---

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UNITED STATES


SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549











FORM 10-K/A











(Mark One)





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




| | For the fiscal year ended September 30, 2000
| | --------------------------------------------




OR





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




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




Commission file number: 0-30863











NETWORK ENGINES, INC.


(Exact name of registrant as specified in its charter)





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




|25 Dan Road, Canton, MA |  | 02021
|----------------------- |  | -----
|




Registrants telephone number, including area code (781) 332-1000





Securities registered pursuant to Section 12 (b) of the Act:





None





Securities registered pursuant to Section 12 (g) of the Act:





Common Stock, $0.01 par value











Indicate by check mark whether the registrant:  (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period than the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days.  Yes x No  ̈





Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statement incorporated by reference in part III of this Form 10-K or any amendment to this Form 10-K.  ̈





The aggregate market value of the voting Common Stock held by non-affiliates of the registrant on
November 15, 2000 was approximately $172,411,000.





The number of shares outstanding of the registrants Common Stock as of November 15, 2000:
34,772,969 shares.





Documents incorporated by reference:





Portions of the registrants definitive Proxy Statement for its Annual Meeting of Stockholders
for the year ended September 30, 2000, which will be filed with the Securities and Exchange Commission within 120 days after the end of the Companys fiscal year, are incorporated by reference into Part III hereof.





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TABLE OF CONTENTS







|                 |  |                                                                   |  | Page
|---------------- |  | ----------------------------------------------------------------- |  | ----
|                
|                
|PART II          |  |                                                                  
|                
|                
|EXPLANATORY NOTE |  | 1                                                                
|                
|                
|ITEM 6.          |  | SELECTED CONSOLIDATED FINANCIAL DATA                              |  | 2   
|                
|ITEM 8.          |  | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                       |  | 3   
|                
|PART IV          |  |                                                                  
|                
|ITEM 14.         |  | EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K |  | 27  
|                 |  | SIGNATURE                                                         |  | 28  
|                
|                
|                




EXPLANATORY NOTE





Network Engines, Inc. (the "Company") is filing this amendment to its Annual Report on Form 10-K for the
fiscal year ended September 30, 2000 (the "Original 10-K") in order to remove pro forma information regarding the conversion of the Company's convertible redeemable preferred stock into common stock, which occurred upon the effectiveness
of the Company's initial public offering in July 2000. This pro forma information was included in Items 6 and 8 of the Original 10-K.In addition, the Company is also
amending Item 8 of the Original 10-K to include in Note 10 of its consolidated financial statements information previously disclosed in Part I, Item 3 of the Original 10-K and to include, as Note 15 to its consolidated financial statements on this
Form 10-K/A, certain quarterly financial data previously excluded from the Original 10-K. Items 6, 8, and 14, as amended, are hereby provided in their entirety.









ITEM 6.    SELECTED CONSOLIDATED FINANCIAL DATA





The following selected consolidated financial data are derived from the financial statements of
Network Engines, Inc. The historical results presented are not necessarily indicative of future results. The selected consolidated financial data set forth below should be read in conjunction with Managements Discussion and Analysis of
Financial Condition and Results of Operations and Network Engines Consolidated Financial Statements and the Related Notes.





Selected Consolidated Financial Data


(in thousands, except per share data)





|                                                                                    |  | Year ended September 30,
|----------------------------------------------------------------------------------- |  | ------------------------
|
|Net product revenues                                                                |  | $1,515                  
|Net license revenues                                                                |  |                        
|                                                                                    |  |                         
|Total net
revenues                                                                  |  | 1,515                   
|Cost of product revenues                                                            |  | 718                     
|Cost of license revenues                                                            |  |                        
|                                                                                    |  |                         
|Total cost of
revenues                                                              |  | 718                     
|                                                                                    |  |                         
|Gross profit (loss)                                                                 |  | 797                     
|Operating expenses:                                                                 |  |                         
|Research and development                                                            |  | 169                     
|Selling and marketing                                                               |  | 233                     
|General and administrative                                                          |  | 268                     
|Stock compensation                                                                  |  |                        
|                                                                                    |  |                         
|Total operating
expenses                                                            |  | 670                     
|                                                                                    |  |                         
|Income (loss) from operations                                                       |  | 127                     
|Other income (expense), net                                                         |  | (69                     
|                                                                                    |  |                         
|Income (loss) before extraordinary item                                             |  | 58                      
|Extraordinary gain on extinguishment of debt                                        |  |                        
|                                                                                    |  |                         
|Net income (loss)                                                                   |  | 58                      
|Accretion of redeemable convertible preferred stock                                 |  |                        
|                                                                                    |  |                         
|Net income (loss) attributable to common stockholders                               |  | $    58                 
|                                                                                    |  |                         
|Income (loss) per common share before extraordinary itembasic and

     diluted    |  | $  0.02                 
|Extraordinary item per common sharebasic and diluted                               |  |                        
|                                                                                    |  |                         
|Net income (loss) per common sharebasic and diluted                                |  | $  0.02                 
|                                                                                    |  |                         
|Shares used in computing basic and diluted net income (loss) per common

     share |  | 3,025                   
|                                                                                   
|
|
|Balance Sheet Data:                                                                 |  |                         
|Cash, cash equivalents and restricted cash                                          |  | $    32                 
|Working capital (deficit)                                                           |  | 205                     
|Total assets                                                                        |  | 804                     
|Long-term debt, less current portion                                                |  | 82                      
|Redeemable convertible preferred stock                                              |  |                        
|Total stockholders equity (deficit)                                                |  | 227                     




ITEM 8.    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





INDEX TO
CONSOLIDATED
FINANCIAL
STATEMENTS





|                                                                                                                    |  | Page
|------------------------------------------------------------------------------------------------------------------- |  | ----
|REPORT OF INDEPENDENT ACCOUNTANTS                                                                                   |  | 4   
|                                                                                                                    | 
|                                                                                                                   
|CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 1999 AND 2000                                                       |  | 5   
|                                                                                                                    | 
|                                                                                                                   
|CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEARS ENDED SEPTEMBER 30,

     1998, 1999 AND 2000                    |  | 6   
|                                                                                                                    | 
|                                                                                                                   
|CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY (DEFICIT) FOR THE YEARS

     ENDED SEPTEMBER 30,1998, 1999 AND 2000 |  | 7   
|                                                                                                                    | 
|                                                                                                                   
|CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED SEPTEMBER 30,

     1998, 1999 AND 2000                    |  | 8   
|                                                                                                                    | 
|                                                                                                                   
|NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                                          |  | 9   




REPORT OF INDEPENDENT ACCOUNTANTS





To the Board of Directors and Stockholders


of Network Engines, Inc.:





In our opinion, the accompanying consolidated balance sheets and the related consolidated statements
of operations, of stockholders equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Network Engines, Inc. and its subsidiaries at September 30, 2000 and 1999, and the results of their
operations and their cash flows for each of the three years in the period ended September 30, 2000 in conformity with accounting principles generally accepted in the United States of America. 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 of
America, 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
our opinion.





| | /s/    PRICEWATERHOUSE
COOPERS
LLP
| | ----------------------------------

| | PricewaterhouseCoopers LLP
| | --------------------------




Boston, Massachusetts


November 8, 2000





NETWORK ENGINES, INC.





