 and 1999, the Company issued
warrants to purchase 1,645,732 and 798,562 shares of common stock,
respectively, in connection with the issuance of a series of subordinated
promissory notes. Each warrant expires ten years from the date of issuance and
has an exercise price of $0.37 per share. The number of shares and the exercise
price are subject to anti-dilution adjustments. In the event that the Company
is obligated to redeem all or any portion of the Preferred Stock, the Company
must concurrently redeem an equivalent portion of these warrants. The fair
value of the warrants on the date of issue of approximately $588,000 and
$608,000 for the warrants issued in fiscal year 1998 and 1999, respectively,
was recorded in additional paid-in capital and interest expense over the
estimated life of the notes.
During the year ended September 30, 1999, the Company entered into
agreements with the holders of the 1998 subordinated promissory notes whereby
the warrants originally issued were reduced from the right to purchase
1,645,732 shares of common stock to 1,096,125 shares of common stock. Also,
during the year ended September 30, 1999, the Company issued warrants to
purchase 206,250 shares of common stock to some of the holders of Series C
Preferred, in connection with that financing. Each warrant expires ten years
from the date of issuance and has an exercise price of $0.37 per share. The
number of shares and the exercise price are subject to anti-dilution
adjustments. In the event the Company is obligated to redeem all or any portion
of the Preferred Stock, the Company must concurrently redeem an equivalent
portion of these warrants. The fair value of the warrants of approximately
$157,000 was recorded as a discount on the Series C Preferred and in additional
paid-in capital.
Prior to October 1, 1997, the Company issued warrants for the right to
purchase 249,487 shares of common stock. These warrants have exercise prices
which range from $0.07 per share to $0.53 per share and expire at various dates
between August 31, 2002 and February 23, 2003. These warrants, which were
issued in connection with notes payable, were determined to have an aggregate
value of $41,000 on the various dates of grant and were recorded in additional
paid-in capital and interest expense over the life of the related notes
payable.
As of September 30, 1999, the Company had reserved 2,350,424 shares of
common stock for the exercise of all of the Company's outstanding warrants.
10. COMMITMENTS AND CONTINGENCIES
Operating Leases
As of September 30, 1999, the Company had five months remaining on its
corporate headquarters lease. This lease provides for base rent and certain
additional expenses such as utilities and taxes. The Company also leases sales
offices in Virginia and California. These additional office leases expire
during fiscal year 2000. Extensions of sales office leases will be executed as
needed. Rent expense was approximately $18,000, $37,000 and $50,000 for the
years ended September 30, 1997, 1998 and 1999, respectively. As of September
30, 1999, the future noncancelable lease payments on all committed operating
leases were $23,502 for the year ended September 30, 2000.
F-20
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Capital Leases
The Company leases certain furniture, equipment and software under non-
cancelable capital leases. The lease terms range from 36 to 60 months and have
interest rates of 12% to 15.5%. As of September 30, 1999, the required monthly
installment of principal and interest for all capital leases was approximately
$6,000.
Future minimum lease payments under all noncancelable capital leases as of
September 30, 1999 were as follows (in thousands):
<TABLE>
<S> <C>
Year ended September 30,
2000................................................................. $ 74
2001................................................................. 74
2002................................................................. 61
2003................................................................. 13
----
Total payments....................................................... 222
Less amounts representing interest................................... 42
----
Present value of future minimum payments............................. 180
Less amounts due within one year..................................... 48
----
Long-term portion.................................................... $132
====
</TABLE>
Contingencies
As a normal incidence of the nature of the Company's business, various
claims, charges and litigation have been asserted or commenced against the
Company arising from or related to employee relations. Management does not
believe these claims will have a material adverse effect of the financial
position or results of operations of the Company.
