---



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

_____________________

FORM 10-Q
_____________________

(Mark One)

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

For the quarterly period ended March 31, 2001

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                      |                | (I.R.S. Employer   
|incorporation)                                       |                | Identification No.)
|                                                     |                |                    
|25 Dan Road, Canton, MA                              |                | 02021              
|(Address of principal executive                      |                | (Zip Code)         
|offices)                                             |                |                    
|                                                     |                |                    
|                                                     | (781) 332-1000 |                    
|(Registrant's telephone number, including area code)
|                                                    
|_____________________                               

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

As of April 30, 2001, there were 35,020,056 shares of the registrants Common Stock, par value $.01 per share, outstanding.

---



NETWORK ENGINES, INC.

INDEX

|                                                                                              | PAGENUMBER | 
|--------------------------------------------------------------------------------------------- | ---------- | 
|                                                                                              |           
|                                                                                              |            | 
|                                                                                              |            | 
|PART I. FINANCIAL INFORMATION                                                                 |            | 
|                                                                                              |            | 
|ITEM 1. FINANCIAL STATEMENTS                                                                  |            | 
|                                                                                              |            | 
|CONDENSED CONSOLIDATED BALANCE SHEETS                                                         | 2          | 
|CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                                               | 3          | 
|CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                                               | 4          | 
|NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                          | 5          | 
|                                                                                              |            | 
|ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION | 9          | 
|                                                                                              |            | 
|ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            | 25         | 
|                                                                                              |            | 
|PART II. OTHER INFORMATION                                                                    |            | 
|                                                                                              |            | 
|ITEM 1. LEGAL PROCEEDINGS                                                                     | 26         | 
|                                                                                              |            | 
|ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                             | 26         | 
|                                                                                              |            | 
|ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                   | 26         | 
|                                                                                              |            | 
|ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                      | 27         | 
|                                                                                              |            | 
|SIGNATURES                                                                                    | 28         | 
|                                                                                              |            | 
|EXHIBIT INDEX                                                                                 | 29         | 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NETWORK ENGINES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

|                                                                    | March 31,2001                       |   | September 30 ,2000                  |  
|------------------------------------------------------------------- | ----------------------------------- | - | ----------------------------------- | -
|                                                                    |                                     |  
|                                                                    |                                     |   |                                     |  
|ASSETS                                                              | (unaudited)                         |   |                                     |  
|                                                                    |                                     |   |                                     |  
|Current assets:                                                     |                                     |   |                                     |  
|Cash and cash equivalents                                           | $                          93,104   |   | $                         112,382   |  
|Restricted cash                                                     | 1,098                               |   | 47                                  |  
|Accounts receivable, net of allowance                               | 2,001                               |   | 11,805                              |  
|Inventories                                                         | 4,075                               |   | 6,600                               |  
|Prepaid expenses and other current assets                           | 1,321                               |   | 1,031                               |  
|Due from contract manufacturer                                      | 1,057                               |   | 7,113                               |  
|                                                                    |                                     |   |                                     |  
|                                                                    |                                     |   |                                     |  
|Total current assets                                                | 102,656                             |   | 138,978                             |  
|                                                                    |                                     |   |                                     |  
|Property and equipment, net                                         | 6,935                               |   | 7,098                               |  
|Goodwill and intangible assets                                      | 2,322                               |   | -                                   |  
|Other assets                                                        | 1,206                               |   | 136                                 |  
|                                                                    |                                     |   |                                     |  
|                                                                    |                                     |   |                                     |  
|Total assets                                                        | $                         113,119   |   | $                         146,212   |  
|                                                                    |                                     |   |                                     |  
|                                                                    |                                     |   |                                     |  
|LIABILITIES AND STOCKHOLDERS' EQUITY                                |                                     |   |                                     |  
|                                                                    |                                     |   |                                     |  
|Current liabilities:                                                |                                     |   |                                     |  
|Accounts payable                                                    | $                             5,370 |   | $                             6,906 |  
|Due to contract manufacturer                                        | 12,653                              |   | -                                   |  
|Accrued compensation and other related benefits                     | 1,319                               |   | 1,773                               |  
|Other accrued expenses                                              | 538                                 |   | 1,077                               |  
|Deferred revenue                                                    | 610                                 |   | 827                                 |  
|Current portion of capital lease obligations and notes payable      | 59                                  |   | 63                                  |  
|                                                                    |                                     |   |                                     |  
|                                                                    |                                     |   |                                     |  
|Total current liabilities                                           | 20,549                              |   | 10,646                              |  
|                                                                    |                                     |   |                                     |  
|Capital lease obligations and notes payable, net of current portion | 41                                  |   | 90                                  |  
|                                                                    |                                     |   |                                     |  
|Stockholders' equity:                                               |                                     |   |                                     |  
|Preferred stock                                                     | -                                   |   | -                                   |  
|Common stock                                                        | 350                                 |   | 342                                 |  
|Additional paid-in capital                                          | 179,859                             |   | 171,314                             |  
|Accumulated deficit                                                 | (72,579                             | ) | (23,915                             | )
|Note receivable from stockholder                                    | (98                                 | ) | (94                                 | )
|Deferred stock compensation                                         | (15,003                             | ) | (12,171                             | )
|                                                                    |                                     |   |                                     |  
|                                                                    |                                     |   |                                     |  
|Total stockholders' equity                                          | 92,529                              |   | 135,476                             |  
|                                                                    |                                     |   |                                     |  
|                                                                    |                                     |   |                                     |  
|Total liabilities and stockholders' equity                          | $                         113,119   |   | $                         146,212   |  
|                                                                    |                                     |   |                                     |  

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

NETWORK ENGINES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(in thousands, except per share data)

(unaudited)

|                                                                                 | Three months ended March 31,     |   | Six months ended March 31,     |  
|-------------------------------------------------------------------------------- | -------------------------------- | - | ------------------------------ | -
|                                                                                 |                                  |   |                                |  
|                                                                                 | 2001                             |   | 2000                           |  
|                                                                                 |                                  |   |                                |  
|                                                                                 |                                  |   |                                |  
|                                                                                 |                                  |   |                                |  
|Net revenues                                                                     | $                         2,516  |   | $                       6,051  |  
|Cost of revenues:                                                                |                                  |   |                                |  
|Cost of revenues (excluding stock compensation)                                  | 3,452                            |   | 4,192                          |  
|Cost of revenues stock compensation                                              | 80                               |   | 52                             |  
|Inventory write-down                                                             | 8,692                            |   | -                              |  
|                                                                                 |                                  |   |                                |  
|                                                                                 |                                  |   |                                |  
|Total cost of revenues                                                           | 12,224                           |   | 4,244                          |  
|                                                                                 |                                  |   |                                |  
|Gross profit (loss)                                                              | (9,708                           | ) | 1,807                          |  
|                                                                                 |                                  |   |                                |  
|Operating expenses:                                                              |                                  |   |                                |  
|Research and development                                                         | 3,968                            |   | 1,910                          |  
|Selling and marketing                                                            | 5,891                            |   | 3,012                          |  
|General and administrative                                                       | 1,876                            |   | 759                            |  
|Stock compensation (excluding cost of revenues stock compensation)               | 1,373                            |   | 627                            |  
|Amortization of goodwill and intangible assets                                   | 225                              |   | -                              |  
|Loss on retirement of property and equipment                                     | 1,203                            |   | -                              |  
|                                                                                 |                                  |   |                                |  
|                                                                                 |                                  |   |                                |  
|Total operating expenses                                                         | 14,536                           |   | 6,308                          |  
|                                                                                 |                                  |   |                                |  
|                                                                                 |                                  |   |                                |  
|Loss from operations                                                             | (24,244                          | ) | (4,501                         | )
|Interest income, net                                                             | 1,442                            |   | 280                            |  
|                                                                                 |                                  |   |                                |  
|                                                                                 |                                  |   |                                |  
|Net loss                                                                         | (22,802                          | ) | (4,221                         | )
|                                                                                 |                                  |   |                                |  
|Accretion of redeemable convertible preferred stock                              | -                                |   | (3,449                         | )
|                                                                                 |                                  |   |                                |  
|                                                                                 |                                  |   |                                |  
|Net loss attributable to common stockholders                                     | $                       (22,802  | ) | $                      (7,670  | )
|                                                                                 |                                  |   |                                |  
|                                                                                 |                                  |   |                                |  
|Net loss per common share - basic and diluted                                    | $                          (0.67 | ) | $                        (2.11 | )
|                                                                                 |                                  |   |                                |  
|                                                                                 |                                  |   |                                |  
|Shares used in computing net loss per common share - basic and diluted           | 34,219                           |   | 3,633                          |  
|                                                                                 |                                  |   |                                |  
|Pro forma net loss per common share - basic and diluted                          |                                  |   | $                        (0.17 | )
|                                                                                 |                                  |   |                                |  
|Shares used in computing pro forma net loss per common share - basic and diluted |                                  |   | 25,079                         |  

