**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

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**Form 10-Q**

 

| **(Mark One)** |                                                                                         |
|---------------------|----------------------------------------------------------------------------------------------|
|                |                                                                                         |
| **ý**          | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|                | **for the quarterly period ended  March 31, 2002.**                                          |

** **

**OR**

 

| **o**  | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**                                                                                                                                                                               |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | **for the Transition Period from                     to                   .** |

 

**COMMISSIONFILE NUMBER 000-29927**

 

**IMPROVENET, INC.**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                    |   | **77-0452868**                           |
|-----------------------------------------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction of incorporation or organization) |   | (I.R.S. Employer  Identification Number) |
|                                                            |   |                                     |
| **1286  Oddstad Drive  Redwood City, CA 94063-2469**            |
| (Address of principal  executive offices)                       |
|                                                            |   |                                     |
| **(650)  839-8752**                                             |
| (Registrant’s telephone  number, including area code)      |

 

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

YES ý                            NO o

 

The number of shares outstanding of the registrant’scommon stock, $.001 par value, was 17,296,282 as of April 30, 2002

 

 

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ImproveNet, Inc.

 

Form 10-Q

 

For the Quarter EndedMarch 31, 2002

 

Index

 
| **PART  I  FINANCIAL INFORMATION** |
|-----------------------------------------|
|                                    |   |
| Item 1                                  | Financial Statements: |
|                                    | Condensed Consolidated Balance Sheets as of  March 31, 2002 and December 31, 2001 |
|                                    | Condensed Consolidated Statements of  Operations for the three months ended March 31, 2002 and 2001 |
|                                    | Condensed Consolidated Statements of Cash  Flows for the three months ended March 31, 2002 and 2001 |
|                                    | Notes to Condensed Consolidated Financial  Statements |
|                                    |   |
| Item  2                                 | Management’s Discussion and Analysis of Financial Condition and  Results of Operations |
|                                    |   |
| Item 3                                  | Quantitative and Qualitative Disclosures  About Market Risk |
|                                    |   |
| **PART II  OTHER INFORMATION**     |
|                                    |   |
| Item 1                                  | Legal Proceedings |
|                                    |   |
| Item 2                                  | Changes in Securities and Use of Proceeds |
|                                    |   |
| Item 3                                  | Defaults upon Senior Securities |
|                                    |   |
| Item 4                                  | Submission of Matters to a Vote of Security  Holders |
|                                    |   |
| Item 5                                  | Other Information |
|                                    |   |
| Item 6                                  | Exhibits and Reports on Form 8-K |
|                                    |   |
| **SIGNATURES**                          |

 

i

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**PARTI****- FINANCIAL INFORMATION**

 

**Item1****.  FinancialStatements**

** **

**IMPROVENET, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(In thousands, except per share amounts)**

** **
|                                                                                                                                       |   | **March 31,  2002** |   | **December 31,  2001** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|------------------------|--------|
|                                                                                                                                       |   | **(UNAUDITED)**     |   |                   |   |
| **Assets**                                                                                                                                 |   |                |   |                   |   |
|                                                                                                                                       |   |                |   |                   |   |
| Current assets:                                                                                                                            |   |                |   |                   |   |
| Cash and cash equivalents                                                                                                                  |   | $                   | 6,517  |                   | $      | 9,612 |   |
| Accounts receivable, net of allowance of  $127 in 2002 and $350 in 2001                                                                    |   | 622                 |   | 1,000                  |   |
| Prepaid expenses                                                                                                                           |   | 452                 |   | 549                    |   |
| Total current assets                                                                                                                       |   | 7,591               |   | 11,161                 |   |
|                                                                                                                                       |   |                |   |                   |   |
| Property and equipment, net                                                                                                                |   | 681                 |   | 1,496                  |   |
| Other assets                                                                                                                               |   | 599                 |   | 478                    |   |
|                                                                                                                                       |   |                |   |                   |   |
| Total assets                                                                                                                               |   | $                   | 8,871  |                   | $      | 13,135 |   |
|                                                                                                                                       |   |                |   |                   |   |
| **Liabilities & Stockholders’ Equity**                                                                                            |   |                |   |                   |   |
|                                                                                                                                       |   |                |   |                   |   |
| Current liabilities:                                                                                                                       |   |                |   |                   |   |
| Accounts payable                                                                                                                           |   | $                   | 360    |                   | $      | 636 |   |
| Accrued liabilities                                                                                                                        |   | 1,280               |   | 2,267                  |   |
| Accrual for restructuring                                                                                                                  |   | 1,539               |   | 1,026                  |   |
| Deferred revenue                                                                                                                           |   | 218                 |   | 180                    |   |
| Total current liabilitites                                                                                                                 |   | 3,397               |   | 4,109                  |   |
|                                                                                                                                       |   |                |   |                   |   |
| Long-term liabilities                                                                                                                      |   | 10                  |   | 10                     |   |
|                                                                                                                                       |   |                |   |                   |   |
| Total liabilities                                                                                                                          |   | 3,407               |   | 4,119                  |   |
|                                                                                                                                       |   |                |   |                   |   |
| Stockholders’ equity:                                                                                                                 |   |                |   |                   |   |
| Common stock, $.001 par value:  Authorized:  100,000,000 shares, Issued and outstanding:  17,296 in 2002 and 17,320 in 2001 |   | 17                  |   | 17                     |   |
| Treasury stock, 139 shares in 2002 and 2001                                                                                                |   | (56                 | )      | (56                    | )      |
| Additional paid-in-capital                                                                                                                 |   | 144,992             |   | 145,362                |   |
| Unearned stock-based compensation                                                                                                          |   | (4,489              | )      | (5,711                 | )      |
| Accumulated deficit                                                                                                                        |   | (135,000            | )      | (130,596               | )      |
| Total stockholders’ equity                                                                                                            |   | 5,464               |   | 9,016                  |   |
|                                                                                                                                       |   |                |   |                   |   |
| Total liabilities and stockholders’ equity                                                                                            |   | $                   | 8,871  |                   | $      | 13,135 |   |

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

1

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** **

**IMPROVENET, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(In thousands, except per share amounts)**

** **
|                                                                                               |   | **THREE MONTHS ENDED  MARCH 31,** |   |
|----------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                               |   | **2002**                          |   | **2001** |   |
|                                                                                               |   | **(UNAUDITED)**                   |   | **(UNAUDITED)** | ** ** |
| REVENUES                                                                                           |   |                              |   |   |   |
| Service revenues                                                                                   |   | $                                 | 1,060  |   | $ | 1,138 |   |
| Marketing revenues                                                                                 |   | 100                               |   | 473 |   |
| Total revenues                                                                                     |   | 1,160                             |   | 1,611 |   |
| COST OF REVENUES                                                                                   |   |                              |   |   |   |
| Cost of service revenues (excludes  stock-based compensation of $(38) in 2002 and $244 in 2001)    |   | 734                               |   | 1,277 |   |
| Cost of marketing revenues (excludes  stock-based compensation of $(16) in 2002 and $88 in 2001)   |   | 59                                |   | 136 |   |
| Total cost of revenues                                                                             |   | 793                               |   | 1,413 |   |
| Gross profit                                                                                       |   | 367                               |   | 198 |   |
| OPERATING EXPENSES                                                                                 |   |                              |   |   |   |
| Sales & marketing (excludes stock-based  compensation of $826 in 2002 and $1,090 in 2001)      |   | 1,170                             |   | 6,381 |   |
| Product development                                                                                |   | 639                               |   | 1,057 |   |
| General & administrative (excludes  stock-based compensation of $(4) in 2002 and $143 in 2001) |   | 644                               |   | 1,566 |   |
| Stock-based compensation                                                                           |   | 768                               |   | 1,409 |   |
| Corporate restructuring                                                                            |   | 1,587                             |   | 1,992 |   |
| Total operating expenses                                                                           |   | 4,808                             |   | 12,405 |   |
|                                                                                               |   |                              |   |   |   |
| Operating loss                                                                                     |   | (4,441                            | )      | (12,207 | ) |
| Interest/other income                                                                              |   | 37                                |   | 416 |   |
| Net loss                                                                                           |   | $                                 | (4,404 | ) | $ | (11,791 | ) |
| Basic and diluted net loss per common share                                                        |   | $                                 | (0.25  | ) | $ | (0.67 | ) |
| Weighted average shares used in calculating  basic and diluted net loss per common share           |   | 17,302                            |   | 17,672 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

2

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**IMPROVENET, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(In thousands)**