11. INCOME TAXES
Due to the loss incurred during fiscal years 1997, 1998 and 1999, the
Company did not record a provision for any federal or state income taxes in
those years. The following is a reconciliation between the amount of the
Company's income taxes utilizing the U.S. federal statutory rate and the
Company's actual provision for income taxes for the years ended September 30,
1997, 1998 and 1999 (in thousands):
<TABLE>
<CAPTION>
1997 1998 1999
<S> <C> <C> <C>
At U.S. federal statutory rate................. $(393) $(1,428) $(1,781)
State taxes, net of federal effect............. (92) (261) (381)
Research and development credits............... (17) (20) (92)
Non-deductible stock option compensation
charge........................................ -- -- 43
Non-deductible expenses and other charges...... 1 132 (103)
Effect of change in valuation allowance........ 501 1,577 2,314
----- ------- -------
Provision for income taxes..................... $ -- $ -- $ --
===== ======= =======
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax
F-21
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
purposes. As of September 30, 1998 and 1999, net deferred tax assets consisted
of the following (in thousands):
<TABLE>
<CAPTION>
1998 1999
<S> <C> <C>
Net operating losses.................................... $ 1,795 $ 2,690
Tax credit carryforwards................................ 86 238
Capitalized research and engineering.................... -- 1,227
Temporary differences................................... 298 338
------- -------
Total deferred tax asset................................ 2,179 4,493
Valuation allowance..................................... (2,179) (4,493)
------- -------
Net deferred tax asset.................................. $ -- $ --
======= =======
</TABLE>
A valuation allowance is established if it is more likely than not that all
or a portion of the deferred tax asset will not be realized. Accordingly, as of
September 30, 1998 and 1999, a valuation allowance was recorded for the full
amount of the deferred tax asset due to the uncertainty of their realization.
As of September 30, 1999, the Company had net operating loss carryforwards
for both federal and state income tax purposes of approximately $6.7 million,
which expire at various dates through 2019 and 2004, respectively. The Company
also has available research and development credits for federal and state
income tax purposes of approximately $140,000 and $109,000, respectively, which
expire at various dates through 2014.
12. EMPLOYEE SAVINGS PLAN
The Company sponsors a savings plan for its employees, who meet certain
eligibility requirements, which is designed to be a qualified plan under
section 401(k) of the Internal Revenue Code. Eligible employees are permitted
to contribute to the 401(k) plan through payroll deductions within statutory
and plan limits. The Company does not contribute to the plan.
13. SUBSEQUENT EVENTS
Series D Preferred Stock Offering
On December 20, 1999, the Company issued 3,581,554 shares of Series D
redeemable convertible preferred stock ("Series D Preferred"), for proceeds to
the Company of $25,250,000, prior to any fees or offering costs.
Each share of Series D Preferred is convertible at any time at the option of
the holder into 2.5 shares of common stock, subject to anti-dilution
adjustments, as defined. Each share of Series D Preferred will automatically be
converted into shares of common stock upon the closing of an initial public
offering of the Company's common stock at a price per share of at least $7.05
and proceeds to the Company of at least $30,000,000.
F-22
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Each share of Series D Preferred entitles the holder to the number of votes
equal to the number of shares of common stock issuable upon conversion. The
Series D Preferred holders have the right to receive cumulative dividends, when
and if declared by the Board of Directors, at a rate of $0.6345 per share per
annum. If the Company pays less than the total amount of dividends then
accrued, such payment will be made first to the holders of Series D Preferred
and Series C Preferred on a pro-rata basis until paid in full before any
payments are made to the holders of Series B Preferred and Series A Preferred.
The Series D Preferred has a liquidation preference of $7.05 per share plus
all declared and unpaid dividends. If the Company distributes less than the
total liquidation preference, such payments will be made first to the holders
of Series D Preferred and Series C Preferred on a pro-rata basis until paid in
full before any payments are made to holders of Series B Preferred and Series A
Preferred. Both the holders Series D Preferred and Series C Preferred
participate ratably, as if converted into shares of common stock, with holders
of common stock up to a maximum of four times their respective purchase price
per share. However, if the amount of net assets to be distributed to common
shareholders is greater than four times the Series D Preferred and Series C
Preferred purchase price, then the holders of Series D Preferred and Series C
Preferred will be liquidated as if converted into shares of common stock.
The Series D Preferred has a redemption provision that is substantially
identical to the Series C Preferred except that the Series D Preferred will be
redeemed prior to the Series C Preferred. The redemption option for all series
of Preferred Stock begins on the fourth anniversary of the Series D Preferred
closing and will extend to the time of a public offering. After the affirmative
election of redemption and payment to all holders of Series D Preferred, the
holders of Series C Preferred, Series B Preferred and Series A Preferred may
elect to redeem all or a portion, but not less than one-third, of their shares.
The Series D Preferred has the same pre-emptive rights as the Series C
Preferred and has anti-dilution protection. In connection with the Series D
Preferred offering, the Company increased the number of authorized shares of
common stock to 16,000,000.