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

NETWORK ENGINES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

|                                                                                        | Six months ended March 31, |        
|--------------------------------------------------------------------------------------- | -------------------------- | -------
|                                                                                        |                            |        
|                                                                                        | 2001                       |        
|                                                                                        |                            |        
|                                                                                        |                            |        
|Cash flows from operating activities:                                                   |                            |        
|Net loss                                                                                | $                          | (48,664
|Adjustments to reconcile net loss to net cash used in                                   |                            |        
|operating activities:                                                                   |                            |        
|Depreciation and amortization                                                           |                            | 1,911  
|Provision for inventory reserve                                                         |                            | 23,835 
|Provision for doubtful accounts                                                         |                            | 620    
|Stock compensation                                                                      |                            | 2,798  
|Interest on note receivable from stockholder                                            |                            | (4     
|Loss on retirement of property and equipment                                            |                            | 1,203  
|Changes in operating assets and liabilities, net of effects of acquisition:             |                            |        
|Accounts receivable                                                                     |                            | 9,184  
|Inventories                                                                             |                            | (21,310
|Prepaid expenses and other current assets                                               |                            | (262   
|Due from contract manufacturer                                                          |                            | 6,056  
|Accounts payable                                                                        |                            | (1,740 
|Due to contract manufacturer                                                            |                            | 12,653 
|Accrued expenses                                                                        |                            | (999   
|Deferred revenue                                                                        |                            | (217   
|                                                                                        |                            |        
|                                                                                        |                            |        
|Net cash used in operating activities                                                   |                            | (14,936
|                                                                                        |                            |        
|Cash flows from investing activities:                                                   |                            |        
|Purchases of property and equipment                                                     |                            | (2,522 
|Deposit of restricted cash                                                              |                            | (1,051 
|Increase in other assets                                                                |                            | (1,070 
|Cash of business acquired, net of acquisition expenses                                  |                            | (30    
|                                                                                        |                            |        
|                                                                                        |                            |        
|Net cash used in investing activities                                                   |                            | (4,673 
|                                                                                        |                            |        
|Cash flows from financing activities:                                                   |                            |        
|Proceeds from notes payable                                                             |                            | -      
|Payments on capital lease obligations and notes payable                                 |                            | (53    
|Proceeds from issuance of common stock                                                  |                            | 384    
|Proceeds from issuance of redeemable convertible preferred stock, net of issuance costs |                            | -      
|                                                                                        |                            |        
|                                                                                        |                            |        
|Net cash provided by financing activities                                               |                            | 331    
|                                                                                        |                            |        
|                                                                                        |                            |        
|Net increase (decrease) in cash and cash equivalents                                    |                            | (19,278
|Cash and cash equivalents, beginning of period                                          |                            | 112,382
|                                                                                        |                            |        
|                                                                                        |                            |        
|Cash and cash equivalents, end of period                                                | $                          | 93,104 
|                                                                                        |                            |        

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

NETWORK ENGINES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements have been prepared by Network Engines, Inc. (Network Engines or the Company) in accordance with generally accepted accounting principles and
pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the audited financial statements and the accompanying notes included in the Company's 2000 Annual Report on Form 10-K filed by
the Company with the Securities and Exchange Commission.

The information furnished reflects all adjustments, which, in the opinion of management, are of a normal recurring nature and are considered necessary for a fair presentation of results for the interim
periods. It should also be noted that results for the interim periods are not necessarily indicative of the results expected for the full year or any future period.

The preparation of these condensed consolidated 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 the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates
included in the financial statements are inventory valuation, accounts receivable and sales allowances and the recoverability of goodwill and intangible assets. Actual results could differ from those estimates.

2. SIGNIFICANT ACCOUNTING POLICIES

Recent Accounting Pronouncements

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 principles 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.

Comprehensive Loss

During each period presented, comprehensive loss was equal to net loss.

Segment Reporting

During each period presented, the Company operated in a single business segment, primarily in the United States.

3. NET LOSS PER 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

NETWORK ENGINES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)

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 (in thousands):

|                                  | As ofMarch 31, | 
|--------------------------------- | -------------- | 
|                                  |               
|                                  |                | 
|                                  | 2001           | 
|                                  |                | 
|                                  |                | 
|Options to purchase common stock  | 6,364          | 
|Warrants to purchase common stock | 1,625          | 
|Unvested restricted common stock  | 438            | 
|                                  |                | 
|                                  |                | 
|                                  | 8,427          | 
|                                  |                | 

Pro forma basic and diluted net loss for the three and six months ended March 31, 2000 is calculated assuming the automatic conversion of all preferred stock outstanding had occurred as of the date of issuance of the preferred stock.
Therefore, accretion of redeemable convertible preferred stock is excluded from the calculation of pro forma net loss per common share. The redeemable convertible preferred stock automatically converted into 21,448,442 shares of common stock upon
the completion of the Companys initial public offering in July 2000. During the three and six months ended March 31, 2001, no shares of preferred stock were outstanding; accordingly, pro forma basic and diluted net loss per share equaled
actual basic and diluted net loss per share.

4. INVENTORIES

|Inventories consisted of the following (in thousands): |               |       |                   |   |       | 
|------------------------------------------------------ | ------------- | ----- | ----------------- | - | ----- | 
|                                                       | March 31,2001 |       | September 30,2000 |  
|                                                       |               |      
|                                                       |               |       |                   |  
|Raw materials                                          | $             | 3,383 |                   | $ | 3,524 | 
|Work in process                                        |               | 57    |                   |   | 847   | 
|Finished goods                                         |               | 635   |                   |   | 2,229 | 
|                                                       |               |       |                   |  
|                                                       |               |       |                   |   |       | 
|                                                       | $             | 4,075 |                   | $ | 6,600 | 
|                                                       |               |       |                   |  

5. CONTINGENCIES

As a normal incidence of the nature of the Company's business, various claims, charges and litigation have been asserted or commenced against the Company arising from or related to employee relations. Management does not believe
these claims will have a material adverse effect on the financial position or results of operations of the Company.

6. ACQUISITION OF IP PERFORMANCE

On November 8, 2000, the Company completed its acquisition of IP Performance, Inc. (IP Performance), a developer of network acceleration technology, through the exchange of 128,693 shares of unrestricted Network Engines
common stock for all outstanding shares of IP Performance capital stock. The acquisition was accounted for using the purchase method of accounting. Accordingly, the fair market value of the acquired assets and assumed liabilities have been included
in the Companys financial

NETWORK ENGINES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)

statements as of the acquisition date and the results of IP Performance operations have been included in the Companys financial statements thereafter. The purchase price of approximately $2,540,000, assumed net liabilities of
approximately $94,000 and acquisition expenses of approximately $63,000, resulted in goodwill and intangible assets of approximately $2,697,000. The Company is amortizing the goodwill and intangible assets over a three-year period. Through March 31,
2001, the Company amortized approximately $375,000 of goodwill and intangible assets. The Companys pro forma statements of operations prior to the acquisition would not differ materially from reported results.

The Company also issued 321,756 shares of restricted common stock to key employee shareholders of IP Performance. These shares are restricted as to sale and such restrictions lapse in three equal annual installments beginning on
November 8, 2001, contingent upon continued employment of the holder. In connection with the issuance of these restricted shares, the Company recorded approximately $6,351,000 of deferred compensation, which is being recognized as stock compensation
expense ratably over the vesting period. Through March 31, 2001, the Company recognized approximately $882,000 of stock compensation expense. The amount of stock compensation expense to be recorded in future periods could change if holders of
unvested restricted stock cease to be employees of the Company prior to the lapse of the vesting period.

7. INVENTORY WRITE-DOWN

During the six months ended March 31, 2001, the Company recorded an inventory write-down of approximately $23,657,000 for excess and obsolete inventory related to the Companys WebEngine Blazer, WebEngine Sierra and
StorageEngine Voyager products. This excess and obsolete inventory was due to an unanticipated shortfall in sales of these products in the six months ended March 31, 2001 and the resulting reduction in expected future sales of these products. This
write-down includes inventory held at our contract manufacturer, inventory on-hand and firm purchase commitments as of March 31, 2001.

8. RETIREMENT OF PROPERTY AND EQUIPMENT

In the three months ended March 31, 2001, the Company retired fixed assets related to its WebEngine Blazer product line. These fixed assets had a total net book value of approximately $1,203,000 and consisted primarily of computer
equipment previously utilized in the production and sales of the WebEngine Blazer, our previous generation web content server appliance product.

9. RELATED PARTY TRANSACTIONS

In January 2001, the Company entered into a series of related agreements with Lawrence A. Genovesi, the Companys current Chairman and Chief Technology Officer and former Chief Executive Officer. These agreements were entered
into in order to avoid significant sales of the Companys stock by Mr. Genovesi as a result of a margin call on a personal loan that was collateralized by Mr. Genovesis holdings of the Companys common stock. The Company agreed to
guarantee a personal loan obtained by Mr. Genovesi from a financial institution (the Bank) through a deposit of $1,051,850 of the Companys cash with the Bank (the Guarantee). The Guarantee period ends on January 9, 2002
and the balance of the amount deposited with the Bank will be returned to the Company. Mr. Genovesi and the Company also entered into an agreement whereby Mr. Genovesi has agreed to reimburse the Company for any obligations incurred by the Company
under the Guarantee (the Reimbursement Agreement). Any unpaid balances under the Reimbursement Agreement bear interest at a rate of 10% per annum. In the event of a default of the Reimbursement Agreement by Mr. Genovesi, the Company has
the right to apply any and all compensation due to Mr. Genovesi against all of Mr. Genovesis obligations outstanding under the Reimbursement Agreement. In addition, the Company and Mr. Genovesi entered into a revolving promissory note of up to
$210,000 (the Note). The Note bears interest at a rate of 5.9% per annum and is due and payable in full upon the earlier of January 9, 2002 or 30 days following the date Mr. Genovesi ceases to be an employee of the Company.