** **
|                                                                         |   | **THREE MONTHS ENDED  MARCH 31,** |   |
|------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                         |   | **2002**                          |   | **2001** |   |
|                                                                         |   | **(UNAUDITED)**                   |   | **(UNAUDITED)** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                                         |   |                              |   |   |   |
| Net loss                                                                     |   | $                                 | (4,404 | ) | $ | (11,791 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |   |                              |   |   |   |
| Depreciation and amortization                                                |   | 242                               |   | 409 |   |
| Restructuring charges net of cash  expenditures                              |   |                              |   |   |   |
| Reduction in force                                                           |   | 363                               |   | 629 |   |
| Facilities exit costs                                                        |   | 150                               |   | 593 |   |
| Asset write-downs                                                            |   | —                            |   | 770 |   |
| Write-down of assets                                                         |   | 562                               |   | — |   |
| Allowance for doubtful accounts                                              |   | (222                              | )      | 107 |   |
| Amortization of stock based compensation                                     |   | 768                               |   | 1,409 |   |
| Warrant charges amortized                                                    |   | 84                                |   | 84 |   |
| Notes receivable from related party                                          |   | —                            |   | (60 | ) |
| Net change in operating assets and  liabilities:                             |   |                              |   |   |   |
| Accounts receivable                                                          |   | 601                               |   | (395 | ) |
| Prepaid expenses                                                             |   | 97                                |   | 703 |   |
| Other assets                                                                 |   | (116                              | )      | (1 | ) |
| Accounts payable and accrued liabilities                                     |   | (1,263                            | )      | (1,824 | ) |
| Deferred revenue                                                             |   | 38                                |   | (102 | ) |
| Net cash 1used in operating activities                                       |   | (3,100                            | )      | (9,469 | ) |
|                                                                         |   |                              |   |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                         |   |                              |   |   |   |
| Purchase of property and equipment                                           |   | —                            |   | (38 | ) |
| Restricted cash                                                              |   | 5                                 |   | (60 | ) |
| Net cash (used in) provided by investing  activities                         |   | 5                                 |   | (98 | ) |
|                                                                         |   |                              |   |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                                         |   |                              |   |   |   |
| Proceeds from issuance of common stock, net  of offering costs               |   | —                            |   | 76 |   |
| Payment of long-term debt                                                    |   | —                            |   | 9 |   |
| Net cash provided by financing activities                                    |   | —                            |   | 85 |   |
|                                                                         |   |                              |   |   |   |
| Net decrease in cash and cash equivalents                                    |   | (3,095                            | )      | (9,482 | ) |
| Cash and cash equivalents, beginning of  period                              |   | 9,612                             |   | 31,565 |   |
| Cash and cash equivalents, end of period                                     |   | $                                 | 6,517  |   | $ | 22,083 |   |

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

 

3

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**IMPROVENET, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**NOTE 1 — FORMATION AND BUSINESS OFTHE COMPANY**

 

***Nature of the business***

 

ImproveNet, Inc.(“ImproveNet” or the “Company”) (formerly Netelligence, Inc.) was incorporatedin California in January 1996 and reincorporated in Delaware in September 1998.The Company is a source for home improvement information and services on theInternet. Through its ImproveNet.com and ImproveNetPro.com Web sites, matchingservices and targeted advertising, the Company is creating a nationalmarketplace for home improvement products and services in which homeowners,service providers and suppliers of home improvement products and relatedservices benefit from an organized and efficient online flow of information andcommunication. The Company generates quality job leads for its network ofscreened contractors from interested homeowners within their geographic areausing its proprietary matching service.

 

***Basis of Presentation***

 

The accompanying interimcondensed consolidated financial statements as of March 31, 2002 and for thethree months ended March 31, 2002 and 2001 are unaudited. The unaudited interimcondensed consolidated financial statements have been prepared on the samebasis as the annual condensed consolidated financial statements and, in theopinion of management, reflect all adjustments, which are of a normal recurringnature, necessary to present fairly the Company’s financial position as ofMarch 31, 2002, results of operations for the three months ended March 31, 2002and 2001, and cash flows for the three months ended March 31, 2002 and 2001. TheCompany’s results for an interim period are not necessarily indicative of theresults that may be expected for the year.

 

Although the Companybelieves that all adjustments necessary for a fair presentation of the interimperiods presented are included and that the disclosures are adequate, thesecondensed consolidated financial statements and notes thereto are unaudited andshould be read in conjunction with the audited condensed consolidated financialstatements and notes thereto for the year ended December 31, 2001 included inthe Company’s Form 10-K filed on April 12, 2002 with the Securities andExchange Commission. The balance sheet at December 31, 2001 has been derivedfrom audited financial statements, but does not include all disclosuresrequired by generally accepted accounting principles in the United States ofAmerica. Such disclosures are contained in our annual report on Form 10-K.

 

The Company has completedseveral rounds of private equity financing and raised, in its initial publicoffering, approximately $39.7 million, net of issuance costs, in March 2000.However, the Company has incurred substantial and negative cash flows fromoperations in every fiscal period since inception. For the period ended March31, 2002, the Company incurred a loss from operations of approximately $4.4million and negative cash flows from operations of $3.1 million. As of March31, 2002 the Company had an accumulated deficit of approximately $135million.  Management expects operatinglosses and negative cash flows to continue for the foreseeable future.

 

The Company expects thatlosses will decrease from fiscal year 2001 levels due to new sales initiativesand operational cost efficiencies, through decreased marketing expenditure andreductions in its workforce. Operational cost efficiency restructuring hasalready been initiated - the Company reduced its workforce by 7% in 2000, 46%in 2001, and 69% as of the first quarter ended March 31, 2002. If workingcapital decreases significantly the Company could further reduce expenses byfurther reductions in headcount. The Company has $6.5 million of cash and cashequivalents as at March 31, 2002. Failure to generate sufficient revenues,raise additional capital or reduce certain operational discretionary spendingcould have a material adverse effect on the Company’s ability to continue as agoing concern and to achieve its intended business objectives.

 

**NOTE 2 — NET LOSS PER SHARE**

 

Basic net loss per commonshare is calculated by dividing net loss by the average number of outstandingcommon shares during the period. Diluted net loss per common share is calculated by adjusting the averagenumber of outstanding common shares assuming conversion of all potentiallydilutive stock options and warrants under the treasury stock

 

4

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method. For all periods presented, potentiallydilutive convertible preferred stock, stock options and warrants were excludedfrom the calculation of diluted net loss per common share, as their effect wouldhave been anti-dilutive.

 

Options to purchaseapproximately 0.6 million shares and warrants to purchase approximately 1.3million shares were outstanding as of March 31, 2002.

 

The reconciliation of thenumerator and denominator used in the calculation of the basic and diluted netloss per common share follows: (in thousands, except per share amounts):

 
|                                                  |   | **Three Months Ended, March 31** |   |
|-------------------------------------------------------|--------|----------------------------------|--------|
|                                                  |   | **2002**                         |   | **2001** |   |
| Numerator                                             |   |                             |   |   |   |
| Net loss attributable to common  stockholders         |   | $                                | (4,404 | ) | $ | (11,791 | ) |
|                                                  |   |                             |   |   |   |
| Denominator                                           |   |                             |   |   |   |
| Weighted average common shares                        |   | 17,304                           |   | 18,376 |   |
| Weighted average common shares subject to  repurchase |   | (2                               | )      | (704 | ) |
|                                                  |   |                             |   |   |   |
| Denominator for basic and diluted  calculation        |   | 17,302                           |   | 17,672 |   |
| Basic and diluted net loss per common share           |   | $                                | (0.25  | ) | $ | (0.67 | ) |

 

**NOTE 3 — MULTI-YEAR COMMERCIALCONTRACTS**

 

Commencing in September 1999, theCompany entered into multi–year commercial marketing contracts, some ofwhich are with related parties. These commercial contracts generally providedfor a fixed annual fee, an advertising or branding package that includes a mixof buttons, banners, SmartLeads and other marketing or branding services,including Find–A–Contractor or Powered by ImproveNet, plus acontinuous presence, as defined, on the Company’s Web sites. These commercialcontracts were for periods ranging between 2 and 12 years, including renewaloptions. These commercial contracts also include cooperative marketingarrangements under which the Company is obligated to fund, as defined, co–operativebranding expenditures on television and in the print media, with or on behalfof the commercial party. Most commercial contracts provide for the Company tospend 50% to 100% of the fees the Company expected to receive. In return, theCompany expected to receive significant marketing and branding benefitsincluding better advertising rates, stronger brand recognition, and access tocustomer databases, direct mail inserts and marketing resources—all designed togenerate more traffic to its sites and jobs to its proprietary matchingservices.

 

As the Company does not have an establishedhistorical practice of selling advertising for cash for similar multi–yearcommercial contracts, the Company has not assigned any value to the exchange ofservices or barter element of these transactions and accordingly, the Companyhas not recorded either revenue or sales and branding expense for the barterelement. However, some of these multi–year commercial contracts dogenerate an overall net cash component to the Company, and in these cases, theCompany has recorded revenue based on the cash received or receivable under thecontract, net of the obligation, if any, to reimburse the commercial party forthe cooperative branding and other marketing services. These revenues are recognizedover the term of the commercial contract once marketing and other services havebeen delivered to the commercial party and collection of the resulting netreceivable is deemed probable.