CONSOLIDATED BALANCE SHEETS





(in thousands, except share and per share data)





|                                                                                                                                                                                                                                                     |  | September 30,
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------
|
|ASSETS                                                                                                                                                                                                                                               |  |              
|Current assets:                                                                                                                                                                                                                                      |  |              
|Cash and cash equivalents                                                                                                                                                                                                                            |  | $    1,435   
|Restricted cash                                                                                                                                                                                                                                      |  | 100          
|Accounts receivable, net of allowance for doubtful accounts of $227 and $370 at September 30, 1999
and

            2000, respectively                                                                                                               |  | 2,025        
|Inventories                                                                                                                                                                                                                                          |  | 1,251        
|Prepaid expenses and other current assets                                                                                                                                                                                                            |  | 222          
|Due from contract manufacturer                                                                                                                                                                                                                       |  |             
|                                                                                                                                                                                                                                                     |  |              
|Total current assets                                                                                                                                                                                                                                 |  | 5,033        
|Property and equipment, net                                                                                                                                                                                                                          |  | 831          
|Other assets                                                                                                                                                                                                                                         |  |             
|                                                                                                                                                                                                                                                     |  |              
|Total assets                                                                                                                                                                                                                                         |  | $    5,864   
|                                                                                                                                                                                                                                                     |  |              
|LIABILITIES
, REDEEMABLE
CONVERTIBLE
PREFERRED
STOCK AND
STOCKHOLDERS
EQUITY
(DEFICIT
)                                                                                                                                                             |  |              
|Current liabilities:                                                                                                                                                                                                                                 |  |              
|Accounts payable                                                                                                                                                                                                                                     |  | $    2,354   
|Accrued compensation and other related benefits                                                                                                                                                                                                      |  | 98           
|Other accrued expenses                                                                                                                                                                                                                               |  | 516          
|Deferred revenue                                                                                                                                                                                                                                     |  | 105          
|Current portion of capital lease obligations and notes payable                                                                                                                                                                                       |  | 63           
|                                                                                                                                                                                                                                                     |  |              
|Total current liabilities                                                                                                                                                                                                                            |  | 3,136        
|Capital lease obligations and notes payable, net of current portion                                                                                                                                                                                  |  | 158          
|Commitments and contingencies (Note 10)                                                                                                                                                                                                              |  |              
|Redeemable convertible preferred stock:                                                                                                                                                                                                              |  |              
|Series C redeemable convertible preferred stock, $.01 par value, 1,123,549 shares authorized,
issued and

            outstanding at September 30, 1999 and no shares authorized, issued and outstanding at September 30,

            2000          |  | 8,705        
|Series B redeemable convertible preferred stock, $.01 par value, 360,000 authorized and 357,142
shares issued

            and outstanding at September 30, 1999 and no shares authorized, issued and outstanding at September 30,

            2000 |  | 2,750        
|Series A redeemable convertible preferred stock, $.01 par value, 185,250 shares authorized, issued
and

            outstanding at September 30, 1999 and no shares authorized, issued and outstanding at September 30,

            2000            |  | 1,012        
|                                                                                                                                                                                                                                                     |  |              
|Total redeemable convertible preferred
stock                                                                                                                                                                                                         |  | 12,467       
|Stockholders equity (deficit):                                                                                                                                                                                                                      |  |              
|Preferred stock, $.01 par value, no shares authorized, issued and outstanding at September 30,
1999 and

            5,000,000 authorized, no shares issued and outstanding at September 30, 2000                                                    |  |             
|Common stock, $.01 par value, 60,000,000 and 100,000,000 shares authorized; 3,429,862 and
34,218,585

            shares issued and outstanding at September 30, 1999 and 2000, respectively                                                         |  | 34           
|Additional paid-in capital                                                                                                                                                                                                                           |  | 2,942        
|Accumulated deficit                                                                                                                                                                                                                                  |  | (11,434      
|Note receivable from stockholder                                                                                                                                                                                                                     |  |             
|Deferred stock compensation                                                                                                                                                                                                                          |  | (1,439       
|                                                                                                                                                                                                                                                     |  |              
|Total stockholders equity
(deficit)                                                                                                                                                                                                                 |  | (9,897       
|                                                                                                                                                                                                                                                     |  |              
|Total liabilities, redeemable convertible preferred stock and stockholders equity (deficit)                                                                                                                                                         |  | $    5,864   
|                                                                                                                                                                                                                                                     |  |              




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





NETWORK ENGINES, INC.





CONSOLIDATED STATEMENT OF OPERATIONS


(in thousands, except per share data)





|                                                                                                                                                                          |  | Year ended September 30,
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------
|
|Net product revenues                                                                                                                                                      |  | $  1,102                
|Net license revenues                                                                                                                                                      |  |                        
|                                                                                                                                                                          |  |                         
|Total net
revenues                                                                                                                                                        |  | 1,102                   
|Cost of product revenues (excluding stock compensation of $16 and $254 for

     the years ended September 30, 1999 and 2000, respectively)                               |  | 1,591                   
|Cost of license revenues                                                                                                                                                  |  |                        
|                                                                                                                                                                          |  |                         
|Total cost of
revenues                                                                                                                                                    |  | 1,591                   
|Gross profit (loss)                                                                                                                                                       |  | (489                    
|Operating expenses:                                                                                                                                                      
|Research and development (excluding stock compensation of $37 and $430

               for the years ended September 30, 1999 and 2000, respectively)                     |  | 923                     
|Selling and marketing (excluding stock compensation of $53 and $1,217

               for the years ended September 30, 1999 and 2000, respectively)                      |  | 1,593                   
|General and administrative (excluding stock compensation of $25 and

               $1,020 for the years ended September 30, 1999 and 2000,

               respectively) |  | 620                     
|Stock compensation                                                                                                                                                        |  |                        
|                                                                                                                                                                          |  |                         
|Total operating
expenses                                                                                                                                                  |  | 3,136                   
|                                                                                                                                                                          |  |                         
|Loss from operations                                                                                                                                                      |  | (3,625                  
|Interest income                                                                                                                                                           |  | 18                      
|Interest expense                                                                                                                                                          |  | (592                    
|Loss on disposal of property and equipment                                                                                                                                |  |                        
|                                                                                                                                                                          |  |                         
|Loss before extraordinary item                                                                                                                                            |  | (4,199                  
|Extraordinary gain on extinguishment of debt                                                                                                                              |  |                        
|                                                                                                                                                                          |  |                         
|Net loss                                                                                                                                                                  |  | (4,199                  
|Accretion of redeemable convertible preferred stock                                                                                                                       |  |                        
|                                                                                                                                                                          |  |                         
|Net loss attributable to common stockholders                                                                                                                              |  | $(4,199                 
|                                                                                                                                                                          |  |                         
|Loss per common share before extraordinary itembasic and diluted                                                                                                         |  | $  (1.31                
|Extraordinary item per common sharebasic and diluted                                                                                                                     |  |                        
|                                                                                                                                                                          |  |                         
|Net loss per common sharebasic and diluted                                                                                                                               |  | $  (1.31                
|                                                                                                                                                                          |  |                         
|Shares used in computing basic and diluted net loss per common share                                                                                                      |  | 3,200                   




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





NETWORK ENGINES, INC.


CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY (DEFICIT)


(in thousands, except share data)





|                                                                                                                                   |  | Common Stock |  | Additional

Paid-in

Capital |  | Accumulated

Deficit |   | Note

Receivable

from

Stockholder |           | Deferred

Stock

Compensation |  | Total

Stockholders

Equity

(Deficit)
|---------------------------------------------------------------------------------------------------------------------------------- |  | ------------ |  | ---------------------------- |  | -------------------- | - | ----------------------------------- | --------- | ----------------------------- |  | ---------------------------------------
|
|Balance, September 30, 1997                                                                                                        |  | 3,182,250    |  | $  32                        |  | $      420           |   |                                     | $  (1,405 | )                             |  | $                                     
|Issuance of restricted common stock                                                                                                |  | 225,000      |  | 2                            |  | 15                   |   |                                     |           |                               |  |                                        
|Issuance of common stock warrants in

    connection with bridge loans                                                             |  |              |  |                              |  | 581                  |   |                                     |           |                               |  |                                        
|Net loss                                                                                                                           |  |              |  |                              |  |                      |   |                                     | (4,199    | )                             |  |                                        
|                                                                                                                                   |  |              |  |                              |  |                      |   |                                     |           |                               |  |                                        
|Balance, September 30, 1998                                                                                                        |  | 3,407,250    |  | 34                           |  | 1,016                |   |                                     | (5,604    | )                             |  |                                       
|Issuance costs associated with Series C

    redeemable convertible preferred

    stock                                           |  |              |  |                              |  | (188                 | ) |                                     |           |                               |  |                                        
|Issuance of common stock upon stock

    option exercise                                                                           |  | 22,612       |  |                             |  | 2                    |   |                                     |           |                               |  |                                        
|Issuance of common stock warrants in

    connection with bridge loans                                                             |  |              |  |                              |  | 608                  |   |                                     |           |                               |  |                                        
|Issuance of common stock warrants in

    connection with Series C redeemable

    convertible preferred stock                     |  |              |  |                              |  | 157                  |   |                                     |           |                               |  |                                        
|Issuance of common stock options to

    consultants and compensation

    expense for stock option

    modifications             |  |              |  |                              |  | 4                    |   |                                     |           |                               |  |                                        
|Deferred stock compensation related to

    grants of stock options                                                                |  |              |  |                              |  | 1,566                |   |                                     |           |                               |  |                                        
|Amortization of deferred stock

    compensation to expense                                                                        |  |              |  |                              |  |                      |   |                                     |           |                               |  |                                        
|Accretion of redeemable convertible

    preferred stock to redemption

    value                                                  |  |              |  |                              |  | (223                 | ) |                                     |           |                               |  |                                        
|Net loss                                                                                                                           |  |              |  |                              |  |                      |   |                                     | (5,830    | )                             |  |                                        
|                                                                                                                                   |  |              |  |                              |  |                      |   |                                     |           |                               |  |                                        
|Balance, September 30, 1999                                                                                                        |  | 3,429,862    |  | 34                           |  | 2,942                |   |                                     | (11,434   | )                             |  |                                       
|Issuance of restricted common stock                                                                                                |  | 650,000      |  | 6                            |  | 221                  |   |                                     |           |                               |  | (90                                    
|Issuance costs associated with Series D

    redeemable convertible preferred

    stock                                           |  |              |  |                              |  | (82                  | ) |                                     |           |                               |  |                                        
|Issuance of common stock upon initial

    public offering, net of issuance

    costs                                             |  | 7,475,000    |  | 75                           |  | 116,809              |   |                                     |           |                               |  |                                        
|Conversion of redeemable convertible

    preferred stock to common stock in

    connection with the initial public

    offering |  | 21,448,442   |  | 214                          |  | 45,606               |   |                                     |           |                               |  |                                        
|Issuance of common stock upon stock

    option exercises                                                                          |  | 650,577      |  | 7                            |  | 66                   |   |                                     |           |                               |  |                                        
|Issuance of common stock upon

    warrant exercises                                                                               |  | 564,704      |  | 6                            |  | 202                  |   |                                     |           |                               |  |                                        
|Interest on note receivable from

    stockholder                                                                                  |  |              |  |                              |  |                      |   |                                     |           |                               |  | (4                                     
|Deferred stock compensation related to

    grants of stock options                                                                |  |              |  |                              |  | 13,916               |   |                                     |           |                               |  |                                        
|Amortization of deferred stock

    compensation to expense                                                                        |  |              |  |                              |  |                      |   |                                     |           |                               |  |                                        
|Deferred compensation related to

    cancellation of stock options for

    terminated employees                                  |  |              |  |                              |  | (263                 | ) |                                     |           |                               |  |                                        
|Accretion of redeemable convertible

    preferred stock to redemption

    value                                                  |  |              |  |                              |  | (8,103               | ) |                                     |           |                               |  |                                        
|Net loss                                                                                                                           |  |              |  |                              |  |                      |   |                                     | (12,481   | )                             |  |                                        
|                                                                                                                                   |  |              |  |                              |  |                      |   |                                     |           |                               |  |                                        
|Balance, September 30, 2000                                                                                                        |  | 34,218,585   |  | $342                         |  | $171,314             |   |                                     | $(23,915  | )                             |  | $(94                                   
|                                                                                                                                   |  |              |  |                              |  |                      |   |                                     |           |                               |  |                                        




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





NETWORK ENGINES, INC.