NETWORK ENGINES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (CONTINUED)

In conjunction with the Guarantee, the Reimbursement Agreement and the Note, the Company and Mr. Genovesi entered into a pledge agreement whereby Mr. Genovesi pledged to the Company all shares of the Companys common stock owned
by Mr. Genovesi as of the date of the agreement or subsequently acquired, and all options and other rights to acquire shares of the Companys common stock owned by Mr. Genovesi as of the date of the agreement or subsequently acquired
(collectively the Pledged Securities). Additionally, Mr. Genovesi pledged to the Company all additional securities or other consideration from time to time acquired by Mr. Genovesi in substitution for, or in respect of, the Pledged
Securities. If Mr. Genovesi elects to sell any of the Pledged Securities during the term of the agreement, all proceeds of such sale will be applied first to any outstanding obligations related to the Note and then to any amounts payable under the
Reimbursement Agreement. In addition to the Pledged Securities, the Note is collateralized by a second mortgage on certain real property owned by Mr. Genovesi. As of May 14, 2001, no amounts were outstanding under the Note or were required to be
reimbursed to the Company under the Reimbursement Agreement.

10. SUBSEQUENT EVENTS

In April 2001, the Company entered into full recourse loan agreements with certain employees and executive officers of the Company (the Loan Agreements). These loan agreements were entered into to avoid substantial sales
of the Companys common stock by these employees and executive officers as a result of alternative minimum tax obligations incurred by these employees and executive officers. The total amount loaned to the employees and executive officers under
the Loan Agreements was approximately $737,000. Outstanding amounts under the Loan Agreements accrue interest at a rate of 4.63% per annum and are due and payable in full upon the earlier of one year from the date of each individual agreement or
thirty days after termination of employment with the Company, unless termination is involuntary and without cause. In conjunction with the Loan Agreements, each employee and executive officer pledged all shares of capital stock of the Company now
owned, or acquired in the future, (the Pledged Stock), and any distributions on the Pledged Stock or proceeds from their sale.

In April 2001, as a result of the effect that the recent economic down-turn has had on the Company and its customers information technology spending, the Company announced a restructuring plan to align the Companys
operating expenses and cash requirements with current market conditions. This plan includes a reduction in the Companys workforce from 243 employees to 170 employees, the curtailment of a planned expansion into currently leased facilities, the
consolidation of international operations, a reduction of marketing programs as well as other items. The Company expects to record a total charge of approximately $3,500,000 in the quarter ended June 30, 2001 as a result of this
restructuring.

ITEM 2.  MANAGEMENTS DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

Special Note Regarding Forward-looking Statements

This form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties. All statements other than statements of historical
information provided herein are forward-looking statements and may contain information about financial results, economic conditions, trends and known uncertainties. Our actual results could differ materially from those discussed in the
forward-looking statements as a result of a number of factors, which include those discussed in this section and elsewhere in this report and the risks discussed in our other filings with the Securities and Exchange Commission. Readers are cautioned
not to place undue reliance on these forward-looking statements, which reflect managements analysis, judgment, belief or expectation only as of the date hereof. We undertake no obligation to publicly reissue these forward-looking statements to
reflect events or circumstances that arise after the date hereof.

The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in Item 1 in this Quarterly Report on Form 10-Q and our 2000 Annual Report on
Form 10-K filed by the Company with the Securities and Exchange Commission.

Overview

We are a leading provider of scalable server appliances. Server appliances combine hardware and software to deliver information and applications over the Internet. By combining specific application functionality within small physical
packaging, our server appliances are designed to meet the complex needs and requirements of e-commerce and Internet-based organizations, including web-hosting and service providers, content infrastructure providers, application service providers and
larger enterprises.

In June 1999, we introduced our WebEngine Blazer product, our first generation of server appliances. Since July 1999, substantially all of our revenue has been attributable to the WebEngine Blazer product. We introduced our
AdminEngine server appliance in February 2000 and our WebEngine Roadster and WebEngine Viper server appliances in the third quarter of fiscal 2000. In February 2001, we began shipping our StorageEngine Voyager network attached server appliance and
our WebEngine Sierra, our next generation server appliance, designed to replace our WebEngine Blazer product.

Since the introduction of our first server appliance in June 1999, we experienced significant growth as we invested in the development of our technology and products, the recruitment and training of personnel for our engineering,
sales and marketing and technical support departments, and the establishment of an administrative organization. As a result, our employee base grew from 39 as of June 30, 1999 to 244 as of March 31, 2001, and our operating expenses grew
significantly. In April 2001, we announced a planned restructuring of our business as a result of the recent economic slowdown and its negative effect on our revenues. This restructuring includes a reduction in our work force to 170 employees, costs
associated with the curtailment of planned facility expansion and other costs. We expect to incur a total charge of approximately $3.5 million in the three months ended June 30, 2001 as a result of this restructuring. In addition, we have revised
our future spending plans in an effort to reduce operating expenses and conserve cash. We expect to realize the benefits of these revisions by the fourth quarter of fiscal 2001. At March 31, 2001, we had an accumulated deficit of $72.6
million.

Our revenues are derived from sales of our server appliances. We recognize revenues when title to the goods has passed, provided evidence of an arrangement has been received, no obligations remain outstanding and collectibility is
reasonably assured. The majority of our sales to date have been to customers in the United States.

In the past, we generated revenues from license arrangements, which allowed certain customers to sell our WebEngine Blazer product under their name in exchange for per unit fees. We recognized license revenues upon the
licensees sale to its customers. While these arrangements remain in effect, we did not record any

revenue from them during the three months ended March 31, 2001 and do not anticipate future revenues from them.

We need to generate significant revenues to achieve profitability. Our limited operating history, increasing competition in the server appliance market and general economic uncertainty make it difficult for us to predict future
operating results, and, accordingly, there can be no assurances that we will achieve revenue growth or profitability in future periods.

Gross profit (loss) represents net revenues recognized less the cost of revenues. Cost of revenues includes cost of materials, manufacturing costs, manufacturing personnel expenses, obsolescence charges, packaging, license fees and
shipping and warranty costs. Our gross profit (loss) will be affected primarily by the mix of product revenues, product pricing, the timing, size and configuration of customer orders, and new product introductions by us and our
competitors.

Research and development expenses consist primarily of salaries and related expenses for personnel engaged in research and development, fees paid to consultants and outside service providers, material costs for prototype and test
units and other expenses related to the design, development, testing and enhancements of our products. We expense all of our research and development costs as they are incurred. We believe that a significant level of investment in product research
and development is required to remain competitive. We expect to continue to devote substantial resources to product research and development, however, as a result of our April 2001 restructuring plan, we expect research and development expenses to
decrease in absolute dollars over the remainder of fiscal 2001 but continue to fluctuate as a percentage of net revenues. After our April 2001 restructuring, there were 81 employees in research in development compared to 85 employees at March 31,
2001.

Selling and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in sales, marketing and customer support functions, as well as costs associated with advertising, trade shows,
public relations and marketing materials. As a result of our April 2001 restructuring plan, we intend to curtail discretionary spending in selling and marketing, consolidate our European operations and defer our expansion into Asia. Accordingly, we
expect selling and marketing expenses to decrease in absolute dollars over the remainder of fiscal 2001 but continue to fluctuate as a percentage of net revenues. After our April 2001 restructuring, there were 52 employees in sales, marketing and
customer support compared to 98 employees at March 31, 2001.

General and administrative expenses consist primarily of salaries and other related costs for executive, finance, accounting, information technology, facilities and human resources personnel, as well as accounting, legal, other
professional fees and allowance for doubtful accounts. As a result of our April 2001 restructuring plan, we intend to curtail discretionary general and administrative expenses. We expect these expenses to decrease in absolute dollars over the
remainder of fiscal 2001 but continue to fluctuate as a percentage of net revenues. After our April 2001 restructuring, there were 19 general and administrative employees compared to 30 employees at March 31, 2001.

We have recorded deferred stock compensation on our balance sheet of $15.5 million in connection with stock option and restricted stock grants to our employees and directors that were granted between February 1,
1999 and June 30, 2000. This amount represents the difference between the exercise price and the deemed fair value of our common stock for financial reporting purposes at the date of grant. We are amortizing this stock compensation over the vesting
period of the related options. All options granted subsequent to June 30, 2000 have been issued with exercise prices equal to the deemed fair market value of the common stock and, accordingly, no additional deferred compensation has been recorded.
Through March 31, 2001, we amortized $4.9 million to stock compensation expense and $985,000 of deferred stock compensation has been cancelled due to the cancellation of options for terminated employees.

We recorded $6.4 million of deferred compensation on our balance sheet as a result of restricted stock issued in connection with our acquisition of IP Performance, Inc. (IP Performance) in November 2000. Through March 31,
2001, we amortized $882,000 to stock compensation expense.

