** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

** **

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**Form 10-Q**

 

(MarkOne)

 
| ý | **Quarterly Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934** |
|--------|----------------------------------------------------------------------------------------------|

**For thequarterly period ended September 30, 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 _________.**

 

**COMMISSION FILE NUMBER 000-29927**

** **

**IMPROVENET, INC.**

(Exactname of registrant as specified in its charter)

 

 

| **Delaware**                    | **77-0452868**                           |
|---------------------------------|------------------------------------------|
| (State or other jurisdiction of | (I.R.S. Employer  Identification Number) |
| incorporation or organization)  |                                     |

 

**1286 Oddstad Drive**

**Redwood City, CA 94063-2469**

(Addressof principal executive offices)

 

**(888) 777-2212**

(Registrant’stelephone number, including area code)

 

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.              YES ý    NO o

 

The number of sharesoutstanding of the registrant’s common stock, $.001 par value, was 17,706,540as of October 31, 2002

 

 

 

 

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ImproveNet,Inc.

 

Form10-Q

 

Forthe Quarter Ended September 30, 2002

 

Index

 
| **PART I  FINANCIAL INFORMATION** |                                                                                                                          |
|----------------------------------------|-------------------------------------------------------------------------------------------------------------------------------|
|                                   |                                                                                                                          |   |
| Item 1                                 | Financial Statements:                                                                                                         |   |
|                                   | Condensed  Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001  (Unaudited)                            |   |
|                                   | Condensed  Consolidated Statements of Operations for the three and nine months ended  September 30, 2002 and 2001 (Unaudited) |   |
|                                   | Condensed  Consolidated Statements of Cash Flows for the nine months ended  September 30, 2002 and 2001 (Unaudited)      |   |
|                                   | Notes  to Unaudited 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                                                                   |   |
|                                   |                                                                                                                          |   |
| Item 4                                 | Controls and  Procedures                                                                                                      |   |
|                                   |                                                                                                                          |   |
| **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**                         |                                                                                                                          |
|                                   |                                                                                                                          |   |
| Section 302  Certifications            |                                                                                                                          |

 

 

i

 

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**PART I- FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

** **

**IMPROVENET, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(In thousands, except per shareamounts)**

**(UNAUDITED)**

 
|                                             |   | **September  30,** |   | **December  31,** |   |
|--------------------------------------------------|--------|--------------------|--------|-------------------|--------|
|                                             |   | **2002**           |   | **2001**          |   |
|                                             |   |               |   |              |   |
| **Assets**                                       |   |               |   |              |   |
|                                             |   |               |   |              |   |
| Current assets:                                  |   |               |   |              |   |
| Cash and cash  equivalents                       |   | $                  | 2,697  |              | $      | 9,612 |   |
| Accounts  receivable, net                        |   | 560                |   | 1,000             |   |
| Prepaid expenses                                 |   | 499                |   | 549               |   |
| Total current  assets                            |   | 3,756              |   | 11,161            |   |
|                                             |   |               |   |              |   |
| Property and  equipment, net                     |   | 221                |   | 1,496             |   |
| Other assets                                     |   | 75                 |   | 478               |   |
|                                             |   |               |   |              |   |
| Total assets                                     |   | $                  | 4,052  |              | $      | 13,135 |   |
|                                             |   |               |   |              |   |
| **Liabilities & Stockholders’  Equity** |   |               |   |              |   |
|                                             |   |               |   |              |   |
| Current  liabilities:                            |   |               |   |              |   |
| Accounts payable                                 |   | $                  | 281    |              | $      | 636 |   |
| Accrued  liabilities                             |   | 1,014              |   | 2,267             |   |
| Accrual for  restructuring                       |   | 140                |   | 1,026             |   |
| Deferred revenue                                 |   | 8                  |   | 180               |   |
| Total current  liabilitites                      |   | 1,443              |   | 4,109             |   |
|                                             |   |               |   |              |   |
| Long-term  liabilities                           |   | —             |   | 10                |   |
|                                             |   |               |   |              |   |
| Total  liabilities                               |   | 1,443              |   | 4,119             |   |
|                                             |   |               |   |              |   |
| Stockholders’  equity:                      |   |               |   |              |   |
| Common stock                                     |   | 17                 |   | 17                |   |
| Treasury stock                                   |   | (56                | )      | (56               | )      |
| Additional  paid-in-capital                      |   | 144,529            |   | 145,362           |   |
| Unearned  stock-based compensation               |   | —             |   | (5,711            | )      |
| Accumulated  deficit                             |   | (141,881           | )      | (130,596          | )      |
| Total  stockholders’ equity                 |   | 2,609              |   | 9,016             |   |
|                                             |   |               |   |              |   |
| Total  liabilities and stockholders’ equity |   | $                  | 4,052  |              | $      | 13,135 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

1

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**IMPROVENET,INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

**(Inthousands, except per share data)**

**(UNAUDITED)**

** **

 
|                                                                                                                |   | **THREE  MONTHS ENDED** |   | **NINE MONTHS  ENDED** |   |
|---------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                                                                |   | **SEPTEMBER  30,**      |   | **SEPTEMBER  30,**     |   |
|                                                                                                                |   | **2002**                |   | **2001**               |   | **2002** |   | **2001** |   |
| REVENUES                                                                                                            |   |                    |   |                   |   |   |   |   |   |
| Service revenues                                                                                                    |   | $                       | 890    |                   | $      | 1,597 |   | $ | 3,044 |   | $ | 4,562 |   |
| Marketing  revenues                                                                                                 |   | 5                       |   | 325                    |   | 145 |   | 1,170 |   |
| Total revenues                                                                                                      |   | 895                     |   | 1,922                  |   | 3,189 |   | 5,732 |   |
| COST OF REVENUES                                                                                                    |   |                    |   |                   |   |   |   |   |   |
| Cost of service  revenues (excludes stock-based compensation of $0 and $(118) in 2002 and $86  and $297 in 2001)    |   | 444                     |   | 1,283                  |   | 1,889 |   | 3,671 |   |
| Cost of  marketing revenues (excludes stock-based compensation of $0 and $(49) in 2002  and $33 and $116 in 2001)   |   | 5                       |   | 88                     |   | 65 |   | 314 |   |
| Total cost of  revenues                                                                                             |   | 449                     |   | 1,371                  |   | 1,954 |   | 3,985 |   |
| Gross profit                                                                                                        |   | 446                     |   | 551                    |   | 1,235 |   | 1,747 |   |
| OPERATING  EXPENSES                                                                                                 |   |                    |   |                   |   |   |   |   |   |
| Sales &  marketing (excludes stock-based compensation of $0 and $4,889 in 2002 and $1,228  and $3,370 in 2001)  |   | 430                     |   | 3,199                  |   | 2,373 |   | 14,094 |   |
| Product  development                                                                                                |   | 58                      |   | 735                    |   | 1,135 |   | 2,731 |   |
| General &  administrative (excludes stock-based compensation of $0 and $(12) in 2002 and  $12 and $183 in 2001) |   | 661                     |   | 1,185                  |   | 1,872 |   | 3,811 |   |
| Stock-based  compensation and warrant amortization                                                                  |   | —                  |   | 1,358                  |   | 4,710 |   | 3,966 |   |
| Corporate  restructuring                                                                                            |   | 7                       |   | 1,448                  |   | 2,569 |   | 3,621 |   |
| Total operating  expenses                                                                                           |   | 1,156                   |   | 7,925                  |   | 12,659 |   | 28,223 |   |
|                                                                                                                |   |                    |   |                   |   |   |   |   |   |
| Operating loss                                                                                                      |   | (710                    | )      | (7,374                 | )      | (11,424 | ) | (26,476 | ) |
| Interest/other  income                                                                                              |   | 69                      |   | 28                     |   | 136 |   | 675 |   |
| Net loss                                                                                                            |   | $                       | (641   | )                      | $      | (7,346 | ) | $ | (11,288 | ) | $ | (25,801 | ) |
| Basic and  diluted net loss per common share                                                                        |   | $                       | (0.04  | )                      | $      | (0.42 | ) | $ | (0.65 | ) | $ | (1.47 | ) |
| Weighted average  shares used in calculating basic and diluted net loss per common share                            |   | 17,705                  |   | 17,294                 |   | 17,435 |   | 17,503 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

2

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** **

**IMPROVENET,INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(Inthousands)**

**(UNAUDITED)**

 
|                                                                         |   | **NINE  MONTHS ENDED** |    |
|------------------------------------------------------------------------------|--------|------------------------|---------|
|                                                                         |   | **SEPTEMBER  30,**     |    |
|                                                                         |   |                   |    |   |   |
|                                                                         |   | **2002**               |    | **2001** |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES                                        |   |                   |    |   |   |
| Net loss                                                                     |   | $                      | (11,288 | ) | $ | (25,801 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |   |                   |    |   |   |
| Depreciation and  amortization                                               |   | 427                    |    | 1,081 |   |
| Loss on disposal  of property                                                |   | —                 |    | 5 |   |
| Restructuring  charges net of cash expenditures                              |   |                   |    |   |   |
| Reduction in  force                                                          |   | 10                     |    | 294 |   |
| Facilities exit  costs                                                       |   | (896                   | )       | 843 |   |
| Asset  write-downs                                                           |   | 848                    |    | 1,588 |   |
| Allowance for  (recovery of) doubtful accounts                               |   | (196                   | )       | 307 |   |
| Amortization of  stock based compensation                                    |   | 1,376                  |    | 3,966 |   |
| Accelerated  warrant amortization                                            |   | 3,334                  |    | — |   |
| Warrant charges  amortized                                                   |   | 169                    |    | 253 |   |
| Notes receivable  from related party                                         |   | —                 |    | (120 | ) |
| Net change in  operating assets and liabilities:                             |   |                   |    |   |   |
| Accounts  receivable                                                         |   | 636                    |    | (451 | ) |
| Prepaid expenses                                                             |   | 51                     |    | 1,300 |   |
| Other assets                                                                 |   | 403                    |    | 239 |   |
| Accounts payable                                                             |   | (354                   | )       | (1,383 | ) |
| Accrued  liabilities                                                         |   | (1,253                 | )       | (1,374 | ) |
| Deferred revenue                                                             |   | (172                   | )       | (107 | ) |
| Other long-term  liabilities                                                 |   | —                 |    | 23 |   |
| Net cash used in  operating activities                                       |   | (6,905                 | )       | (19,337 | ) |
|                                                                         |   |                   |    |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES                                        |   |                   |    |   |   |
| Purchase of  property and equipment                                          |   | —                 |    | (213 | ) |
| Restricted cash                                                              |   | —                 |    | (61 | ) |
| Net cash used in  investing activities                                       |   | —                 |    | (274 | ) |
|                                                                         |   |                   |    |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES                                        |   |                   |    |   |   |
| Proceeds from  issuance of common stock                                      |   | —                 |    | 76 |   |
| Payment of  long-term debt                                                   |   | (10                    | )       | — |   |
| Payment for  treasury stock purchase                                         |   | —                 |    | (56 | ) |
| Net cash (used  in) provided by financing activities                         |   | (10                    | )       | 20 |   |
|                                                                         |   |                   |    |   |   |
| Net decrease in  cash and cash equivalents                                   |   | (6,915                 | )       | (19,591 | ) |
| Cash and cash  equivalents, beginning of period                              |   | 9,612                  |    | 31,565 |   |
| Cash and cash  equivalents, end of period                                    |   | $                      | 2,697   |   | $ | 11,974 |   |

 

 

3

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**IMPROVENET,INC.**

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1- FORMATION AND BUSINESS OF THE COMPANY**

 

                ***Natureof the Business***

 

                ImproveNet, Inc. (“ImproveNet” or the “Company”)(formerly Netelligence, Inc.) was incorporated in California in January 1996and reincorporated in Delaware in September 1998. The Company is a source forhome improvement information and services on the Internet. Through itsImproveNet.com and ImproveNetPro.com Web sites, matching services and targetedadvertising, the Company is creating a national marketplace for homeimprovement products and services in which homeowners, service providers andsuppliers of home improvement products and related services benefit from anorganized and efficient online flow of information and communication. TheCompany generates quality job leads for its network of screened contractorsfrom interested homeowners within their geographic area using its proprietarymatching service.