 

Furthermore, in connection with certain ofthese multi–year commercial contracts, the Company also issued warrantsto purchase shares of the Company’s common stock to the commercial parties.These warrants have been valued by the Company using the Black Scholesoption-pricing model. As the fair value of these warrants represent anadditional rebate on the revenue otherwise recorded under the contracts, theamortization of the warrants is further netted against this revenue over theterm of the respective commercial contract. To the extent that there isinsufficient revenues, the remaining amortization of warrant stock–basedcompensation is expensed and characterized as sales and marketing expense.

 

For the three monthsended March 31, 2002, the Company did not have any barter element amounts forthese commercial contracts.

 

5

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**NOTE 4 — SEGMENT INFORMATION**

 

The Company currentlyoperates in a single business segment, as there is only one measurement ofprofitability for its operations. Through March 31, 2002, foreign operations have not been significant ineither revenues or investments in long-lived assets.

 

A summary of theCompany’s revenue by service offerings is as follows (in thousands):

 
|                                 |   | **Three Months Ended, March 31,** |   |
|--------------------------------------|--------|-----------------------------------|--------|
|                                 |   | **2002**                          |   | **2001** |   |
| Service revenues:                    |   |                              |   |   |   |
| Lead fees                            |   | $                                 | 563    |   | $ | 336 |   |
| Win fees                             |   | 220                               |   | 704 |   |
| Other fees                           |   | 277                               |   | 98 |   |
| Total service revenues               |   | 1,060                             |   | 1,138 |   |
| Marketing revenue                    |   | 100                               |   | 473 |   |
| Total service and marketing revenues |   | $                                 | 1,160  |   | $ | 1,611 |   |

 

For the three-monthperiods ended March 31, 2002 and 2001, no customers represented over 10% ofservice or marketing revenues.

 

**NOTE 5 — COMPREHENSIVE LOSS**

 

The Company follows SFASNo. 130, “Reporting Comprehensive Income” (“SFAS No. 130”). SFAS No. 130establishes standards for reporting and display of comprehensive income and itscomponents in a full set of general-purpose financial statements. There was nodifference between the Company’s net loss and its comprehensive loss for any ofthe periods presented in the accompanying condensed consolidated statements ofoperations.

 

**NOTE 6 — RESTRUCTURING ACCRUAL**

 

During 2001 the Companyannounced several restructuring plans to reduce costs and to improveproductivity.  These related tofacilities costs, workforce reductions and asset write-downs.

 

During 2001 the Bay Road, Redwood City, and Camarillofacilities were closed and the Company took a charge of approximately $1.8million. Approximately $780,000 of rental payments were made during the yearresulting in an accrual as at December 31, 2001 of $1 million.   During 2001 the Company terminated 101employees and incurred a charge of $738,000 for termination benefits which werealmost fully utilized as at December 31, 2001. In addition under the restructuring plan the Company took a charge ofapproximately $1.7 million net of salvage value in the year ended December 31,2001 for the write-down of assets included in property, plant, andequipment.  These assets primarilyincluded office furniture and equipment.

 

In February and March2002, the Company announced further restructuring plans to further reduce costsand to improve productivity which including the closure of its Ft. Lauderdale,Florida, facility, the termination of 71 employees, and asset write-downs.

 

In the first quarter of 2002 an additional $391,000restructuring charges were recorded relating to the exiting costs of FtLauderdale, Florida and the Northern California facility.  After subtracting rental payments made of$241,000 the balance at March 31,2002 is $1.2million, of which approximately $80,000relates to Ft. Lauderdale and the remainder relates to the facilities closed aspart of the restructurings in the prior year.

 

The Companyrecorded $634,000 of costs relating to employee termination benefits, of which$271,000 was utilized in the period. The remaining liability of $383,000 is expected to be fully utilized bythe fourth quarter of 2002.  Under therestructuring plan the Company took a charge of $562,000 net of salvage valuein the first quarter, for the write-down of assets included in property, plantand equipment.  This was fully utilizedin the period.

 

Therestructuring charges were determined based on formal plans approved by theCompany’s management using the best information available to it at thetime.  The amounts the Company mayultimately incur may change as the restructuring initiative is executed.

 

6

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The activity impacting the accrual for restructuringcharges through the first quarter ending March 31, 2002 are summarized in thetable below:

 
| **(In  thousands)**                                             |   | **Facilities** |   | **Workforce  reductions** |   | **Asset  write-downs** |   | **Total** |   |
|-----------------------------------------------------------------|--------|----------------|--------|---------------------------|--------|------------------------|--------|-----------|--------|
| Balance at December 31, 2000                                    |   | $              | — |                      | $      | —                 |   | $         | — |   | $ | — |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges to operations in three months ended  March 31, 2001     |   | 593            |   | 629                       |   | 770                    |   | 1,992     |   |
| Charges utilized in three months ended  March 31, 2001          |   | —         |   | —                    |   | —                 |   | —    |   |
| Balance at March 31, 2001                                       |   | 593            |   | 629                       |   | 770                    |   | 1,992     |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges to operations in three months ended  June 30, 2001      |   | 181            |   | —                    |   | —                 |   | 181       |   |
| Charges utilized in three months ended June  30, 2001           |   | (167           | )      | (411                      | )      | (770                   | )      | (1,348    | )      |
| Balance at June 30, 2001                                        |   | 607            |   | 218                       |   | —                 |   | 825       |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges to operations in three months ended  September 30, 2001 |   | 421            |   | 209                       |   | 818                    |   | 1,448     |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges utilized in three months ended  September 30, 2001      |   | (184           | )      | (134                      | )      | (818                   | )      | (1,136    | )      |
| Balance at September 30, 2001                                   |   | 844            |   | 293                       |   | —                 |   | 1,137     |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges to operations in three months ended  December 31, 2001  |   | 590            |   | (100                      | )      | 70                     |   | 560       |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges utilized in three months ended December  31, 2001       |   | (428           | )      | (173                      | )      | (70                    | )      | (671      | )      |
| Balance at December 31, 2001                                    |   | 1,006          |   | 20                        |   | —                 |   | 1,026     |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges to operations in three months ended  March 31, 2002     |   | 391            |   | 634                       |   | 562                    |   | 1,587     |   |
| Charges utilized in three months ended  March 31, 2002          |   | (241           | )      | (271                      | )      | (562                   | )      | (1,074    | )      |
| Balance at March 31, 2002                                       |   | $              | 1,156  |                      | $      | 383                    |   | $         | — |   | $ | 1,539 |   |

 

7

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**Item 2****.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

The following discussionand analysis should be read with “Selected condensed consolidated financialData” and our condensed consolidated financial statements and notes includedelsewhere in this Report on Form 10-Q. The discussion in this Report on Form 10-Q contains forward-lookingstatements that involve risks and uncertainties, such as statements of ourplans, objectives, expectations and intentions. The cautionary statements madein this Report on Form 10-Q should be read as applying to all relatedforward-looking statements wherever they appear in this Report on Form 10-Q.Our actual results could differ materially from those discussed here. Factorsthat could cause or contribute to these differences include those discussed in“Business Risks” below as well as those discussed elsewhere.

 

**OVERVIEW**

 

Our businessstarted in January 1996 as a regional contractor matching service, and we spentmost of 1996 and 1997 building our service provider database, developing ourservices and technology, recruiting personnel and raising capital. We launchedour Web site and homeowner/service provider matching service on a nationalscale in August 1997. In December 1998, we began selling Web site advertisingand direct marketing services to suppliers of home improvement products as away to send targeted messages about their products, including productpromotions, to homeowners at the time of purchase, as well as to our network ofservice providers. In March 1999, we began to hire our new senior managementteam, including our chief executive officer. In April 1999, we introducedPowered by ImproveNet, a service that allows third parties to offer theImproveNet matching services and content on their Web sites. We completed theacquisition of two regional contractor referral companies, Contractor ReferralService, LLC and The J.L. Price Corporation, in September and November 1999,respectively.  These entities wereintegrated into our operations during the course of calendar year 2000.  In March 2000, we completed our IPO.  From January through June 2000 we spentsubstantial amounts primarily on marketing and marketing related activities, aswell as the development and expansion of our service and operationsinfrastructure. In July 2000 we had a reduction in force, reducing our staff byapproximately 7%.  In March 2001 werestructured our operations, resulting in a staff reduction of 25% and weclosed our largest facility in Redwood City, California.  In September 2001 we further reduced ourstaff by 29% and closed our Camarillo, California facility.  At December 31, 2001, we employed 111full-time employees. In the first quarter 2002, we reduced staff by anadditional 69%.  We currently haveapproximately 34 full-time employees.

 

We currentlygenerate the majority of our revenues from service provider referral services,installed sales services, marketing packages and advertisements placed on ourWeb site. We generate service revenues primarily in the form of lead fees andwin fees from our service providers and, to a much lesser extent, other feesfor the enrollment of service providers. We generate installed sales revenue from the fees that we charge homeimprovement suppliers (primarily Home Depot) to provide labor services whenthey sell products on an installed basis. We generate marketing revenues fromthe sale of banner, button and other advertising on our Web sites, from thesale of SmartLeads generated from the traffic of homeowners visiting our Websites and from the sale of Find-A-Contractor or Powered by ImproveNet productsOur marketing revenues generally come from suppliers of home improvementproducts.