During the next twelve months, after adjusting for deferred compensation of employees included in the April 2001 restructuring plan, we expect to amortize stock compensation of:

|                      | Expected

Amortization of

Stock
Compensation | 
|--------------------- | --------------------------------------------- | 
|                      |                                              
|                      |                                              
|Fiscal Quarter Ending |                                              
|                      | (in thousands)                                | 
|June 30, 2001         | $2,845                                        | 
|September 30, 2001    | 1,202                                         | 
|December 31, 2001     | 1,189                                         | 
|March 31, 2002        | 1,183                                         | 

We then expect aggregate per quarter stock compensation amortization of approximately $1.2 million during the remainder of fiscal 2002 and fiscal 2003 and between $17,000 and $857,000 during fiscal 2004 and the quarter ended December
31, 2004. The amount of stock compensation expense to be recorded in future periods could change if restricted common stock, or options, for accrued but unvested compensation are forfeited.

Results of Operations

The following table sets forth financial data for the periods indicated as a percentage of net revenues:

|                                                                   | Three months endedMarch 31, |    | Six months ended March 31, |   
|------------------------------------------------------------------ | --------------------------- | -- | -------------------------- | --
|                                                                   |                             |   
|                                                                   |                             |    |                            |   
|                                                                   |                             |    |                            |   
|                                                                   | 2001                        |    | 2000                       |   
|                                                                   |                             |    |                            |   
|                                                                   |                             |    |                            |   
|                                                                   |                             |    |                            |   
|Net revenues                                                       | 100                         | %  | 100                        | % 
|                                                                   |                             |    |                            |   
|Cost of revenues:                                                  |                             |    |                            |   
|Cost of revenues (excluding stock compensation)                    | 137                         |    | 69                         |   
|Cost of revenues stock compensation                                | 3                           |    | 1                          |   
|Inventory write-down                                               | 346                         |    | -                          |   
|                                                                   |                             |    |                            |   
|                                                                   |                             |    |                            |   
|Total cost of revenues                                             | 486                         |    | 70                         |   
|                                                                   |                             |    |                            |   
|                                                                   |                             |    |                            |   
|Gross profit (loss)                                                | (386                        | )  | 30                         |   
|                                                                   |                             |    |                            |   
|Operating expenses:                                                |                             |    |                            |   
|Research and development                                           | 158                         |    | 32                         |   
|Selling and marketing                                              | 234                         |    | 49                         |   
|General and administrative                                         | 74                          |    | 13                         |   
|Stock compensation (excluding cost of revenues stock compensation) | 55                          |    | 10                         |   
|Amortization of goodwill and intangible assets                     | 9                           |    | -                          |   
|Loss on retirement of property and equipment                       | 48                          |    | -                          |   
|                                                                   |                             |    |                            |   
|                                                                   |                             |    |                            |   
|Total operating expenses                                           | 578                         |    | 104                        |   
|                                                                   |                             |    |                            |   
|                                                                   |                             |    |                            |   
|Loss from operations                                               | (964                        | )  | (74                        | ) 
|Interest income, net                                               | 58                          |    | 4                          |   
|                                                                   |                             |    |                            |   
|                                                                   |                             |    |                            |   
|Net loss                                                           | (906                        | %) | (70                        | %)
|                                                                   |                             |    |                            |   

Three Months Ended March 31, 2001 and March 31, 2000

Net Revenues

Net revenues decreased to $2.5 million in the three months ended March 31, 2001 from $6.1 million in the three months ended March 31, 2000. The decrease is due primarily to a decrease in product sales volumes as a result of the
general economic slowdown, which significantly impacted the information technology spending of our new economy customer base. To a lesser extent, the decline in net revenues is the result of a lower average selling price of our products
due to increased competitive pricing pressure as well as a decrease in license revenues. During the three months ended March 31, 2000, we earned license revenues of approximately $435,000, primarily from IBMs sales of its Netfinity 4000R,
which incorporated our WebEngine Blazer hardware design, compared to no license revenues during the three months ended March 30, 2001. We do not expect significant future license revenues.

Gross Profit (Loss)

Gross profit (loss) decreased to a loss of ($9.7) million for the three months ended March 31, 2001 from a profit of $1.8 million in the three months ended March 31, 2000. This decrease is primarily attributable to a charge of
approximately $8.7 million to write-down excess inventory in the three months ended March 31, 2001, for which there was no comparable charge in the three months ended March 31, 2000. The inventory write-down resulted from a high level of inventory,
and firm inventory purchase commitments, compared to the Companys current reduced expectations for future product sales. Excluding the inventory write-down and stock compensation, gross profit (loss) decreased to a loss of ($936,000), or (37%)
of net revenues, in the three months ended March 31, 2001 from a profit of $1.9 million, or 31% of net revenues, in the three months ended March 31, 2000. This decrease was primarily due to lower sales volumes and lower average selling prices of our
products during the three months ended March 31, 2001. To a lesser extent, the decrease in gross profit (loss) was due to the lack of license revenues during the three months ended March 31, 2001 compared with $435,000 of license revenues in the
three months ended March 31, 2000.

Operating Expenses

Research and Development. Research and development expenses increased to $4.0 million in the three months ended March 31, 2001 from $1.9 million in the three months ended March 31, 2000. This increase was
due primarily to increased compensation costs as research and development personnel increased from 42 employees at March 31, 2000 to 85 employees at March 31, 2001. To a lesser extent, the increase in research and development expenses was due to
increased prototype and test unit costs related to development efforts associated with our WebEngine Sierra product.

Selling and Marketing. Selling and marketing expenses increased to $5.9 million in the three months ended March 31, 2001 from $3.0 million in the three months ended March 31, 2000. This increase was due
primarily to increased compensation costs as sales, marketing and customer support personnel increased from 48 employees at March 31, 2000 to 98 employees at March 31, 2001. To a lesser extent, the increase in selling and marketing expenses is also
attributable to increased advertising costs and increased travel costs associated with the increase in sales, marketing and customer support personnel.

General and Administrative. General and administrative expenses increased to $1.9 million in the three months ended March 31, 2001 from $759,000 in the three months ended March 31, 2000. This increase was
due primarily to increased compensation costs as general and administrative personnel increased from 17 employees at March 31, 2000 to 30 employees at March 31, 2001. To a lesser extent, the increase in general and administrative expenses was due to
increased accounting, legal and other professional service fees associated with our operation as a public company.

Stock Compensation. We recognized stock compensation expense of $924,000 and $679,000 in the three months ended March 31, 2001 and 2000, respectively, related to the grant of options and restricted stock
to

employees and directors during fiscal 1999 and prior to our initial public offering in fiscal 2000. In connection with restricted stock issued to employees as a result of our acquisition of IP Performance, Inc., we recorded deferred
stock compensation of $6.4 million, of which we recognized $529,000 as stock compensation expense during the three months ended March 31, 2001.

Amortization of Goodwill and Intangible Assets.In connection with our acquisition of IP Performance, Inc. in November 2000, we recorded goodwill and intangible assets of $2.7 million, of which we amortized
$225,000 in the three months ended March 31, 2001.

Loss on Retirement of Property and Equipment.In the three months ended March 31, 2001, we retired fixed assets related to our WebEngine Blazer product line. These fixed assets had a total net book value of
approximately $1,203,000 and consisted primarily of computer equipment previously utilized in the production and sales of the WebEngine Blazer, our previous generation web content server appliance product.

Interest income, net

Interest income, net increased to $1.4 million in the three months ended March 31, 2001 from $280,000 in the three months ended March 31, 2000. This increase was due to the investment of the net proceeds from our initial public
offering in July 2000.

Six Months Ended March 31, 2001 and March 31, 2000

Net Revenues

Net revenues decreased to $9.4 million in the six months ended March 31, 2001 from $10.5 million in the six months ended March 31, 2000. The decrease is due primarily to a decrease in product sales volumes as a result of the general
economic slowdown and its impact on the information technology spending of our new economy customer base. To a lesser extent, the decline in net revenues is the result of a lower average selling price of our products due to increased
competitive pricing pressure.

Gross Profit (Loss)

Gross profit (loss) decreased to a loss of ($23.1) million for the six months ended March 31, 2001 from a profit of $3.6 million in the six months ended March 31, 2000. This decrease is primarily attributable to a charge of
approximately $23.7 million to write-down excess and obsolete inventory in the six months ended March 31, 2001, for which there was no comparable charge in the six months ended March 31, 2000. The inventory write-down resulted from an unanticipated
decline in sales during the six months ended March 31, 2001 as well as a high level of inventory, and firm inventory purchase commitments, compared to the Companys current reduced expectations for future product sales. Excluding the inventory
write-down, and stock compensation, gross profit (loss) decreased to a profit of $762,000, or 8% of net revenues, in the six months ended March 31, 2001 from a profit of $3.7 million, or 35% of net revenues, in the six months ended March 31, 2000.
This decrease was primarily due to a cost-plus sales arrangement with a significant customer during the six months ended March 31, 2000, which we were not engaged in during the six months ended March 31, 2001. This cost-plus sales arrangement
generated higher gross profits as a percentage of net revenues.