CONSOLIDATED STATEMENT OF CASH FLOWS


(in thousands)





|                                                                                                                   |  | Year ended September 30,
|------------------------------------------------------------------------------------------------------------------ |  | ------------------------
|
|Cash flows from operating activities:                                                                              |  |                         
|Net loss                                                                                                           |  | $(4,199                 
|Adjustments to reconcile net loss to net cash used in operating activities:                                        |  |                         
|Depreciation and
amortization                                                                                      |  | 194                     
|Provision for inventory
reserve                                                                                    |  | 350                     
|Amortization of discount on notes
payable                                                                          |  | 348                     
|Provision for doubtful
accounts                                                                                    |  | 50                      
|Gain on extinguishment of
debt                                                                                     |  |                        
|Compensation expense related to common
stock options                                                               |  |                        
|Interest on note receivable from
stockholder                                                                       |  |                        
|Loss on disposal of property and
equipment                                                                         |  |                        
|Changes in operating assets and
liabilities:                                                                      
|Accounts receivable                                                                                                |  | (427                    
|Inventories                                                                                                        |  | (587                    
|Prepaid expenses and other current assets                                                                          |  | (71                     
|Due from contract manufacturer                                                                                     |  |                        
|Accounts payable                                                                                                   |  | 447                     
|Accrued compensation and related benefits and other accrued expenses                                               |  | 458                     
|Deferred revenue                                                                                                   |  | 29                      
|                                                                                                                   |  |                         
|& cash used in operating activities                                                                                |  | (3,408                  
|Cash flows from investing activities:                                                                             
|Purchase of property and equipment                                                                                 |  | (343                    
|Proceeds from sale of property and equipment                                                                       |  |                        
|Change in restricted cash                                                                                          |  |                        
|Increase in other assets                                                                                           |  |                        
|                                                                                                                   |  |                         
|& cash used in investing activities                                                                                |  | (343                    
|Cash flows from financing activities:                                                                             
|Proceeds from bridge loans                                                                                         |  | 3,950                   
|Proceeds from notes payable                                                                                        |  | 4                       
|Payments on capital lease obligations and notes payable                                                            |  | (123                    
|Proceeds from issuance of common stock, net of issuance costs                                                      |  | 17                      
|Proceeds from issuance of redeemable convertible preferred stock, net of issuance

             costs              |  |                        
|                                                                                                                   |  |                         
|& cash provided by financing activities                                                                            |  | 3,848                   
|                                                                                                                   |  |                         
|Net increase in cash and cash equivalents                                                                          |  | 97                      
|Cash and cash equivalents, beginning of year                                                                       |  | 16                      
|                                                                                                                   |  |                         
|Cash and cash equivalents, end of year                                                                             |  | $    113                
|                                                                                                                   |  |                         
|Supplemental cash flow information:                                                                                |  |                         
|Interest paid                                                                                                      |  | $      29               
|Non-cash transactions:                                                                                             |  |                         
|Acquisition of property and equipment under capital leases                                                         |  | $    101                
|Bridge loans and accrued interest converted to Series B and C redeemable convertible

             preferred stock |  | $                      
|Restricted common stock issued in exchange for note receivable from stockholder                                    |  | $                      
|Redeemable convertible preferred stock converted to common stock                                                   |  | $                      




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





NETWORK ENGINES, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





1. NATURE OF BUSINESS





Business





Network Engines, Inc. (the Company) provides high-density, scalable Internet server
appliances that support large Web-based applications for web hosting and service providers, content infrastructure providers, application service providers and larger enterprises. The Company markets its products globally through a direct sales
organization, as well as through indirect channels consisting of original equipment manufacturers, resellers and systems integrators.





2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Basis of Presentation





The accompanying consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Certain amounts in the prior years financial statement have been reclassified to conform to current year presentation. 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.





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 and 2000, the Companys cash equivalents of $1,372,000 and $112,382,000, respectively, consisted primarily of investments in commercial paper and money market funds. These investments are
stated at amortized cost, which approximates fair value. At September 30, 1999, $100,000 of cash was restricted and pledged as collateral to the Companys primary contract manufacturer. At September 30, 2000, $47,000 of cash was restricted and
pledged as collateral to the Companys facility landlord.





The Company accounts for its investments in accordance with Statement of Financial Accounting
Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. Under the provisions of SFAS No. 115, the Company has classified investments as available-for-sale and any associated
unrealized gains or losses, if material, are recorded as separate components of stockholders equity until realized. As of and for the years ended September 30, 1999 and 2000, any realized and unrealized gains or losses were
immaterial.





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 commercial paper and 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 $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. Revenue of
approximately $6,819,000 (16%) and $4,968,000 (12%) was attributable to two customers during the year ended September 30, 2000.





Three customers accounted for approximately $1,809,000 (80%) of accounts receivable as of September
30, 1999 and two customers accounted for approximately $2,818,000 (23%) of accounts receivable at September 30, 2000.





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, notes
receivable, accounts payable and redeemable convertible preferred stock, are carried in the financial statements at amortized cost which approximates fair value as of September 30, 1999 and 2000.





Inventories





Inventories are valued at the lower of cost or market, with cost determined using the first-in,
first-out method.





Due from Contract Manufacturer





In September 2000, the Company sold certain inventory components to its contract manufacturer at cost.
Through December 20, 2000, the Company had received payments totaling approximately $4,740,000 related to this receivable.





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
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.





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. 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.





Advertising Costs





Advertising costs are charged to expense as incurred. Advertising expenses for the year ended
September 30, 2000 were approximately $1,271,000. Prior to the year ended September 30, 2000, advertising expenses were not material.





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.





Web Site Development Costs





The Company follows the guidance of EITF 00-02, Accounting for Web Site Development Costs
(EITF 00-02) to account for web site costs. EITF 00-02 separates web site development costs into stages and provides guidance for the accounting of each stage. All costs incurred in the planning stage are expensed as incurred. Costs
relating to software used to operate a web site and other web site application and infrastructure development costs are accounted for in accordance with AICPA Statement of Position 98-1, Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use (SOP 98-1). The Company capitalizes internal and external costs incurred to develop web site software and applications. Such capitalizable costs include external direct costs of material and services
consumed in developing software and applications and payroll and payroll-related costs for employees who are directly associated with and who devote time to web site software and application development projects. Initial web site graphics, including
the design or layout of each page, images and the overall look and feel of the web site, are also capitalized. Costs
incurred in the operating stage, including post implementation training, maintenance and other operating costs, are expensed as incurred. To date, costs eligible for capitalization were not material.





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.





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, 1998, 1999 and 2000.





Net Loss Per Common Share





Basic net loss per share is computed by dividing the net loss attributable to common stockholders for
the period by the weighted average number of shares of common stock outstanding during the period, excluding shares of common stock subject to repurchase by the Company (restricted shares). Diluted net loss per share is computed by
dividing the net loss attributable to common stockholders for the period by the weighted average number of shares of common stock and potential common stock outstanding during the period, if dilutive. Potential common stock includes restricted
shares and incremental shares of common stock issuable upon the exercise of stock options and warrants and upon conversion of redeemable convertible preferred stock. Because the inclusion
of potential common stock would be anti-dilutive for all periods presented, diluted net loss per share is the same as basic net loss per share.