 

**RESULTS OF OPERATIONS**

 

***REVENUES***

 

Our revenues decreased toapproximately $1.2 million for the three months ended March 31, 2002 fromapproximately $1.6 million for the three months ended March 31, 2001, adecrease of $451,000 or 28%.

 

The decrease in servicerevenues was due to a decrease in match rate and win rate due to restructuringduring the quarter.  The decline inmarketing revenues reflects the overall softening of the market for onlineadvertising and marketing services due to current economic conditions.ImproveNet also completed contracts in the fourth quarter 2001 that were notrenewed this year.

 

The followingtable and discussion highlights our revenues for the three months ended March31, 2002 and 2001 (In thousands):

 

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|              |   | **Three Months Ended, March 31,** |   |
|-------------------|--------|-----------------------------------|--------|
|              |   | **2002**                          |   | **2001** |   |
|              |   |                              |   | **% Change** |   |   |   |
| Revenues:         |   |                              |   |   |   |   |   |
| Service Revenue   |   | $                                 | 1,060  |   | -7% |   | $ | 1,138 |   |
| Marketing Revenue |   | 100                               |   | -79% |   | 473 |   |
|              |   |                              |   |   |   |   |   |
| Total Revenue     |   | $                                 | 1,160  |   | -28% |   | $ | 1,611 |   |

 

***Service Revenues***

 

Servicerevenues decreased to $1,060,000 for the three months ended March 31, 2002 from$1,138,000 for the three months ended March 31, 2001, a decrease of $78,000 or7%.

 

As of October15, 2001, additional pricing changes were announced wherein service providerspay an individual lead fee based on the budgeted dollar value of the job.  This lead fee ranges from $10 to $100.  Additionally our service providers pay a feeof 1% (based on actual contract value) for all jobs they win.  The win fee is waived for all jobs with anactual contract value less than $2,500.

 

Lead fee revenues arerecognized at the time the service providers and the homeowner are firstmatched, while win fee revenues are recognized at the time the service provideror the homeowner notifies us that a job has been sold. For both lead fees andwin fees, the recognition of revenues coincides with the service providers’obligation to pay us. The following table details the components of servicerevenues, based on a percentage of service revenues:

 
|                  |   | **Three Months Ended, March 31,** |   |
|-----------------------|--------|-----------------------------------|--------|
|                  |   | **2002**                          |   | **2001** |   |
| Lead Fees             |   | 53                                | %      | 30 | % |
| Win Fees              |   | 21                                | %      | 62 | % |
| Other Fees            |   | 26                                | %      | 8 | % |
|                  |   |                              |   |   |   |
| Total Service Revenue |   | 100                               | %      | 100 | % |

 

The revenues we generatefrom lead and win fees are largely a function of:

 

•                  Thenumber of job submissions;

•                  Theeffectiveness in finding a service provider or match for each job submission;

•                  Thesuccess of the service provider to win a job; and

•                  Theamount we charge the service provider for a lead or a win.

 

The following tableprovides information on some of our key business metrics (numbers inthousands):

 
| Key Metrics (In thousands)             |   | **Three Months Ended, March 31,** |   |
|----------------------------------------|--------|-----------------------------------|--------|
|                                   |   | **2002**                          |   | **2001** |   |
| Job submissions                        |   | 25.4                              |   | 35.4 |   |
| Matched jobs                           |   | 7.4                               |   | 23.8 |   |
| Won jobs                               |   | 1.0                               |   | 2.5 |   |
|                                   |   |                              |   |   |   |
| Matched Jobs as a % of job submissions |   | 29.1                              | %      | 67.2 | % |
|                                   |   |                              |   |   |   |
| Won Jobs as a % of job submissions     |   | 3.9                               | %      | 7.1 | % |

 

Revenues fromnew service provider enrollment fees are recognized as revenue ratably over theexpected period they participate in our contractor matching service, which isinitially estimated to be one year. Revenues from premium service fees tohomeowners are recognized at the time the service is provided.

 

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***Marketing Revenues***

 

Marketing revenuesdecreased to $100,000 for the three months ended March 31, 2002 from $473,000for the three months ended March 31, 2001, a decrease of $373,000 or 79%.

 

We generate marketingrevenues from the sale of banner, button and other advertising on our Websites, and from the sale to suppliers of SmartLeads generated from the trafficof homeowners visiting our Web sites and from the sale of Find-A-Contractor orPowered by ImproveNet products Our marketing revenues generally come fromsuppliers of home improvement products.

 

Revenues from banner,button and other branding are largely a function of:

 

•                  Thenumber of Web pages that we serve;

•                  Thepercentage of those pages on which we are able to sell advertisements; and

•                  Theamount we charge per advertisement.

 

Advertisers pay us todisplay their banner, button and other advertisements on the Web pages we servewhen a user is visiting our Web sites. Our marketing revenues historically havebeen derived from short-term advertising contracts based on either a guaranteedminimum number of impressions or a fixed fee per thousand impressions.

 

***Multi-yearCommercial Contracts***

 

CommencingSeptember 1999, we entered into multi-year commercial contracts, some of whichare with related parties. These commercial contracts generally provide for afixed annual fee, an advertising or branding package that includes a mix ofbuttons, banners, SmartLeads and other marketing or branding services,including Find-A-Contractor or Powered by ImproveNet, plus a continuouspresence, on our Web sites. These commercial contracts are for periods rangingbetween 2 and 12 years, including renewal options. These commercial contractsalso include cooperative marketing arrangements under which we are obligated tofund cooperative branding expenditures on television and in the print media,with or on behalf of the commercial party. Most commercial contracts providefor us to spend 50% to 100% of the fees that we expect to receive. In return,we expect to receive significant marketing and branding benefits includingbetter advertising rates, stronger brand recognition, and access to customerdatabases, direct mail inserts and marketing resources - all of which aredesigned to generate more traffic to sites and jobs to proprietary matchingservices.

 

We do not have anestablished historical practice of selling advertising for cash for similarmulti-year commercial contracts, we have not assigned any value to the exchangeof services or barter element of these transactions and accordingly, we havenot recorded either revenue or sales and branding expense for the barterelement. However, some of these multi-year commercial contracts do generate anoverall net cash component, and in these cases we have recorded revenue basedon the cash received or receivable under the contract, net of the obligation,if any, to reimburse the commercial party for the cooperative branding andother marketing services. These revenues are recognized over the term of thecommercial contract once advertising and other services have been delivered tothe commercial party and collection of the resulting net receivable is deemedprobable. Revenue from multi-year commercial contracts, net of warrant charges,was nil for the three months ended March 31, 2002, and $425,000 for the threemonths ended March 31, 2001.

 

Furthermore,in connection with certain of these multi-year commercial contracts, we issuedwarrants to purchase shares of our common stock to the commercial parties.These warrants have been valued by us using the Black Scholes option-pricingmodel. As the fair value of these warrants represent an additional rebate onthe revenue otherwise recorded under the contracts, the amortization of thewarrants is further netted against this revenue over the term of the respectivecommercial contract. To the extent that there are insufficient revenues, theremaining amortization of warrant stock-based compensation is expensed andcharacterized as sales and branding expense.

 

Total revenues may beanalyzed as follows (in thousands):

 

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|                                                                                                  |   | **Three Months Ended, March 31,** |   |
|-------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                                  |   | **2002**                          |   | **2001** |   |
| Service revenues                                                                                      |   | $                                 | 1,060  |   | $ | 1,138 |   |
| Marketing revenues                                                                                    |   | 100                               |   | 876 |   |
| Less:   Amounts invoiced and accrued under multi-year commercial contracts  with related parties |   | —                            |   | (319 | ) |
| Less:   Amortization of warrant stock-based compensation                                         |   | —                            |   | (84 | ) |
| Total marketing revenues                                                                              |   | 100                               |   | 473 |   |
|                                                                                                  |   |                              |   |   |   |
| Total revenues                                                                                        |   | $                                 | 1,160  |   | $ | 1,611 |   |

 

**OPERATING EXPENSES**

 

***Cost of Revenues***

 

Our cost of revenuesdecreased to $793,000 for the three months ended March 31, 2002 from $1,413,000for the three months ended March 31, 2001, a decrease of $620,000 or 44%.

 

Cost of revenues consists of materials andrelated subcontractor labor costs for premiere kitchen and bath remodels,employee payroll and related costs and occupancy, telecommunications and otheradministrative costs for our project service group, which is responsible forall phases of our proprietary matching services and includes our projectadvisors. In addition, cost of revenues includes an allocation of direct Website operations costs, consisting of payroll and related costs, datatransmission costs and equipment depreciation. The decrease in the cost of revenue was a result of the restructuringduring the first quarter of 2002.