Litigation
On December 29, 1999, a former employee commenced a lawsuit against the
Company, a current officer and director and a former officer and director for
unlawful termination of employment. Although the Company intends to vigorously
defend these claims, an adverse resolution could have a material impact of the
Company's future results of operations.
F-23
<PAGE>
NETWORK ENGINES, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Office Leases
During October and November 1999, the Company entered into operating leases
for its new corporate headquarters located in Massachusetts and additional
sales offices located in New York, Virginia and California. The term of the
lease for the corporate headquarters is five years, plus an additional five-
month commitment for temporary office space. The sales offices all have
commitment terms of three months or less. The total noncancelable lease
payments for all new committed operating leases are approximately $3,028,000
over the next five years.
Increase of Authorized Shares of the 1999 Plan
In March 2000, the Company's Board of Directors approved, subject to
shareholder approval, an increase of 3,300,000 in the number of shares
authorized under the 1999 Plan.
Line of Credit
In April 2000, the Company amended its equipment line of credit to provide
for an additional amount of $2,000,000 and to provide a working capital
revolving line of credit of $4,000,000. The additional equipment line amount is
separated into two consecutive six-month borrowing periods for $1,000,000
beginning on the date of amendment. The equipment line amount has an interest
rate of prime plus 1.25%, which is payable monthly. Any outstanding balances at
the end of each of the equipment line borrowing periods will be repaid in 36
equal monthly installments. The working capital line of credit bears interest
at prime plus 1% and matures in April 2001.
Sale of P6000 Product Line
In April 2000, the Company sold all inventory and test equipment related to
its P6000 product line to Copernicus Systems, Inc., a company wholly-owned by a
stockholder and former officer and director of the Company. The production and
development of the P6000 product line had been discontinued and all related
assets and inventory had been reserved as of September 30, 1999. In exchange
for these assets, Copernicus Systems agreed to pay the Company royalties on
future sales of the inventory and agreed to support P6000 units for which the
Company had obligations under warranty or services contracts.
Stock Split and Increase in Authorized Common Shares
On May 17, 2000, the Company's shareholders approved a 2.5-for-one split of
the Company's common stock (the "2000 Stock Split"). All common stock share and
per share amounts that appear in the financial statements and the notes thereto
have been restated to reflect the 2000 Stock Split. The shareholders also
approved an increase in the authorized number of common shares to 60,000,000.
F-24
<PAGE>
[The inside back cover includes a picture of a cluster of five of our
WebEngine Roadster products. Above the picture appears the following text:
"Internet Server Appliances." Below the picture appears our logo.]
<PAGE>
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
, 2000
[LOGO OF NETWORK ENGINES]
5,500,000 Shares of Common Stock
----------------
PROSPECTUS
----------------
Donaldson, Lufkin & Jenrette
Dain Rauscher Wessels
Robertson Stephens
DLJdirect Inc.
--------------------------------------------------------------------------------
We have not authorized any dealer, salesperson or other person to give you
written information other than this prospectus or to make representations as to
matters not stated in this prospectus. You must not rely on unauthorized
information. This prospectus is not an offer to sell these securities or our
solicitation of your offer to buy the securities in any jurisdiction where that
would not be permitted or legal. Neither the delivery of this prospectus nor
any sales made hereunder after the date of this prospectus shall create an
implication that the information contained herein or our affairs have not
changed since the date hereof.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
Until , 2000 (25 days after the date of this prospectus), all dealers
that effect transactions in these shares of common stock may be required to
deliver a prospectus. This is in addition to the dealer's obligation to deliver
a prospectus when acting as an underwriter in its offering and when selling
previously unsold allotments or subscriptions.
--------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution.
The following table sets forth the costs and expenses, other than the
underwriting discount, payable by the Registrant in connection with the sale of
common stock being registered. All amounts are estimates except the SEC
registration fee, the NASD filing fees and the Nasdaq National Market listing
fee.
<TABLE>
<S> <C>
SEC registration fee.............................................. $ 24,668
NASD filing fee................................................... 9,988
Nasdaq National Market listing fee................................ 95,000
Printing and engraving expenses................................... 200,000
Legal fees and expenses........................................... 285,000
Accounting fees and expenses...................................... 350,000
Blue Sky fees and expenses (including legal fees)................. 15,000
Transfer agent and registrar fees and expenses.................... 10,000
Miscellaneous..................................................... 10,344
---------
Total......................................................... 1,000,000
=========
</TABLE>
The Registrant will bear all expenses shown above.
