**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

### **Washington,D.C. 20549**

 

----

 

# **Form 10-Q**

 
| **(Mark One)** |   |
|----------------|--------|
| **ý**     |   | **Quarterly Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly  period ended September 30, 2001.** |
|           |   |   |
| **Or**         |
|           |   |   |
| **o**          |   | **Transition Report Pursuant to  Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition  Period from ___________ to _________.** |
|                |        |  |  |

 

 

### **COMMISSIONFILE NUMBER 000-29927**

 

**IMPROVENET, INC.**

(Exact name of registrant as specified in its charter)

 

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

 

 

**1286 Oddstad Drive,Redwood City, CA 94063**

(Address of principal executive offices)

 

**(650)-839-8752**

(Registrant's telephone number, including area code)

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.

 

YES   ý   NO  o

 

The number of sharesoutstanding of the registrant's common stock, $.001 par value, was 17,324,213as of October 31, 2001.

 

 

 

**ImproveNet, Inc.**

 

**Form 10-Q**

 

**For the Quarter EndedSeptember 30, 2001**

 

**Index**

 

 
| **PART I  FINANCIAL INFORMATION** |
|----------------------------------------|
|                                   |
| Item 1                                 | Financial Statements: |
|                                   |   |
|                                   | Condensed Consolidated Balance Sheets as of  September 30, 2001 and December 31, 2000 |
|                                   |   |
|                                   | Condensed Consolidated Statements of  Operations for the three and nine months ended September 30, 2001 and 2000 |
|                                   |   |
|                                   | Condensed Consolidated Statements of Cash  Flows for the nine months ended September 30, 2001 and 2000 |
|                                   |   |
|                                   | Notes to Condensed Consolidated Financial  Statements |
|                                   |   |
| Item 2                                 | Management's Discussion and Analysis of  Financial Condition and Results of Operations |
|                                   |   |
| Item 3                                 | Quantitative and Qualitative Disclosures  About Market Risk |
|                                   |   |
| **PART II  OTHER INFORMATION**    |
|                                   |
| Item 1                                 | Legal Proceedings |
|                                   |   |
| Item 2                                 | Changes in Securities and Use of Proceeds |
|                                   |   |
| Item 3                                 | Defaults upon Senior Securities |
|                                   |   |
| Item 4                                 | Submission of Matters to a Vote of Security  Holders |
|                                   |   |
| Item 5                                 | Other Information |
|                                   |   |
| Item 6                                 | Exhibits and Reports on Form 8-K |
|                                   |   |
| **SIGNATURES**                         |

 

 

PARTI - FINANCIAL INFORMATION

ITEM1 . FINANCIAL STATEMENTS

**IMPROVENET,INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

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

 

 
|                                                                     |   | **SEPTEMBER  30,** |       | **DECEMBER  31,** |       |
|--------------------------------------------------------------------------|--------|--------------------|------------|-------------------|------------|
|                                                                     |   | **2001**           |       | **2000**          |       |
|                                                                     |   | **(UNAUDITED)**    |       |              |       |
|                                                                     |   |               |       |              |       |
| **Assets**                                                               |   |               | ** ** |              | ** ** |
| Current assets:                                                          |   |               |       |              |       |
| Cash and cash equivalents                                                |   | $                  | 11,974     |              | $          | 31,565 |   |
| Accounts receivable, net                                                 |   | 2,453              |       | 2,309             |       |
| Prepaid expenses                                                         |   | 989                |       | 2,289             |       |
|                                                                     |   |               |       |              |       |
| Total current assets                                                     |   | 15,416             |       | 36,163            |       |
| Property and equipment, net                                              |   | 1,918              |       | 4,261             |       |
| Other assets                                                             |   | 996                |       | 1,292             |       |
|                                                                     |   |               |       |              |       |
| Total assets                                                             |   | $                  | 18,330     |              | $          | 41,716 |   |
|                                                                     |   |               |       |              |       |
|                                                                     |   |               |       |              |       |
| **Liabilities  & Stockholders' Equity**                              |   |               | ** ** |              | ** ** |
| Current liabilities:                                                     |   |               |       |              |       |
| Accounts payable                                                         |   | $                  | 2,064      |              | $          | 2,796 |   |
| Accrued liabilities                                                      |   | 1,945              |       | 3,970             |       |
| Accrual for restructuring                                                |   | 1,137              |       | -                 |       |
| Deferred revenue                                                         |   | 142                |       | 249               |       |
|                                                                     |   |               |       |              |       |
| Total current liabilities                                                |   | 5,288              |       | 7,015             |       |
| Long-term liabilities                                                    |   | 122                |       | 99                |       |
|                                                                     |   |               |       |              |       |
| Total liabilities                                                        |   | 5,410              |       | 7,114             |       |
|                                                                     |   |               |       |              |       |
| Stockholders' equity                                                     |   |               |       |              |       |
| Common stock, $0.001 par  value:                                         |   |               |       |              |       |
| Authorized: 100,000 shares                                               |   |               |       |              |       |
| Issued and outstanding:  17,324 shares in 2001 and 18,016 shares in 2000 |   | 18                 |       | 18                |       |
| Treasury stock, 139 shares  in 2001, and none in 2000                    |   | (56                | )          | -                 |       |
| Additional paid-in capital                                               |   | 145,553            |       | 146,334           |       |
| Unearned stock-based  compensation                                       |   | (7,043             | )          | (11,999           | )          |
| Accumulated deficit                                                      |   | (125,552           | )          | (99,751           | )          |
|                                                                     |   |               |       |              |       |
| Total stockholders' equity                                               |   | 12,920             |       | 34,602            |       |
|                                                                     |   |               |       |              |       |
| Total liabilities and  stockholders' equity                              |   | $                  | 18,330     |              | $          | 41,716 |   |

 

The accompanying notes are an integral part of these condensedconsolidated financial statements.