 

***                Basisof Presentation***

 

                The accompanying interim condensed consolidatedfinancial statements as of September 30, 2002 and for the three and nine monthsended September 30, 2002 and 2001 are unaudited. The unaudited interimcondensed consolidated financial statements have been prepared on the samebasis as the annual consolidated financial statements and, in the opinion ofmanagement, reflect all adjustments, which are of a normal recurring nature,necessary to present fairly the Company’s financial position as of September30, 2002, results of operations for the three and nine months ended September30, 2002 and 2001, and cash flows for the nine months ended September 30, 2002and 2001. The Company’s results for an interim period are not necessarilyindicative of the results that may be expected for the year.

 

                Although the Company believes that all adjustmentsnecessary for a fair presentation of the interim periods presented are includedand that the disclosures are adequate, these condensed consolidated financialstatements and notes thereto are unaudited and should be read in conjunctionwith the audited consolidated financial statements and notes thereto for theyear ended December 31, 2001 included in the Company’s Form 10-K filed on April12, 2002 with the Securities and Exchange Commission. The accompanying balancesheet at December 31, 2001 has been derived from audited financial statements,but does not include all disclosures required by generally accepted accountingprinciples in the United States of America. Such disclosures are contained in our annual report on Form 10-K.

 

TheCompany has completed several rounds of private equity financing and raised, inits initial public offering, approximately $39.7 million, net of issuancecosts, in March 2000. However, the Company has incurred substantial negativecash flows from operations in every fiscal period since inception. For the ninemonth period ended September 30, 2002, the Company incurred a loss fromoperations of approximately $11.4 million and negative cash flows fromoperations of approximately $6.9 million. As of September 30, 2002, the Companyhad an accumulated deficit of approximately $142 million.  Management expects operating losses andnegative cash flows to continue for the foreseeable future.

 

TheCompany expects that losses will decrease from fiscal year 2001 levels dueprimarily to operational cost reductions, that have included decreasedmarketing expenditures and reductions in its workforce. Operationalrestructuring has already been initiated - the Company reduced its workforce by7% in 2000, 46% in 2001, and 95% as of the third quarter ended September 30,2002 and had 6 employees at that date. The Company has approximately $2.7 million of cash and cash equivalentsas at September 30, 2002. Failure to generate sufficient revenues, raiseadditional capital or reduce certain operational discretionary spending couldhave a material adverse effect on the Company’s ability to continue as a goingconcern and to achieve its intended business objectives.

 

OnJune 25, 2002, the Company announced it would begin the process of liquidatingcertain assets while it continued to review strategic alternatives.  On August 6, 2002, the Company announced anagreement to merge with eTechLogix.  TheCompany continues to operate its websites and provide referral services untilfurther notice.  The Company isoperating with a minimal level of staffing.

 

4

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**NOTE 2- NET LOSS PER SHARE**

 

                Basic net loss per common share is calculated bydividing net loss by the average number of outstanding common shares during theperiod.  Diluted net loss per commonshare is calculated by adjusting the average number of outstanding commonshares assuming conversion of all potentially dilutive stock options andwarrants under the treasury stock method. For all periods presented,potentially dilutive convertible preferred stock, stock options and warrantswere excluded from the calculation of diluted net loss per common share, astheir effect would have been anti-dilutive.

 

Optionsto purchase approximately 0.2 million shares and warrants to purchaseapproximately 1.3 million shares were outstanding as of September 30, 2002.

 

Thereconciliation of the numerator and denominator used in the calculation of thebasic and diluted net loss per common share follows: (unaudited - in thousands,except per share amounts):

 
|                                                  |   | **Three  Months Ended,** |   | **Nine  Months**         |   |
|-------------------------------------------------------|--------|--------------------------|--------|--------------------------|--------|
|                                                  |   | **September  30,**       |   | **Ended  September 30,** |   |
|                                                  |   | **2002**                 |   | **2001**                 |   | **2002** |   | **2001** |   |
| Numerator                                             |   |                     |   |                     |   |   |   |   |   |
| Net loss attributable  to common stockholders         |   | $                        | (641   | )                        | $      | (7,346 | ) | $ | (11,288 | ) | $ | (25,801 | ) |
|                                                  |   |                     |   |                     |   |   |   |   |   |
| Denominator                                           |   |                     |   |                     |   |   |   |   |   |
| Weighted average  common shares                       |   | 17,707                   |   | 17,427                   |   | 17,437 |   | 17,892 |   |
| Weighted average  common shares subject to repurchase |   | (2                       | )      | (133                     | )      | (2 | ) | (389 | ) |
|                                                  |   |                     |   |                     |   |   |   |   |   |
| Denominator for  basic and diluted calculation        |   | 17,705                   |   | 17,294                   |   | 17,435 |   | 17,503 |   |
| Basic and  diluted net loss per common share          |   | $                        | (0.04  | )                        | $      | (0.42 | ) | $ | (0.65 | ) | $ | (1.47 | ) |

 

 

**NOTE 3— MULTI-YEAR COMMERCIAL CONTRACTS**

 

                Commencing in September 1999,the Company entered into multi–year commercial marketing contracts, someof which are with related parties. These commercial contracts generallyprovided for a fixed annual fee, an advertising or branding package thatincludes a mix of buttons, banners, SmartLeads and other marketing or brandingservices, including Find–A–Contractor or Powered by ImproveNet,plus a continuous presence, as defined, on the Company’s Web sites. Thesecommercial contracts were for periods ranging between 2 and 12 years, includingrenewal options. 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 is 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 anestablished historical practice of selling advertising for cash for similarmulti–year commercial contracts, the Company has not assigned any valueto the exchange of services or barter element of these transactions andaccordingly, the Company has not recorded either revenue or sales and brandingexpense for the barter element. However, some of these multi–yearcommercial contracts do generate an overall net cash component to the Company,and in these cases, the Company has recorded revenue based on the cash receivedor receivable under the contract, net of the obligation, if any, to reimbursethe commercial party for the cooperative branding and other marketing services.These revenues are recognized over the term of the commercial contract oncemarketing and other services have been delivered to the commercial party andcollection of the resulting net receivable is deemed probable.

 

                Furthermore, in connection withcertain of these multi–year commercial contracts, the Company also issuedwarrants to purchase shares of the Company’s common stock to the commercialparties. 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.

 

5

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Forthe three and nine months ended September 30, 2002, the Company did not haveany barter element amounts for these commercial contracts.

 

OnJune 25, 2002, the Company announced it would begin the process of liquidatingcertain assets while it continues to review strategic alternatives.  On August 6, 2002, the Company announced anew agreement to merge with eTechLogix. As a result, the Company believes that there is little benefit to bedelivered from the remaining long-term multi-year commercial contracts and,accordingly, the remaining unamortized stock based compensation arising fromthe warrants associated with these contracts was expensed in the three monthsended June 30, 2002 in the amount of approximately  $3,334,000.

 

**NOTE 4— SEGMENT INFORMATION**

 

TheCompany currently operates in a single business segment, as there is only onemeasurement of profitability for its operations.  Through September 30, 2002, foreign operations have not beensignificant in either revenues or investments in long-lived assets.

 

Asummary of the Company’s revenue by service offerings is as follows (unaudited- in thousands):

 
|                                  |   | **Three  Months Ended,** |   | **Nine Months  Ended** |   |
|---------------------------------------|--------|--------------------------|--------|------------------------|--------|
|                                  |   | **September  30,**       |   | **September  30,**     |   |
|                                  |   | **2002**                 |   | **2001**               |   | **2002** |   | **2001** |   |
| Service  revenues:                    |   |                     |   |                   |   |   |   |   |   |
| Lead fees                             |   | $                        | 510    |                   | $      | 298 |   | $ | 1,501 |   | $ | 1,109 |   |
| Win fees                              |   | 346                      |   | 1,245                  |   | 921 |   | 3,222 |   |
| Other fees                            |   | 34                       |   | 54                     |   | 622 |   | 231 |   |
| Total service  revenues               |   | 890                      |   | 1,597                  |   | 3,044 |   | 4,562 |   |
| Marketing  revenue                    |   | 5                        |   | 325                    |   | 145 |   | 1,170 |   |
| Total service  and marketing revenues |   | $                        | 895    |                   | $      | 1,922 |   | $ | 3,189 |   | $ | 5,732 |   |

 

                For the three and nine month periods ended September30, 2002 and 2001, no customers represented over 10% of service or marketingrevenues.

 

**NOTE 5— COMPREHENSIVE LOSS**

 

                The Company follows Statement of Financial AccountingStandard (“SFAS”) No. 130, “Reporting Comprehensive Income” (“SFAS No. 130”).SFAS No. 130 establishes standards for reporting and display of comprehensiveincome and its components in a full set of general-purpose financialstatements. There was no difference between the Company’s net loss and itscomprehensive loss for any of the periods presented in the accompanyingcondensed consolidated statements of operations.

 

**NOTE 6— RECENT PRONOUNCEMENTS**

 

InJuly 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No.141, “Business Combinations” and SFAS No. 142, “Goodwill and Other IntangibleAssets”, Under SFAS No. 141, all business combinations initiated after June 30,2001 must be accounted for using the purchase method, SFAS No. 142 Requires,among other things, the discontinuance of goodwill amortization.  In addition, the standard includesprovisions upon adoption for the reclassification of certain existingrecognized intangibles as goodwill, reassessment of the useful lives ofexisting recognized intangibles and the testing for impairment of existinggoodwill and other intangibles.  TheCompany has adopted the provisions of SFAS No. 142 effective January 1,2002.  The implementation of SFAS No.142 did not have a material effect on the Company’s financial position andresults of operations.

 

InOctober 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets”, which addresses financial accounting andreporting for the impairment or disposal of long-lived assets.  This Statement supersedes SFAS No. 121 andthe accounting and reporting provisions of Accounting Principles Board, or APB,Opinion No. 30 “Reporting the Results of Operations-Reporting the Effects ofDisposal of a Segment of a Business, 

 

6

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and Extraordinary,Unusual and Infrequently Occurring Events and Transactions”, for the disposalof a segment of a business.  The Companyadopted the provisions of SFAS No. 144 effective January 1, 2002.  The implementation of SFAS No. 144 did nothave a material effect on the Company’s financial position and results ofoperations.