Operating Expenses

Research and Development. Research and development expenses increased to $7.8 million in the six months ended March 31, 2001 from $3.1 million in the six months ended March 31, 2000. This increase was due
primarily to increased compensation costs as research and development personnel increased from 42 employees at March 31, 2000 to 85 employees at March 31, 2001. To a lesser extent, the increase in research and development expenses was due to
increased prototype and test unit costs and higher consulting costs related to development efforts associated with our StorageEngine Voyager and WebEngine Sierra products.

Selling and Marketing. Selling and marketing expenses increased to $12.4 million in the six months ended March 31, 2001 from $4.6 million in the six months ended March 31, 2000. This increase was due
primarily to increased compensation costs as sales, marketing and customer support personnel increased from 48 employees at March 31, 2000 to 98 employees at March 31, 2001. To a lesser extent, the increase in selling and marketing expenses is also
attributable to increased advertising costs and increased travel costs associated with the increase in sales, marketing and customer support personnel.

General and Administrative. General and administrative expenses increased to $4.5 million in the six months ended March 31, 2001 from $1.2 million in the six months ended March 31, 2000. This increase was
due primarily to increased compensation costs as general and administrative personnel increased from 17 employees at March 31, 2000 to 30 employees at March 31, 2001. In addition, this increase was due to increased accounting, legal and other
professional service fees associated with our operation as a public company and increased bad debt expense. To a lesser extent, the increase was due to increase consulting costs associated with the expansion of our information technology
infrastructure.

Stock Compensation. We recognized stock compensation expense of $1.9 million and $876,000 in the six months ended March 31, 2001 and 2000, respectively, related to the grant of options and restricted stock
to employees and directors during fiscal 1999 and prior to our initial public offering in fiscal 2000. In connection with restricted stock issued to employees as a result of our acquisition of IP Performance, Inc., we recorded deferred stock
compensation of $6.4 million, of which we recognized $882,000 as stock compensation expense during the six months ended March 31, 2001.

Amortization of Goodwill and Intangible Assets.In connection with our acquisition of IP Performance, Inc. in November 2000, we recorded goodwill and intangible assets of $2.7 million, of which we amortized
$375,000 in the six months ended March 31, 2001.

Loss on Retirement of Property and Equipment.In the three months ended March 31, 2001, we retired fixed assets related to our WebEngine Blazer product line. These fixed assets had a total net book value of
approximately $1,203,000 and consisted primarily of computer equipment previously utilized in the production and sales of the WebEngine Blazer, our previous generation web content server appliance product.

Interest income, net

Interest income, net increased to $3.3 million in the six months ended March 31, 2001 from $310,000 in the six months ended March 31, 2000. This increase was due to the investment of the net proceeds from our initial public offering
in July 2000.

Liquidity and Capital Resources

Since fiscal 1997, we have financed our operations primarily through the sale of equity securities, borrowings and the sale of our products. On July 18, 2000, we completed our initial public offering by selling 7,475,000 shares of
our common stock, including the exercise of the underwriters overallotment option of 975,000 shares, at $17 per share and raised approximately $116.9 million, net of offering costs and underwriting fees totaling approximately $10.2 million.
Prior to our initial public offering, we raised approximately $37.3 million, net of offering costs, from the issuance of preferred stock. As of March 31, 2000, we had $93.1 million in cash and cash equivalents, excluding restricted cash of $1.1
million.

In April 2000, we amended our equipment line of credit agreement to provide for an additional $2.0 million of equipment financing and a $4.0 million working capital revolving line of credit. The additional equipment financing is
separated into two consecutive six-month borrowing periods of $1.0 million beginning on the date of the amendment. Interest at the rate of prime plus 1.25% is payable monthly. Any outstanding balances at the end of each of the two borrowing periods
will be repaid in 36 equal monthly installments. The revolving line of credit matured in April 2001 and bore interest at prime plus 1%. As of March 31, 2001, no amounts were outstanding under these lines of credit. These credit lines expired and
have not been renewed.

Cash used in operating activities was $14.9 million and $7.6 million in the six months ended March 31, 2001 and 2000, respectively. Cash used in operating activities during the six months ended March 31, 2001 was primarily due to a
net loss of $48.7 million, an increase in inventories and decreases in accounts payable and accrued expenses, offset in part by a net increase in the amount due to our contract manufacturer and a decrease in accounts receivable, adjusted for
non-cash charges for inventory reserves, stock compensation, depreciation and amortization and a loss on the retirement of property and equipment. Cash used in operations during the six months ended March 31, 2000 was primarily due to a net loss of
$5.8 million and increases in accounts receivable, inventories and prepaid expenses, offset in part by increases in accounts payable, accrued expenses and deferred revenue and adjusted for charges for depreciation, inventory reserves and stock-based
compensation.

Cash used in investing activities was $4.7 million and $2.4 million in the six months ended March 31, 2001 and 2000, respectively. Cash used in investing activities was primarily for purchases of property and equipment, deposits of
restricted cash for an executive loan guarantee and an increase in other assets during the six months ended March 31, 2001. For the six months ended March 31, 2000, cash used in investing activities was primarily for purchases of property and
equipment, a security deposit on our corporate headquarters in Canton, Massachusetts and an increase in other assets.

Cash provided by financing activities was $331,000 and $25.4 million in the six months ended March 31, 2001 and 2000, respectively. Cash provided by financing activities in the six months ended March 31, 2001 was primarily generated
through the issuance of common stock from the exercise of stock options and through our employee stock purchase plan. Cash provided by financing activities in the six months ended March 31, 2000 was primarily from the sale of our series D preferred
stock through which we raised net proceeds of approximately $25.2 million.

Our future liquidity and capital requirements will depend upon numerous factors, including:

- the costs and timing of product development efforts and the success of these development efforts;
- the extent to which our existing and new products gain market acceptance;
- the costs involved in maintaining and enforcing intellectual property rights;
- market developments; and
- other factors.

We believe that our available cash resources, including cash and cash equivalents, together with cash we expect to generate from sales of our products will be sufficient to meet our debt service, operating and capital requirements
through at least the next 12 months. After that, we may need to raise additional funds. We may seek to raise additional funds through borrowings, public or private equity financings or from other sources. There can be no assurance that additional
financing will be available at all or, if available, will be on terms acceptable to us. If additional financing is needed and is not available on acceptable terms, we would need to reduce our operating expenses.

Recent Accounting Pronouncements

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 principles 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.

FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

The risks and uncertainties described below are not the only ones we are faced with. Additional risks and uncertainties not presently known to us, or that are currently deemed immaterial, may also impair our business operations. If
any of the following risks actually occur, our financial condition and operating results could be materially adversely affected.

Risks Related to Our Financial Results

We are an early-stage company in the rapidly evolving market for server appliances and have recently released key new products.

Because of our limited operating history in the server appliance market, it is difficult to discern trends that may emerge and affect our business. We may experience negative trends associated with seasonality that, due to our
limited operating history, we have not experienced in the past. We began shipping our WebEngine Blazer and AdminEngine in June 1999 and February 2000, respectively. We began shipping our WebEngine Roadster and WebEngine Viper products in the third
quarter of fiscal 2000. In February 2001 we began shipping our WebEngine Sierra, our next generation web content server appliance, designed to replace our WebEngine Blazer product, as well as our StorageEngine Voyager network attached storage server
appliance. We can not be sure whether these new products will obtain market acceptance, whether they will capture adequate market share or whether we will be able to recognize significant revenue from them. Our limited historical financial
performance may make it difficult for you to evaluate the success of our business to date and to assess its future viability.

If our customers do not purchase our new and enhanced products, our revenues and operating results will be adversely affected. Factors that may affect the market acceptance of our products, some of which are beyond our control,
include the following:

- the growth and changing requirements of the server appliance market;
- the performance, quality, price and total cost of ownership of our products;
- the availability, price, quality and performance of competing products and technologies; and
- the successful development of our relationships with existing and potential channel partners.

We have a history of losses and expect to experience losses in the future, which could result in the market price of our common stock declining.

Since our inception, we have incurred significant net losses, including net losses of $4.2 million, $5.8 million and $12.5 million in fiscal 1998, 1999 and 2000, respectively, as well as net losses of $22.8 million and $48.7 million
in the three and six month periods ended March 31, 2001, respectively. We expect to have net losses in the future. In addition, we had an accumulated deficit of $72.6 million as of March 31, 2001. We believe that our future growth depends upon the
success of our new product development and selling and marketing efforts, which will require us to incur significant product development, selling and marketing and administrative expenses. As a result, we will need to generate significant revenues
to achieve profitability. We cannot be certain that we will achieve profitability in the future or, if we achieve profitability, that we will be able to sustain it. If we do not achieve and maintain profitability, the market price for our common
stock may continue to decline.

We anticipate that our expenses will decrease through at least the remainder of the current fiscal year as a result of our April 2001 restructuring plan as we curtail discretionary selling, general and administrative expenses,
consolidate our international operations, defer our expansion into Asia, implement new business

strategies to efficiently maximize our resources and utilize other cost saving methods. If these, or other cost control measures that we may employ, are unsuccessful, our expenses could increase and our losses could be greater than
expected, which could negatively impact the market price for our common stock.