The following table sets forth the potential common stock excluded from the calculation of net loss
per common share because their inclusion would be anti-dilutive:





|                                       |  | As of September 30,
|-------------------------------------- |  | -------------------
|
|Options to purchase common stock       |  | 608                
|Warrants to purchase common stock      |  | 1,895              
|Unvested restricted common stock       |  | 132                
|Redeemable convertible preferred stock |  | 1,389              
|                                       |  |                    
|                                       |  | 4,024              
|                                       |  |                    










Recent Accounting Pronouncements





In June 1998, the Financial Accounting Standards 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. In June 2000, Statement of Financial Accounting Standards No. 138, Accounting for Certain Derivative Instruments and Hedging Activitiesan Amendment of
FASB Statement No. 133, was issued to clarify certain provisions of SFAS 133. 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. In
June 2000, the Staff issued Staff Accounting Bulletin No. 101B, Second Amendment: Revenue Recognition in Financial Statements, (SAB 101B). SAB 101B delays the implementation of SAB 101 until the fourth quarter of the
Companys fiscal year 2001. 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.





3. INVENTORIES





Inventories consisted of the following (in thousands):





|                |  | September 30,
|--------------- |  | -------------
|
|Raw materials   |  | $  845       
|Work in process |  | 120          
|Finished goods  |  | 286          
|                |  |              
|                |  | $1,251       
|                |  |              




4. PROPERTY AND EQUIPMENT





Property and equipment consisted of the following (in thousands):





|                                                 |  |                                 |  | September 30,
|------------------------------------------------ |  | ------------------------------- |  | -------------
|
|Office furniture and equipment                   |  | 5 years                         |  | $  351       
|Engineering and production

equipment            |  | 3 years                         |  | 404          
|Computer equipment and

software                 |  | 3 years                         |  | 642          
|Leasehold improvements                           |  | Lesser of 3 years or lease term |  | 210          
|Demonstration equipment                          |  | 1.53 years                     |  |             
|                                                 |  |                                 |  |              
|                                                 |  |                                 |  | 1,607        
|Less: accumulated depreciation

and amortization |  |                                 |  | 776          
|                                                 |  |                                 |  |              
|                                                 |  |                                 |  | $  831       
|                                                 |  |                                 |  |              




As of September 30, 1999 and 2000, the Company had approximately $165,000 and $153,000 (net of
approximately $53,000 and $123,000 of accumulated amortization) of office furniture, computer software and equipment under capital leases, respectively.





Depreciation and amortization expense was approximately $194,000, $361,000 and $1,353,000 for the
years ended September 30, 1998, 1999 and 2000, respectively.





NETWORK ENGINES, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





5. BRIDGE LOANS





As of September 30, 1998, the Company had uncollateralized subordinated promissory notes totaling
$3,950,000 outstanding that were payable on demand with an interest rate of 10% per annum. 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.





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 was recorded as an
extraordinary gain on extinguishment of debt in the year ended September 30, 1999.





6. CAPITAL LEASE OBLIGATIONS AND NOTES PAYABLE





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, 2000, the required monthly installment of principal and interest for all capital leases was approximately $6,000.


NETWORK ENGINES, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)








Future minimum lease payments under all noncancelable capital leases as of September 30, 2000 were
as follows (in thousands):





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




Notes Payable





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 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 were recorded as an extraordinary gain on
extinguishment of debt during the year ended September 30, 1999.





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% (10.5% at September 30, 2000). 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. At September 30, 1999 and 2000, the Company had approximately $41,000 and $21,000 outstanding under the equipment line, respectively.





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% (10.75% at September 30, 2000), 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% (10.5% at
September 30, 2000) and matures in April 2001. No amounts were outstanding under the additional equipment line or the working capital revolving line of credit at September 30, 2000.





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, 1999 or
2000.





7. STOCKHOLDERS EQUITY (DEFICIT) AND REDEEMABLE CONVERTIBLE PREFERRED STOCK





Preferred Stock





The Company has authorized up to 5,000,000 shares of preferred stock, $0.01 par value per share for
issuance. The preferred stock will have such rights, preferences, privileges and restrictions, including voting rights, dividend rights, conversion rights, redemption privileges, and liquidation preferences, as shall be determined by the Board of
Directors.





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). On May 17, 2000, the Company completed a 2.5-for-one split of the Companys common stock, which was effected through a stock dividend (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 both the 1999 Stock Split and the 2000 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, which vested over a two year period.





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 vested 50% on November 18, 2000 and 12.5% per quarter thereafter and 187,500 shares vested 25% on November 18, 2000 and will vest 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 September 30, 2000, the Company had achieved certain financial targets and, accordingly, 78,125 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. 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. For
the year ended September 30, 2000, the Company recognized approximately $269,000 of related stock compensation expense.





In March 2000, the Company issued 12,500 shares of restricted stock at $6.00 per share to a director
of the Company. These shares vest on the earlier of one year after the date of grant or on the day prior to the Companys fiscal 2000 annual stockholders meeting.





On July 12, 2000, the Company completed its initial public offering of common stock. The Company sold
7,475,000 shares of its common stock, par value $.01 per share (the Common Stock) at $17 per share including the underwriters over-allotment option. The Company received proceeds of approximately $116,900,000, net of offering costs
and underwriting fees totaling approximately $10,175,000, from its initial public offering.





Redeemable Convertible Preferred Stock





The following table summarizes redeemable convertible preferred stock activity (in thousands, except
share data):





|                                                                                                                                     |  | Redeemable Convertible

Preferred Stock
|------------------------------------------------------------------------------------------------------------------------------------ |  | ---------------------------------------
|
|Balance, September 30, 1997 and 1998                                                                                                 |  | 185,250                                
|January 1999 issuance of Series B redeemable convertible

     preferred stock upon conversion of bridge loans                       |  | 357,142                                
|January 1999 issuance of Series C redeemable convertible

     preferred stock upon conversion of bridge loans                       |  | 299,631                                
|June 1999 issuance of Series C redeemable convertible

     preferred stock for cash                                                 |  | 401,816                                
|Accretion of redeemable convertible preferred stock to

     redemption value                                                        |  |                                       
|                                                                                                                                     |  |                                        
|Balance, September 30, 1999                                                                                                          |  | 1,665,941                              
|December 1999 issuance of Series D redeemable convertible

     preferred stock for cash                                             |  | 3,581,554                              
|Accretion of redeemable convertible preferred stock to

     redemption value                                                        |  |                                       
|Conversion of Series A, B, C and D redeemable convertible

     preferred stock into common stock upon initial public

     offering |  | (5,247,495                             
|                                                                                                                                     |  |                                        
|Balance, September 30, 2000                                                                                                          |  |                                       
|                                                                                                                                     |  |                                        




NETWORK ENGINES, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





In connection with the Companys initial public offering in July 2000, all outstanding shares
of preferred stock converted into 21,448,442 shares of common stock, in accordance with the Companys certificate of incorporation. Prior to the conversion, the Company had four series of redeemable convertible preferred stock: Series A
preferred stock , Series B preferred stock, Series C preferred stock and Series D preferred stock (collectively, the Preferred Stock).