 

***Cost of ServiceRevenues***

 

Our cost of servicerevenues decreased to $734,000 for the three months ended March 31, 2002 from$1,277,000 for the three months ended March 31, 2001, a decrease of $543,000 or43%.

 

The decreasein the cost of service revenues was primarily a result of the restructuring asat March 31, 2002, which reduced payroll and related costs, facilities andrelated costs, as well as the leveraging of our infrastructure againstrevenues.

 

***Cost of MarketingRevenues***

 

Our cost of marketingrevenues decreased to $59,000 for the three months ended March 31, 2002 from$136,000 for the three months ended March 31, 2001, a decrease of $77,000 or57%.

 

Cost of marketing revenue includes an allocation of direct Web siteoperations costs, consisting of payroll and related costs, data transmissioncosts and equipment depreciation. The decrease in the cost of marketing revenuewas a result of the restructuring during thefirst quarter of 2002.

 

***Sales and Marketing***

 

Our sales and marketingexpense decreased to approximately $1.2 million for the three months endedMarch 31, 2002 from approximately $6.4 million for the three months ended March31, 2001, a decrease of approximately $5.2 million or 81%.

 

Our sales and marketingexpense includes all of our online and offline direct marketing andadvertising, public relations and trade show expenses. Sales and marketingexpenses also include payroll and related costs, support staff expenses, travelcosts and other general expenses of our marketing, professional services andpartnership services departments.

 

The decrease in sales andmarketing expenses was primarily attributable to:

 

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•                  Renegotiating ortransitioning new or existing agreements from a high fixed cost formula to avariable performance-based formula based on jobs won;

•                  Reduced onlineand offline brand advertising spending; and

•                  Reducedstaffing-related expenses as a result of our restructuring during the firstquarter.

 

We plan to leverage ourexisting infrastructure and to continue the process of negotiating ortransitioning agreements from a high fixed cost formula to a variableperformance-based formula.

 

***Product Development***

 

Our product developmentexpenses decreased to $639,000 for the three months ended March 31, 2002 from$1,057,000 for the three months ended March 31, 2001, a decrease of $418,000 or40%.

 

Our product developmentcosts include the payroll and related costs of our editorial and technologystaff, fees for contract content providers, other costs of Web site design andnew technologies required to enhance the performance of our Web sites.

 

The decreasein product development expenses was primarily attributable to decreased payrolland related costs and decreased usage of contract content providers.  We expect product development costs toremain at these levels or decline for the foreseeable future.

 

***General andAdministrative***

 

Our general and administrativeexpenses decreased to $644,000 for the three months ended March 31, 2002 from$1,566,000 for the three months ended March 31 2001, a decrease of $922,000 or59%.

 

Our general andadministrative expenses include payroll and related costs and travel, recruiting,professional and advisory services and other general expenses for ourexecutive, finance, legal, and human resource departments. The decrease in ourgeneral and administrative expenses was a result of the restructuring during the first quarter of 2002.

 

***CorporateRestructuring***

 

During thefirst quarter ended March 31, 2002, the Company announced additionalrestructuring plans which resulted in a total charge of $1.6 million of which$634,000 related to reduction in workforce costs, $391,000 related to facilityexit costs, and $562,000 related to asset write-downs.  During the first quarter of 2002, a total of$1,074,000 of costs was charged against the restructuring accrual of which$271,000 related to reduction in workforce costs, $241,000 related to facilityexit costs, and $562,000 related to asset write-downs.

 

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| **(In  thousands)**                                             |   | **Facilities** |   | **Workforce  reductions** |   | **Asset  write-downs** |   | **Total** |   |
|-----------------------------------------------------------------|--------|----------------|--------|---------------------------|--------|------------------------|--------|-----------|--------|
| Balance at December 31, 2000                                    |   | $              | — |                      | $      | —                 |   | $         | — |   | $ | — |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges to operations in three months ended  March 31, 2001     |   | 593            |   | 629                       |   | 770                    |   | 1,992     |   |
| Charges utilized in three months ended  March 31, 2001          |   | —         |   | —                    |   | —                 |   | —    |   |
| Balance at March 31, 2001                                       |   | 593            |   | 629                       |   | 770                    |   | 1,992     |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges to operations in three months ended  June 30, 2001      |   | 181            |   | —                    |   | —                 |   | 181       |   |
| Charges utilized in three months ended June  30, 2001           |   | (167           | )      | (411                      | )      | (770                   | )      | (1,348    | )      |
| Balance at June 30, 2001                                        |   | 607            |   | 218                       |   | —                 |   | 825       |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges to operations in three months ended  September 30, 2001 |   | 421            |   | 209                       |   | 818                    |   | 1,448     |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges utilized in three months ended  September 30, 2001      |   | (184           | )      | (134                      | )      | (818                   | )      | (1,136    | )      |
| Balance at September 30, 2001                                   |   | 844            |   | 293                       |   | —                 |   | 1,137     |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges to operations in three months ended  December 31, 2001  |   | 590            |   | (100                      | )      | 70                     |   | 560       |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges utilized in three months ended  December 31, 2001       |   | (428           | )      | (173                      | )      | (70                    | )      | (671      | )      |
| Balance at December 31, 2001                                    |   | 1,006          |   | 20                        |   | —                 |   | 1,026     |   |
|                                                            |   |           |   |                      |   |                   |   |      |   |
| Charges to operations in three months ended  March 31, 2002     |   | 391            |   | 634                       |   | 562                    |   | 1,587     |   |
| Charges utilized in three months ended  March 31, 2002          |   | (241           | )      | (271                      | )      | (562                   | )      | (1,074    | )      |
| Balance at March 31, 2002                                       |   | $              | 1,156  |                      | $      | 383                    |   | $         | — |   | $ | 1,539 |   |

 

***Stock-basedCompensation***

 

Our stock-basedcompensation expenses decreased to $768,000 for the three months ended March31, 2002 from $1,409,000 for the three months ended March 31, 2001, a decreaseof $641,000 or 45%.  The decrease in ourstock-based compensation expenses is due to the workforce reduction associatedwith the restructuring initiatives in the first quarter.

 

In connection with certain employee and non–employeestock option grants during 1998 and 1999, the Company recorded unearned stock–basedcompensation totaling $13,385,000 which is being amortized over the vestingperiods of the related options, generally four years using the method set outin FASB Interpretation No. 28 (“FIN 28”). Under the FIN 28 method, each vestedtranche of options is accounted for as a separate option grant awarded for pastservices. Accordingly, the compensation expense is recognized over the periodduring which the services have been provided. This method results in highercompensation expense in the earlier vesting periods of the related options.Stock based compensation charges associated with employees who terminate theiremployment with the Company and have unvested options are reversed.

 

***Interest Income***

 

Our interest incomedecreased to $37,000 for the three months ended March 31, 2002 from $416,000for the three months ended March 31, 2001, a decrease of $379,000 or 91%.

 

The decreasein interest income in the quarter is attributable to a decrease in our averageinvested cash balances. We expect a decline in our interest income during theremainder of 2002 due to the expected decline in our cash and cash equivalentsbalances during the year.

 

***Income Taxes***

 

We have recorded a 100%valuation allowance against our net deferred tax assets, which arose primarilyas a result of our aggregate operating losses. The valuation allowance willremain at this level until such time as we believe that the realization of thenet deferred tax assets is more likely than not.  Accordingly, our results of operations do not reflect any taxbenefits for our reported losses.

 

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***LIQUIDITY ANDCAPITAL RESOURCES***

 

Cash and cash equivalentstotaled $6.5 million at March 31, 2002, a decrease of $3.1 million or 32% from$9.6 million at December 31, 2001. The decrease primarily came from the $3.1million cash used in operating activities.

 

Since our inception, wehave primarily financed our operations through private sales of our convertiblepreferred stock and common stock. In March 2000, we closed our initial publicoffering that generated net cash proceeds of approximately $39.7 million. Ourprimary capital needs have been to fund our operating losses; the prepayment ofour large media purchases and to make capital expenditures.

 

Net cash used inoperating activities was $3.1 million in the three months ended March 31, 2002,a decrease of $6.4 million or 67% from $9.5 million at March 31, 2001.  Net cash used in operating activitiesresulted primarily from our net loss before non-cash charges for amortizationof stock-based compensation, depreciation, and allowances for doubtfulaccounts, offset by smaller changes in operating assets and liabilities.

 

Net cash provided byinvesting activities was $5,000 in the three months ended March 31, 2002, anincrease of $103,000 or 105% from net cash used of $98,000 at March 31, 2001.Net cash provided by investing activities was a result of interest earned fromthe restricted cash.

 

There were no cash flowsfrom financing activities in the three months ended March 31, 2002, a decreaseof $85,000 since the prior year.