 

 

**IMPROVENET,INC.**

### **CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

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

 
|                                                                                                                   |   | **THREE  MONTHS ENDED** |   | **NINE  MONTHS ENDED** |   |
|------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                                                                   |   | **SEPTEMBER  30,**      |   | **SEPTEMBER  30,**     |   |
|                                                                                                                   |   | **2001**                |   | **2000**               |   | **2001** |   | **2000** |   |
|                                                                                                                   |   | **(UNAUDITED)**         |   | **(UNAUDITED)**        |   | **(UNAUDITED)** |   | **(UNAUDITED)** |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Revenues                                                                                                               |   |                    |   |                   |   |   |   |   |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Service revenues                                                                                                       |   | $                       | 1,597  |                   | $      | 1,277 |   | $ | 4,562 |   | $ | 3,332 |   |
| Marketing revenues                                                                                                     |   | 325                     |   | 778                    |   | 1,170 |   | 2,034 |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Total revenues                                                                                                         |   | 1,922                   |   | 2,055                  |   | 5,732 |   | 5,366 |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Cost of Revenues                                                                                                       |   |                    |   |                   |   |   |   |   |   |
| Cost of service revenues  (excludes stock-based compensation of $86 and $297 in 2001 and $146 and $503  in 2000)       |   |                    |   |                   |   |   |   |   |   |
|                                                                                                                   |   | 1,283                   |   | 1,409                  |   | 3,671 |   | 3,725 |   |
| Cost of marketing revenues  (excludes stock- based compensation of $33 and $116 in 2001 and $57 and $214  in 2000)     |   |                    |   |                   |   |   |   |   |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
|                                                                                                                   |   | 88                      |   | 107                    |   | 314 |   | 282 |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Total cost of revenues                                                                                                 |   | 1,371                   |   | 1,516                  |   | 3,985 |   | 4,007 |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Gross profit                                                                                                           |   | 551                     |   | 539                    |   | 1,747 |   | 1,359 |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Operating expenses:                                                                                                    |   |                    |   |                   |   |   |   |   |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Sales & marketing  (excludes stock-based compensation of $1,228 and $3,370 in 2001 and $1,256  and $4,414 in 2000) |   | 3,199                   |   | 9,759                  |   | 14,094 |   | 32,719 |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Product development  (excludes stock-based compensation of $0 and $0 in 2001 and $6 and $(44) in  2000)                |   | 735                     |   | 1,006                  |   | 2,731 |   | 4,150 |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| General &  administrative (excludes stock-based compensation of $12 and $183 in 2001 and  $(187) and $652 in 2000) |   | 1,185                   |   | 2,240                  |   | 3,811 |   | 6,612 |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Stock-based compensation                                                                                               |   | 1,358                   |   | 1,278                  |   | 3,966 |   | 5,739 |   |
| Restructuring charges                                                                                                  |   | 1,448                   |   | -                      |   | 3,621 |   | - |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Total operating expenses                                                                                               |   | 7,925                   |   | 14,283                 |   | 28,223 |   | 49,220 |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Operating loss                                                                                                         |   | (7,374                  | )      | (13,744                | )      | (26,476 | ) | (47,861 | ) |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Interest income                                                                                                        |   | 28                      |   | 817                    |   | 675 |   | 2,042 |   |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Net loss                                                                                                               |   | $                       | (7,346 | )                      | $      | (12,927 | ) | $ | (25,801 | ) | $ | (45,819 | ) |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Basic & diluted net  loss per share                                                                                |   | $                       | (0.42  | )                      | $      | (0.79 | ) | $ | (1.47 | ) | $ | (3.68 | ) |
|                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Weighted average shares  used in calculating basic and diluted net loss per share                                      |   | 17,294                  |   | 16,446                 |   | 17,503 |   | 12,467 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

 

**IMPROVENET,INC.**

### **CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Inthousands)**

 

 
|                                                                         |   | **NINE  MONTHS ENDED** |    |
|------------------------------------------------------------------------------|--------|------------------------|---------|
|                                                                         |   | **SEPTEMBER  30,**     |    |
|                                                                         |   | **2001**               |    | **2000** |   |
|                                                                         |   | **(UNAUDITED)**        |    | **(UNAUDITED)** |   |
|                                                                         |   |                   |    |   |   |
| **Cash flows  from operating activities:**                                   |   |                   |    |   |   |
| Net loss                                                                     |   | $                      | (25,801 | ) | $ | (45,819 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities: |   |                   |    |   |   |
| Depreciation and  amortization                                               |   | 1,081                  |    | 907 |   |
| Loss on disposal of  property                                                |   | 5                      |    |   |   |
| Restructuring charges net  of cash expenditures                              |   |                   |    |   |   |
| Reduction in force                                                           |   | 294                    |    | - |   |
| Facilities exit costs                                                        |   | 843                    |    | - |   |
| Asset write-downs                                                            |   | 1,588                  |    | - |   |
| Allowance for doubtful  accounts                                             |   | 307                    |    | 792 |   |
| Amortization of stock based  compensation                                    |   | 3,966                  |    | 5,907 |   |
| Warrant charges amortized                                                    |   | 253                    |    | 84 |   |
| Notes receivable from  related party                                         |   | (120                   | )       | - |   |
| Net change in operating  assets and liabilities:                             |   |                   |    |   |   |
| Accounts receivable                                                          |   | (451                   | )       | (2,549 | ) |
| Prepaid expenses                                                             |   | 1,300                  |    | (2,043 | ) |
| Other assets                                                                 |   | 239                    |    | 474 |   |
| Accounts payable and  accrued liabilities                                    |   | (2,757                 | )       | 1,781 |   |
| Deferred revenue                                                             |   | (107                   | )       | 104 |   |
| Other long-term liabilities                                                  |   | 23                     |    | (39 | ) |
|                                                                         |   |                   |    |   |   |
| Net cash used in operating  activities                                       |   | (19,337                | )       | (40,401 | ) |
|                                                                         |   |                   |    |   |   |
| **Cash flows  from investing activities:**                                   |   |                   |    |   |   |
| Purchase of property and  equipment                                          |   | (213                   | )       | (3,473 | ) |
| Restricted cash                                                              |   | (61                    | )       | (7 | ) |
| Issuance of note receivable  to related party                                |   | -                      |    | (1,000 | ) |
|                                                                         |   |                   |    |   |   |
| Net cash used in investing  activities                                       |   | (274                   | )       | (4,480 | ) |
|                                                                         |   |                   |    |   |   |
| **Cash flows  from financing activities:**                                   |   |                   |    |   |   |
|                                                                         |   |                   |    |   |   |
| Proceeds from issuance of  common stock, net of offering costs               |   | -                      |    | 39,075 |   |
| Proceeds from exercise of  stock options/warrants/ESPP                       |   | 76                     |    | 566 |   |
| Payment for treasury stock  purchase                                         |   | (56                    | )       | - |   |
| Repayment of stockholder  notes receivable                                   |   | -                      |    | 5 |   |
| Net cash provided by  financing activities                                   |   | 20                     |    | 39,646 |   |
|                                                                         |   |                   |    |   |   |
| **Net  decrease in cash and cash equivalents**                               |   | (19,591                | )       | (5,235 | ) |
|                                                                         |   |                   |    |   |   |
| **Cash and  cash equivalents, beginning of period**                          |   | 31,565                 |    | 45,291 |   |
|                                                                         |   |                   |    |   |   |
| **Cash and  cash equivalents, end of period**                                |   | $                      | 11,974  |   | $ | 40,056 |   |

 

The accompanying notes are anintegral part of these condensed consolidated financial statements.