8. STOCK INCENTIVE PLANS





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.





In October 1999, the Companys shareholders approved the 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 may be issued to employees, officers, directors, consultants and advisors of the Company. 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.





In May 2000, the Companys shareholders approved an increase of 3,300,000 in the number of shares
authorized under the 1999 Plan and an automatic annual increase in the number of shares authorized under the 1999 Plan. The automatic annual increase is equal to the lesser of: 5% of the outstanding shares on the first day of each fiscal year;
4,000,000 shares or an amount determined by the Board of Directors, which is subject to a maximum of 20,047,902 authorized shares under the plan.


NETWORK ENGINES, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)








Stock option activity for the 1997 Plan and 1999 Plan (the Plans), since October 1, 1997
was as follows:





|                                |  | Number of

Options |   | Weighted

Average

Exercise

Price
|------------------------------- |  | ------------------ | - | ----------------------------------
|Outstanding, October 1, 1997    |  |                   |   |                                   
|Granted                         |  | 882,150            |   |                                   
|Exercised                       |  | (225,000           | ) |                                   
|Cancelled                       |  | (48,750            | ) |                                   
|                                |  |                    |   |                                   
|Outstanding, September 30, 1998 |  | 608,400            |   |                                   
|Granted                         |  | 1,593,975          |   |                                   
|Exercised                       |  | (22,612            | ) |                                   
|Cancelled                       |  | (242,610           | ) |                                   
|                                |  |                    |   |                                   
|Outstanding, September 30, 1999 |  | 1,937,153          |   |                                   
|Granted                         |  | 3,323,299          |   |                                   
|Exercised                       |  | (650,577           | ) |                                   
|Cancelled                       |  | (229,287           | ) |                                   
|                                |  |                    |   |                                   
|Outstanding, September 30, 2000 |  | 4,380,588          |   |                                   
|                                |  |                    |   |                                   




As of September 30, 1999 and 2000, options to purchase 199,915 and 107,057 shares of common stock,
respectively, were exercisable with a weighted-average exercise price per share of $0.08 and $0.14, 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 and 2000 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 and $16.01 (781,925 options) and $7.40 (2,541,374 options), respectively. As of
September 30, September 30, 2000, 2,374,237 shares were available for future grants under the Plans.





The following table summarizes the stock options outstanding at September 30, 2000:





|              |  | Options Outstanding |  | Options Exercisable
|------------- |  | ------------------- |  | -------------------
|
|$0.07$0.24   |  | 1,912,539           |  | $  0.17            
|$1.20$2.00   |  | 1,016,374           |  | $  1.78            
|$4.00$6.00   |  | 261,125             |  | $  4.93            
|$8.00$14.50  |  | 1,073,550           |  | $11.96             
|$26.38$45.38 |  | 117,000             |  | $33.93             
|              |  |                     |  |                    
|              |  | 4,380,588           |  |                    
|              |  |                     |  |                    

NETWORK ENGINES, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)








During the years ended September 30, 1999 and 2000, 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 $13,916,000 respectively. The Company is recognizing the compensation expense
over the vesting period. The Company recognized compensation expense relating to deferred compensation of approximately $131,000 and $2,921,000 for the years ended September 30, 1999 and 2000, 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, 1999 and 2000
would have increased to the pro forma amounts indicated below:





|            |  | 1998    |   | 1999 |        | 2000
|----------- |  | ------- | - | ---- | ------ | ----
|
|
|As reported |  | $(4,199 | ) |      | $(1.31 | )   
|Pro forma   |  | $(4,201 | ) |      | $(1.31 | )   




For this purpose, the fair value of options at the date of grant were estimated using the Black
Scholes option pricing model with the following assumptions: risk-free interest rates of 6.0%, 5.5% and 6.2% for 1998, 1999 and 2000, respectively; no dividend yield for each of the years presented; no volatility factor for 1998 and 1999 and a
volatility factor of 150% for 2000; and a weighted-average expected life of the options of five years for each of the years presented.





In May 2000, the Companys shareholders approved the 2000 Director Option Plan. Under the 2000
Director Option Plan, the Company may make formula grants of stock options to non-employee directors of up to 500,000 shares of common stock. As of September 30, 2000, no option grants have been made from the 2000 Director Option Plan.





In May 2000, the Companys shareholders approved the 2000 Employee Stock Purchase Plan (the
Purchase Plan). Under the Purchase Plan, the Company may issue up to an aggregate of 750,000 shares of common stock to eligible employees. Eligible employees are those who are customarily employed by the Company for more than 20 hours
per week and more than five months in a fiscal year. Under the Purchase Plan, the Company makes two offerings each fiscal year, at the end of which employees may purchase shares of common stock through payroll deductions made over the term of each
offering. The per-share purchase price at the end of each offering is equal to lesser of 85% of the closing price of the common stock at the beginning or end of the offering period. The first offering period under the Purchase Plan began on August
7, 2000 and ended on November 14, 2000. Future offering periods will begin on the 15th day of November and May each year. As of September 30, 2000, no shares had been issued under the Purchase Plan.





NETWORK ENGINES, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





9. STOCK WARRANTS





The following table summarizes stock warrant activity during each of the three years ended September
30, 2000:





|                                                                                                                            |  | Common Stock Warrants
|--------------------------------------------------------------------------------------------------------------------------- |  | ---------------------
|
|Outstanding, October 1, 1997                                                                                                |  | 249,487              
|Issuance of warrants in connection with

               issuance of bridge loans (1998 bridge

               loans)      |  | 1,645,732            
|                                                                                                                            |  |                      
|Outstanding, September 30, 1998                                                                                             |  | 1,895,219            
|Issuance of warrants in connection with

               issuance of bridge loans                                            |  | 798,562              
|Cancellation of warrants in connection

               with conversion of bridge loans into

              &nbs stock       |  | (549,607             
|Issuance of warrants in connection with

               issuance of Series C redeemable

              &nbs preferred stock |  | 206,250              
|                                                                                                                            |  |                      
|Outstanding, September 30, 1999                                                                                             |  | 2,350,424            
|Exercise of warrants                                                                                                        |  | (564,704             
|                                                                                                                            |  |                      
|Outstanding September 30, 2000                                                                                              |  | 1,785,720            
|                                                                                                                            |  |                      




Warrants issued prior to October 1, 1997 were issued in connection with notes payable. The fair value
of these warrants of approximately $41,000 was recorded in additional paid-in capital and as interest expense over the life of the related notes payable. These warrants expire at various dates between August 31, 2002 and February 23,
2003.