Item 14. Indemnification of Directors and Officers.
The Registrant's Second Amended and Restated Certificate of Incorporation
(the "Restated Certificate") provides that, except to the extent prohibited by
the Delaware General Corporation Law (the "DGCL"), the Registrant's directors
shall not be personally liable to the Registrant or its stockholders for
monetary damages for any breach of fiduciary duty as directors of the
Registrant. Under the DGCL, the directors have a fiduciary duty to the
Registrant which is not eliminated by this provision of the Restated
Certificate and, in appropriate circumstances, equitable remedies such as
injunctive or other forms of nonmonetary relief will remain available. In
addition, each director will continue to be subject to liability under the DGCL
for breach of the director's duty of loyalty to the Registrant, for acts or
omissions which are found by a court of competent jurisdiction to be not in
good faith or involving intentional misconduct, for knowing violations of law,
for actions leading to improper personal benefit to the director, and for
payment of dividends or approval of stock repurchases or redemptions that are
prohibited by the DGCL. This provision also does not affect the directors'
responsibilities under any other laws, such as the federal securities laws or
state or federal environmental laws. The Registrant has obtained liability
insurance for its officers and directors.
Section 145 of the DGCL empowers a corporation to indemnify its directors
and officers and to purchase insurance with respect to liability arising out of
their capacity or status as directors and officers, provided that this
provision shall not eliminate or limit the liability of a director: (i) for any
breach of the director's duty of loyalty to the corporation or its
stockholders, (ii) for acts or omissions not in good faith or which involve
intentional misconduct or a knowing violation of law, (iii) arising under
Section 174 of the DGCL including for an unlawful payment of dividend or
unlawful stock purchase or redemption, or (iv) for any transaction from which
the director derived an
II-1
<PAGE>
improper personal benefit. The DGCL provides further that the indemnification
permitted thereunder shall not be deemed exclusive of any other rights to which
the directors and officers may be entitled under the corporation's by-laws, any
agreement, a vote of stockholders or otherwise. The Restated Certificate
eliminates the personal liability of directors to the fullest extent permitted
by the DGCL and, together with the Registrant's Second Amended and Restated By-
Laws (the "Restated By-Laws"), provides that the Registrant shall fully
indemnify any person who was or is a party or is threatened to be made a party
to any threatened, pending or completed action, suit or proceeding (whether
civil, criminal, administrative or investigative) by reason of the fact that
such person is or was a director or officer of the Registrant, or is or was
serving at the request of the Registrant as a director or officer of another
corporation, partnership, joint venture, trust, employee benefit plan or other
enterprise, against expenses (including attorneys' fees), judgments, fines and
amounts paid in settlement actually and reasonably incurred by such person in
connection with such action, suit or proceeding. Reference is made to the
Registrant's Form of Amended and Restated Certificate of Incorporation and Form
of Amended and Restated By-Laws filed as Exhibits 3.2 and 3.4 hereto,
respectively.
The Underwriting Agreement provides that the Underwriters are obligated,
under certain circumstances, to indemnify directors, officers and controlling
persons of the Registrant against certain liabilities, including liabilities
under the Securities Act of 1933, as amended (the "Act"). Reference is made to
the form of Underwriting Agreement to be filed as Exhibit 1.1 hereto.
Item 15. Recent Sales of Unregistered Securities.
In the three years preceding the filing of this registration statement,
through a series of private placements and its stock option plan, the
Registrant has issued the following securities that were not registered under
the Securities Act (all information in this item has been adjusted to reflect
stock splits effected to date for the Registrants' common stock, including the
2.5-for-1 stock split to be effected prior to the completion of this offering):
(a) Issuances of Capital Stock:
. On April 9, 1997, the Registrant sold to Pioneer Ventures Limited
Partnership and Pioneer Ventures Limited Partnership II an aggregate of
185,250 shares of series A convertible preferred stock for $1,000,000.
. On January 7, 1998, the Registrant sold to Mr. Kirshy 225,000 shares of
our common stock, subject to a stock restriction agreement, for $16,500.
. On January 13, 1999, the Registrant sold to Pioneer Ventures Limited
Partnership and Pioneer Ventures Limited Partnership II an aggregate of
357,142 shares of series B convertible preferred stock for $2,749,993.