 

 

**IMPROVENET, INC.**

 

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

 

**1. Formation and Business of the Company**

 

***                Nature of the business***

 

                ImproveNet, Inc. ("ImproveNet" orthe "Company") (formerly Netelligence, Inc.) was incorporated inCalifornia in January 1996 and reincorporated in Delaware in September 1998.The Company is a source for home improvement services.   The Company generates quality job leads forservice providers, including contractors, designers, and architects, frominterested homeowners within their geographic area using its proprietarymatching service.  In addition, theCompany provides marketing services on behalf of home improvements suppliers(including manufacturers, distributors, and financial services companies) whowish to advertise their services to the Company’s service provider andhomeowner audiences. On October 15, 2001 the Company launched its PremiereServices program, which offers the consumer the opportunity to have ImproveNet,Inc. to act as the contractor of record for selected remodeling projects.

 

                ***Basis of Presentation***

 

                The accompanying interim condensedconsolidated financial statements as of September 30, 2001 and for the threeand nine months ended September 30, 2001 and 2000 are unaudited. The unauditedinterim condensed consolidated financial statements have been prepared on thesame basis as the annual condensed consolidated financial statements and, inthe opinion of management, reflect all adjustments, which are of a normalrecurring nature, necessary to present fairly the Company's financial positionas of September 30, 2001, results of operations for the three and nine monthsended September 30, 2001 and 2000, and cash flows for the nine months endedSeptember 30, 2001 and 2000. The Company's results for an interim period arenot necessarily indicative of the results that may be expected for the year.

 

                Although the Company believes that alladjustments necessary for a fair presentation of the interim periods presented areincluded and that the disclosures are adequate, these condensed consolidatedfinancial statements and notes thereto are unaudited and should be read inconjunction with the audited condensed consolidated financial statements andnotes thereto for the year ended December 31, 2000 included in the Company'sannual report on Form 10-K filed on April 10, 2001 with the Securities andExchange Commission derived from audited financial statements. Such disclosuresare contained in the Company’s annual report on Form 10-K.

 

                The Company has completed several rounds ofprivate equity financing and raised, in its initial public offering,approximately $39.7 million, net of issuance cost, in March 2000. However, theCompany has incurred substantial negative cash flows from operations in everyfiscal period since inception. For the year ended December 31, 2000, theCompany incurred a loss from operations of approximately $57.8 million andnegative cash flows from operations of approximately $49.3 million. As of September30, 2001 the Company had an accumulated deficit of approximately $125.6million.  Management expects operatinglosses and negative cash flows to continue for the foreseeable future.

 

                The Company expects that losses will decreasefrom fiscal year 2000 levels due to new sales initiatives and operational costefficiencies, through decreased marketing expenditures and reduced headcountlevels. Operational cost efficiency restructuring has already been initiated -the Company reduced headcount by 7% in July 2000, by 25% in March 2001, andfurther reduced headcount by another 30% in September 2001.  The Company had approximately $12.0 millionof cash and cash equivalents at September 30, 2001. Failure to generate sufficientrevenues, raise additional capital or reduce operational discretionary spendingcould have a material adverse effect on the Company's ability to continue as agoing concern and to achieve its intended business objectives.

 

**2. Net Loss Per Share**

 

                Basic net loss per share is calculated by dividingnet loss by the average number of outstanding shares during the period. Dilutednet loss per share is calculated by adjusting the average number of outstandingshares 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 share, as theireffect would have been anti-dilutive.

                Options topurchase approximately 767,000 shares and warrants to purchase approximately1.3 million shares were outstanding as of September 30, 2001.

 

                A reconciliation of the numerator anddenominator used in the calculation of the basic and diluted net loss per sharefollows: (in thousands, except per share amounts):

 
|                                           |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|------------------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                                           |   | **September 30,**      |   | **September 30,**     |   |
|                                           |   |                   |   |                  |   |   |   |   |   |
|                                           |   | **2001**               |   | **2000**              |   | **2001** |   | **2000** |   |
|                                           |   |                   |   |                  |   |   |   |   |   |
| Numerator                                      |   |                   |   |                  |   |   |   |   |   |
|                                           |   |                   |   |                  |   |   |   |   |   |
| Net loss attributable to  stockholders         |   | $                      | (7,346 | )                     | $      | (12,927 | ) | $ | (25,801 | ) | $ | (45,819 | ) |
|                                           |   |                   |   |                  |   |   |   |   |   |
| Denominator                                    |   |                   |   |                  |   |   |   |   |   |
| Weighted average shares                        |   | 17,427                 |   | 16,809                |   | 17,892 |   | 12,961 |   |
|                                           |   |                   |   |                  |   |   |   |   |   |
| Weighted average shares  subject to repurchase |   | (133                   | )      | (363                  | )      | (389 | ) | (494 | ) |
|                                           |   |                   |   |                  |   |   |   |   |   |
| Denominator for basic and  diluted calculation |   | 17,294                 |   | 16,446                |   | 17,503 |   | 12,467 |   |
|                                           |   |                   |   |                  |   |   |   |   |   |
| Basic and diluted net loss  per share          |   | $                      | (0.42  | )                     | $      | (0.79 | ) | $ | (1.47 | ) | $ | (3.68 | ) |

 

**3. Multi-Year Commercial Contracts**

 

                The Company has entered into multi-yearcommercial marketing contracts, some of which are with related parties. Thesecommercial contracts generally provide marketing services that include a mix ofbanners and button advertising, SmartLeads and other marketing services,including FIND-A-CONTRACTOR or POWERED BY IMPROVENET, plus a continuouspresence, on the Company's Web sites for a fixed annual fee. These commercialcontracts are for periods ranging between 2 and 12 years, including renewaloptions. These commercial contracts also include cooperative marketingarrangements under which the Company is obligated to spend 50% to 100% of thefees the Company expects to receive. Cooperative marketing expenditures are incurred on behalf of thesecommercial parties for principally television and print media.  In return, the Company expects to receivesignificant marketing benefits including better advertising rates, strongerbrand recognition, and access to customer databases, direct mail inserts andmarketing resources - all designed to generate more traffic to the Company’ssites and jobs to its proprietary matching services.