We may not be able to return to our historical revenue growth rates, which could cause our stock price to decline.

Our revenues grew rapidly in fiscal 1999 and fiscal 2000 and fell sharply in the six months ended March 31, 2001. We are unable to predict whether or not we will be able to return to the rate of revenue growth achieved in fiscal 1999
and fiscal 2000 because of uncertain economic conditions, growing competition, the incremental manner in which customers implement server appliances and our inexperience in selling our recently introduced products. If we are unable to return to our
historical rate of revenue growth, our stock price could experience further declines.

If the commodification of products and competition in the server appliance market increases, then the average unit price of our products may decrease and our operating results may suffer.

Products in the server appliance market may be subject to further commodification as the industry matures and other businesses introduce more competing products. The average unit price of some of our products has already decreased,
and may continue to decrease, in response to changes in product mix, competitive pricing pressures, or new product introductions by us or our competitors. If we are unable to offset decreases in our average selling prices by increasing our sales
volumes, our revenues will decline. Changes in the mix of sales of our products, including the mix of higher margin sales of products sold in smaller quantities and somewhat lower margin sales of products sold in larger quantities, could adversely
affect our operating results for future quarters. To maintain our gross margins, we also must continue to reduce the manufacturing cost of our products. Our efforts to produce higher margin products, continue to improve our products and produce new
products may make it difficult to reduce our manufacturing cost per product. Further, our current reliance on our single manufacturer, SCI Systems, may not allow us to reduce our cost per product.

Our quarterly revenues and operating results may fluctuate due to a lack of growth of the server appliance market in general or failure of our products to achieve market acceptance.

Our quarterly revenues and operating results are difficult to predict and may fluctuate significantly from quarter to quarter because server appliances generally, and our current products in particular, are relatively new and the
future growth of the market for our products is uncertain. In addition, we expect to rely on additional new products for growth in our net revenues in the future. If the server appliance market in general fails to grow as expected or our products
fail to achieve market acceptance, our quarterly net revenues and operating results may fall below the expectations of investors and public market research analysts. In this event, the price of our common stock could decline.

We derive a substantial portion of our revenues from a small number of customers, and our revenues may decline significantly if any major customer cancels or delays a purchase of our products.

A relatively small number of customers accounted for a significant portion of our net revenues. In fiscal 1999, sales to three customers accounted for 46%, 28% and 14% of net revenues. In fiscal 2000, sales to two customers accounted
for 16% and 12% of net revenues. In the six months ended March 31, 2001, sales to one customer accounted for 12% of net revenues. None of our customers is obligated to purchase any quantity of our products in the future. If any of our large
customers stop purchasing from us, delay future purchases or discontinue use of our technology, our revenues and profitability may be adversely affected, our reputation in the industry may suffer and our ability to predict cash flow accurately may
decrease. Accordingly, unless and until we diversify and expand our customer base, our future success will depend upon the timing and size of future purchase orders, if any, from our largest customers.

Risks Related to Competition Within Our Industry

If we are not able to effectively compete against providers of general-purpose servers or specific-purpose servers, our revenues will not increase and may decrease.

In the market for server appliances, we face significant competition from larger companies who market general-purpose or specific-purpose servers and have greater financial resources and name recognition than we do. Many of these
companies have larger and more established service organizations to support these products. These and other large competitors may be able to leverage their existing resources, including their service organizations, and provide a wider offering of
products and higher levels of support on a more cost-effective basis than we can. In addition, competing companies may be able to undertake more extensive promotional activities, adopt more aggressive pricing policies and offer more attractive terms
to their customers than we can. If these large competitors provide lower cost server appliances with greater functionality or support than our products, or if some of their products are comparable to ours and are offered as part of a range of
products that is broader than ours, our products could become undesirable. Even if the functionality of competing products is equivalent to ours, we face a substantial risk that a significant number of customers would elect to pay a premium for
similar functionality rather than purchase products from a less-established vendor. Increased competition may negatively affect our business and future operating results by leading to price reductions, higher selling expenses or a reduction in our
market share.

Our revenues could be reduced if general-purpose server, or specific-purpose server, manufacturers make acquisitions in order to join their extensive distribution capabilities with our smaller competitors' products.

Compaq, Dell, Hewlett-Packard, IBM, Sun Microsystems, Network Appliance and other server manufacturers may not only develop their own server appliance solutions, but they may also acquire or establish cooperative relationships with
our other current competitors, including smaller private companies. Because general-purpose server, and certain specific-purpose server, manufacturers have significant financial and organizational resources available, they may be able to quickly
penetrate the server appliance market by leveraging the technology and expertise of smaller companies and utilizing their own extensive distribution channels. For example, Cobalt, a server appliance company was acquired by Sun Microsystems in
December 2000. We expect that the server appliance industry will experience further consolidation. It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share through
consolidation.

We may sell fewer products if other vendors' products are no longer compatible with ours or other vendors bundle their products with those of our competitors and sell them at lower prices.

Our ability to sell our products depends in part on the compatibility of our products with other vendors' software and hardware products. Developers of these products may change their products so that they will no longer be
compatible with our products. These other vendors may also decide to bundle their products with other server appliances for promotional purposes and discount the sales price of the bundle. If that were to happen, our business and future operating
results could suffer if we were no longer able to offer commercially viable products.

If we fail to retain and expand our customer base and the composition thereof, our revenues could decline.

To date, our revenues have been principally derived from smaller companies in the Internet marketplace, otherwise known as new economy customers. We have begun to focus our sales and marketing efforts to larger corporate
and enterprise-level customers. This strategy to broaden our customer base by pursuing business opportunities from larger corporate and enterprise accounts may fail to generate sufficient revenues to offset the substantial demands that this strategy
will place on our business, in particular the longer sales cycles, higher levels of service and support and volume pricing are terms that larger corporate and enterprise accounts often demand. A failure to successfully transition more of our
revenues to the larger customers could materially adversely affect our operations.

Server appliance products are subject to rapid technological change due to changing operating system software and network hardware and software configurations, and our sales will suffer if our products are rendered obsolete by new
technologies.

The server appliance market is characterized by rapid technological change, frequent new product introductions and enhancements, potentially short product life cycles, changes in customer demands and evolving industry standards. Our
products could be rendered obsolete if products based on new technologies are introduced or new industry standards emerge.

New products and product enhancements can require long development and testing periods, which requires us to hire and retain scarce, technically competent personnel. Significant delays in new product releases or significant problems
in installing or implementing new products could seriously damage our business. We have on occasion experienced delays in the scheduled introduction of new and enhanced products and cannot be certain that we will avoid similar delays in the
future.

Our future success depends upon our ability to enhance existing products, develop and introduce new products, satisfy customer requirements and achieve market acceptance. We cannot be certain that we will successfully identify new
product opportunities and develop and bring new products to market in a timely and cost-effective manner.

Risks Related to Growth of the Internet and the Server Appliance Market

If server appliances are not increasingly adopted as a means to deliver information and conduct commerce over the Internet, the market for our products will not grow and the market price for our common stock could decline as a
result of lower revenues or reduced investor expectations.

We expect that substantially all of our revenues will come from sales of our newest and future server appliance products. As a result, we depend on the growing use of server appliances as a means to deliver information and conduct
commerce over the Internet. The market for server appliance products, particularly those using the Internet to deliver information and process commercial transactions, has only recently begun to develop and is evolving rapidly. Because this market
is new, we cannot predict its potential size or future growth rate. Our revenues may not grow and the market price for our common stock could decline if the server appliance market does not grow rapidly.

We believe that our expectations for the growth of the server appliance market may not be fulfilled if customers continue to use general-purpose servers. The role of our server appliances could, for example, be limited if
general-purpose servers become better at performing functions currently being performed by our server appliances or are offered at a lower cost. This could force us to further lower the prices of our products or result in fewer sales of our
products.

If the market for server appliance products does not grow because medium to large Internet service providers and application service providers in our target market are not receptive to them, our revenues may not
grow.

Large Internet service providers and application service providers that offer hosting services may not be as receptive to our products as other organizations because they currently rely on, and their buying programs are more likely
to be based on, established, proprietary operating systems and general-purpose servers. In addition, we expect that Internet service providers that specialize in providing Internet access and non-hosting services to consumers will not be substantial
purchasers of our products. Consolidation has begun to occur in the Internet service provider and application service provider market, with many large Internet service providers and application service providers acquiring smaller and regional
companies. Continued consolidation in this market could result in some of our customers being absorbed into larger organizations. This consolidation may increase the number of larger corporations that may not be as receptive to our products and, as
a result, our revenues would not grow and may even decrease.

Potential increases or changes in governmental regulation of Internet communication and commerce could discourage the growth of the Internet, which could decrease the demand for our products.

Due to concerns arising from the increasing use of the Internet, a number of laws and regulations have been, and may be, adopted covering issues including user privacy, taxation, pricing, acceptable content and quality of products
and services. Legislative changes could dampen the growth in use of the Internet generally and decrease the acceptance of the Internet as a communications and commercial medium. Further, due to the global nature of the Internet, it is possible that
multiple federal, state or foreign jurisdictions might attempt to regulate Internet transmissions or levy sales or other taxes relating to Internet-based activities. Moreover, the applicability to the Internet of existing laws, including laws
governing property ownership, libel and personal privacy, is uncertain. We cannot assess the possible negative impact of any future regulation of the Internet on our business.