 

InNovember 2001, the Emerging Issues Task Force (“EITF”) reached a consensus onEITF Issue No. 01-09, “Accounting for Consideration Given by a Vendor to aCustomer or a Reseller of the Vendor’s Products,” EITF No. 01-09 requiresrecording certain consideration paid to distributors of the Company’s productsas a reduction of revenue.  The Companyadopted the provisions of EITF No. 01-09 effective January 1, 2002.  The implementation of EITF No. 01-09 did nothave a material effect on the Company’s financial position and results ofoperations.

 

InJune 2002, the FASB issued SFAS No. 146, “Accounting for Exit or DisposalActivities”.  SFAS No. 146 addressessignificant issues regarding the recognition, measurement, and reporting ofcosts that are associated with exit and disposal activities, includingrestructuring activities that are currently accounted for under EITF No. 94-3,“Liability Recognition for Certain Employee Termination Benefits and OtherCosts to Exit and Activity (including Certain Costs Incurred in a Restructuring).”The scope of the SFAS No. 146 also includes cots related to terminating acontract that is not a capital lease and termination benefits that employeeswho are involuntarily terminated receive under the terms of a one-time benefitarrangement that is not an ongoing benefit arrangement or an individualdeferred-compensation contract. SFAS No. 146 will be effective for exit ordisposal activities that are initiated after December 31, 2002 but earlyapplication is encouraged.  Theprovisions of EITF No. 94-3 shall continue to apply for an exit activityinitiated under an exit plan that met the criteria of EITF No. 94-3 prior tothe adoption of SFAS No. 146.  Adoptingthe provisions of SFAS No. 146 will change, on a prospective basis, the timingof when restructuring charges are recorded from a commitment date approach towhen the liability is incurred.  Theimplementation of SFAS No. 146 did not have a material effect on the Company’sfinancial position and results of operations. The Company does not expect the implementation of SFAS No. 146 to have amaterial effect on the Company’s financial position and results of operations.

 

**NOTE 7- RESTRUCTURING ACCRUAL**

 

During 2001 the Company announced several restructuring plans to reducecosts and to improve productivity. These related to facilities costs, workforce reductions and assetwrite-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 in rental payments was made during the yearresulting in an accrual as at December 31, 2001 of approximately $1million.  During 2001 the Companyterminated 101 employees and incurred a charge of $738,000 for terminationbenefits which were almost fully utilized as at December 31, 2001.  In addition, under the restructuring planthe Company took a charge of approximately $1.7 million net of salvage value inthe year ended December 31, 2001 for the write-down of assets included inproperty and equipment.  These assetsprimarily included office furniture and equipment.

 

In February and March 2002, the Company announcedfurther restructuring plans to further reduce costs and to improveproductivity, which included the closure of its Ft. Lauderdale, Florida,facility, the termination of 71 employees, and additional asset write-downs.

 

In the second quarter of 2002, the Company announced restructuringplans to further reduce costs, which included the termination of 27 employees,the write-down of fixed assets and terminating facility leases.

 

In the third quarter of 2002, an additionalrestructuring charge of approximately $40,000 was recorded relating to the costof exiting the Redwood City, California facility.  After subtracting the payment of rent and settlement fees ofapproximately $8,000, the remaining facilities accrual at September 30, 2002 isapproximately $110,000, of which approximately $90,000 is related to theRedwood City facility and the remainder is related to the facilities closed aspart of the restructurings in the prior year.

 

Also in the third quarter, the Company recordedapproximately $106,000 of additional costs relating to employee terminationbenefits for the remaining six employees. Approximately $177,000 was paid in the period relating to prior periodand third quarter severance agreements. The remaining liability of approximately $30,000 is expected to be fullyutilized by the fourth quarter of 2002.

 

7

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In the third quarter 2002, we made an adjusting entryof approximately $12,000 to reverse previously overly accrued facility exitcosts in previous quarters.  Also in thethird quarter, we made an adjusting entry of approximately $127,000 to reversepreviously overly accrued employee severance costs mostly relating to overestimating expected COBRA usage.

 

The restructuring charges were determined based onformal plans approved by the Company’s management using the best informationavailable to it at the time.  Theamounts the Company may ultimately incur may change as the restructuringinitiative is executed.

 

Theactivity impacting the accrual for restructuring charges through the thirdquarter ended September 30, 2002 are summarized in the table below (unaudited -in thousands):

 

 
|                                                                          |   | **Facilities** |   | **Workforce  reductions** |   | **Asset  write-  downs** |   | **Total** |   |
|-------------------------------------------------------------------------------|--------|----------------|--------|---------------------------|--------|--------------------------|--------|-----------|--------|
| Balance at  December 31, 2001                                                 |   | 1,006          |   | 20                        |   | —                   |   | 1,026     |   |
|                                                                          |   |           |   |                      |   |                     |   |      |   |
| Restructuring  charges to operations in three months ended March 31, 2002     |   | 391            |   | 634                       |   | 562                      |   | 1,587     |   |
| Cash payment  made during the three months ended June 30, 2002                |   | (241           | )      | (271                      | )      | —                   |   | (512      | )      |
| Non cash  write-offs during the three months ended June 30, 2002              |   |           |   |                      |   | (562                     | )      | (562      | )      |
| Balance at March  31, 2002                                                    |   | 1,156          |   | 383                       |   | —                   |   | 1,539     |   |
|                                                                          |   |           |   |                      |   |                     |   |      |   |
| Restructuring  charges to operations in three months ended June 30, 2002      |   | —         |   | 689                       |   | 286                      |   | 975       |   |
| Cash payment  made during the three months ended June 30, 2002                |   | (1,066         | )      | (844                      | )      | —                   |   | (1,910    | )      |
| Non cash  write-offs during the three months ended June 30, 2002              |   |           |   |                      |   | (286                     | )      | (286      | )      |
| Balance at June  30, 2002                                                     |   | 90             |   | 228                       |   | —                   |   | 318       |   |
|                                                                          |   |           |   |                      |   |                     |   |      |   |
| Restructuring  charges to operations in three months ended September 30, 2002 |   | 40             |   | 106                       |   | —                   |   | 146       |   |
| Cash payment  made during the three months ended September 30, 2002           |   | (8             | )      | (177                      | )      | —                   |   | (185      | )      |
| Non cash  adjusting entries during the three months ended September 30, 2002  |   | (12            | )      | (127                      | )      | —                   |   | (139      | )      |
| Balance at  September 30, 2002                                                |   | 110            |   | 30                        |   | —                   |   | 140       |   |

 

 

**NOTE 8— ETECHLOGIX MERGER**

 

OnJuly 30, 2002, ImproveNet, Inc. and eTechLogix, Inc. entered into an Agreementand Plan of Merger to merge the two companies. Pursuant to the terms of the Agreement and Plan of Merger, the merger isscheduled to close no later than December 31, 2002.  Under the terms of the merger, ImproveNet agreed to present acash tender offer to its current stockholders, which is anticipated to occurimmediately following the closing of the merger.  The price will be based in part on ImproveNet’s available cashbalance at the closing of the merger.

 

Aspart of our restructuring Ron Cooper has stepped down as President and ChiefExecutive Officer.  Mr. Cooper willprovide management support, as well as remain ImproveNet’s Chairman of theBoard until the merger is completed. Upon completion of the merger Mr. Cooper, will serve as a board memberof the merged company.

 

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

                The following discussion and analysis of ourfinancial condition and results of operation should be read with “SelectedCondensed Consolidated Financial Data” and our unaudited condensed consolidatedfinancial statements and notes included elsewhere in this Report on Form10-Q.  The discussion in this Report onForm 10-Q contains forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended, including statements using terminology suchas “can,” “may,” “believe,” “designated to,” “will,” “expect,” “plan,”“anticipate,” “estimate,” “potential,” or “continue,” or the negative thereofor other comparable terminology regarding beliefs, plans, expectations orintentions regarding the future. Forward-looking statements involve risks and uncertainties and actualresults could differ materially from those discussed in the forward-lookingstatements.  All forward-lookingstatements and risk factors included in this document are made as of the datehereof, based on information available to the Company as of the date thereof,and the Company assumes no obligation to update any forward-looking statementor risk factors, unless we are required to do so by law.  The cautionary statements made in thisReport on Form 10-Q should be read as applying to all related forward-lookingstatements wherever they appear in this Report on Form 10-Q. Our actual resultscould differ materially from those discussed here. Factors that could cause orcontribute to these differences include those discussed in “Business Risks” belowas well as those discussed elsewhere.

 

## ***CRITICAL ACCOUNTINGPOLICIES AND ESTIMATES***

ImproveNet, Inc.’sdiscussion and analysis of its financial condition and results of operationsare based upon ImproveNet, Inc. unaudited condensed consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States of America. The preparation of these financialstatements requires ImproveNet to make estimates and judgments that affect thereported amounts of assets, liabilities, revenues and expenses, and relateddisclosure of contingent assets and liabilities. On an on-going basis,ImproveNet evaluates its estimates, including those related to customerprograms, bad debts, intangible assets, income taxes, restructuring, andcontingencies and litigation. ImproveNet bases its estimates on historicalexperience and on various other assumptions that are believed to be reasonableunder the circumstances, the results of which form the basis for making judgmentsabout the carrying values of assets and liabilities that are not readilyapparent from other sources. Actual results may differ from these estimatesunder different assumptions or conditions.

 

                ImproveNet believes the following critical accountingpolicies affect its more significant judgments and estimates used in thepreparation of its consolidated financial statements. ImproveNet recordsestimated reductions to revenue for customer allowances and incentive offeringsincluding special pricing agreements, and promotions.  ImproveNet recognizes revenue, profit and potential losses onfixed price contracts using the completed contract method. Provisions forestimated losses on uncompleted contracts are made in the period in which suchlosses are determined.  Costs in excessof amounts billed on uncompleted contracts are classified as deferredcosts.  Billings in excess of costs onuncompleted contracts are classified as deferred revenue.  ImproveNet maintains allowances for doubtfulaccounts for estimated losses resulting from the inability of its customers tomake required payments. If the financial condition of ImproveNet’s customerswere to deteriorate, resulting in an impairment of their ability to makepayments, additional allowances may be required.  ImproveNet records a valuation allowance to reduce its deferredtax assets to the amount that is more likely than not to be realized. WhileImproveNet has considered future taxable income and ongoing prudent andfeasible tax planning strategies in assessing the need for the valuationallowance, in the event ImproveNet were to determine that it would be able torealize its deferred tax assets in the future in excess of its net recordedamount, an adjustment to the deferred tax asset would increase income in theperiod such determination was made. Likewise, should ImproveNet determine thatit would not be able to realize all or part of its net deferred tax asset inthe future, an adjustment to the deferred tax asset would be charged to incomein the period such determination was made.