 

                As the Company does not have an establishedhistorical practice of selling advertising for cash for similar multi-yearcommercial contracts, the Company has not assigned any value to the exchange ofservices or barter element of these transactions and accordingly, the Companyhas not recorded either revenue or sales and marketing expense for the barterelement. However, some of these multi-year commercial contracts do generate anoverall net cash component to the Company, and in these cases, the Company hasrecorded revenue based on the cash received or receivable under the contract,net of the obligation, if any, to reimburse the commercial party for thecooperative marketing and other marketing services. These revenues arerecognized over the term of the commercial contract once marketing and otherservices have been delivered to the commercial party and collection of theresulting net receivable is deemed probable.

 

                Furthermore, in connection with certain ofthese multi-year commercial contracts, the Company also issued warrants topurchase shares of the Company's common stock to the commercial parties. Thesewarrants have been valued by the Company using the Black Scholes option pricingmodel.  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.

 

**4. Segment Information**

 

                The Company currently operates in a singlebusiness segment, as there is only one measurement of profitability for itsoperations.  Through September 30, 2001,foreign operations have not been significant in either revenues or investmentsin long-lived assets.

 

A summary of the Company’s revenuesby service offerings is as follows (in thousands):

 
|                   |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|------------------------|--------|------------------------|--------|-----------------------|--------|
|                   |   | **September 30,**      |   | **September 30,**     |   |
|                   |   |                   |   |                  |   |   |   |   |   |
|                   |   | **2001**               |   | **2000**              |   | **2001** |   | **2000** |   |
|                   |   |                   |   |                  |   |   |   |   |   |
| Service revenues:      |   |                   |   |                  |   |   |   |   |   |
|                   |   |                   |   |                  |   |   |   |   |   |
| Lead fees              |   | $                      | 298    |                  | $      | 421 |   | $ | 1,109 |   | $ | 1,066 |   |
| Win fees               |   | 1,245                  |   | 792                   |   | 3,223 |   | 2,132 |   |
| Other fees             |   | 54                     |   | 64                    |   | 231 |   | 133 |   |
|                   |   |                   |   |                  |   |   |   |   |   |
| Total service revenues |   | 1,597                  |   | 1,277                 |   | 4,563 |   | 3,332 |   |
| Marketing revenue      |   | 325                    |   | 778                   |   | 1,170 |   | 2,034 |   |
|                   |   |                   |   |                  |   |   |   |   |   |
| Total revenues         |   | $                      | 1,922  |                  | $      | 2,055 |   | $ | 5,733 |   | $ | 5,366 |   |

 

For the nine month period endedSeptember 30, 2001 one customer represented approximately 12% of totalrevenues.  No other customersrepresented over 10% of total revenues.

 

 

**5. Comprehensive Loss**

 

                The Company follows SFAS No. 130,"Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No.130 establishes standards for reporting and display of comprehensive income andits components in a full set of general-purpose financial statements. There wasno difference between the Company's net loss and its comprehensive loss for anyof the periods presented in the accompanying condensed consolidated statementsof operations.

 

**Recent Accounting Pronouncements**

 

                In June 2001, the Financial AccountingStandards Board (FASB) issued Statement of Financial Accounting Standard (SFAS)No. 141, "Business Combinations" and SFAS No. 142, "Goodwill andOther Intangible Assets". SFAS 141 requires the purchase method ofaccounting be used for all business combinations initiated after June 30, 2001.Use of the pooling-of-interests method is prohibited. SFAS141 also provides newcriteria to determine whether an acquired intangible asset should be recognizedseparately from goodwill.

                Upon adoption of SFAS 142,amortization of existing goodwill would cease and the remaining book valuewould be tested for impairment at least annually at the reporting unit levelusing a new two-step impairment test. Amortization of goodwill recorded onequity investments would also cease, but this embedded goodwill will continueto be tested for impairment under current accounting rules for equityinvestments. In addition, we will have adjustments to the equity in net incomeof affiliates line item to reflect the impact of adopting these new statementson the operations of our equity investments. We will adopt both statements on January 1, 2002 and are currentlyevaluating the impact of these statements.

 

                We have not yet quantified the impact ofthese statements on the operations of our equity investments. Annual pre-taxamortization expense of our existing and embedded goodwill for 2001 will be approximately$133,000.  During 2002, we will perform the first of the required impairmenttests of goodwill as of January 1,2002, and we have not yet determined what theeffect of these tests will be on our earnings and financial position. Anyimpairment resulting from our initial application of the statements will berecorded as a cumulative effect of accounting change as of January 1, 2002.

 

**6. Related Party Transactions**

 

***NotesReceivable from Officer***

 

                In May 1999, the Company entered into anemployment related promissory note agreement with its Chairman and ChiefExecutive Officer, Ronald B. Cooper, whereby the Company agreed to loan theofficer up to $500,000. The full amount was loaned in August 1999. The noteaccrues interest at 5.25% per annum and is due and payable on the earlier ofApril 1, 2002 or within 90 days after the voluntary termination of theofficer's employment or the termination of the officer's employment for cause.The note is collateralized by the officer's shares of stock and options topurchase shares of stock. In April 2000, the Company loaned its Chairman andChief Executive Officer $1.0 million accruing interest at a rate of 6.46% perannum and repayable on the earlier of April 30, 2002 or when the borrower isable to collateralize or borrow on margin using his Company stock. Both loansare collateralized by the stock owned by the borrower. In accordance with FAS114 “Accounting by Creditors for Impairment of a Loan", these notesreceivable were valued at the market value of the stock held as collateral.

 

                In July 2001, the Board of Directorsdetermined that it was in the best interests of the Company to settle the twonon-recourse loans in order to retain Ronald B. Cooper as President andCEO.  The additional write down of thetwo non-recourse notes was approximately $178,000 on September 30, 2001 toreflect the fair market value during the period.  In July 2001, ImproveNet, Inc. repurchased all outstanding stock,which had been collateralized against the notes, totaling 400,000 shares with afair market value of approximately $120,000. Ronald B. Cooper remains a less than 5% shareholder in ImproveNet, Inc.