Risks Related to Our Marketing and Sales Efforts

We need to effectively manage our sales and marketing operations to continue to increase market awareness and sales of our products. If we fail to do so, our growth could be limited.

As a result of our April 2001 restructuring plan, we reduced our selling and marketing personnel significantly in an attempt to reduce operating expenses and to conserve cash. Although we have fewer selling and marketing personnel,
we must continue to increase market awareness and sales of our products. If we fail in this endeavor, our growth will be limited.

Our efforts to promote our brand may not result in the desired brand recognition by customers or increased sales.

In the fast growing market for server appliances, we believe we need a strong brand to compete successfully. In order to attract and retain customers, we believe that our brand must be recognized and viewed favorably by our customers
and end users. Included in our April 2001 restructuring plan is a reduction in our marketing programs and although we will continue to advertise and promote our brand, these strategies may fail. If we are unable to design and implement effective
marketing campaigns or otherwise fail to promote and maintain our brand, our sales may not increase. Our business may also suffer if we incur excessive expenses promoting and maintaining our brand but fail to achieve the expected or desired increase
in revenues.

If we are unable to effectively manage our customer service and support activities, we may not be able to retain our existing customers and attract new customers.

We have a small customer service and support organization. We need to effectively manage our customer support operations to ensure that we maintain good relationships with our customers. If our customer support organization is
unsuccessful in maintaining good customer relationships, we may lose customers to our competitors and our reputation in the market could be damaged. As a result, we may lose revenue and incur losses greater than expected.

Risks Related to Our Product Manufacturing

Our dependence on sole source and limited source suppliers for key components makes us susceptible to supply shortages that could prevent us from shipping customer orders on time, if at all, and could result in lost sales or
customers.

We depend upon single source and limited source suppliers for our industry-standard processors and power supplies and our custom-printed circuit boards, chassis and sheet metal parts. We also depend on limited sources to supply
several other industry-standard components. We have in the past experienced, and may in the future experience, shortages of, or difficulties in acquiring, components needed to produce our products. Shortages have been of limited duration and have
not yet caused delays in production of our products. However, shortages in supply of these key components for an extended time would cause delays in the production of our products, prevent us from satisfying our contractual obligations and meeting
customer expectations, and result in lost sales or customers. If we are unable to buy components we need or

if we are unable to buy components at acceptable prices, we will not be able to manufacture and deliver our products on a timely or cost-effective basis to our customers.

We rely on a single contract manufacturer to produce our products and, if our manufacturer fails to meet our requirements, we will be unable to meet customer requirements and our customer relationships would suffer.

Our agreement with SCI Systems does not guarantee production levels or manufacturing prices. SCI Systems may not have additional facilities available when we need them. Commencing volume production or expanding production to another
facility owned by SCI Systems may be expensive and time-consuming. In addition, commencement of the manufacturing of our products at additional SCI Systems manufacturing sites we may need in the future may cause transitional problems, including
delays and quality control issues, which could cause us to lose sales and impair our ability to achieve profitability. We may need to find new outside manufacturers to manufacture our products in higher volume and at lower costs to meet increased
demand and competition. If we are required to, or if we choose to, change outside manufacturers, we may experience transitional difficulties and we may lose sales and customer relationships may suffer.

If we do not accurately forecast our component requirements, our manufacturing may be interrupted and delivery of products may be delayed.

We use rolling forecasts based on anticipated product orders to determine our component requirements. Lead times for materials and components that we order vary significantly and depend on factors including specific supplier
requirements, contract terms and current market demand for those components. In addition, a variety of factors, including the timing of product releases, potential delays or cancellations of orders and the timing of large orders, make it difficult
to predict product orders. As a result, our component requirement forecasts may not be accurate. If we overestimate our component requirements, we may have excess inventory, which would increase our costs. If we underestimate our component
requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences would negatively impact our business and operating results.

Risks Related to Our Products Dependence on Intellectual Property and Our Use of Our Brand

Our reliance upon contractual provisions and domestic trademark laws to protect our proprietary rights may not be sufficient to protect our intellectual property from others who may sell similar products.

Our products are differentiated from those of our competitors by our internally developed software and hardware and the manner in which they are integrated into our products. If we fail to protect our intellectual property, other
vendors could sell products with features similar to ours, and this could reduce demand for our products. We believe that the steps we have taken to safeguard our intellectual property afford only limited protection. Others may develop technologies
that are similar or superior to our technology or design around the copyrights and trade secrets we own. Despite the precautions we have taken, laws and contractual restrictions may not be sufficient to prevent misappropriation of our technology or
deter others from developing similar technologies.

In addition, the laws of the countries in which we decide to market our services and solutions may offer little or no effective protection of our proprietary technology. Reverse engineering, unauthorized copying or other
misappropriation of our proprietary technology could enable third-parties to benefit from our technology without paying us for it, which would significantly harm our business.

We have invested substantial resources in developing our products and our brand, and our operating results would suffer if we were subject to a protracted infringement claim or one with a significant damages award.

Substantial litigation regarding intellectual property rights and brand names exists in our industry. We expect that server appliance products may be increasingly subject to third-party infringement claims as the

number of competitors in our industry segment grows and the functionality of products in different industry segments overlaps. We are not aware that our products employ technology that infringes any proprietary rights of third
parties. However, third parties may claim that we infringe their intellectual property rights. Any claims, with or without merit, could:

- be time-consuming to defend;
- result in costly litigation;
- divert our management's attention and resources;
- cause product shipment delays; or
- require us to enter into royalty or licensing agreements.

Royalty or licensing agreements may not be available on terms acceptable to us, if at all. A successful claim of product infringement against us or our failure or inability to license the infringed or similar technology could
adversely affect our business because we would not be able to sell the impacted product without redeveloping it or incurring significant additional expenses.

Other Risks Related to Our Business

If we fail to retain a significant number of qualified technical personnel and key management personnel, we may not be able to develop and introduce our products on a timely basis.

We require the services of a substantial number of qualified technical personnel and certain members of our management team. The market for qualified personnel is characterized by intense competition, as well as a high level of
employee mobility, which makes it particularly difficult to attract and retain the qualified technical personnel we require. Certain members of our management team have skills and knowledge that are critical to our success. We have recently
experienced the negative effects of an economic slowdown. Our revenues have declined significantly during the past six months and the market price of our common stock has decreased significantly. As a result, we have undertaken plans to
substantially reduce our operating expenditures including a reduction in the number of personnel in our organization. This reduction in personnel places added pressure on the remaining employees and management of the Company. These and other factors
may make it difficult for us to retain the qualified employees and management that we need to effectively manage our business operations, including key research and development activities. If we are unable to retain a sufficient number of technical
personnel, or if we are unable to retain key members of our management team, we may not be able to complete development of, or upgrade or enhance, our products in a timely manner, which could negatively impact our business and could hinder our
future growth.

If we cannot manage our international operations profitably, our revenues may not increase and our business and results of operations would be adversely affected.

We have limited experience managing an international sales operation. There are risks and complexities inherent in conducting international operations, including, for example, longer payment cycles, local labor laws and practices and
the complexity of complying with additional regulatory requirements. Any of these factors, and our inexperience, may limit our ability to profitably manage our international operations and, consequently, our business and results of operations may
suffer.

If we are unable to find and acquire suitable acquisition candidates, our growth could be impeded.

A component of our business strategy is the acquisition of, or investment in, complementary businesses, technologies or products. In November 2000, we completed our acquisition of IP Performance, Inc., a developer of network
acceleration technology. Our ability to continue to identify and invest in suitable acquisition and investment candidates on acceptable terms is crucial to this strategy. We may not be able to identify, acquire or make investments in promising
acquisition candidates on acceptable terms. Moreover,

in pursuing acquisition and investment opportunities, we may be in competition with other companies having similar growth and investment strategies. Competition for these acquisitions or investment targets could result in increased
acquisition or investment prices and a diminished pool of businesses, technologies, services or products available for acquisition or investment. The decline in our stock price will make it more difficult to complete acquisitions involving the
issuance of our stock. An inability to find and acquire suitable acquisition candidates at reasonable prices could impede our growth.

Our acquisition strategy could have an adverse effect on our existing business, customer satisfaction and operating results.

Acquisitions involve a number of risks, including:

- adverse effects on our reported operating results due to accounting charges associated with the acquisitions;
- difficulties in management and integration of the acquired business;
- increased expenses, including compensation expense resulting from newly-hired employees;
- diversion of management resources and attention; and
- potential disputes with sellers of acquired businesses, technologies, services or products.

If our products fail to perform properly and conform to our specifications, our customers may demand refunds or assert claims for damages and our reputation and operating results may suffer.

Because our server appliance products are complex, they could contain errors or bugs that can be detected at any point in a product's life cycle. In the past we have discovered errors in some of our products and have experienced
delays in the shipment of our products during the period required to correct these errors or we have had to replace defective products that were already shipped. These delays and replacements have principally related to new product releases. Errors
in our products may be found in the future and any of these errors could be significant. Detection of any significant errors may result in:

- the loss of or delay in market acceptance and sales of our products;
- diversion of development resources;
- injury to our reputation; or
- increased maintenance and warranty costs.