 

**OVERVIEW**

 

Our business started in January 1996 as a regionalcontractor matching service.  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 

 

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time of purchase, as well as to our network of service providers. InMarch 1999, we began to hire our senior management team, including our chiefexecutive officer. In April 1999, we introduced Powered by ImproveNet, aservice that allows third parties to offer the ImproveNet matching services andcontent on their Web sites. We completed the acquisition of two regionalcontractor referral companies, Contractor Referral Service, LLC and The J.L.Price Corporation, in September and November 1999, respectively.  These entities were integrated into ouroperations during the course of calendar year 2000.  In March 2000, we completed our IPO.  From January through June 2000 we spent substantial amounts ofmoney primarily on marketing and marketing related activities, as well as thedevelopment and expansion of our service and operations infrastructure. In July2000 we had a reduction in force, reducing our staff by approximately 7%.  In March and September 2001 we restructuredour operations, resulting in a staff reduction of 46% and the closure of ourlargest facility in Redwood City, California and closed our Camarillo,California facility.  At December 31,2001, we employed 111 full-time employees. In the first three quarters 2002, wereduced staff by an additional 95% and closed our Ft Lauderdale, Floridafacility.  We currently have 6 full-timeemployees.

 

                We currentlygenerate the majority of our revenues from service provider referral services.We generate service revenues primarily in the form of lead fees and win feesfrom our service providers and, to a much lesser extent, other fees for theenrollment of service providers.  Wehave completed our contract with Home Depot and do not expect to have installedsales revenue in the future.  Wegenerate marketing revenues from the sale of banner, button and otheradvertising on our Web sites, and from the sale of Find-A-Contractor or Poweredby ImproveNet products.  Our marketingrevenues are generally derived from suppliers of home improvement products.

 

OnJune 25, 2002, the Company announced it would begin the process of liquidatingcertain assets while it continues to review strategic alternatives.  On August 6, 2002, the Company announced anew agreement to merge with eTechLogix. The Company continues to operate its websites and provide referralservices until further notice.  TheCompany is operating with a minimal level of staffing.  As a result the Company believes that thereis little benefit to be delivered from the remaining long-term multi-yearcommercial contracts and accordingly the remaining unamortized stock basedcompensation arising from the warrants associated with these contracts wasexpensed in the three months ended June 30, 2002.

 

OnJuly 30, 2002, ImproveNet, Inc. and eTechLogix, Inc. entered into an Agreementand Plan of Merger to merge the two companies. Pursuant to the terms of the Agreement and Plan of Merger, the merger isscheduled to close no later than December 31, 2002.  Under the terms of the merger, ImproveNet agreed to present acash tender offer to its current stockholders, which is anticipated to occurimmediately following the closing of the merger.  The price will be based in part on ImproveNet’s available cashbalance at the closing of the merger.

 

Aspart of our restructuring Ron Cooper stepped down on June 13, 2002, asPresident and Chief Executive Officer. Mr. Cooper continues to provide management support and remainsImproveNet’s Chairman of the Board until the merger is completed.  Upon completion of the merger, Mr. Cooperintends to serve as a board member of the merged company.

 

**RESULTSOF OPERATIONS**

 

***REVENUES***

 

                Our revenues decreased to approximately $895,000 forthe three months ended September 30, 2002 from approximately $1.9 million forthe three months ended September 30, 2001, a decrease of approximately $1.0million or 53%.  For the nine monthsended September 30, 2002, revenues decreased to approximately $3.2 million ascompared to approximately $5.7 million for the nine months ended September 30,2001, a decrease of approximately $2.5 million or 44%.

 

10

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                The following table and discussion highlights ourrevenues for the three and nine months ended September 30, 2002 and 2001 (inthousands):

 
|               |   | **Three  Months Ended, September 30** |   |     | **Nine  Months Ended, September 30,** |            |
|--------------------|--------|---------------------------------------|--------|----------|---------------------------------------|-----------------|
|               |   | **2002**                              |   | **2001** |                                  | **%****Change** |   |   | **2002** |   | **2001** |   | **%****Change** |   |
| Revenues:          |   |                                  |   |     |                                  |            |   |   |   |   |   |   |   |   |
| Service revenue    |   | $                                     | 890    |     | $                                     | 1,597           |   | –44 | % |   | $ | 3,044 |   | $ | 4,562 |   | –33 | % |
| Marketing  revenue |   | 5                                     |   | 325      |                                  | –98        | % |   | 145 |   | 1,170 |   | –88 | % |
|               |   |                                  |   |     |                                  |            |   |   |   |   |   |   |   |   |
| Total revenue      |   | $                                     | 895    |     | $                                     | 1,922           |   | –53 | % |   | $ | 3,189 |   | $ | 5,732 |   | –44 | % |

 

 

***Service Revenues***

 

                Service revenues decreased to approximately $890,000for the three months ended September 30, 2002 from approximately $1.6 millionfor the three months ended September 30, 2001, a decrease of approximately$707,000 or 44%.  For the nine months endedSeptember 30, 2002, revenues decreased to approximately $3.0 million ascompared to approximately $4.6 million for the nine months ended September 30,2001, a decrease of approximately $1.5 million or 33%.  The decrease in service revenues was primarilydue to a decrease in match rate and win rate as a result of the restructuringof operations during previous quarters.

 

                As of April 7, 2002, additional pricing changes wereannounced wherein service providers pay an individual lead fee based on thebudgeted dollar value of the job.  Thislead fee ranges from $25 to $100. Additionally, our service providers pay a fee of between 1% and 7%(based on the actual contract value) for all jobs they win.  The lead fee is waived for all jobs with anactual contract value less than $5,000.

 

                Lead fee revenues are recognized at the time theservice providers and the homeowner are first matched, while win fee revenuesare recognized at the time the service provider or the homeowner notifies usthat a job has been sold. For both lead fees and win fees, the recognition ofrevenues coincides with the service providers’ obligation to pay us. Thefollowing table details the components of service revenues, based on apercentage of service revenues:

 
|                   |   | **Three  Months Ended,** |   | **Nine  Months Ended,** |   |
|------------------------|--------|--------------------------|--------|-------------------------|--------|
|                   |   | **September  30,**       |   | **September  30,**      |   |
|                   |   | **2002**                 |   | **2001**                |   | **2002** |   | **2001** |   |
| Lead Fees              |   | 57                       | %      | 19                      | %      | 49 | % | 24 | % |
| Win Fees               |   | 39                       | %      | 78                      | %      | 30 | % | 71 | % |
| Other Fees             |   | 4                        | %      | 3                       | %      | 21 | % | 5 | % |
|                   |   |                     |   |                    |   |   |   |   |   |
| Total Service  Revenue |   | 100                      | %      | 100                     | %      | 100 | % | 100 | % |

 

 

                The revenues we generate from lead and win fees arelargely a function of:

 
| • | The number of job  submissions;                                                    |
|--------|------------------------------------------------------------------------------------|
| • | The effectiveness in  finding a service provider or match for each job submission; |
| • | The success of the  service provider to win a job; and                             |
| • | The amount we charge  the service provider for a lead or a win.                    |

 

 

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Thefollowing table provides information on some of our key business metrics (inthousands):

 
| Key Metrics (in thousands)              |   | **Three Months Ended,** |   | **Nine Months Ended,** |   |
|-----------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                    |   | **September 30,**       |   | **September 30,**      |   |
|                                    |   | **2002**                |   | **2001**               |   | **2002** |   | **2001** |   |
| Job submissions                         |   | 26.9                    |   | 28.7                   |   | 80.5 |   | 98.6 |   |
| Matched jobs                            |   | 14.2                    |   | 16.6                   |   | 35.3 |   | 62.3 |   |
| Won jobs                                |   | 1.3                     |   | 2.4                    |   | 3.8 |   | 8.4 |   |
|                                    |   |                    |   |                   |   |   |   |   |   |
| Matched jobs as  a % of job submissions |   | 52.6                    | %      | 57.8                   | %      | 43.9 | % | 63.2 | % |
|                                    |   |                    |   |                   |   |   |   |   |   |
| Won jobs as a %  of job submissions     |   | 4.9                     | %      | 8.4                    | %      | 4.7 | % | 8.5 | % |

 

 

Thedecrease in Match Rate and Win Rate for the three months ended September 30,2002, was due primarily to reductions in field staff during our restructuring.  The decrease in Match Rate and Win Rate forthe nine months ended September 30, 2002 was due primarily to the economicdown-turn during the first three quarters of 2002 and a change in the pricingschedule of Lead Fees and Win Fees in the fourth quarter of 2001.

 

Revenuesfrom new service provider enrollment fees are recognized as revenue ratablyover the expected period they participate in our contractor matching service,which is initially estimated to be one year. Revenues from premium service feesto homeowners are recognized at the time the service is provided.

 

***Marketing Revenues***

 

                Marketing revenues decreased to approximately $5,000for the three months ended September 30, 2002, from approximately $325,000 forthe three months ended September 30, 2001, a decrease of approximately $320,000or 98%. For the nine months ended September 30, 2002, revenues decreased toapproximately $145,000 as compared to approximately $1.2 million for the ninemonths ended September 30, 2001, a decrease of approximately $1.0 million or86%. The decline in marketing revenues is primarily a result of the overallsoftening of the market for online advertising and significant reductions instaffing and marketing services due to current economic conditions. ImproveNetalso completed certain commercial contracts in the fourth quarter 2001 thatwere not renewed this year.

 

                We generate marketing revenues from the sale ofbanner, button and other advertising on our Web sites, and from the sale tosuppliers of SmartLeads generated from the traffic of homeowners visiting ourWeb sites and from the sale of Find-A-Contractor or Powered by ImproveNetproducts.  Our marketing revenuesgenerally come from suppliers of home improvement products.

 

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

 
| • | The number of Web  pages that we serve;                                         |
|--------|---------------------------------------------------------------------------------|
| • | The percentage of  those pages on which we are able to sell advertisements; and |
| • | The amount we charge  per advertisement.                                        |

 

                Advertisers pay us to display their banner, button andother advertisements on the Web pages we serve when a user is visiting our Websites. Our marketing revenues historically have been derived from short-termadvertising contracts based on either a guaranteed minimum number ofimpressions or a fixed fee per thousand impressions.

 

***Multi-year Commercial Contracts***

 

                Commencing September 1999, we enteredinto multi-year commercial contracts, some of which are with related parties.These commercial contracts generally provide for a fixed annual fee, anadvertising or branding package that includes a mix of buttons, banners,SmartLeads and other marketing or branding services, includingFind-A-Contractor or Powered by ImproveNet, plus a continuous presence, on ourWeb sites. These commercial contracts are for periods ranging between 2 and 12years, including renewal options. These commercial contracts also includecooperative marketing arrangements under which we are obligated to fundcooperative branding expenditures on television and in the 

 

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print media, with or on behalf of the commercial party. Most commercialcontracts provide for us to spend 50% to 100% of the fees that we expect toreceive. In return, we expect to receive significant marketing and brandingbenefits including better advertising rates, stronger brand recognition, andaccess to customer databases, direct mail inserts and marketing resources - allof which are designed to generate more traffic to sites and jobs to proprietarymatching services.