 

**7. Restructuring Accrual**

 

                In March 2001 the Company announced arestructuring plan to reduce costs and improve productivity which resulted in arestructuring charge in the first quarter of 2001 of $1,992,000 and $181,000 inthe second quarter.  In September 2001,the Company announced an additional restructuring plan in an effort to reducecosts, which totaled  $1,448,000 andincluded the additional termination of employees and the closure of itsCamarillo facilities located in Southern California.

 

                Of the total restructuring charge of approximately$3.6 million, $629,000 relates to employee termination benefits related to thefirst quarter restructuring and $209,000 relates to employee terminationbenefits for the third quarter restructuring, for a total workforcerestructuring charge of $838,000.  Thecompany terminated approximately 55 employees as of April 1, 2001 and 46additional employees in September 2001. At the end of the third quarter $545,000 of the termination benefits hadbeen paid.  This resulted in a remainingliability of  $293,000 at September 30,2001 which is expected to be fully utilized by the first quarter of 2002.

 

                The Company has downsized its facilities inNorthern California in order to increase efficiencies.  The restructuring charge of $593,000 in thefirst quarter and $181,000 in the second quarter relate to facility exit costsand the calculation is based on current market conditions with this amountbeing reviewed by management on a quarterly basis.  An additional $421,000 of restructuring charges for both the Camarilloand the Northern California facilities was recorded in the third quarter.  After subtracting rental payments madeduring the quarter of $167,000 in the second quarter and $184,000 in the thirdquarter the balance at the end of the third quarter is $844,000.

                Under therestructuring plan the company took a charge of $770,000 and $818,000 net ofsalvage value, in the first and third quarters, respectively, for thewrite-down of assets included in property, plant and equipment.  These assets primarily includedoffice furniture and equipment.

 

                The restructuring charges were determinedbased on formal plans approved by the Company's management using the bestinformation available to it at the time. The amounts the Company may ultimatelyincur may change as the restructuring initiative is executed.

 

The activity impacting theaccrual for restructuring charges during 2001 are summarized in the tablebelow:

 
|                                                            |   |           |   | **Workforce**  |   | **Asset write-** |   |      |   |
|-----------------------------------------------------------------|--------|----------------|--------|----------------|--------|------------------|--------|-----------|--------|
| (In  thousands)                                                 |   | **Facilities** |   | **reductions** |   | **downs**        |   | **Total** |   |
|                                                            |   |           |   |           |   |             |   |      |   |
| Balance  at December 31, 2000                                   |   | $              | -      |           | $      | -                |   | $         | -      |   | $ | - |   |
|                                                            |   |           |   |           |   |             |   |      |   |
| Charges  to operations in three months ended March 31, 2001     |   | 593            |   | 629            |   | 770              |   | 1,992     |   |
|                                                            |   |           |   |           |   |             |   |      |   |
| Charges  utilized in three months ended March 31, 2001          |   | -              |   | -              |   | -                |   | -         |   |
|                                                            |   |           |   |           |   |             |   |      |   |
| Balance  at March 31, 2001                                      |   | 593            |   | 629            |   | 770              |   | 1,992     |   |
|                                                            |   |           |   |           |   |             |   |      |   |
| Charges  to operations in three months ended June 30, 2001      |   | 181            |   | -              |   | -                |   | 181       |   |
|                                                            |   |           |   |           |   |             |   |      |   |
| Charges  utilized in three months ended June 30, 2001           |   | (167           | )      | (411           | )      | (770             | )      | (1,348    | )      |
|                                                            |   |           |   |           |   |             |   |      |   |
| Balance  at June 30, 2001                                       |   | 607            |   | 218            |   | -                |   | 825       |   |
|                                                            |   |           |   |           |   |             |   |      |   |
| Charges  to operations in three months ended September 30, 2001 |   | 421            |   | 209            |   | 818              |   | 1,448     |   |
|                                                            |   |           |   |           |   |             |   |      |   |
| Charges  utilized in three months ended September 30, 2001      |   | (184           | )      | (134           | )      | (818             | )      | (1,136    | )      |
|                                                            |   |           |   |           |   |             |   |      |   |
| Balance  at September 30, 2001                                  |   | 844            |   | 293            |   | -                |   | 1,137     |   |
|                                                                 |        |                |        |                |        |                  |        |           |        |  |  |  |  |

 

**ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

                The following discussion and analysis shouldbe read with our condensed consolidated financial statements and notes includedelsewhere in this Report on Form 10-Q. The discussion in this Report on Form10-Q contains forward-looking statements that involve risks and uncertainties,such as statements of our plans, objectives, expectations and intentions. Thecautionary statements made in this Report on Form 10-Q should be read asapplying to all related forward-looking statements wherever they appear in thisReport on Form 10-Q. Our actual results could differ materially from thosediscussed here. Factors that could cause or contribute to these differencesinclude those discussed in "Business Risks" below as well as thosediscussed elsewhere.

 

**OVERVIEW**

 

                Our business started in January 1996 as aregional contractor matching service, and we spent most of 1996 and 1997building our service provider database, developing new services and technology,recruiting personnel and raising capital. We launched our Web site andhomeowner/service provider matching service on a national scale in August 1997.In December 1998, we began selling Web site advertising, including SmartLeadsservices, a way for suppliers of home improvement products to send targetedmessages about their products, including product promotions, to homeowners atthe time of purchase, as well as to our network of service providers. In March1999, we began to hire our new 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, for national suppliers of home improvement andrepair products. We completed the acquisition of two regional contractorreferral companies, Contractor Referral Service, LLC and The J.L. PriceCorporation, in September and November 1999, these entities were integratedinto our operations during the course of calendar year 2000.  In March 2000, we completed our IPO.  From January through June 2000 we spentsubstantial amounts primarily on marketing and other marketing relatedactivities, as well as the development and expansion of our service andoperations infrastructure. In July 2000 we had a reduction in force, reducingour staff by approximately 7%. Additionally, in March 2001 we restructured our operations, resulting ina staff reduction of 25% and we closed our largest facility in Redwood City,California.  A further reduction instaff of 29% and the closure of our Camarillo, California facility occurred inSeptember 2001.  We estimate that thecumulative effect of our restructuring activities, in combination with otheroperating efficiencies, will reduce pro forma annualized operating expenses bymore than 35 percent to approximately $19 million in calendar year 2002 versusapproximately $30 million in calendar year 2001 and $60 million in calendaryear 2000.