These problems could harm our business and future operating results. Product errors or delays could be material, including any product errors or delays associated with the introduction of new products or the versions of our products
that support Windows or Linux operating systems. If our products fail to conform to warranted specifications, customers could demand a refund for the purchase price or assert claims for damages.

Moreover, because our products are used in connection with critical distributed computing systems services, we may receive significant liability claims if our products do not work properly. Our agreements with customers typically
contain provisions intended to limit our exposure to liability claims. However, these limitations may not preclude all potential claims. Liability claims could exceed our insurance coverage and require us to spend significant time and money in
litigation or to pay significant damages. Any claims for damages, whether or not successful, could seriously damage our reputation and our business.

We may need additional capital that may not be available to us and, if raised, may dilute our existing investors ownership interest in us.

We may need to raise additional funds to develop or enhance our services and solutions, to fund expansion, to respond to competitive pressures or to acquire complementary products, businesses or technologies. Additional financing may
not be available on terms that are acceptable to us. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders would be reduced and these securities might have rights,
preferences and privileges senior to those of our current stockholders. If adequate funds are not available on acceptable terms, our ability to fund our expansion, take advantage of unanticipated opportunities, develop or enhance products or
services, or otherwise respond to competitive pressures would be significantly limited.

Our stock may be subject to substantial price and volume fluctuations due to a number of factors, many of which will be beyond our control that may prevent our stockholders from reselling our common stock at a
profit.

The securities markets have experienced significant price and volume fluctuations in the past and the market prices of the securities of technology companies have been especially volatile. This market volatility, as well as general
economic, market or political conditions, could reduce the market price of our common stock in spite of our operating performance. In addition, our operating results could be below the expectations of public market analysts and investors, and in
response the market price of our common stock could decrease significantly. Investors may be unable to resell their shares of our common stock for a profit. In the past, companies that have experienced volatility in the market price of their stock
have been the object of securities class action litigation. If we were the object of securities class action litigation, it could result in substantial costs and a diversion of management's attention and resources. The recent decline in the market
price of our common stock and market conditions generally could adversely affect our ability to raise additional capital, to complete future acquisitions of or investments in other businesses and to attract and retain qualified technical and sales
and marketing personnel.

We have anti-takeover defenses that could delay or prevent an acquisition and could adversely affect the price of our common stock.

Our board of directors has the authority to issue up to 5,000,000 shares of preferred stock and, without any further vote or action on the part of the stockholders, will have the authority to determine the price, rights, preferences,
privileges and restrictions of the preferred stock. This preferred stock, if issued, might have preference over the rights of the holders of common stock and could adversely affect the price of our common stock. The issuance of this preferred stock
may make it more difficult for a third party to acquire us or to acquire a majority of our outstanding voting stock. We currently have no plans to issue preferred stock.

In addition, provisions of our second amended and restated certificate of incorporation, second amended and restated by-laws and equity compensation plans may deter an unsolicited offer to purchase Network Engines. These provisions,
coupled with the provisions of the Delaware General Corporation Law, may delay or impede a merger, tender offer or proxy contest involving Network Engines. For example, our board of directors will be divided into three classes, only one of which
will be elected at each annual meeting. These factors may further delay or prevent a change of control of our business.

Future sales by existing stockholders could depress the market price of our common stock.

Sales of a substantial number of shares of our common stock by existing stockholders could depress the market price of our common stock and impair our ability to raise capital through the sale of additional equity
securities.

If market price of our common stock is not quoted on a national exchange, our ability to raise future capital may be hindered and the market price of our common stock may be negatively impacted.

The market price for our common stock has significantly declined recently. As a result, there is the potential that our common stock could be de-listed from the NASDAQ National Market. If this occurs we may experience difficulties in
raising future capital, if needed, to continue our business operations. In addition, in the event that the market price of our common stock is not quoted on the NASDAQ National Market our stock price may be negatively impacted.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We do not engage in any foreign currency hedging transactions and therefore, do not believe we are subject to material exchange rate risk. We are exposed to market risk related to changes in interest rates. We invest excess cash
balances in cash equivalents. We believe that the effect, if any, of reasonably possible near-term changes in interest rates on our financial position, results of operations and cash flows will not be material.

PART II--OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On December 29, 1999, a former employee, George Flate, commenced a lawsuit against us, a current officer and director and a former officer and director in Suffolk Superior Court, a Massachusetts state
court. Mr. Flate alleges that he was unlawfully terminated as Vice President of OEM Sales in an effort to deprive him of commission payments. He is seeking undisclosed damages based on two contractual claims relating to his employment, although we
anticipate he will claim damages in the multi-million dollar range. Specifically, he is alleging a breach of the implied covenant of good faith and fair dealing against Network Engines and a claim of intentional interference with contractual
relations against the current and former officers of the company named in the lawsuit. Both of these claims are based on Mr. Flate's allegations that he is entitled to commissions from several transactions that were negotiated after Mr. Flate was no
longer with the company. Mr. Flate was employed by Network Engines for approximately one year. Currently, the matter is in the early stages of discovery. Although we believe these claims are without merit and we intend to vigorously defend against
each claim asserted in the complaint, an adverse resolution of either of these claims could require the payment of substantial monetary damages. Moreover, our defense against these claims might result in the expenditure of significant financial and
managerial resources.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

(d) Use of Proceeds from Sales of Registered Securities

On July 18, 2000, we sold 7,475,000 shares of our common stock in an initial public offering at a price of $17.00 per share pursuant to a Registration Statement on Form S-1 (the "Registration Statement") (Registration No. 333-34286),
which was declared effective by the Securities and Exchange Commission on July 12, 2000. The aggregate proceeds to us from the offering were approximately $116.9 million reflecting gross proceeds of $127.0 million net of underwriting fees of
approximately $8.9 million and other offering costs of approximately $1.3 million. None of the proceeds of the offering was paid by us, directly or indirectly, to any director, officer or general partner of ours or any of their associates, to any
persons owning ten percent or more of our outstanding stock, or to any of our affiliates. During the period from the offering to March 31, 2001, we have used the proceeds as follows: approximately $22.5 million was used to fund the operations of the
Company and approximately $4.0 million was used for capital acquisitions.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The Companys Annual Meeting of Stockholders was held on March 15, 2001 at the Courtyard Marriott Hotel, 200 Technology Center Drive, Stoughton, Massachusetts, 02072. Of the 34,964,867 outstanding as of January 23, 2001 (the
record date),28,218,856shares (80.71%)were present or represented by proxy at the meeting.

1. The table below presents the results of the election to the Companys board of directors.

|Dennis A. Kirshy | 28,165,103 | For | 53,753Against
|---------------- | ---------- | --- | -------------

The terms of Lawrence Kernan, Frank M. Polestra, Lawrence A. Genovesi, John A. Blaeser and Robert M. Wadsworth, as directors of the Company, continued after this meeting.

The stockholders ratified the appointment of PricewaterhouseCoopers LLP as the Companys independent accountants for the fiscal year ended September 30, 2001. This proposal received28,133,433shares voted for and58,650shares voted against, with26,773shares abstaining.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)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 period covered by this report.

SIGNATURES

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

|                   | NETWORK ENGINES, INC.                     
|------------------ | ------------------------------------------
|                   |                                           
|                   |                                           
|                   |                                           
|                   |                                           
|Date: May 15, 2001 |                                           
|                   |                                           
|                   | /s/ John H. Curtis                        
|                   |                                           
|                   |                                           
|                   | John H. Curtis                            
|                   | President and Chief Executive Officer     
|                   | (Principal Executive Officer)             
|                   |                                           
|                   | /s/ Douglas G. Bryant                     
|                   |                                           
|                   |                                           
|                   | Douglas G. Bryant                         
|                   | Vice President of Administration, Chief   
|                   | Financial Officer, Treasurer and Secretary
|                   | (Principal Financial Officer and Principal
|                   | Accounting Officer)                       

EXHIBIT INDEX

|Exhibit No. | Exhibit                                                                                  
|----------- | -----------------------------------------------------------------------------------------
|10.22       | Employment Agreement, dated March 21, 2001, between the Registrant and John H. Curtis    
|10.23       | Incentive Stock Option Agreement, dated March 21, 2001, between the Registrant and John  
|            | H. Curtis                                                                                
|10.24       | Nonstatutory Stock Option Agreement, dated March 21, 2001, between the Registrant and    
|            | John H. Curtis                                                                           
|10.25       | Secured Promissory Note, dated April 9, 2001, between the Registrant and Rene E. Thibault
|10.26       | Secured Promissory Note, dated April 6, 2001, between the Registrant and Douglas G.      
|            | Bryant                                                                                   
|10.27       | Secured Promissory Note, dated April 6, 2001, between the Registrant and Timothy J.      
|            | Dalton                                                                                   
|10.28       | Pledge Agreement, dated April 9, 2001, between the Registrant and Rene E. Thibault       
|10.29       | Pledge Agreement, dated April 6, 2001, between the Registrant and Douglas G. Bryant      
|10.30       | Pledge Agreement, dated April 6, 2001, between the Registrant and Timothy J. Dalton