Warrants issued during the years ended September 30, 1998 and 1999, with fair values of approximately
$588,000 and $608,000, respectively, were issued in connection with bridge loans. The fair value of these warrants was recorded in additional paid-in capital and interest expense over the life of the related bridge loans.





During the year ended September 30, 1999, the Company entered into agreements with the holders of the
1998 Bridge Loans whereby 549,607 of the warrants granted in conjunction with the 1998 Bridge Loans were cancelled in connection with the conversion of the 1998 Bridge Loans into redeemable convertible preferred stock. Also during the year ended
September 30, 1999, the Company issued warrants to some of the holders of Series C preferred stock, in connection with that financing. The fair value of those warrants of approximately $157,000 was recorded as a discount on the Series C Preferred
stock and in additional paid-in capital.





As of September 30, 2000, the Company had reserved 1,785,720 shares of common stock for the exercise
of all of the Companys outstanding warrants.


NETWORK ENGINES, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)








10. COMMITMENTS AND CONTINGENCIES





Operating Leases





The Company leases its office space under non-cancelable operating leases. As of September 30, 2000,
the future minimum lease payments under these non-cancelable operating leases were as follows (in thousands):





|Year Ending September 30,
|-------------------------
|2001                     
|2002                     
|2003                     
|2004                     
|2005                     
|                         
|Total                    
|                         




Rent expense was approximately $37,000, $50,000 and $614,000 for the years ended September 30, 1998,
1999 and 2000, respectively.





Contingencies





On December 29, 1999, a former employee, George Flate, commenced a lawsuit against the Company, 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. The Company anticipates that Mr. Flate will claim damages in excess of one million dollars. Specifically, he is alleging that the Company breached its implied
covenant of good faith and fair dealing and that current and former officers of the Company named in the lawsuit intentionally interfered with contractual relations. 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 the Company for approximately one year. Currently, the matter is in the early stages of discovery. Although the
Company believes these claims are without merit and intends 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, the
Company's defense against these claims might result in the expenditure of significant financial and managerial resources.  The Company may be, from time to time, a party to
other litigation arising in the normal course of our business. The Company believes that none of these other actions, individually or in the aggregate, will have a material adverse affect on the Company's financial position or results of operations.





11. INCOME TAXES





Due to the loss incurred during fiscal years 1998, 1999 and 2000, 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, 1998, 1999 and 2000 (in thousands):





|                                                |  | 1998     |   | 1999 |          | 2000
|----------------------------------------------- |  | -------- | - | ---- | -------- | ----
|At US federal statutory rate                    |  | $(1,428  | ) |      | $(1,781  | )   
|State taxes, net of federal effect              |  | (261     | ) |      | (381     | )   
|Research and development credits                |  | (20      | ) |      | (92      | )   
|Non-deductible stock option compensation charge |  |         |   |      | 43       |     
|Non-deductible expenses and other charges       |  | 132      |   |      | (103     | )   
|Effect of change in valuation allowance         |  | 1,577    |   |      | 2,314    |     
|                                                |  |          |   |      |          |     
|Provision for income taxes                      |  | $       |   |      | $       |     
|                                                |  |          |   |      |          |     




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
purposes. As of September 30, 1999 and 2000, net deferred tax assets consisted of the following (in thousands):


|                                     |  | 1999   |   | 2000
|------------------------------------ |  | ------ | - | ----
|Net operating losses                 |  | $2,690 |   |     
|Tax credit carryforwards             |  | 238    |   |     
|Capitalized research and engineering |  | 1,227  |   |     
|Temporary differences                |  | 338    |   |     
|                                     |  |        |   |     
|Total deferred tax asset             |  | 4,493  |   |     
|Valuation allowance                  |  | (4,493 | ) |     
|                                     |  |        |   |     
|Net deferred tax asset               |  | $     |   |     
|                                     |  |        |   |     




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, 1999 and 2000, 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, 2000, the Company had net operating loss carryforwards for both federal and state
income tax purposes of approximately $12.8 million, which expire at various dates through 2020 and 2005, respectively. The Company also has available research and development credits for federal and state income tax purposes of approximately
$360,000 and $280,000, respectively, which expire at various dates through 2020.





An ownership change, as defined in the Internal Revenue Code, resulting form the issuance of
additional stock may limit the amount of net operating loss and tax credit carryforwards that can be utilized annually to offset future taxable income and tax liabilities. The amount of the annual limitation is determined based upon the
Companys value immediately prior to the ownership change. Subsequent significant changes in ownership could further affect the limitations in future years.





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. SEGMENT AND GEOGRAPHIC DATA





The Company organizes itself as one segment and through September 30, 2000 conducted its operations
primarily in the United States. Revenues were generated from the following geographic regions:


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

NETWORK ENGINES, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)








All of the Companys long-lived assets were located in the United States as of September 30,
1998, 1999 and 2000.





14. SUBSEQUENT EVENTS





Acquisition of IP Performance, Inc.





On November 8, 2000, the Company completed the acquisition of IP Performance, Inc. (IP
Performance). The Company acquired all of the outstanding common stock of IP Performance in exchange for an aggregate of 450,449 shares of the Companys common stock. Of the 450,449 shares issued to the shareholders of IP Performance,
321,755 shares are restricted as to resale. The restrictions vest in equal amounts on the first, second and third anniversaries of the consummation of the acquisition, provided the individual shareholders of IP Performance, Inc. prior to the
acquisition, continue to be employed by the Company as of each anniversary date. The acquisition will be accounted for as a purchase and will result in approximately $855,000 of annual amortization expense and approximately $2,117,000 of annual
stock compensation expense, which will be recognized ratably over the next three fiscal years. The amount of stock compensation expense to be recorded in future periods could decrease if common stock for accrued but unvested compensation is
forfeited.