 

                We currently generate the majority of ourrevenues from service provider referral services, installed sales services,marketing packages and advertisements placed on our Web site. We generateservice revenues primarily in the form of lead fees and win fees from ourservice providers and, to a much lesser extent, other fees for the enrollmentof service providers.  We generateinstalled sales revenue from the fees that we charge home improvement suppliers(primarily Home Depot) to provide labor services when they sell products on aninstalled basis. We generate marketing revenues from the sale of banner, buttonand other advertising on our Web sites, and from the sale to suppliers ofSmartLeads generated from the traffic of homeowners visiting our Web sites andfrom the sale of Find-A-Contractor or Powered by ImproveNet products incommercial agreements. Our marketing revenues generally come from suppliers ofhome improvement products.

 

                As part of the restructuring initiativesoccurring in September 2001 ImproveNet’s field sales team and inside supportorganization will focus primarily on Premiere Services, which includesInstalled Sales for home improvement retailers and Managed Repair of insuranceand warranty claims, as well as upcoming new homeowner offerings with extensiveproject support.

 

**RESULTS OF OPERATIONS**

 

***REVENUES***

 

                Our revenues decreased to approximately $1.9million for the three months ended September 30, 2001 from approximately $2.1million for the three months ended September 30, 2000, a decrease of $133,000or 6%. For the nine months ended September 30, 2001, revenues increased toapproximately $5.7 million as compared to approximately $5.4 million for thenine months ended September 30, 2000, an increase of $366,000 or 7%.

 

                The decline in revenues for the 3rd quarter2001 is primarily due to the overall decline in the market for advertisingservices.

 

                The following table and discussion highlightsour revenues for the three and nine months ended September 30, 2001 and 2000(in thousands):

 
|              |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|-------------------|--------|------------------------|--------|-----------------------|--------|
|              |   | **September 30,**      |   | **September 30,**     |   |
|              |   |                   |   |                  |   |   |   |   |   |   |   |   |   |
|              |   | **2001**               |   | **2000**              |   | **% Change** |   | **2001** |   | **2000** |   | **% Change** |   |
|              |   |                   |   |                  |   |   |   |   |   |   |   |   |   |
| Revenues:         |   |                   |   |                  |   |   |   |   |   |   |   |   |   |
|              |   |                   |   |                  |   |   |   |   |   |   |   |   |   |
| Service revenue   |   | $                      | 1,597  |                  | $      | 1,277 |   | 25 | % | $ | 4,562 |   | $ | 3,332 |   | 37 | % |
| Marketing revenue |   | 325                    |   | 778                   |   | -58 | % | 1,170 |   | 2,034 |   | -42 | % |
|              |   |                   |   |                  |   |   |   |   |   |   |   |   |   |
| Total revenues    |   | $                      | 1,922  |                  | $      | 2,055 |   | -6 | % | $ | 5,732 |   | $ | 5,366 |   | 7 | % |

 

***ServiceRevenues***

 

                Service revenues increased to approximately$1.6 million for the three months ended September 30, 2001 from approximately$1.3 million for the three months ended September 30, 2000, an increase of$320,000 or 25%. For the nine months ended September 30, 2001, revenuesincreased to approximately $4.6 million as compared to approximately $3.3million for the nine months ended September 30, 2000, an increase ofapproximately $1.2 million or 37%.  Theincrease in revenues was attributable to a combination of changes to theCompany’s fee structure, and growth in the installed sales revenue.

 

                Service revenues consists of lead fees thatour service providers pay to bid a job, win fees that they pay if they areawarded the job, and enrollment fees that they pay to participate in ournetwork.  The following table detailsthe components of service revenues, based on a percentage of service revenues:

 
|                  |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|-----------------------|--------|------------------------|--------|-----------------------|--------|
|                  |   | **September 30,**      |   | **September 30,**     |   |
|                  |   | **2001**               |   | **2000**              |   | **2001** |   | **2000** |   |
|                  |   | **%**                  |   | **%**                 |   | **%** |   | **%** |   |
|                  |   |                   |   |                  |   |   |   |   |   |
| Lead Fees             |   | 19                     |   | 33                    |   | 24 |   | 32 |   |
| Win Fees              |   | 78                     |   | 62                    |   | 71 |   | 64 |   |
| Other Fees            |   | 3                      |   | 5                     |   | 5 |   | 4 |   |
|                  |   |                   |   |                  |   |   |   |   |   |
| Total Service Revenue |   | 100                    |   | 100                   |   | 100 |   | 100 |   |

 

                Lead fee revenues are recognized at the timethe service providers and the homeowner are first matched, while win feerevenues are recognized at the time the service provider or the homeownernotifies us that a job has been sold. For both lead fees and win fees, therecognition of revenues coincides with the service providers' obligation to payus.  Installed sales revenues, which areincluded in lead fees and win fees are recognized when the service is deliveredon behalf of Home Depot, evidence of approval is in place, the project iscomplete, and the fees are fixed and determinable and collectible.  Revenues from new service providerenrollment fees are recognized as revenue ratably over the expected period theyparticipate in our contractor matching service, which is initially estimated tobe one year.

 

                The revenues we generate from lead and winfees are largely a function of:

•      thenumber of job submissions;

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

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

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

 

The following table providesinformation on some of our key business metrics (numbers in thousands):

 
| **Key Metrics**                         |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|-----------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                                    |   | **September 30,**      |   | **September 30,**     |   |
|                                    |   | **2001**               |   | **2000**              |   | **2001** |   | **2000** |   |
|                                    |   |                   |   |                  |   |   |   |   |   |
| Job submissions                         |   | 28.7                   |   | 41.7                  |   | 98.6 |   | 106.0 |   |
| Matched jobs                            |   | 16.6                   |   | 31.6                  |   | 62.3 |   | 76.0 |   |
| Won jobs                                |   | 2.4                    |   | 3.2                   |   | 8.4 |   | 8.4 |   |
|                                    |   |                   |   |                  |   |   |   |   |   |
| Matched jobs as a % of job  submissions |   | 57.8                   | %      | 76                    | %      | 63.2 | % | 72 | % |
|                                    |   |                   |   |                  |   |   |   |   |   |
| Won jobs as a % of job  submissions     |   | 8.4                    | %      | 7.7                   | %      | 8.5 | % | 8 | % |

 