 

Our capital requirements depend on numerous factors, including thesuccess of our strategies for generating revenues and the amount of resourceswe devote to operating activities.  Ourexpenditures have substantially decreased as a result of our restructuring.Based on the realignment of our resources, we expect a decrease in most of ouroperating expenses categories detailed above for the year 2002 as compared toyear 2001. We do expect to experience ongoing operating losses for theforeseeable future. Pursuant to the agreement with Microsoft that we enteredinto during December 1999 and renegotiated in April 2002, an annual fee of$400,000 is due and payable to Microsoft in 2002 for services through April2003.  Pursuant to the two-yearagreement with AT&T that we entered into during December 2000 of $1.4million, the Company is in the process of disputing the commitment based onprovision within the agreement that allowedfor revision of commitment levels based on actual experience.  No resolution has been reached as of thefiling of this document.  As atMarch 31, 2002, operating lease commitments of approximately $3.1 million arepayable over the next four years.

 

Our limited operatinghistory and operating losses have limited our ability to obtain vendor creditor extended payment terms and bank financing on favorable terms; accordingly,we depend on our cash and cash equivalent balances to fund our operations.

 

We currently believe thatour available cash resources will be sufficient to meet our anticipated needsfor operations and capital expenditures for at least the next 12 months. Wewill strive to make ongoing realignments, as required, to achieve positive cashflow with our existing cash resources. We are additionally decreasing ourmarketing expenditures to assist us in maintaining our available cashresources.  We may need to raiseadditional funds, however, in order to develop new or enhance existingservices, to respond to competitive pressures or to acquire complementarybusinesses, services or technologies. If we raise additional funds by sellingequity securities, the percentage ownership of our stockholders will bereduced. We cannot be sure that additional financing will be available on termsfavorable to us, or at all. If adequate funds were not available on acceptableterms, our ability to fund expansion, react to competitive pressures, or takeadvantage of unanticipated opportunities would be substantially limited. Ifthis occurred, our business would be significantly harmed. We will continue toevaluate our needs for funds based on our assessment of access to public orprivate capital markets and the timing of our need for funds. Although we haveno present intention to conduct additional public equity offerings, we may seekto raise these additional funds through private or public debt or equityfinancings.

 

**RISK FACTORS THAY MAY AFFECT OURRESULTS OF OPERATIONS AND FINANCIAL CONDITION**

 

This document containscertain forward-looking statements. These statements relate to future events orour future financial performance. In some cases, you can identifyforward-looking statements by terminology such as “anticipates’,

 

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“believes”, “continue”, “could”, “estimates”,“expects”, “intends”, “plans”, “potential”, “predicts”, “should” or “will” orthe negative of these terms or other comparable terminology which are intendedto identify certain of these forward-looking statements. The cautionarystatements made in this document should be read as being applicable to allrelated forward-looking statements wherever they appear in this document. TheCompany’s actual results could differ materially from those discussed in thisdocument. Factors that could cause or contribute to such differences includethose discussed below, as well as those discussed in the Company’s AnnualReport on Form 10-K.

 

**We have large accumulated losses, weexpect future losses, and we may not achieve or maintain profitability.**

 

We have incurredsubstantial losses and used substantial cash to support our operations as wehave expanded our sales and marketing programs, funded the development of ourservices, promoted our Web sites and matching service and expanded ouroperations infrastructure. As of March 31, 2002, our accumulated loss wasapproximately $135 million. We expect our expenditures on sales and marketingactivities, support field services and the development of new products,services and technologies to continue at a reduced rate, as we restructured ourbusiness in February and March 2002. These restructuring included operationalefficiencies caused by headcount reductions of approximately 69%. We willcontinue to lose money unless we significantly increase our revenues. We cannotpredict when, if ever, we will operate profitably.

 

**We are an early stage company and wehave recently restructured our business to offer new services. As a result, wehave a limited history, which makes it difficult to evaluate our business.**

 

We wereincorporated in January 1996; however, we did not begin offering homeimprovement services on the Internet until August 1997. In December 1998, webegan selling Web site advertising. Until March 1999, we focused primarily onbuilding our network of service providers and refining our matching servicesprocesses. In March 1999, we hired our Chief Executive Officer and commencedrecruiting our senior management team. In April 1999, we introduced Powered byImproveNet, a service that allows third parties to offer the ImproveNetmatching services and content on their Web sites, for national suppliers ofhome improvement and repair products. In November 1999, we launched ourcustomized Web site for service providers. We completed the acquisition of tworegional contractor referral companies, Contractor Referral Service, LLC andThe J.L. Price Corporation, in September and November 1999. We experiencedreductions in force in July 2000. In the second half of 2000 we significantlyreduced our marketing expenditures. In the first and third quarters of 2001 andmost recently as of March 2002, we implemented cost restructuring initiativesthat included a reduction in workforce. Furthermore, even if our business issuccessful, we may change our business to enter into new business areas such asour Premiere Services offerings, which are in the process of launching intoselected geographic regions.  These andother new business initiatives are areas in which we do not have extensiveexperience.

 

**Because we are no longer listed on the NasdaqNational Market, the liquidity of our common stock may be seriously limited.**

 

On June 29,2001, we received a Nasdaq Qualification Panel Decision indicating that we havefailed to comply with the minimum bid price requirement for continued listing,and were delisted from the Nasdaq National Market. Our stock is currently beingtraded on the Nasdaq Over-The-Counter Bulletin Board; however, we believe thatour liquidity will be significantly lower than when it was on the NasdaqNational Market.

 

**Failure to raise additional capital orgenerate the significant capital necessary to expand our operations and investin new products and services could reduce our ability to compete and result inlower revenues.**

 

We expect thatcurrently available funds will be sufficient to meet our working capital andcapital expenditure needs during the next 12 months; however, if we are unableto generate sufficient cash flows from operations to meet our anticipated needsfor working capital and capital expenditures, we will need to raise additionalfunds.  We cannot be certain that wewill be able to obtain additional financing on favorable terms, or at all. Ifwe need additional capital and cannot raise it on acceptable terms, we may notbe able, among other things, to:

 

•              Developor enhance our services;

•              Develop or acquire newtechnologies, products or businesses;

•              Expand operations in the UnitedStates or internationally;

•              Hire, train and retain employees;or

 

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•              Respondto competitive pressures or unanticipated capital requirements.

 

Ourfailure to do any of these things could result in lower revenues and could harmour business or cause us to discontinue operations.

 

In addition, we may seek to raise additionalfunds, finance acquisitions or develop commercial relationships by issuingequity or convertible debt securities, which would reduce the percentageownership of existing stockholders. Furthermore, any new securities could haverights, preferences or privileges senior to those of our common stock.

 

**Our market is competitive and we may sufferprice reductions, be unable to attract homeowners to our Web site, be unable tomaintain our service provider network or enter into new multi–yearcommercial contracts if we do not compete effectively.**

 

The market for our services is intenselycompetitive, evolving and subject to rapid technological change. To remaincompetitive, we must continue to enhance and improve the ease of use,responsiveness, functionality and features of our online and offline servicesin order to attract homeowners to our Web site and maintain our serviceprovider network. We expect the intensity of competition to increase in thefuture. Increased competition may result in changes in our pricing model, fewerhomeowners visiting our Web site, service providers leaving our network, lessmarketing revenue, reduced gross margins and loss of market share, any one ofwhich could significantly reduce any future profitability. In addition,technological barriers to entry are relatively low. As a result, currentcompetitors, including local referral businesses and online referral companiesincluding ServiceMagic.com, iMandi, Bid Express, and Contractor.com as well aspotential competitors such as The Home Depot, Lowe’s and Sears Roebuck &Company who have launched Web sites similar to ours that could gain broadermarket acceptance based on content, products and services.

 

Some of our competitors have more resourcesand broader and deeper customer access than we do. In addition, several of thesecompetitors have or can readily obtain extensive knowledge of the homeimprovement industry. Our competitors may be able to respond more quickly thanwe can to new technologies or changes in Internet user preferences and devotegreater resources than we can to the development, promotion and sale of theirservices. We may not be able to maintain our competitive position againstcurrent and future competitors, especially those with significantly greaterresources and brand recognition.

 

**Homeowners and service providers may bereluctant to accept an Internet–based service provider matching service.**

 

Currently most homeowners use traditionalmeans including word–of–mouth referrals, Yellow Pages and localcontractor matching services to obtain service providers for their homeimprovement projects. In addition, many service providers do not use theInternet for business purposes and may be reluctant to become part of a networkof service providers on an Internet–based service provider matchingservice. If homeowners do not use our matching service or service providers donot join our network, we will not be able to generate significant revenues fromeither services or advertising.

 

**If we do not attract and retain a network ofhigh quality service providers, our business could be harmed.**

 

We expect to derive the majority of ourrevenues from our network of service providers in the form of payments for eachhomeowner referral that we provide to them and for each home improvementproject that they win. Our business is highly dependent on homeowners’ use ofour Web site to find service providers for their home improvement projects sothat service providers will achieve a satisfactory return on theirparticipation in the ImproveNet program.