 

Wedo not have an established historical practice of selling advertising for cashfor similar multi-year commercial contracts. We have not assigned any value tothe exchange of services or barter element of these transactions andaccordingly, we have not recorded either revenue or sales and branding expensefor the barter element. However, some of these multi-year commercial contractsdo generate an overall net cash component, and in these cases we have recordedrevenue based on the cash received or receivable under the contract, net of theobligation, if any, to reimburse the commercial party for the cooperativebranding and other marketing services. These revenues are recognized over theterm of the commercial contract once advertising and other services have beendelivered to the commercial party and collection of the resulting netreceivable is deemed probable. There was no revenue generated by multi-yearcommercial contracts, net of warrant charges, for the three months and ninemonths ended September 30, 2002, and revenue was approximately $306,000 for thethree months and approximately $1.1 million for the nine months ended September30, 2001.

 

Totalrevenues may be analyzed as follows (in thousands):

 
|                                                                                                 |   | **Three  Months Ended,** |   | **Nine  Months Ended,** |   |
|------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|-------------------------|--------|
|                                                                                                 |   | **September  30,**       |   | **September  30,**      |   |
|                                                                                                 |   | **2002**                 |   | **2001**                |   | **2002** |   | **2001** |   |
| Service revenues                                                                                     |   | $                        | 890    |                    | $      | 1,597 |   | $ | 3,044 |   | $ | 4,562 |   |
| Marketing  revenues                                                                                  |   | 5                        |   | 680                     |   | 145 |   | 2,402 |   |
| Less:  Amounts invoiced and accrued under  multi-year commercial contracts with related parties |   | —                   |   | (271                    | )      | — |   | (979 | ) |
| Less:  Amortization of warrant stock-based  compensation                                        |   | —                   |   | (84                     | )      | — |   | (253 | ) |
| Total marketing  revenues                                                                            |   | 5                        |   | 325                     |   | 145 |   | 1,170 |   |
|                                                                                                 |   |                     |   |                    |   |   |   |   |   |
| Total revenues                                                                                       |   | $                        | 895    |                    | $      | 1,922 |   | $ | 3,189 |   | $ | 5,732 |   |

 

 

Furthermore, in connection with certain of thesemulti-year commercial contracts, we issued warrants to purchase shares of ourcommon stock to the commercial parties. These warrants have been valued by ususing the Black Scholes option-pricing model. As the fair value of thesewarrants represent an additional rebate on the revenue otherwise recorded underthe contracts, the amortization of the warrants is further netted against thisrevenue over the term of the respective commercial contract. To the extent thatthere are insufficient revenues, the remaining amortization of warrantstock-based compensation is expensed and characterized as sales and marketingexpense.

 

On June 25, 2002, the Company announced it would beginthe process of liquidating certain assets while it continues to reviewstrategic alternatives.  On August 6,2002, the Company announced a new agreement to merge with eTechLogix.  As a result, the Company believes that thereis little benefit to be delivered from the remaining long-term multi-yearcommercial contracts and, accordingly, the remaining unamortized stock basedcompensation arising from the warrants associated with these contracts wasexpensed in the three months ended June 30, 2002 in the amount ofapproximately  $3,334,000.

 

***OPERATING EXPENSES***

 

***Cost of Revenues***

 

Ourcost of revenues decreased to approximately $449,000 for the three months endedSeptember 30, 2002 from approximately $1.4 million for the three months endedSeptember 30, 2001, a decrease of approximately $922,000 or 67%.  For the nine months ended September 30,2002, cost of revenues decreased to approximately $2.0 million as compared toapproximately $4.0 million for the nine months ended September 30, 2001 adecrease of approximately $2.0 million or 51%.

 

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                Cost of revenuesconsists of materials and related subcontractor labor costs for premierekitchen and bath remodels, employee payroll and related costs and occupancy,telecommunications and other administrative costs for our project service group,which is responsible for all phases of our proprietary matching services andincludes our project advisors. In addition, cost of revenues includes anallocation of direct Web site operations costs, consisting of payroll andrelated costs, data transmission costs and equipment depreciation.

 

***Cost of Service Revenues***

 

Ourcost of service revenues decreased to approximately $444,000 for the threemonths ended September 30, 2002 from approximately $1.3 million for the threemonths ended September 30, 2001, a decrease of approximately $839,000 or 65%.For the nine months ended September 30, 2002, cost of service revenuesdecreased to approximately $1.9 million as compared to approximately $3.7million for the nine months ended September 30, 2001, a decrease ofapproximately $1.8 million or 49%.

 

Thedecrease in the cost of service revenues was primarily a result ofrestructuring during the first three quarters of 2002, which reduced payrolland related costs and facilities and related costs.

 

***Cost of Marketing Revenues***

 

Ourcost of marketing revenues decreased to approximately $5,000 for the threemonths ended September 30, 2002 from approximately $88,000 for the three monthsended September 30, 2001, a decrease of approximately $83,000 or 94%. For thenine months ended September 30, 2002, cost of marketing revenues decreased toapproximately $65,000 as compared to approximately $314,000 for the nine monthsended September 30, 2001, a decrease of approximately $249,000 or 79%.

 

                Cost of marketing revenue includes an allocation ofdirect Web site operations costs, consisting of payroll and related costs, datatransmission costs and equipment depreciation. The decrease in the cost ofmarketing revenue was a result of therestructuring during the first three quarters of 2002.

 

 

***Sales and Marketing***

 

Oursales and marketing expense decreased to approximately $430,000 for the threemonths ended September 30, 2002 from approximately $3.2 million for the threemonths ended September 30, 2001, a decrease of approximately $2.8 million or87%.  For the nine months endedSeptember 30, 2002 sales and marketing expense decreased to approximately $2.4million as compared to approximately $14.1 million for the nine months endedSeptember 30, 2001, a decrease of $11.7 million or 83%.

 

Oursales and marketing expense includes all of our online and offline directmarketing and advertising, public relations and trade show expenses. Sales andmarketing expenses also include payroll and related costs, support staffexpenses, travel costs and other general expenses of our marketing,professional services and partnership services departments.

 

                The decrease in sales and marketing expenses wasprimarily attributable to:

 
| • | Renegotiating or transitioning new or existing  agreements from a high fixed cost formula to a variable performance-based  formula based on jobs won; |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|
| • | Reduced online and offline brand advertising  spending; and                                                                                           |
| • | Reduced staffing-related expenses as a result of our  restructuring during the first and second quarter.                                              |

 

                We plan to leverage our existing infrastructure andto continue the process of negotiating or transitioning agreements from a highfixed cost formula to a variable performance-based formula.

 

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***Product Development***

 

Ourproduct development expenses decreased to approximately $58,000 for the threemonths ended September 30, 2002 from approximately $735,000 for the threemonths ended September 30, 2001, a decrease of sapproximately $677,000 or 92%.  For the nine months ended September 30,2002, product development expense decreased to approximately $1.1 million ascompared to approximately $2.7 million for the nine months ended September 30,2001, a decrease of approximately $1.6 million or 58%.

 

                Our product development costs include the payroll andrelated costs of our technology staff, fees for contract content providers,other costs of Web site design and new technologies required to enhance theperformance of our Web sites.

 

                The decrease in product development expenseswas primarily attributable to decreased payroll and related costs and decreasedusage of contract content providers.  Weexpect product development costs to be minimal until the close of the merger.

 

***General and Administrative***

 

                Our general and administrative expenses decreased toapproximately $661,000 for the three months ended September 30, 2002 fromapproximately $1.2 million for the three months ended September 30 2001, adecrease of approximately $524,000 or 44%. For the nine months ended September 30, 2002, general and administrativeexpense decreased to approximately $1.9 million as compared to approximately$3.8 million for the nine months ended September 30, 2001, a decrease ofapproximately $1.9 million or 51%.

 

                Our general and administrative expenses includepayroll and related costs and travel, recruiting, professional and advisoryservices and other general expenses for our executive, finance, legal, andhuman resource departments. The decrease in our general and administrativeexpenses was a result of the restructuringduring the first three quarters of 2002.

 

***Stock-based Compensation******and Warrant Amortization***

 

TheCompany had no stock-based compensation expense for the three months endedSeptember 30, 2002 compared to approximately $1.4 million for the three monthsended September 30, 2001, an increase of approximately $1.4 million or100%.  For the nine months endedSeptember 30, 2002, stock-based compensation increased to approximately $4.7million as compared to approximately $4.0 million for the nine months endedSeptember 30, 2001, an increase of approximately $0.7 million or 18%.  The increase of stock-based compensation wasdue to a one-time write-off of approximately $3.3 million of warrants that wetook in the second quarter of 2002.

 

The Company believes that there is little benefit tobe delivered from the remaining long-term multi-year commercial contracts andaccordingly the remaining unamortized stock-based compensation arising from thewarrants associated with these contracts of approximately $3.3 million wasexpensed in the three months ended June 30, 2002.  Due to the write-off, we will not have stock-based compensationexpense in the future.

 

***Corporate Restructuring***

 

During the first quarter ended March 31, 2002, theCompany continued restructuring plans initiated in July 2000, which resulted ina total charge in the quarter of approximately $1.6 million, of whichapproximately $634,000 related to reduction in workforce costs, approximately$391,000 related to facility exit costs, and approximately $562,000 related toasset write-downs.  During the firstquarter of 2002, a total of approximately $1.1 million of costs was chargedagainst the restructuring accrual, of which approximately $271,000 related toreduction in workforce costs, approximately $241,000 related to facility exitcosts and approximately $562,000 related to asset write-downs.

 

During the second quarterended June 30, 2002, the Company announced additional restructuring plans,which resulted in at total charge of approximately $975,000, of whichapproximately $689,000 related to reduction in workforce costs, andapproximately $286,000 related to asset write-downs.  During the second quarter of 2002, a total of approximately $2.2million of costs was charged against the restructuring accrual, of whichapproximately $844,000 related to reduction in workforce costs, approximately$1.1 million related to facility exit costs, and approximately $286,000 relatedto asset write-downs.

 

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During the third quarter ended September 30, 2002, theCompany announced additional restructuring plans, which resulted in a totalcharge of approximately $146,000 of which approximately $106,000 related toreduction in workforce costs, and approximately $40,000 related to facilityexit costs.  During the third quarter of2002, a total of approximately $185,000 of costs was charged against therestructuring accrual, of which approximately $177,000 related to reduction inworkforce costs and approximately $8,000 related to facility exit costs.

 

In the third quarter 2002, we made an adjusting entryof approximately $12,000 to reverse previously overly accrued facility exitcosts in previous quarters.  Also in thethird quarter, we made an adjusting entry of approximately $127,000 to reversepreviously overly accrued employee severance costs mostly relating to overestimating expected COBRA usage.

 

***Interest and Other Income***

 

                Our interest and other income decreased toapproximately $69,000 for the three months ended September 30, 2002 fromapproximately $28,000 for the three months ended September 30, 2001, anincrease of approximately $41,000 or 146%. For the nine months ended September 30, 2002, interest and other incomedecreased to approximately $136,000 as compared to approximately $675,000 forthe nine months ended September 30, 2001, a decrease of approximately $539,000or 80%.

 

                The increase in interest and other incomein the quarter is attributable to a settlement refund for telephone equipmentthat was in dispute. We expect the decline in our interest and other income tocontinue during the remainder of 2002 due to the expected decline in our cashand cash equivalents balances during the year.