. On January 13, 1999, the Registrant sold to existing and new individual
and venture capital investors an aggregate of 721,733 shares of series C
convertible participating preferred stock for $5,557,344.10. On June 30,
1999, we sold to existing and new individual and venture capital
investors an additional 401,816 shares of series C convertible
participating preferred stock for $3,093,983.
II-2
<PAGE>
. On November 18, 1999, the Registrant sold to Mr. Genovesi, Mr. Blaeser
and Mr. Kirshy an aggregate of 637,500 shares of our common stock,
subject to stock restriction agreements, for $153,000. Mr. Genovesi paid
for his 375,000 shares by making a full recourse promissory note payable
to the Registrant for $90,000.
. On December 20, 1999, the Registrant sold to existing and new individual
and venture capital investors an aggregate of 3,581,554 shares of series
D convertible participating preferred stock for $25,249,956.
(b) Issuances of Warrants. From October 16, 1997 to January 13, 1999, the
Registrant issued warrants to purchase common stock to individual and venture
capital investors at an exercise price of $0.36667. In the case of the warrants
issued from October 16, 1997 to September 8, 1998, the number of shares of
common stock underlying those warrants was amended in exchange for each warrant
holder's waiver of its preemptive rights that would otherwise have been
triggered when the Registrant agreed to sell its shares of series C convertible
participating preferred stock to new and existing individual and venture
capital investors. These warrants were issued in the following numbers on the
following dates:
. On October 16, 1997, warrants exercisable for 138,937 shares were issued
in connection with the issuance of promissory notes made by the
Registrant on the same date in exchange for $1,000,000. On December 8,
1998, the number of shares of common stock underlying these warrants was
revised to equal 277,500.
. On January 30, 1998, warrants exercisable for 104,205 shares were issued
in connection with the issuance of promissory notes made by the
Registrant on the same date in exchange for $750,000. On December 8,
1998, the number of shares of common stock underlying these warrants was
revised to equal 208,125.
. On May 21, 1998, warrants exercisable for 27,787 shares were issued in
connection with the issuance of promissory notes made by the Registrant
on the same date in exchange for $200,000. On December 8, 1998, the
number of shares of common stock underlying these warrants was revised
to equal 55,500.
. On June 4, 1998, warrants exercisable for 111,150 shares were issued in
connection with the issuance of promissory notes made by the Registrant
on the same date in exchange for $800,000. On December 8, 1998, the
number of shares of common stock underlying these warrants was revised
to equal 222,000.
. On August 12, 1998, warrants exercisable for 159,562 shares were issued
in connection with the issuance of promissory notes made by the
Registrant on the same date in exchange for $1,150,000. On December 8,
1998, the number of shares of common stock underlying these warrants was
revised to equal 319,125.
. On September 8, 1998, warrants exercisable for 6,937 shares were issued
in connection with the issuance of promissory notes made by the
Registrant on the same date in exchange for $50,000. On December 8,
1998, the number of shares of common stock underlying this warrant was
revised to equal 13,875.
II-3
<PAGE>
. On November 2, 1998, warrants exercisable for 48,562 shares were issued
in connection with the issuance of promissory notes made by the
Registrant on the same date in exchange for $350,000.
. On December 8, 1998, warrants exercisable for 750,000 shares were issued
in connection with the issuance of promissory notes made by the
Registrant on the same date in exchange for $750,000.
. On January 13, 1999, warrants exercisable for 206,250 shares were issued
in connection with the sale of 680,639 shares of series C convertible
participating preferred stock in exchange for an aggregate of
$5,240,920.
(c) Grants and Exercises of Stock Options. The Registrant's 1999 Stock
Incentive Plan was approved by the Board of Directors in October 1999, subject
to stockholder approval. As of June 15, 2000, options to purchase and awards of
an aggregate of 1,438,042 shares of common stock granted to the Registrant's
employees and officers had been exercised for a consideration of $305,568 under
the Registrant's 1999 Stock Incentive Plan and options to purchase 3,775,810
shares of common stock granted to the Registrant's employees, officers and
directors were outstanding under the Registrant's 1999 Stock Incentive Plan.
(d) Issuances of Promissory Notes. On the following dates, the Registrant
issued promissory notes to new and existing individual and venture capital
investors in the following aggregate amounts each bearing interest at 10% per
year, except as otherwise noted:
. On October 16, 1997, the Registrant issued notes for an aggregate of
$1,000,000 in exchange for loans of the same principal amount.