 

A key element of the growth of our businessis the pace at which service providers adopt the ImproveNet matching process.This adoption includes responding to homeowner inquiries within 72 hours,providing a competitive, firm quote to homeowners quickly, and paying theservice fees to ImproveNet. We devote significant effort and resources toscreening and supporting participating service providers and to developingprograms that monitor service providers’ job wins and that collect service feesfrom service providers for these wins. Our inability to screen and supportservice providers effectively, or the failure of our service providers torespond professionally and in a timely manner to homeowner inquiries, couldresult in low homeowner satisfaction and harm our business. In addition, thefailure of our service providers to win home improvement projects, report theirwins to us, or pay us service fees could harm our business.

 

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We must actively recruit new serviceproviders and retain and motivate our current service providers to ensure thatwe continually have adequate coverage. We believe that service providers in thehome improvement industry suffer from a relatively high failure or turnoverrate that makes it difficult for us to retain service providers. Accordingly,we expect that not all of our service providers will remain active participantsin our network. If we are unable to achieve low turnover among our network ofservice providers our business could be harmed.

 

**If homeowners fail to report, and serviceproviders fail to report and to pay to us win fees, directly or indirectly, ourbusiness would be harmed.**

 

Our service providers are responsible forpaying us a win fee for each job that they obtain from us. We ask service providersnot to pass on the cost of the win fee to the homeowner. However, we do notcurrently provide any guarantee to the homeowner that our service providershave not raised their rates to cover the win fee nor do we audit or plan toaudit our service providers to confirm that they have not raised their rates.Homeowners may believe that they are indirectly paying us our win fee throughthe higher rates of service providers and, therefore, choose to select serviceproviders through word–of–mouth referrals, Yellow Pages, localcontractor matching services or other means rather than using our matchingservice. If homeowners choose not to use our service, we will lose servicerevenues and visitors to our Web sites and our business will be harmed.

 

We depend on our service providers to reportthat they have won a job and pay us our win fee. We rely on our relationshipswith our service providers and the incentive to receive future leads from us toencourage service providers to report wins and pay win fees. Currently, we donot have a control or an oversight mechanism in place with either serviceproviders or homeowners to ensure that they report wins and pay win fees. Ifservice providers do not report wins or pay us win fees, we will lose servicerevenues and our business will be harmed.

 

**We depend on third–party relationshipsto attract visitors to our Web sites.**

 

We have entered into commercial contractswith suppliers of home improvement products and services to generate revenuesand increase the number of visitors to our Web sites. Under these contracts,suppliers have placed links to our Web site from their Web sites to allow theircustomers to visit our Web site if the customers are interested in obtaininghome improvement information or searching for a service provider. We believethat increasing the number of visitors to our Web sites will increase thenumber of job submissions. We cannot assure you that these contracts will leadto increased visits to our Web sites or that increased visits to our Web siteswill result in increased job submissions. If we do not maintain our existingcontracts on terms as favorable as currently in effect or if we are not able toestablish new contracts on commercially reasonable terms, our business could beharmed.

 

Companies that we may pursue for a commercialcontract may offer services competitive with suppliers with which we currentlyhave contracts. As a result, these suppliers may be reluctant to enter intocommercial contracts with us.

 

We purchase preferential placement on high–trafficWeb sites. We believe these Web sites can help us to increase the number ofvisitors to ImproveNet.com. Web site traffic originated from AltaVista,Excite@Home, Lycos, Microsoft HomeAdvisor and Yahoo! There is intensecompetition for preferential placements on these Web sites. If we lose ourrelationships with any one of these Web sites, job submissions onImproveNet.com may decrease and we may not be able to enter into commerciallyreasonable contracts with replacement high–traffic Web sites, if at all.

 

**We depend on third–party relationshipsto provide software tools and infrastructure.**

 

We integrate third–party software intoour service offerings on our Web sites. We would be harmed if the providersfrom which we license software ceased to deliver and support reliable products,to enhance their current products, or to respond to emerging industrystandards. In addition, third–party software may not continue to beavailable to us on commercially reasonable terms or at all. The loss of, or inabilityto maintain or obtain, this software could limit the features available on ourWeb sites, which could harm our business.

 

**If we fail to attract and retain qualifiedpersonnel, our ability to compete could be harmed.**

 

We depend on the continued service of our keytechnical, sales and senior management personnel. In particular, the loss ofthe services of Ronald B. Cooper, our President and Chief Executive Officer, orother senior management personnel,

 

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individually or as a group, could cause us to incur increased operatingexpenses and divert other senior management time in searching for theirreplacements. We do not have employment agreements with any employee, and we donot maintain any key person life insurance policies for any of our keyemployees, except for Mr. Cooper. The loss of any of our key technical,sales or senior management personnel could harm our business.

 

In addition, we must attract, retain andmotivate highly skilled employees. We face significant competition forindividuals with the skills required to develop, market and support ourservices. We may not be able to recruit and retain sufficient numbers of highlyskilled employees, and as a result our business could suffer.

 

**If we fail to adequately protect ourproprietary rights, we could lose these rights and our business could beharmed.**

 

We depend upon our ability to develop andprotect our intellectual property rights, including our databases of homeownersand service providers and our internally–developed matching criteria andalgorithms, to distinguish our services from our competitors’ services. We relyon a combination of copyright, trademark and trade secret laws, as well asconfidentiality agreements and licensing arrangements, to establish and protectour proprietary rights. We have no issued patents. Our databases are protectedby trade secret laws and our matching service is protected primarily by tradesecret and copyright laws. Existing laws afford only limited protection ofintellectual property rights. Attempts could be made to copy or reverseengineer aspects of our processes or services or to obtain and use informationthat we regard as proprietary. Accordingly, we may not be able to protect ourintellectual property rights against unauthorized third–party copying oruse. Furthermore, policing the unauthorized use of our intellectual property isdifficult, and expensive litigation may be necessary in the future to enforceour intellectual property rights. The use by others of our proprietary rightscould harm our business.

 

**Our services could infringe the intellectualproperty rights of others causing costly litigation and the loss of significantrights.**

 

Third parties could claim that we haveinfringed their intellectual property rights by claiming that our matchingservice infringes their patents, trade secrets or copyrights. In the ordinarycourse of business, we have received, and may receive in the future, noticesfrom third parties claiming infringement of their proprietary rights. Inaddition, providers of goods and services over the Internet are increasinglysubject to claims that they infringe patents that cover basic elements ofelectronic commerce. The resolution of any claims could be time–consuming,result in costly litigation, delay or prevent us from offering our services orrequire us to enter into royalty or licensing agreements, any of which couldharm our business. In the event an infringement claim against us is successfuland we cannot obtain a license on acceptable terms, license a substitutetechnology or redesign our services, our business would be harmed. Furthermore,former employers or our current and future employees may assert that ouremployees have improperly disclosed to us or are using confidential orproprietary information in our business.

 

**If we experience system failures, ourreputation would be harmed and users might seek alternative service providers,causing us to lose revenues.**

 

We depend on the efficient and uninterruptedoperation of our computer and communications hardware and software systems.Substantially all of our computer hardware for operating our Web sites iscurrently located at Qwest Communications in Sunnyvale, California, withbackups located at our facility in Redwood City, California. These systems andoperations are vulnerable to damage or interruption from earthquakes, floods,fires, power loss, telecommunication failures and similar events. They are alsosubject to break–ins, sabotage, intentional acts of vandalism and similarmisconduct. We do not have fully redundant systems, a formal disaster recoveryplan or alternative providers of hosting services, and we do not carry businessinterruption insurance to compensate us for losses that could occur. Despiteany precautions we may take, the occurrence of a natural disaster or otherunanticipated problems either at Qwest or at our facility could result ininterruptions in our services. Any damage to or failure of our systems couldresult in interruptions in our service. In addition to placing an increasedburden on our engineering staff, any system failure could create user questionsand complaints that must be responded to by our customer support personnel. Thesystem failures of various third–party Internet service providers, onlineservice providers and other Web site operators could result in interruptions inour service to those users who require the services of these third–partyproviders and operators to access our Web sites. These interruptions couldreduce our revenues and profits, and our future revenues and profits will beharmed if our users believe that our system is unreliable. Since we have beenkeeping logs of our Web sites, our ImproveNet.com Web site has beenunintentionally interrupted for periods ranging from two minutes to one hour,the latter prior to February 2000.

 

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**We may have capacity restraints that couldlimit the growth of or reduce our revenues.**

 

The satisfactory performance, reliability andavailability of our Web sites, processing systems and network infrastructureare critical to our reputation and our ability to attract and retain largenumbers of users. If the volume of traffic, including at peak times, on our Websites increases, we may need to expand and upgrade our technology, transactionprocessing systems and network infrastructure. We may not be able to accuratelyproject the rate or timing of these increases, if any, in the use of ourservices or to expand or upgrade our systems and infrastructure in a timelymanner to accommodate these increases.