 

***Income Taxes***

 

                We have recorded a 100% valuation allowance againstour net deferred tax assets, which arose primarily as a result of our aggregateoperating losses. The valuation allowance will remain at this level until suchtime as we believe that the realization of the net deferred tax assets is morelikely than not.  Accordingly, ourresults of operations do not reflect any tax benefits for our reported losses.

 

***LIQUIDITY AND CAPITAL RESOURCES***

 

                Cash and cash equivalents totaled approximately $2.7million at September 30, 2002, a decrease of approximately $6.9 million or 72%from approximately $9.6 million at December 31, 2001. The decrease wasprimarily due to the $6.9 million of cash used in operating activities andrestructuring costs.

 

                Since our inception, we have primarily financed ouroperations through private sales of our convertible preferred stock and commonstock. In March 2000, we closed our initial public offering that generated netcash proceeds of approximately $39.7 million. Our primary capital needs havebeen to fund our operating losses, the prepayment of our large media purchasesand to make capital expenditures.

 

                Cash used in operating activities for the nine monthsended September 30, 2002, decreased approximately $12.4 million or 64% fromapproximately $19.3 million for the nine months ended September 30, 2001.  Cash used in operating activities resultedprimarily from our net loss before non-cash charges for amortization ofstock-based compensation, depreciation, and allowances for doubtful accounts,offset by changes in operating assets and liabilities.

 

                Cash provided by investing activities was nil in thenine months ended September 30, 2002, and decreased approximately $274,000 or100% from cash used of approximately $274,000 for the nine months endedSeptember 30, 2001.

 

                Cash used in financing activities was approximately$10,000 in the nine months ended September 30, 2002, a decrease ofapproximately $30,000 or 150% from the cash provided of approximately $20,000at September 30, 2001.  In 2002 the cashwas used to repay debt. In 2001 the cash provided was from the exercise ofstock options.

 

                Our capital requirements depend on numerous factors,including the success of our strategies for generating revenues and the amountof resources we devote to operating activities.  Our expenditures have substantially decreased as a result of ourrestructuring. Based on the realignment of our resources, we expect a decreasein most of our operating 

 

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expense categoriesdetailed above for the year 2002 as compared to year 2001. We do expect toexperience ongoing operating losses for the foreseeable future.

 

                Pursuant to the agreement with Microsoft that weentered into during December 1999 and renegotiated in April 2002, an annual feeof $400,000 was due and payable to Microsoft in May 2002, for services throughApril 2003.  Pursuant to the two-yearagreement with AT&T that we entered into in December 2000, the Company isrequired to pay a minimum of $1.4 million to AT&T for telecommunicationsand teleconferencing services.  TheCompany is in the process of disputing the commitment based on a provision within the agreement that allows for revision ofthe commitment levels based on actual experience and has accrued a reducedliability accordingly.  No resolutionhas been reached as of the filing of this document.  As at September 30, 2002, operating lease commitments ofapproximately $171,000 are payable over the next two years.

 

Ourlimited operating history and operating losses have limited our ability toobtain vendor credit or extended payment terms and bank financing on favorableterms; accordingly, we depend on our cash and cash equivalent balances to fundour operations.

 

On July 30, 2002, ImproveNet, Inc. andeTechLogix, Inc. entered into an Agreement and Plan of Merger to merge the twocompanies. Pursuant to the terms of the Agreement and Plan of Merger, themerger is scheduled to close no later than December 31, 2002. Under the termsof the merger, ImproveNet agreed to present a cash tender offer to its currentstockholders, which is anticipated to occur immediately following the closingof the merger. The price will be based in part on ImproveNet’s available cashbalance at the closing of the merger.

 

                We currently believe that our available cashresources will be sufficient to meet our anticipated needs for operations andcapital expenditures until the merger is complete.  We will strive to make ongoing realignments as required in orderto achieve positive cash flows.  We areadditionally decreasing our marketing expenditures to assist us in maintainingour available cash resources.  We mayneed to raise additional funds, however, in order to develop new, or enhanceexisting, services in order to respond to competitive pressures or to acquirecomplementary businesses, services or technologies.  Although we have no present intention to conduct additionalpublic equity offerings, we may seek to raise these additional funds throughprivate or public debt or equity financings. If we raise additional funds by selling equity securities, thepercentage ownership of our stockholders will be reduced. We cannot be surethat additional financing will be available on terms favorable to us, or atall. If adequate funds were not available on acceptable terms, our ability tofund expansion, react to competitive pressures, or take advantage ofunanticipated opportunities would be substantially limited. If this occurred,our business would be significantly harmed. We will continue to evaluate ourneeds for funds based on our assessment of access to public or private capitalmarkets and the timing of our need for funds.

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

InJuly 2001, the Financial Accounting Standards Board (“FASB”) issued SFAS No.141, “Business Combinations” and SFAS No. 142, “Goodwill and Other IntangibleAssets”, Under SFAS No. 141, all business combinations initiated after June 30,2001 must be accounted for using the purchase method, SFAS No. 142 Requires,among other things, the discontinuance of goodwill amortization.  In addition, the standard includesprovisions upon adoption for the reclassification of certain existingrecognized intangibles as goodwill, reassessment of the useful lives of existingrecognized intangibles and the testing for impairment of existing goodwill andother intangibles.  The Company hasadopted the provisions of SFAS No. 142 effective January 1, 2002.

 

InOctober 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment orDisposal of Long-Lived Assets”, which addresses financial accounting andreporting for the impairment or disposal of long-lived assets.  This Statement supersedes SFAS No. 121 andthe accounting and reporting provisions of Accounting Principles Board, or APB,Opinion No. 30 “Reporting the Results of Operations-Reporting the Effects ofDisposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions”, for the disposal of a segmentof a business.  The Company adopted theprovisions of SFAS No. 144 effective January 1, 2002.  The implementation of SFAS No. 144 did not have a material effecton the Company’s financial position and results of operations.

 

InNovember 2001, the Emerging Issues Task Force (“EITF”) reached a consensus onEITG Issue No. 01-09, “Accounting for Consideration Given by a Vendor to aCustomer or a Reseller of the Vendor’s Products,” EITF No. 01-09 requiresrecording certain consideration paid to distributors of the Company’s productsas a reduction of revenue.  The 

 

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Company adopted theprovisions of EITF No. 01-09 effective January 1, 2002.  The implementation of EITF No. 01-09 did nothave a material effect on the Company’s financial position and results ofoperations.

 

InJune 2002, the FASB issued SFAS No. 146, “Accounting for Exit or DisposalActivities”.  SFAS 146 addressessignificant issues regarding the recognition, measurement, and reporting ofcosts that are associated with exit and disposal activities, includingrestructuring activities that are currently accounted for under EITF No. 94-3,“Liability Recognition for Certain Employee Termination Benefits and OtherCosts to Exit and Activity (including Certain Costs Incurred in aRestructuring).” The scope of the SFAS No. 146 also includes cots related toterminating a contract that is not a capital lease and termination benefitsthat employees who are involuntarily terminated receive under the terms of aone-time benefit arrangement that is not an ongoing benefit arrangement or anindividual deferred-compensation contract. SFAS 146 will be effective for exitor disposal activities that are initiated after December 31, 2002 but earlyapplication is encouraged.  The provisionsof EITF No. 94-3 shall continue to apply for an exit activity initiated underan exit plan that met the criteria of EITF No. 94-3 prior to the adoption ofSFAS No.146. Adopting the provisions of SFAS No.146 will change, on aprospective basis, the timing of when restructuring charges are recorded from acommitment date approach to when the liability is incurred.

 

 

**RISKFACTORS THAY MAY AFFECT OUR RESULTS OF OPERATIONS AND FINANCIAL CONDITION**

 

Thisdocument contains certain forward-looking statements. These statements relateto future events or our future financial performance. In some cases, you canidentify forward-looking statements by terminology such as “anticipates’,“believes”, “continue”, “could”, “estimates”, “expects”, “intends”, “plans”,“potential”, “predicts”, “should” or “will” or the negative of these terms orother comparable terminology which are intended to identify certain of theseforward-looking statements. The cautionary statements made in this documentshould be read as being applicable to all related forward-looking statementswherever they appear in this document. The Company’s actual results coulddiffer materially from those discussed in this document. Factors that couldcause or contribute to such differences include those discussed below, as wellas those discussed in the Company’s Annual Report on Form 10-K.

 

**We havelarge accumulated losses, we expect future losses, and we may not achieve ormaintain profitability.**

 

                We have incurred substantial losses and usedsubstantial cash to support our operations as we have expanded our sales andmarketing programs, funded the development of our services, promoted our Websites and matching service and expanded our operations infrastructure. As ofSeptember 30, 2002, our accumulated loss was approximately $142 million. Weexpect our expenditures on sales and marketing activities, support fieldservices and the development of new products, services and technologies tocontinue at a reduced rate, as we restructured our business in June 2002. Theserestructuring included operational efficiencies caused by headcount reductionsof approximately 82%. We will continue to lose money unless we significantlyincrease our revenues. We cannot predict when, if ever, we will operateprofitably.

** **

**Ifwe do not complete the merger, we will continue with liquidation procedures.**

 

**               **On August 6, 2002, the Company announced an agreement to merge witheTechLogix.  The Company continues tooperate its websites and provide referral services until further notice.  If the Company cannot complete the merger wewill continue the process of liquidation. We may have to shut down the website, sell all assets that containvalue, and distribute the remaining funds to the shareholders.

 

**We arean early stage company and we have recently restructured our business to offernew services. As a result, we have a limited history, which makes it difficultto evaluate our business.**

 

                We were incorporated in January 1996; however, we didnot begin offering home improvement services on the Internet until August 1997.In December 1998, we began selling Web site advertising. Until March 1999, wefocused primarily on building our network of service providers and refining ourmatching services processes. In March 1999, we hired our Chief ExecutiveOfficer and commenced recruiting our senior management team. In April 1999, weintroduced Powered by ImproveNet, a service that allows third parties to offerthe ImproveNet matching services and content on their Web sites, for nationalsuppliers of home improvement and repair products. In November 1999, welaunched our customized Web site for service providers. We completed theacquisition of two regional contractor referral companies, Contractor ReferralService, LLC and The J.L. Price Corporation, in September and November 1999. Weexperienced 

 

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reductions in force inJuly 2000. In the second half of 2000 we significantly reduced our marketingexpenditures. In the first and third quarters of 2001, first quarter of 2001,and most recently as of September 2002, we implemented cost restructuringinitiatives that included a reduction in workforce. Furthermore, even if ourbusiness is successful, we may change our business to enter into new businessareas such as our Premiere Services offerings, which are in the process oflaunching into selected geographic regions. These and other new business initiatives are areas in which we do nothave extensive experience.

