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Notes from Network Engines (NENG) 10-K

Posted on December 15, 2006

Network Engine’s (NENG) released its 10-K last evening. The report is an interesting read since it gives an excellent summary of the company’s changes in 2006 and the new strategic direction for the coming year. As we mentioned when we first started coverage of NENG back in February 2006 at $1.88 per share, 2007 should prove to be a pivotal year for the company, as strategic changes from 2006 finally begin to be reflected in the financial results.

The most important decision the company has made, and one that we have alluded to in the past, is to completely drop the NS Series as a
standalone end-user product and focus on leveraging the technology for
the OEM business. This is a very smart move both from a financial and marketing perspective and it opens up a host of new growth opportunities for the company.

We’ll let the 10-K do the talking:

"During the second half of fiscal 2006, we began transitioning our NS Series security appliance strategy from one in which we were trying to create end-user demand to one in which we began focusing more on working with customers, including systems integrators (“SIs”) and ISVs, who already have strong brand, sales, and marketing presence. We believe this will allow us to focus our sales and marketing effort on the server appliance as the preferred delivery platform of business applications, whether in a standalone or a software-as-a-service utility environment.

As an example of this revised strategy, during the second half of fiscal 2006 we were able to leverage our relationship with Microsoft to establish a new relationship with a global systems integrator (“GSI”), to develop a managed branch solution for its current existing installed customer base. This managed branch solution utilizes a Microsoft ISA Server based appliance to provide a managed branch solution delivering integrated information technology (“IT”) services needed in a branch as a utility."

An excellent example of how an partner/OEM-focused model will help can be seen in the progress Network Engine’s has made in repositioning proprietary software as a value-add to potential partners.

Again from the 10-K:

"To this end, as part of our product development efforts, we are working on leveraging and extending our investment in our proprietary appliance remote maintenance software called Network Engines Web Server, or NEWS™, to enhance our existing hardware, software and service capabilities for current and prospective customers. Previously, our NEWS™ technology was only available on our NS Series Security Appliances as a web-based appliance management sub-system that enabled deployment and maintenance tasks such as provisioning and remote system updates. By offering this technology across a wider range of server appliance solutions, we believe this will enable our customers to remotely monitor and maintain server appliances in widely dispersed networks from a central site."

Overall, we remain pleased with Network Engine’s progress in 2006, and we look forward to finally seeing additional partnerships for the company in 2007, as well as the beginning of sustainable financial improvements at the company as evidenced in last quarters surprise positive cash-flow. We note that the company’s Enterprise Value (EV) to Sales is still  miniscule, as investors discount the reliance on  EMC for sales. However, should any new partnerships provide evidence of substantial new revenue streams we expect the stock to begin to receive a valuation more in line with industry multiples.

Please Note: We first recommended Network Engines (NENG) at $1.88, and still hold a position in the
stock. All ideas, opinions, and/or forecasts, expressed or implied
herein, are for informational purposes only and should not be construed
as a recommendation to invest, trade, and/or speculate in the markets.
Any investments, trades, and/or speculations made in light of the
ideas, opinions, and/or forecasts, expressed or implied herein, are
committed at your own risk, financial or otherwise.

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