. On January 30, 1998, the Registrant issued notes for an aggregate of
$750,000 in exchange for loans of the same principal amount.
. On May 21, 1998, the Registrant issued notes for an aggregate of
$200,000 in exchange for loans of the same principal amount.
. On June 4, 1998, the Registrant issued notes for an aggregate of
$800,000 in exchange for loans of the same principal amount.
. On August 12, 1998, the Registrant issued notes for an aggregate of
$1,150,000 in exchange for loans of the same principal amount.
II-4
<PAGE>
. On September 8, 1998, the Registrant issued notes for an aggregate of
$50,000 in exchange for loans of the same principal amount.
. On November 2, 1998, the Registrant issued notes for an aggregate of
$350,000 in exchange for loans of the same principal amount.
. On December 8, 1998, the Registrant issued notes for an aggregate of
$750,000 bearing interest at 15% per year in exchange for loans of the
same principal amount.
No underwriters were involved in the foregoing sales of securities. Such
sales were made in reliance upon an exemption from the registration provisions
of the Securities Act set forth in Section 4(2) thereof relative to sales by an
issuer not involving any public offering or the rules and regulations
thereunder, or, in the case of options to purchase common stock, Rule 701 of
the Securities Act. All of the foregoing securities are deemed restricted
securities for the purposes of the Securities Act.
Item 16. Exhibits and Financial Statement Schedules.
(a) Exhibits:
<TABLE>
<CAPTION>
Exhibit
No. Description
<C> <S>
1.1 Form of Underwriting Agreement
*3.1 Amended and Restated Certificate of Incorporation of the Registrant
**3.2 Form of Second Amended and Restated Certificate of Incorporation of
the Registrant, to be filed upon the closing of this offering
*3.3 Amended and Restated By-Laws of the Registrant
**3.4 Form of Second Amended and Restated By-Laws of the Registrant, to be
effective upon the closing of this offering
**3.5 Form of Certificate of Amendment of Amended and Restated Certificate
of Incorporation of the Registrant
**4.1 Specimen common stock certificate
*4.2 Provisions of the Second Amended and Restated Certificate of
Incorporation and Second Amended and Restated By-Laws of the
Registrant defining the rights of holders of common stock of the
Registrant (included in Exhibits 3.1, 3.2, 3.3, 3.4 and 3.5)
5.1 Opinion of Hale and Dorr LLP
*10.1 Lease 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, dated December 20, 1999, among the
Registrant and certain investors in our preferred stock and warrants
*10.7 Voting Trust Agreement, dated October 1, 1995 among Mr. Genovesi and
Ms. Smith, as trustees, and members of their families.
*10.8 Restricted Stock Agreement with Lawrence Genovesi, dated November 18,
1999, under the 1999 Stock Incentive Plan
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
Exhibit
No. Description
<C> <S>
*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
**23.1 Consent of Hale and Dorr LLP (included in Exhibit 5.1)
23.2 Consent of PricewaterhouseCoopers LLP
**24.1 Powers of Attorney (see page II-6)
*27.1 Financial Data Schedule
*27.2 Financial Data Schedule
*27.3 Financial Data Schedule
*27.4 Financial Data Schedule
*27.5 Financial Data Schedule
**27.6 Financial Data Schedule
**27.7 Financial Data Schedule
</TABLE>
---------------------
* Filed with the Registrant's initial filing of its registration statement on
Form S-1 on April 7, 2000.
** Filed with the Registrant's filing of Amendment No. 1 to Form S-1 on May
19, 2000.
*** Filed with the Registrant's filing of Amendment No. 2 to Form S-1 on June
19, 2000.
+ 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.
(b) Financial Statement Schedules:
All schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission have been omitted because
they are not required or because the required information is given in the
Financial Statements or Notes to these statements.
Item 17. Undertakings.
The undersigned registrant hereby undertakes to provide to the Underwriter
at the closing specified in the Underwriting Agreement, certificates in such
denominations and registered in such names as required by the Underwriter to
permit prompt delivery to each purchaser.
II-6
<PAGE>
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Act"), may be permitted to directors, officers and
controlling persons of the registrant pursuant to the Delaware General
Corporation Law, the Restated Certificate of the registrant, the Underwriting
Agreement, or otherwise, the registrant has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act, and is, therefore, unenforceable. In the event
that a claim for indemnification against such liabilities (other than the
payment by the registrant of expenses incurred or paid by a director, officer
or controlling person of the registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered
hereunder, the registrant will, unless in the opinion of counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication
of such issue.