 

**Becausewe are no longer listed on the Nasdaq National Market, the liquidity of ourcommon 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 raiseadditional capital or generate the significant capital necessary to expand ouroperations and invest in new products and services could reduce our ability tocompete and result in lower revenues.**

 

We expect that currently available funds will besufficient to meet our working capital and capital expenditure needs until themerger is completed; however, if we are unable to generate sufficient cashflows from operations to meet our anticipated needs for working capital andcapital expenditures, we will need to raise additional funds.  We cannot be certain that we will be able toobtain additional financing on favorable terms, or at all. If we needadditional capital and cannot raise it on acceptable terms, we may not be able,among other things, to:

 
| • | Develop  or enhance our services;                                        |
|--------|--------------------------------------------------------------------------|
| • | Develop  or acquire new technologies, products or businesses;            |
| • | Expand  operations in the United States or internationally;              |
| • | Hire,  train and retain employees; or                                    |
| • | Respond  to 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 toraise additional funds, finance acquisitions or develop commercialrelationships by issuing equity or convertible debt securities, which wouldreduce the percentage ownership of existing stockholders. Furthermore, any newsecurities could have rights, preferences or privileges senior to those of ourcommon stock.

 

**Our market iscompetitive and we may suffer price reductions, be unable to attract homeownersto our Web site, be unable to maintain our service provider network or enterinto new multi–year commercial contracts if we do not competeeffectively.**

 

                The market for our services isintensely competitive, evolving and subject to rapid technological change. Toremain competitive, 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 havemore resources and broader and deeper customer access than we do. In addition,several of these competitors have or can readily obtain extensive knowledge ofthe home improvement industry. Our competitors may be able to respond morequickly than we can to new technologies or changes in Internet user preferencesand devote greater resources than we can to the development, promotion and saleof their services. We may not be able to 

 

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maintainour competitive position against current and future competitors, especiallythose with significantly greater resources and brand recognition.

 

**Homeowners andservice providers may be reluctant to accept an Internet–based serviceprovider matching service.**

 

                Currently most homeowners usetraditional means including word–of–mouth referrals, Yellow Pagesand local contractor matching services to obtain service providers for theirhome improvement 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 notattract and retain a network of high quality service providers, our businesscould be harmed.**

 

                We expect to derive the majorityof our revenues from our network of service providers in the form of paymentsfor each homeowner referral that we provide to them and for each homeimprovement project that they win. Our business is highly dependent onhomeowners’ use of our Web site to find service providers for their homeimprovement projects so that service providers will achieve a satisfactoryreturn on their participation in the ImproveNet program.

 

                A key element ofthe growth of our business is the pace at which service providers adopt theImproveNet matching process. This adoption includes responding to homeownerinquiries within 72 hours, providing a competitive, firm quote tohomeowners quickly, and paying the service fees to ImproveNet. We devotesignificant effort and resources to screening and supporting participatingservice providers and to developing programs that monitor service providers’job wins and that collect service fees from service providers for these wins.Our inability to screen and support service providers effectively, or thefailure of our service providers to respond professionally and in a timelymanner to homeowner inquiries, could result in low homeowner satisfaction andharm our business. In addition, the failure of our service providers to winhome improvement projects, report their wins to us, or pay us service feescould harm our business.

 

                We must actively recruit newservice providers and retain and motivate our current service providers to ensurethat we continually have adequate coverage. We believe that service providersin the home improvement industry suffer from a relatively high failure orturnover rate that makes it difficult for us to retain service providers.Accordingly, we expect that not all of our service providers will remain activeparticipants in our network. If we are unable to achieve low turnover among ournetwork of service providers our business could be harmed.

 

**If homeownersfail to report, and service providers fail to report and to pay to us win fees,directly or indirectly, our business would be harmed.**

 

                Our serviceproviders are responsible for paying us a win fee for each job that they obtainfrom us. We ask service providers not to pass on the cost of the win fee to thehomeowner. However, we do not currently provide any guarantee to the homeownerthat our service providers have not raised their rates to cover the win fee nordo we audit or plan to audit our service providers to confirm that they havenot raised their rates. Homeowners may believe that they are indirectly payingus our win fee through the higher rates of service providers and, therefore,choose to select service providers through word–of–mouth referrals,Yellow Pages, local contractor matching services or other means rather thanusing our matching service. If homeowners choose not to use our service, wewill lose service revenues and visitors to our Web sites and our business willbe harmed.

 

                We depend on our serviceproviders to report that they have won a job, report the correct contractamount, and pay us our win fee. We rely on our relationships with our serviceproviders and the incentive to receive future leads from us to encourageservice providers to report wins and pay win fees. Currently, we do not have acontrol or an oversight mechanism in place with either service providers orhomeowners to ensure that they report wins and pay win fees. If serviceproviders do not report wins, the correct contract amounts, or pay us win fees,we will lose service revenues and our business will be harmed.

 

**We depend onthird–party relationships to attract visitors to our Web sites.**

 

                We have entered into commercialcontracts with suppliers of home improvement products and services to generaterevenues and increase the number of visitors to our Web sites. Under thesecontracts, suppliers have placed links to our Web 

 

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sitefrom their Web sites to allow their customers to visit our Web site if thecustomers are interested in obtaining home improvement information or searchingfor a service provider. We believe that increasing the number of visitors toour Web sites will increase the number of job submissions. We cannot assure youthat these contracts will lead to increased visits to our Web sites or thatincreased visits to our Web sites will result in increased job submissions. Ifwe do not maintain our existing contracts on terms as favorable as currently ineffect or if we are not able to establish new contracts on commerciallyreasonable terms, our business could be harmed.

 

                Companies that we may pursue fora commercial contract may offer services competitive with suppliers with whichwe currently have contracts. As a result, these suppliers may be reluctant toenter into commercial contracts with us.

 

                We purchase preferentialplacement on high–traffic Web sites. We believe these Web sites can helpus to increase the number of visitors to ImproveNet.com. Web site trafficoriginated from AltaVista, Lycos, Microsoft HomeAdvisor and Yahoo! There isintense competition for preferential placements on these Web sites. If we loseour relationships 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 onthird–party relationships to provide software tools and infrastructure.**

 

                We integrate third–partysoftware into our service offerings on our Web sites. We would be harmed if theproviders from which we license software ceased to deliver and support reliableproducts, 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, orinability to maintain or obtain, this software could limit the featuresavailable on our Web sites, which could harm our business.

 

**If we fail toretain qualified personnel, our ability to continue to operate could be harmed.**

 

                We depend on the continuedservice of our key technical, operational and administrative personnel. Inparticular, the loss of the services of any of the remaining personnel,individually or as a group, could cause us to incur increased operatingexpenses and divert other personnel time in searching for their replacements.We do not have employment agreements with any employee, and we do not maintainany key person life insurance policies for any of our employees. The loss ofany of our remaining personnel could harm our business.

 

**If we fail toadequately protect our proprietary rights, we could lose these rights and ourbusiness could be harmed.**

 

                We depend upon our ability todevelop and protect our intellectual property rights, including our databasesof homeowners and service providers and our internally–developed matchingcriteria and algorithms, to distinguish our services from our competitors’services. We rely on a combination of copyright, trademark and trade secretlaws, as well as confidentiality agreements and licensing arrangements, toestablish and protect our proprietary rights. We have no issued patents. Ourdatabases are protected by trade secret laws and our matching service isprotected primarily by trade secret and copyright laws. Existing laws affordonly limited protection of intellectual property rights. Attempts could be madeto copy or reverse engineer aspects of our processes or services or to obtainand use information that we regard as proprietary. Accordingly, we may not beable to protect our intellectual property rights against unauthorized third–partycopying or use. Furthermore, policing the unauthorized use of our intellectualproperty is difficult, and expensive litigation may be necessary in the futureto enforce our intellectual property rights. The use by others of ourproprietary rights could harm our business.

 

**Our servicescould infringe the intellectual property rights of others causing costlylitigation and the loss of significant rights.**

 

                Third parties could claim thatwe have infringed their intellectual property rights by claiming that ourmatching service infringes their patents, trade secrets or copyrights. In theordinary course of business, we have received, and may receive in the future,notices from third parties claiming infringement of their proprietary rights.In addition, providers of goods and services over the Internet are increasinglysubject to claims that they infringe patents that cover basic elements of electroniccommerce. The resolution of any claims could be time–consuming, result incostly litigation, delay or prevent us from offering our services or require usto enter into royalty or licensing agreements, any of which could harm ourbusiness. In the event an infringement claim against us is successful and wecannot obtain a license on acceptable terms, license a substitute technology orredesign our services, our business would be harmed. Furthermore, formeremployers or our current 

 

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andfuture employees may assert that our employees have improperly disclosed to usor are using confidential or proprietary information in our business.

 

**If we experiencesystem failures, our reputation would be harmed and users might seekalternative service providers, causing us to lose revenues.**

 

                We depend on theefficient and uninterrupted operation of our computer and communicationshardware and software systems. Substantially all of our computer hardware foroperating our Web sites is currently located at Qwest Communications inSunnyvale, California, with backups located at our facility in Redwood City,California. These systems and operations are vulnerable to damage orinterruption from earthquakes, floods, fires, power loss, telecommunicationfailures and similar events. They are also subject to break–ins,sabotage, intentional acts of vandalism and similar misconduct. We do not havefully redundant systems, a formal disaster recovery plan or alternativeproviders of hosting services, and we do not carry business interruptioninsurance to compensate us for losses that could occur. Despite any precautionswe may take, the occurrence of a natural disaster or other unanticipatedproblems either at Qwest or at our facility could result in interruptions inour services. Any damage to or failure of our systems could result ininterruptions in our service. In addition to placing an increased burden on ourengineering staff, any system failure could create user questions and complaintsthat must be responded to by our customer support personnel. The systemfailures 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.

 

**We may havecapacity restraints that could limit the growth of or reduce our revenues.**

 

                The satisfactory performance,reliability and availability of our Web sites, processing systems and networkinfrastructure are critical to our reputation and our ability to attract andretain large numbers of users. If the volume of traffic, including at peaktimes, on our Web sites increases, we may need to expand and upgrade ourtechnology, transaction processing systems and network infrastructure. We maynot be able to accurately project the rate or timing of these increases, ifany, in the use of our services or to expand or upgrade our systems andinfrastructure in a timely manner to accommodate these increases.

 

                We use internallydeveloped systems for operating our services and processing our transactions,including billing and collections processing. We must continually improve thesesystems in order to accommodate the use of our Web sites. If we add newfeatures and functionality to our services, we could be required to develop orlicense additional technologies. Our inability to add additional software andhardware or upgrade our technology, transaction processing systems or networkinfrastructure could cause unanticipated system disruptions, slower responsetimes, degradation in levels of customer support, impaired quality of theusers’ experience, delays in accounts receivable collection or losses ofrecorded financial information. Our failure to provide new features orfunctionality also could result in these consequences. The required hardwaremay not be readily available or affordable and we may be unable to effectivelyupgrade and/or expand our systems in a timely manner or to integrate smoothlyany newly developed or purchased technologies with our existing systems. Thesedifficulties could harm or limit our ability to expand our business.

 

**We could be heldliable for products and services.**

 

                We could be subject to claimsrelating to products and services that we perform on behalf of homeowners orreferrals to selected contractors through our Web site. Homeowners may bringclaims against us or our service providers, who may have among other things,provided them with poor workmanship or caused bodily injury or damage toproperty. Our existing insurance coverage may not cover all potential claims,may not adequately cover all costs incurred in defense of potential claims, maynot indemnify us for all liability that may be imposed or may not be renewablein future 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.

