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You need to use the single-serving size one-hole basket, not the double, with the diffuser valve seated beneath the basket. Then the Illy ese pod should be inserted with the decal facing up. Finally, and most importantly, when you lock the filter assembly into the machine, you need to close it firmly. Brown water can mean that the basket assembly is not sealed in tight enough.
Sounds like a problem with the pods. Check they are manufacture recommended. When on espresso the pressure will be higher so a
"weak" pod could cause this. Unless the machine is producing too high a pressure. Check also there are no projections that could rip the pod when you close the holder.
Remove the portafilter and activate the brew switch. Water should stream out of the shower screen. If not you need to clean the group components, or the machine is broken. To clean the group components, remove the center screw. The screen should drop down, the dispersion disk may be stuck, you can pry it loose with a flat head screw driver. Soak both of these in a descaling solution.
With the group components removed (as above) try brewing, water should stream out of a single hole. If not, you may have a faulty pump, or seals.
If water streams out normally, be sure that you are using the single espresso basket. This is the smaller basket that snaps into the portafilter, and has sort of a tulip shape.
Your group head gasket may be worn, and will need to be replaced. These need replacement ever 6 months to 12 months, and need to replaced even if the machine is rarely used, because they are made from natural rubber that dries out. Replacements can be found at many retailers online, a few are: espressocare.com, espressoparts.com, and seattlecoffeegear.com
There are two different handles made for this unit (I own an X1 and have both). Both of these handles have baskets.
First - The pod handle has a basket area that is very shallow, about 1/3 of an inch deep and the basket has very small holes.
Second - The handle for loose grounds came with two baskets, one for a single dose, and one for a double dose. Both removable baskets have the very small holes for the espresso to drip through.
You must have a basket in the handle in order to use the machine. If you try to make espresso without a basket, you'll just make a mess. Besides, the machine will never be able build enough pressure to extract espresso from the grounds.
Search the net (ebay?) for francis francis x1 handle.
My husband threw ours away. So I inquired next time I ordered pods, and you can buy one online when you order. Just put it in the comments box on your order form (although it may be better to call and order it, as the first time I tried this they missed it). Anyway. It was like $3.50. Then my husband threw that one away too, so I gave up. ;)