15.  QUARTERLY FINANCIAL DATA (UNAUDITED)



The following information has been derived from unaudited consolidated financial statements that, in the opinion of management, include all recurring adjustments necessary for a fair
presentation of such information.





|                                             | THREE MONTHS ENDED                   
|-------------------------------------------- | -------------------------------------
|                                             | December 31,

1999                   
|                                             | (in thousands, except per share data)
|                                             |                                      
|Net revenues                                 | $                                    
|Gross profit                                 |                                      
|                                             |                                      
|Loss before extraordinary item               |                                      
|Net loss                                     |                                      
|Net loss attributable to common stockholders |                                      
|                                             |                                      
|Net loss per common share--basic and diluted | $                                    
|                                             |                                      
|                                             | THREE MONTHS ENDED                   
|                                             | December 31,

1998                   
|                                             | (in thousands, except per share data)
|                                             |                                      
|Net revenues                                 | $                                    
|Gross profit (loss)                          |                                      
|                                             |                                      
|Loss before extraordinary item               |                                      
|Net loss                                     |                                      
|Net loss attributable to common stockholders |                                      
|                                             |                                      
|Net loss per common share--basic and diluted | $                                    








PART IV





ITEM 14.    EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K





(a)  (1)  Financial Statements





The following consolidated financial statements are filed as part of this report under Item
8Financial Statements and Supplementary Data:





|                                                                                                                      |  | Page
|--------------------------------------------------------------------------------------------------------------------- |  | ----
|Report of Independent Accountants                                                                                     |  | 4   
|Consolidated Balance Sheet as of September 30, 1999 and 2000                                                          |  | 5   
|Consolidated Statement of Operations for the years ended September 30, 1998, 1999 and 2000                            |  | 6   
|Consolidated Statement of Stockholders Equity (Deficit) for the years ended September 30, 1998, 1999

     and 2000. |  | 7   
|Consolidated Statement of Cash Flows for the years ended September 30, 1998, 1999 and 2000                            |  | 8   
|Notes to Consolidated Financial Statements.                                                                           |  | 9   




(a)  (2)  List of Schedules





Schedule IIValuation and Qualifying Accounts for the three fiscal years ended September 30,
2000.





All other schedules to the consolidated financial statements are omitted as the required information
is either inapplicable or presented in the consolidated financial statements.





(a)  (3)  List of Exhibits





The exhibits which are filed with this report or which are incorporated by reference are set forth in
the Exhibit Index hereto.





(b)  Reports on Form 8-K





We did not file any reports on Form 8-K during the last quarter of the period covered by this
report.







SIGNATURES





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





| | NETWORK ENGINES, INC
| | --------------------




| | /S
/   Douglas G. Byrant
| | ------------------------

| | By:
| | ---

| | Douglas G. Bryant
| | -----------------

|                    | Vice President of Administration, Chief Financial Officer,

Treasurer and Secretary (Principal Financial Officer and

Principal Accounting Officer)
|------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|Date: July 24, 2001 |                                                                                                                                                    











REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL

STATEMENT SCHEDULES



To the Board of Directors

of Network Engines, Inc.:

Our audits of the consolidated financial statements referred to in our report dated November 8, 2000 appearing in this Annual Report on Form 10-K/A of Network Engines, Inc.
also included an audit of the financial statement schedule listed in Item 14(a)(2) of this Form 10-K/A. In our opinion, the financial statement schedule presents fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.



> /s/ PRICEWATERHOUSE COOPERS LLP
> 
> PricewaterhouseCoopers LLP





Boston, Massachusetts

July 23, 2001




SCHEDULE II
 NETWORK ENGINES, INC.


VALUATION AND QUALIFYING ACCOUNTS








|      |                                 |     | Additions |     | Deductions |      | Balance

at End

of

Period |         
|----- | ------------------------------- | --- | --------- | --- | ---------- | ---- | --------------------------- | --------
|
|1998: | ALLOWANCE FOR DOUBTFUL ACCOUNTS | 57  |           | 50  |            | $  - |                             | $      -
|1999: | ALLOWANCE FOR DOUBTFUL ACCOUNTS | 107 |           | 120 |            | -    |                             | -       
|2000: | ALLOWANCE FOR DOUBTFUL ACCOUNTS | 227 |           | 176 |            | -    |                             | 33      




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





EXHIBIT INDEX





|Exhibit

No. |  | Exhibit                                                                                                                                                       
|------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|**3.1        |  | Second Amended and Restated Certificate of Incorporation of the Registrant.                                                                                   
|**3.2        |  | Second Amended and Restated By-laws of the Registrant                                                                                                         
|*4.1         |  | Specimen common stock certificate                                                                                                                             
|**4.2        |  | Agreement and Plan of Merger dated November 7, 2000, among Network Engines, Inc., IPP

Acquisition Co. and IP Performance, Inc.                               
|*10.1        |  | Lease dated October 19, 1999 with New Boston Batterymarch, LP for 25 Dan Road, Canton,

Massachusetts                                                         
|*10.2        |  | The Registrants 1999 Stock Incentive Plan                                                                                                                    
|*10.3        |  | Form of Incentive Stock Option Agreement under the Registrants 1999 Stock Incentive Plan                                                                     
|*10.4        |  | The Registrants 2000 Employee Stock Purchase Plan                                                                                                            
|*10.5        |  | The Registrants 2000 Director Stock Option Plan                                                                                                              
|*10.6        |  | Investor Rights Agreement Investor Rights Agreement, dated December 20, 1999, among the

Registrant and certain investors in our preferred stock and warrants.
|*10.7        |  | Restricted Stock Agreement with Lawrence Genovesi, dated November 18, 1999, under the 1999

Stock Incentive Plan.                                             
|**10.8      |  | Manufacturing and Purchase Agreement, dated August 4, 2000, between the Registrant and SCI

Systems, Inc.                                                     
|*10.9        |  | Restricted Stock Agreement with Dennis Kirshy, dated January 7, 1998, under the 1997 Stock

Incentive Plan                                                    
|*10.10       |  | Restricted Stock Agreement with Dennis Kirshy, dated November 18, 1999, under the 1999 Stock

Incentive Plan                                                  
|*10.11       |  | Restricted Stock Agreement with John Blaeser, dated November 18, 1999, under the 1999 Stock

Incentive Plan                                                   
|*10.12       |  | P6000 Asset Purchase Agreement between the Registrant and Copernicus Systems, Inc. dated

April 13, 2000                                                      
|*10.13       |  | Loan Modification Agreement, dated as of April 5, 2000, between the Registrant and Silicon Valley

Bank                                                       
|*10.14       |  | Restricted Stock Agreement with Michael H. Shanahan, dated April 3, 2000, under the 1999 Stock

Incentive Plan                                                
|*10.15       |  | Form of option granted to each of Frank M. Polestra, Robert M. Wadsworth and Lawrence Kernan

on March 16, 2000                                               
|*10.16       |  | Form of First Amendment to the Registrants 1999 Stock Incentive Plan                                                                                         
|*10.17       |  | License Agreement between the Registrant and International Business Machines Corporation, dated

July 19, 1999                                                
|*10.18       |  | First Amendment dated February 1, 2000 and Second Amendment dated June 1, 2000 to Lease for

25 Dan Road, Canton, Massachusetts                               
|**21.1       |  | Subsidiaries of the Registrant                                                                                                                                
|23.1         |  | Consent of PricewaterhouseCoopers LLP                                                                                                                         
|**27.1       |  | Financial Data Schedule                                                                                                                                       




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



|** | Incorporated by reference from exhibits filed with the Companys Annual Report on Form 10-K, filed with the Securities
and Exchange Commission on December 21, 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.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------