The undersigned registrant hereby undertakes that:
(1) For purpose of determining any liability under the Act, the information
omitted from the form of prospectus filed as part of this Registration
Statement in reliance upon Rule 430A and contained in a form of prospectus
filed by the registrant pursuant to Rule 424(b)(1) or (4), or 497(h) under the
Act shall be deemed to be part of this Registration Statement as of the time it
was declared effective.
(2) For purpose of determining any liability under the Act, each post-
effective amendment that contains a form of prospectus shall be deemed to be a
new Registration Statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
II-7
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 3 to Registration Statement on Form S-1 to
be signed on its behalf by the undersigned, thereunto duly authorized, in
Canton, Massachusetts, on this 10th day of July, 2000.
NETWORK ENGINES, INC.
By /s/ Lawrence A. Genovesi
_____________________________________
Lawrence A. Genovesi
Chairman of the Board, President,
Chief Executive Officer and Chief
Technology Officer
Pursuant to the requirements of the Securities Act of 1933, as amended, this
Amendment No. 3 to Registration Statement on Form S-1 has been signed by the
following persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/ Lawrence A. Genovesi Chairman of the Board of July 10, 2000
____________________________________ Directors, President, Chief
Lawrence A. Genovesi Executive Officer and Chief
Technology Officer
(Principal Executive Officer)
/s/ Douglas G. Bryant Chief Financial Officer July 10, 2000
____________________________________ (Principal Financial Officer
Douglas G. Bryant and Principal Accounting
Officer)
* Director July 10, 2000
____________________________________
John A. Blaeser
* Director July 10, 2000
____________________________________
Lawrence Kernan
</TABLE>
II-8
<PAGE>
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
* Director July 10, 2000
____________________________________
Dennis A. Kirshy
* Director July 10, 2000
____________________________________
Frank M. Polestra
* Director July 10, 2000
____________________________________
Michael H. Shanahan
* Director July 10, 2000
____________________________________
Robert M. Wadsworth
* /s/ Lawrence A. Genovesi
____________________________________
Per Power of Attorney
</TABLE>
II-9
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
No. Description
<C> <S>
1.1 Form of Underwriting Agreement
*3.1 Amended and Restated Certificate of Incorporation of the Registrant
**3.2 Form of Second Amended and Restated Certificate of Incorporation of
the Registrant, to be filed upon the closing of this offering
*3.3 Amended and Restated By-Laws of the Registrant
**3.4 Form of Second Amended and Restated By-Laws of the Registrant, to be
effective upon the closing of this offering
**3.5 Form of Certificate of Amendment of Amended and Restated Certificate
of Incorporation of the Registrant
**4.1 Specimen common stock certificate
*4.2 Provisions of the Second Amended and Restated Certificate of
Incorporation and Second Amended and Restated By-Laws of the
Registrant defining the rights of holders of common stock of the
Registrant (included in Exhibits 3.1, 3.2, 3.3, 3.4 and 3.5)
5.1 Opinion of Hale and Dorr LLP
*10.1 Lease 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, dated December 20, 1999, among the
Registrant and certain investors in our preferred stock and warrants
*10.7 Voting Trust Agreement, dated October 1, 1995 among Mr. Genovesi and
Ms. Smith, as trustees, and members of their families.
*10.8 Restricted Stock Agreement with Lawrence Genovesi, dated November 18,
1999, under the 1999 Stock Incentive Plan
*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
**23.1 Consent of Hale and Dorr LLP (included in Exhibit 5.1)
23.2 Consent of PricewaterhouseCoopers LLP
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
No. Description
<C> <S>
**24.1 Powers of Attorney (see page II-6)
*27.1 Financial Data Schedule
*27.2 Financial Data Schedule
*27.3 Financial Data Schedule
*27.4 Financial Data Schedule
*27.5 Financial Data Schedule
**27.6 Financial Data Schedule
**27.7 Financial Data Schedule
</TABLE>
---------------------
* Filed with the Registrant's initial filing of its registration statement on
Form S-1 on April 7, 2000.
** Filed with the Registrant's filing of Amendment No. 1 to Form S-1 on May 19,
2000.
*** Filed with the Registrant's filing of Amendment No. 2 to Form S-1 on June
19, 2000.
+ 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.