                The decline in job submissions was dueprimarily to softer economic conditions and the impact of recent world eventsupon the repair and remodeling industry. The decrease in matched jobs as a percentage of job submissionsreflected reduced availability of our key service providers along with anincreased focus on bidding jobs that have higher win rates.  The increase in won jobs as a percentage ofjob submissions also reflects the focus on bidding jobs with higher win ratesas well as the effect of pricing changes. Specifically, in calendar year 2000, and for calendar year 2001 throughMarch 31, 2001, the win fees that we charged to our service providers dependedon project size and ranged from 2% to 10% of the estimated cost of the job, upto a maximum of $995 per job.  EffectiveMarch 22, 2001, the win fees we charged our service providers depended onproject size and ranged from 1% to 10% of the estimated cost of the job,without a maximum per job.  As ofOctober 15, 2001, additional pricing changes were announced wherein serviceproviders pay an individual lead fee based on the budgeted dollar value of thejob.  This lead fee ranges from $10 to$100.  Additionally our serviceproviders pay a fee of 1% (based on actual contract value) for all jobs theywin.  The win fee is waived for all jobswith an actual contract value less than $2,500.

 

**Marketing Revenues**

 

                Marketing revenues decreased to $325,000 forthe three months ended September 30, 2001 from $778,000 for the three monthsended September 30, 2000, a decrease of $453,000 or 58%. For the nine monthsended September 30, 2001, revenues decreased to approximately $1.2 million ascompared to approximately $2.0 million for the nine months ended September 30,2000, a decrease of $864,000 or 43%.

 

                We generate marketing revenues from the saleof banner, 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 in commercial agreement products and services. In the 2nd quarter of2001, we launched our Pro Partners Contractor and marketing program, in whichwe provide sales and marketing services to our network of service providers forwhich we are paid a fee based upon their purchases. Our marketing revenuesgenerally come from suppliers of home improvement products.

 

                We anticipate that advertising revenues willcontinue to decline during 2001 as internet advertising spending slows andadvertisers demand better monetary terms for the same number of impressions ormore impressions for the same dollar amounts. Revenues from the Pro Partners contract and marketing program have notprovided significant additional revenue during the remainder of 2001 but areexpected to grow in 2002.

***CashAdvertising***

 

                Cash advertising revenues generally arederived from short-term advertising contracts in which we typically guaranteethat a minimum number of impressions will be delivered to our Web site visitorsover a specified period of time for a fixed fee. Cash advertising revenues frombanner, button and other Web site advertisements are recognized at the lesserof the amount recorded ratably over the period in which the advertising isdelivered or the percentage of guaranteed impressions delivered.

 

                SmartLeads are also paid for in cash andrevenues are recognized when the SmartLeads have been delivered to thecustomer. Cash advertising is recognized when we have delivered theadvertising, evidence of an agreement is in place and fees are fixed,determinable and collectible. Cash advertising decreased to $14,000 for thethree months ended September 30, 2001 from $256,000 for the three months endedSeptember 30, 2000, a decrease of $242,000 or 95%. For the nine months endedSeptember 30, 2001, cash advertising decreased to $103,000 as compared to$673,000 for the nine months ended September 30, 2000, a decrease of $570,000or 85%. This decline is reflective of the slowdown in advertising spending, particularlyon the Internet.

 

***Multi-yearCommercial Contracts***

 

                Commencing September 1999, we entered intomulti-year commercial contracts, some of which are with related parties. Thesecommercial contracts generally provide for a fixed annual fee, an advertisingor branding package that includes a mix of buttons, banners, SmartLeads andother marketing or branding services, including Find-A-Contractor or Powered byImproveNet, plus a continuous presence, on our Web sites. These commercialcontracts are for periods ranging between 2 and 12 years, including renewaloptions. These commercial contracts also include cooperative marketingarrangements under which we are obligated to fund cooperative brandingexpenditures on television and in the print media, with or on behalf of thecommercial party. Most commercial contracts provide for us to spend 50% to 100%of the fees that we expect to receive. In return, we expect to receivesignificant marketing and branding benefits including better advertising rates,stronger brand recognition, and access to customer databases, direct mailinserts and marketing resources - all designed to generate more traffic tosites and jobs to proprietary matching services.

 

                We do not have an established historicalpractice of selling advertising for cash for similar multi-year commercialcontracts, we have not assigned any value to the exchange of services or barterelement of these transactions and accordingly, we have not recorded eitherrevenue or sales and branding expense for the barter element. However, some ofthese multi-year commercial contracts do generate an overall net cashcomponent, and in these cases we have recorded revenue based on the cashreceived or receivable under the contract, net of the obligation, if any, toreimburse the commercial party for the cooperative branding and other marketingservices. These revenues are recognized over the term of the commercialcontract once advertising and other services have been delivered to thecommercial party and collection of the resulting net receivable is deemedprobable. Revenue from multi-year commercial contracts, net of warrant charges,totaled $306,000 for the three months ended September 30, 2001, and $449,000for the three months ended September 30, 2000. For the nine months endedSeptember 30, 2001 and 2000, revenue from multi-year commercial contracts, netof warrant charges, totaled approximately $1.1 million and for the nine monthsended September 30, 2000 revenue totaled $670,000.

 

                Furthermore, in connection with certain ofthese multi-year commercial contracts, we issued warrants to purchase shares ofour common stock to the commercial parties. These warrants have been valued byus using 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 brandingexpense.

 

                Total revenues may be analyzed as follows (inthousands):

 
|                     |   |                                                                                     |   | **Three Months Ended** |   | **Nine Months Ended** |   |
|--------------------------|--------|------------------------------------------------------------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                     |   |                                                                                     |   | **September 30,**      |   | **September 30,**     |   |
|                     |   |                                                                                     |   | **2001**               |   | **2000**              |   | **2001** |   | **2000** |   |
|                     |   |                                                                                     |   |                   |   |                  |   |   |   |   |   |
| Service revenues         |   |                                                                                     |   | $                      | 1,597  |                  | $      | 1,277 |   | $ | 4,562 |   | $ | 3,332 |   |
|                     |   |                                                                                     |   |                   |   |                  |   |   |   |   |   |
| Marketing revenues       |   |                                                                                     |   | 680                    |   | 1,490                 |   | 2,402 |   | 4,165 |   |
|                     |   |                                                                                     |   |                   |   |                  |   |   |   |   |   |
| Less:                    |   | Amounts invoiced and accrued under multi-year  commercial contracts with related parties |   | (271                   | )      | (628                  | )      | (979 | ) | (1,879 | ) |
|                     |   |                                                                                     |   |                   |   |                  |   |   |   |   |   |
| Less:                    |   | Amortization of warrant stock-based compensation                                         |   | (84                    | )      | (84                   | )      | (253 | ) | (252 | ) |
|                     |   |                                                                                     |   |                   |   |                  |   |   |   |   |   |
| Total marketing revenues |   |                                                                                     |   | 325                    |   | 778                   |   | 1,170 |   | 2,034 |   |
|                     |   |                                                                                     |   |                   |   |                  |   |   |   |   |   |
| Total revenues           |   |                                                                                     |   | $                      | 1,922  |                  | $      | 2,055 |   | $ | 5,732 |   | $ | 5,366 |   |
|                          |        |                                                                                          |        |                        |        |                       |        |  |  |  |  |  |  |  |  |  |  |

