Network Engines (NEI)

[blueskywaves]

Network Engines finds profit after the tech bubble burst
Tom Witkowski, Journal Staff
August 11, 2003


CANTON -- Network Engines Inc. rode the success of a recent acquisition and a revamped business model to profitability for the first time as a public company last quarter. The company beat its second-quarter earnings and revenue estimates and leaped into the black earlier than expected. Its stock price surged 28 percent the next day, closing at $5.41, a new one-year high.

Wall Street has warmed to the story of an Internet-era company that rose from near death and found a profitable business.

In late 2000, investors drove the stock price down from a high of $42.50 to less than $1 six months later. Founder Larry Genovesi, who is now the chairman, brought in John Curtis as the new CEO in 2001. Curtis restructured the company, built a new business and bought another company.

The jury stayed out, and the share price hovered around $1 until January of this year. Now investors are jumping back in, lately taking the share price to levels it has not seen since late 2000. Network Engines, once dismissed by Wall Street, today has a growth business and expects to earn a profit in the current quarter as well.

Network Engines was founded in 1997 and went public in mid-2000, raising $117 million just as the Internet bubble burst. The company's web server business evaporated with the dot-com crash. But Network Engines engineered a turnaround over the last two years, landing a well-timed original equipment manufacturing deal with EMC Corp. that would place its technology inside devices bearing EMC's brand and then finding a new way to derive revenue from its hardware business and expertise by working with software companies.

"We made progress across every aspect of our business," said Curtis, citing seven consecutive quarters of sales growth.

The first step in the company's comeback was a deal to build the Centera product for Hopkinton-based data storage company EMC. Centera was designed for storing fixed content, such as medical records and e-mail messages. The product was introduced just as increased health care and securities regulations ignited a demand for exactly such a data storage platform. The relationship was bringing in half of Network Engines' revenue within a year.

"That product has really been 'right place, right time,' " said Mike Riley, Network Engines' vice president of marketing.

The second part of the company's resurrection began with the November 2002 purchase of TidalWire Inc., a Westborough-based data storage technology distributor. Network Engines paid $20 million in cash, stock and assumed debt for TidalWire's distribution channels. That business boosted Network Engines' sales immediately and also gave the company a new source of revenue.

In recent months, Network Engines has been partnering with software companies, licensing their software, installing it on its own hardware and then selling the resulting appliance. Customers are able to buy ready-installed software on a plug-in appliance, simplifying the process for the customers and the software companies and bringing new revenue into Network Engines and its partners.

Funk Software Inc. of Cambridge was the first partner and FalconStor Software of Melville, N.Y., the most recent. Both companies prefer to stick to software development and leave the hardware to others, but see the benefit to their customer of buying an appliance.


"Our customers typically buy our software and go install it on some machine somewhere in the network or even sometimes go buy a new machine. Not a lot of organizations have a lot of hardware laying around doing nothing that meets the minimum customer requirements for the task involved," said Kevin Walsh, Funk's director of product management. Funk sells wireless local area network, or LAN, security software.

FalconStor, a data storage software company, already has its own distributors and system integrators to reach large companies, but it sees the potential for growth in smaller companies with Network Engines' help.

"For midsize businesses or even departments with one specific need, such as tape virtualization, it will be easier for us," said Reijane Huai, CEO of FalconStor. He expects the Network Engines business eventually to account for 20 percent of his company's revenue within the next year.

"Having the appliance in place gives peace of mind. Everything's been preconfigured and tested. With the appliance model, end users can focus on one thing: deployment," said Huai.

Both partners represent storage and security, the two markets Network Engines is pursuing, said Riley.

"The market they decided to go after, helping software companies create appliances, it's a market that's beginning to grow," said founder Genovesi. Network Engines found a new revenue stream without creating a new technology, he said.

"One of the things they had as an advantage is, much of the technology they're using to build products now was technology built in the web engine days. The strategy is not a radical shift. It's essentially taking a skill set and applying it a different way," Genovesi said.

Network Engines, with about 40 people working in manufacturing, is pumping out about 30 percent of its full capacity. The company has 13,000 square feet of manufacturing space at its Canton headquarters, with one shift running on three lines. As business with its software partners grows, Network Engines can add more shifts.

"The company basically has been reinvented over the last year and a half. That is still a work in progress," said Riley.

But progress was faster than expected. Executives predicted a loss of $200,000 to $500,000 for the most recent quarter, with the break-even point on the horizon. Instead, last week CFO Douglas Bryant reported profit of $408,000, or a penny a share, on revenue of $27 million. In the first quarter, the company had lost $684,000, or 2 cents per share, on revenue of $19.4 million. Comparisons with 2002 earnings would not include the TidalWire business.


Even better news was that the company had its lowest cash burn since its IPO, going through just $260,000 during the quarter and ending with $38.6 million in cash, well above the $33 million to $35 million predicted.

For the current quarter, Network Engines expects similar results, with income of $200,000 to $500,000, or a penny a share, on revenue of $27 million to $29 million. The company will go through more cash, taking the cash on hand down to $33 million to $35 million, Bryant said.

The company's expenses will grow as Network Engines increases its engineering and sales costs, said Curtis. The challenge will be maintaining profitability in the coming quarters, while spending enough to continue growing the business, he said.

Today, Network Engines has 94 employees, down from over 200 at the height of the high-tech mania. But the company is once again in a growth mode and will continue partnering with software companies.

"This was the primary reason we acquired TidalWire and is the area of our business where we expect long-term growth," said Curtis. "We apply the engineering and manufacturing capabilities of the OEM business together with the effective go-to-market capabilities of our distribution operation."

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