 

We use internally developed systems foroperating our services and processing our transactions, including billing andcollections processing. We must continually improve these systems in order toaccommodate the use of our Web sites. If we add new features and functionalityto our services, we could be required to develop or license additionaltechnologies. Our inability to add additional software and hardware or upgradeour technology, transaction processing systems or network infrastructure couldcause unanticipated system disruptions, slower response times, degradation inlevels of customer support, impaired quality of the users’ experience, delaysin accounts receivable collection or losses of recorded financial information.Our failure to provide new features or functionality also could result in theseconsequences. The required hardware may not be readily available or affordableand we may be unable to effectively upgrade and/or expand our systems in atimely manner or to integrate smoothly any newly developed or purchasedtechnologies with our existing systems. These difficulties could harm or limitour ability to expand our business.

 

**We could be held liable for products andservices.**

 

We could be subject to claims relating toproducts and services that we perform on behalf of homeowners or referrals toselected contractors through our Web site. Homeowners may bring claims againstus or our service providers, who may have among other things, provided themwith poor workmanship or caused bodily injury or damage to property. Ourexisting insurance coverage may not cover all potential claims, may notadequately cover all costs incurred in defense of potential claims, may notindemnify us for all liability that may be imposed or may not be renewable infuture periods or renewable on terms and conditions satisfactory to us. Inaddition, claims, with or without merit, would result in diversion of ourfinancial resources and management resources.

 

**We depend on the use of the Internet. If theuse of the Internet does not grow, our revenues may not grow and could declineand our business could be harmed.**

 

We depend on increased acceptance and use ofthe Internet. In particular, our matching service depends upon serviceproviders being willing to use the Internet to find jobs through our service.We believe that service providers generally have not traditionally usedcomputers or the Internet to operate their businesses. Demand and market acceptancefor recently introduced products and services over the Internet are subject toa high level of uncertainty. As a result, acceptance and use of the Internetmay not develop or a sufficiently broad base of users may not adopt or continueto use the Internet as a medium of commerce.

 

**The Internet is characterized by rapidlychanging technologies, frequent new product and service introductions andevolving industry standards.**

 

To succeed, we will need to adapt effectivelyto rapidly changing technologies and continually improve the performancefeatures and reliability of our services. We could incur substantial costs inmodifying our products, services or infrastructure to adapt to these changes,and we may also lose customers and revenues if our services fail to adapt tothe rapid changes characteristic of the Internet.

 

Conversely, if the Internet experiencesincreased growth in number of users, frequency of use and bandwidthrequirements, the Internet infrastructure may be unable to support the demandsplaced on it. The success of our business will rely on the Internet providing aconvenient means of interaction and commerce. Our business depends on theability of users to access information without significant delays oraggravation.

 

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**Future government regulations and legaluncertainties pertaining to the Internet could decrease the demand for ourservices or increase the cost of doing business.**

 

There is, and will likely continue to be, anincreasing number of laws and regulations pertaining to the Internet. Theselaws and regulations may relate to liability for information retrieved from ortransmitted over the Internet, online content, user privacy, taxes or thequality of services. Any new law or regulation pertaining to the Internet, orthe adverse application or interpretation of existing laws, could decrease thedemand for our services or increase our cost of doing business.

 

We are not certain how our business may beaffected by the application of existing laws governing issues such as propertyownership, copyrights, encryption and other intellectual property issues,taxation, libel, obscenity and export or import matters. The vast majority ofthese laws were adopted prior to the advent of the Internet. As a result, theydo not contemplate or address the unique issues created by the Internet andrelated technologies. Changes in laws intended to address these issues couldcreate uncertainty for or adversely affect companies doing business on theInternet. This could reduce demand for our services or increase the cost ofdoing business.

 

**General economicconditions may change dramatically from year to year.**

 

General economic conditions, which affectconsumer confidence and home improvement and home-building spending, includinginterest rates, the overall level of economic activity, the availability ofconsumer credit and mortgage financing and unemployment rates may changedramatically and impact our ability to operate.

 

**We are new to thegeneral contracting field and may experience project and managementcoordination problems.**

 

We will act as contractor of record forconstruction of our premium service projects with our personnel supervising theconstruction process.  As contractor ofrecord, we are responsible for managing the construction process, coordinatingthe activities of all subcontractors, suppliers and building inspectors andfollowing design plans generally prepared by consulting architects andengineers whom we may retain and whose designs target the local market.  In addition, we work closely withcontractors and subcontractors on site preparation, purchasing, architecturaldesign, site planning, coordinating governmental approvals, contract managementand closings.  We sometimes require ourgeneral contractors or subcontractors to post lien-free completion andperformance construction bonds.  Webelieve that our relations with our contractors are good.

 

**Legislative and regulatory initiativesregarding the collection and use of our users’ personal information may resultin liability and expenses.**

 

Current computing and Internet technologyallows us to collect personal information about our users. In the past, theFederal Trade Commission has investigated companies that have sold personalinformation to third parties without permission or in violation of a statedprivacy policy. Currently, we collect personal information only with the users’consent and under our privacy policy. If we begin collecting or sellingpersonal information without permission or in violation of our privacy policy,we could face potential liability for compiling and providing information tothird parties.

 

**The imposition of additional state and localtaxes on Internet–based transactions would increase our cost of doingbusiness and harm our ability to become profitable.**

 

We file statetax returns as required by law based on principles applicable to traditionalbusinesses. However, one or more states could seek to impose additional incometax obligations or sales and use tax collection obligations on out–of–statecompanies such as ours that engage in or facilitate Internet–basedcommerce. A number of proposals have been made at state and local levels thatcould impose taxes on the sale of products and services through the Internet orthe income derived from those sales. These proposals, if adopted, couldsubstantially impair the growth of Internet–based commerce and harm ourability to become profitable.

 

United States of America federal law limitsthe ability of the states to impose taxes on Internet-based transactions.  Until October 21, 2001, state and localtaxes on Internet-based commerce that are discriminatory against Internetaccess are prohibited, unless the taxes were generally imposed and actuallyenforced before October 1, 1998.  It ispossible that this tax moratorium will not be renewed by October 21, 2001 or atall.  Failure to renew this legislationwould allow various states to impose taxes on Internet-based commerce.  The imposition of state and local taxescould harm our ability to become profitable.

 

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**Item 3.  Quantitative and Qualitative Disclosures about Market Risk**

 

**Interest Rate Risk**

 

The primary objective ofImproveNet’s investment activities is to preserve principal while at the sametime maximizing yields without significantly increasing risk. To achieve thisobjective, we maintain our portfolio of cash and cash equivalents in a varietyof securities, including both government and corporate obligations and moneymarket funds.

 

Our exposure to marketrisk for changes in interest rates relates primarily to increases or decreasesin the amount of interest income we earn on our investment portfolio and onincreases or decreases in the amount of interest expense we must pay withrespect to any outstanding debt instruments. We mitigate default risk byinvesting in only high credit quality securities that we believe to be low riskand by positioning our portfolio to respond appropriately to a significantreduction in a credit rating of any investment issuer or guarantor.

 

We do not hold derivativefinancial instruments as of March 31, 2002, and have never held suchinstruments in the past. In addition, we had no debt instruments outstanding asof March 31, 2001. We currently transact all of our revenues, which are alltraded in the United States of America, in U.S. dollars.

# ** **

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# **PART II. OTHER INFORMATION**

 

**Item 1.  Legal Proceedings**

 

From time to time, we maybe involved in litigation relating to claims arising out of our operations. Asof the date of this filing, we are not engaged in any material legalproceedings.

 

# **Item 2. Changes in Securities and Use of Proceeds**

 

None

 

**Item 3.  Defaults Upon Senior Securities**

 

None

 

**Item 4.  Submission of Matters to a Vote of Security Holders**

 

No matters were submittedto a vote of security holders during the first quarter of our fiscal year endedDecember 31, 2002.

 

**Item 5.  Other Information**

 

None.

 

**Item 6.  Exhibits and Reports on Form 8-K**

 
| **EXHIBIT  NUMBER** |   | **DESCRIPTION OF DOCUMENT**                            |
|---------------------|--------|--------------------------------------------------------|
| 10.35               |   | AT&T Master Agreement MA Reference No.  DCMT306779 |

 

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**Signatures**

 

Pursuant to therequirements of the Securities and Exchange Act of 1934, the Registrant hasduly caused this report to be signed, May 15, 2002 on its behalf by theundersigned duly authorized.

 
|               | IMPROVENET, INC.                     |
|--------------------|--------------------------------------|
|               | (Registrant)                         |
|               |                                 |
|               |                                 |
|               | By:/s/ Ronald B. Cooper              |
|               | Ronald B. Cooper                     |
|               | Chairman and Chief Executive Officer |
|               | (Principal Financial Officer)        |
|               |                                 |
|               |                                 |
|               | By:/s/ Christopher A. Kendall        |
|               | Christopher A. Kendall               |
|               | Controller                           |
|               | (Principal Accounting Officer)       |
|               |                                 |
|               |                                 |
| Date: May 15, 2002 |                                 |

 

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