 

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

 

                We depend on increasedacceptance and use of the Internet. In particular, our matching service dependsupon service providers being willing to use the Internet to find jobs throughour service. We believe that service providers generally have not traditionallyused computers or the Internet to operate their businesses. Demand and marketacceptance for recently introduced products and services over the Internet aresubject to a high level of uncertainty. As a result, acceptance and use of theInternet may not develop or a sufficiently broad base of users may not adopt orcontinue to use the Internet as a medium of commerce.

 

**TheInternet is characterized by rapidly changing technologies, frequent newproduct and service introductions and evolving industry standards.**

 

                To succeed, we will need toadapt effectively to rapidly changing technologies and continually improve theperformance features and reliability of our services. We could incursubstantial costs in modifying our products, services or infrastructure toadapt to these changes, and we may also lose customers and revenues if ourservices fail to adapt to the rapid changes characteristic of the Internet.

 

                Conversely, if the Internetexperiences increased 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.

 

**Futuregovernment regulations and legal uncertainties pertaining to the Internet coulddecrease the demand for our services or increase the cost of doing business.**

 

                There is, and will likelycontinue to be, an increasing number of laws and regulations pertaining to theInternet. These laws and regulations may relate to liability for informationretrieved from or transmitted over the Internet, online content, user privacy,taxes or the quality of services. Any new law or regulation pertaining to theInternet, or the adverse application or interpretation of existing laws, coulddecrease the demand for our services or increase our cost of doing business.

 

                We are not certain how ourbusiness may be affected by the application of existing laws governing issuessuch as property ownership, copyrights, encryption and other intellectualproperty issues, taxation, libel, obscenity and export or import matters. Thevast majority of these laws were adopted prior to the advent of the Internet.As a result, they do not contemplate or address the unique issues created bythe Internet and related technologies. Changes in laws intended to addressthese issues could create uncertainty for or adversely affect companies doingbusiness on the Internet. This could reduce demand for our services or increasethe cost of doing business.

 

**General economic conditions may change dramatically from yearto year.**

 

                General economic conditions,which affect consumer confidence and home improvement and home-buildingspending, including interest rates, the overall level of economic activity, theavailability of consumer credit and mortgage financing and unemployment ratesmay change dramatically and impact our ability to operate.

 

**We are new to the general contracting field and mayexperience project and management coordination problems.**

 

**               **We will act ascontractor of record for construction of our premium service projects with ourpersonnel supervising the construction process.  As contractor of record, we are responsible for managing theconstruction process, coordinating the activities of all subcontractors,suppliers and building inspectors and following design plans generally preparedby consulting architects and engineers whom we may retain and whose designstarget the local market.  In addition,we work closely with contractors and subcontractors on site preparation,purchasing, architectural design, site planning, coordinating governmentalapprovals, contract management and closings. We sometimes require our general contractors or subcontractors to postlien-free completion and performance construction bonds.  We believe that our relations with ourcontractors are good.

 

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**Legislative andregulatory initiatives regarding the collection and use of our users’ personalinformation may result in liability and expenses.**

 

                Current computing and Internettechnology allows us to collect personal information about our users. In thepast, the Federal Trade Commission has investigated companies that have soldpersonal information to third parties without permission or in violation of astated privacy policy. Currently, we collect personal information only with theusers’ 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 impositionof additional state and local taxes on Internet–based transactions wouldincrease our cost of doing business and harm our ability to become profitable.**

 

                We file state taxreturns 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 federallaw limits the ability of the states to impose taxes on Internet-basedtransactions.  Until October 21, 2001,state and local taxes on Internet-based commerce that are discriminatoryagainst Internet access are prohibited, unless the taxes were generally imposedand actually enforced before October 1, 1998. It is possible that this tax moratorium will not be renewed by October21, 2001 or at all.  Failure to renewthis legislation would allow various states to impose taxes on Internet-basedcommerce.  The imposition of state andlocal taxes could harm our ability to become profitable.

 

**Item3.  Quantitative and QualitativeDisclosures about Market Risk**

 

**InterestRate Risk**

 

                The primary objective of ImproveNet’s investmentactivities is to preserve principal while at the same time maximizing yieldswithout significantly increasing risk. To achieve this objective, we maintainour portfolio of cash and cash equivalents in a variety of securities,including both government and corporate obligations and money market funds.

 

                Our exposure to market risk for changes in interestrates relates primarily to increases or decreases in the amount of interestincome we earn on our investment portfolio and on increases or decreases in theamount of interest expense we must pay with respect to any outstanding debtinstruments. We mitigate default risk by investing in only high credit qualitysecurities that we believe to be low risk and by positioning our portfolio torespond appropriately to a significant reduction in a credit rating of anyinvestment issuer or guarantor.

 

                We do not hold derivative financial instruments as ofSeptember 30, 2002, and have never held such instruments in the past. Inaddition, we had no debt instruments outstanding as of September 30, 2002. Wecurrently transact all of our revenues, which are all traded in the UnitedStates of America, in U.S. dollars.

 

**Item 4.Controls and Disclosures**

 

**Evaluationof disclosure controls and procedures. **Under thesupervision and with the participation of our Chairman and Controller, we have,as of a date within 90 days before the filing date of this quarterly report(the “Evaluation Date”) evaluated the effectiveness of our “disclosure controlsand procedures.”  Disclosure controlsand procedures are controls and procedures that are designed to ensure thatinformation required to be disclosed in Company reports filed or submittedunder the Exchange Act of 1934, as amended, is recorded, processed, summarizedand reported within the time periods specified in the SEC’s rules andforms.  They include, withoutlimitation, controls and procedures designed to ensure that information requiredto be disclosed in such reports is accumulated and communicated to management,including the Chairman and Controller, as appropriate, to allow timelydecisions regarding required disclosure.

 

**Changesin internal controls. **There wereno significant changes in our internal controls or to our knowledge, in otherfactors that could significantly affect these controls, including anycorrective actions with regard to significant deficiencies and materialweaknesses, subsequent to the date of their last evaluation.

 

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**PARTII. OTHER INFORMATION**

 

**Item1.  Legal Proceedings**

 

                From time to time, we may be involved in litigationrelating to claims arising out of our operations. As of the date of thisfiling, we are not engaged in any material legal proceedings.

 

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

 

None

 

**Item3.  Defaults Upon Senior Securities**

 

None

 

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

 

                None

 

**Item5.  Other Information**

 

None.

 

**Item6.  Exhibits and Reports on Form 8-K**

 

(a)          Exhibits

 

Exhibit    Description of Document

 
| **EXHIBIT** |   |                                                                                                                              |
|-------------|--------|-----------------------------------------------------------------------------------------------------------------------------------|
| **NUMBER**  |   | **DESCRIPTION OF DOCUMENT**                                                                                                       |
| 10.35       |   | AT&T Master  Agreement MA Reference No. DCMT306779. (1)                                                                       |
| 10.39       |   | Agreement and Plan of Merger dated July 30, 2002 by and among ImproveNet, Inc., eTechLogix, Inc., and eTech Acquisition, Inc. (2) |
| 99.1        |   | Certification Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002. (3)                                                     |

----

| (1) | Incorporated  by reference to the Registrant’s Form 10-Q for the period ended March 31,  2002 filed on April 15, 2002. |
|-----|-----------------------------------------------------------------------------------------------------------------------------|
| (2) | Incorporated by  reference to the Registrant’s Form 8-K filed on August 6, 2002.                                       |
| (3) | Filed herewith.                                                                                                             |

 

 

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(b)         Reports on Form 8-K

On August 6, 2002, theRegistrant filed a Current Report on Form 8-K relating to the execution of anAgreement and Plan of Merger with eTechLogix, Inc.

 

On October 15, 2002, theRegistrant filed a Current Report on Form 8-K relating to an amendment to theAgreement and Plan of Merger with eTechLogix, Inc. whereby the parties agreedto extend the closing of the merger from November 30, 2002 to December 31,2002.

 

**Signatures**

 

Pursuantto the requirements of the Securities and Exchange Act of 1934, the Registranthas duly caused this report to be signed, November 15, 2002 on its behalf bythe undersigned duly authorized.

 
| IMPROVENET, INC.                |
|---------------------------------|
| (Registrant)                    |
|                            |
|                            |
|                            |
| By:/s/ Ronald B.  Cooper        |
|                            |
| Ronald B. Cooper                |
| Chairman                        |
| (Principal Financial  Officer)  |
|                            |
|                            |
|                            |
| By:/s/ Christopher A.  Kendall  |
|                            |
| Christopher A. Kendall          |
| Controller                      |
| (Principal Accounting  Officer) |

 

 

 

Date: November 15, 2002

 

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**Certification****Pursuant to Securities and Exchange Act of 1934 Rules 13a-15 and 15d-15.(5)**

 

I, Ronald B. Cooper, theChairman and Principal Financial Officer of ImproveNet, Inc. (“the Company”),certify that:

 

1.               I havereviewed this quarterly report on Form 10-Q of ImproveNet, Inc;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respect the financialcondition, results of operations and cash flows of the registrants as of, andfor, the periods presented in this quarterly report;

 

4.               The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-15 and 15d-15) for the registrant and have:

 

a.               Designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period forwhich this quarterly report is being prepared;

 

b.              Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report(“Evaluation Date”); and

 

c.               Presented inthis quarterly report our conclusions about he effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               Theregistrant’s other certifying officers an I have disclosed, abased on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a.                Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b.              Any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               Theregistrant’s other certifying officers and I have indicated in the is quarterlyreport whether there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate of our most recent evaluation, including any corrective actions withregard to significant deficiencies an material weaknesses.

 

 

Dated: November 15, 2002

 
|    /s/Ronald B. Cooper          |
|-------------------------------------------|
| Ronald B. Cooper                          |
| Chairman and principal  financial officer |

 

 

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**Certification Pursuant to Securities and Exchange Act of 1934Rules 13a-15 and 15d-15. (5)**

 

I, Christopher A.Kendall, the Controller and Principal Accounting Officer of ImproveNet, Inc.(“the Company”), certify that:

 

1.               I havereviewed this quarterly report on Form 10-Q of ImproveNet, Inc;

 

2.               Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.               Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respect the financialcondition, results of operations and cash flows of the registrants as of, andfor, the periods presented in this quarterly report;

 

4.               Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-15 and 15d-15) for the registrant and have:

 

a.               Designedsuch disclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period for which thisquarterly report is being prepared;

 

b.              Evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report(“Evaluation Date”); and

 

c.               Presented inthis quarterly report our conclusions about he effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.               Theregistrant’s other certifying officers an I have disclosed, abased on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors (or persons performing the equivalentfunctions):

 

a.                Allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b.              Any fraud,whether or not material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.               Theregistrant’s other certifying officers and I have indicated in the is quarterlyreport whether there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate of our most recent evaluation, including any corrective actions withregard to significant deficiencies an material weaknesses.

 

 

Dated: November 15, 2002

 

 
|     /s/Christopher A. Kendall |
|----------------------------------------------|
| Christopher A. Kendall                       |
| Controller and  principal accounting officer |

 

 

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