 

**OPERATING EXPENSES**

 

***Costof Revenues***

 

                Our total cost of revenues decreased toapproximately $1.4 million for the three months ended September 30, 2001 fromapproximately $1.5 million for the three months ended September 30, 2000, adecrease of $145,000 or 10%. For the nine months ended September 30, 2001, costof revenues remained approximately the same at approximately $4.0 million ascompared to the nine months ended September 30, 2000.

 

                Our cost of service revenues decreased toapproximately $1.3 million for the three months ended September 30, 2001 fromapproximately $1.4 million for the three months ended September 30, 2000, adecrease of $126,000 or 9%. For the nine months ended September 30, 2001, costof service revenues remained approximately the same at $3.7 million as comparedto the nine months ended September 30, 2000.

 

                Our cost of marketing revenues decreased to$88,000 for the three months ended September 30, 2001 from $107,000 for thethree months ended September 30, 2000, a decrease of $19,000 or 18%. For thenine months ended September 30, 2001, cost of marketing revenues increased to$314,000 as compared to $282,000 for the nine months ended September 30, 2000,an increase of $32,000 or 11%.

 

                Total cost of revenues consists of payrolland related costs and occupancy, telecommunications and other administrativecosts for our project services group, which is responsible for all phases ofour proprietary matching services and includes our project advisors. Inaddition, cost of revenues includes an allocation of direct Web site operationscosts, consisting of payroll and related costs, data transmission costs andequipment depreciation.  It alsoincludes subcontractor labor costs for our Installed Sales Services.

 

                The decrease in the cost of service revenuesis a result of the restructuring in the first quarter of 2001, which reducedpayroll and related costs, facilities and related costs, as well as theleveraging of our infrastructure against increased revenues somewhat offset byhigher subcontractor labor costs.  Weanticipate that our cost of service revenues will remain constant or declineduring the remainder of 2001.

***Salesand Marketing***

 

                Our sales and marketing expense decreased toapproximately $3.2 million for the three months ended September 30, 2001 fromapproximately $9.8 million for the three months ended September 30, 2000, adecrease of approximately $6.6 million or 67%. For the nine months endedSeptember 30, 2001, sales and marketing expense decreased to approximately$14.1 million as compared to approximately $32.7 million for the nine monthsended September 30, 2000, a decrease of approximately $18.6 million or 57%.

 

                Our sales and marketing expense includes allof our online and offline direct marketing and advertising, public relationsand trade show expenses. Sales and marketing expenses also include payroll andrelated costs, travel costs and other general expenses of our marketing,professional services and partnership services departments.

 

                The decrease in sales and marketing expenseswas primarily attributable to

•      Renegotiatingor transitioning new or existing agreements from a high fixed cost formula to avariable performance - based formula keyed to won jobs.

•      Reducedonline and offline brand advertising spending, and

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

 

                We fully anticipate that these expenses willcontinue to decline during 2001, as compared to year 2000 as we plan toleverage our existing infrastructure and to continue the process of negotiatingor transitioning agreements from a high fixed cost formula to a variableperformance-based formula keyed to won jobs.

 

***ProductDevelopment***

 

                Our product development expenses decreased to$735,000 for the three months ended September 30, 2001 from approximately $1.0million for the three months ended September 30, 2000, a decrease of $271,000or 27%. For the nine months ended September 30, 2001, product developmentexpenses decreased to approximately $2.7 million as compared to $4.2 millionfor the nine months ended September 30, 2000, a decrease of approximately $1.5million or 36%.

 

                Our product development costs include thepayroll and related costs of our editorial and technology staff, fees forcontract content providers, other costs of Web site design and new technologiesrequired to enhance the performance of our Web sites.

 

                The decrease in product development expenseswere primarily attributable to decreased payroll and related costs anddecreased usage of contract content providers. We expect product development costs to remain at these levels for theforeseeable future.

 

***Generaland Administrative***

 

                Our general and administrative expenses decreasedto approximately $1.2 million for the three months ended September 30, 2001from approximately $2.2 million for the three months ended September 30, 2000,a decrease of approximately $1.0 million or 45%. For the nine months endedSeptember 30, 2001, general and administrative expenses decreased toapproximately $3.8 million as compared to approximately $6.6 million for thenine months ended September 30, 2000, a decrease of approximately $2.8 millionor 42%.  The decrease in general andadministrative expense is a result of restructurings.

 

                Our general and administrative expensesinclude payroll and related costs and travel, recruiting, professional andadvisory services and other general expenses for our executive, finance andhuman resource departments.  We expect General andAdministrative costs to remain at these levels for the foreseeablefuture.

***Restructuring Charges***

 

                During the nine months ended September 30,2001 the Company has announced two major restructuring initiatives to improveoperating efficiencies and support new revenue growth initiatives to driveprofitability.  The first was in March2001 and the second in September 2001.

 

                This resulted in a charge of $629,000 ofreduction in workforce costs, $593,000 of facility costs and $770,000 relatedto asset write-downs incurred in the first quarter of 2001.

 

                During the second quarter, $578,000 of costswas charged against the restructuring accrual of which $411,000 related toemployee termination costs and the remainder to exit facility costs.  An additional $181,000 restructuring chargewas incurred in the quarter, which related to facility costs in NorthernCalifornia.  Due to the currentvolatility of the office leasing industry, management is reviewing these costson a quarterly basis.

 

                ImproveNet announced an additionalrestructuring plan in the third quarter of 2001, in an effort to furtherimprove operating efficiencies which resulted in the charge of $209,000 forreduction in workforce costs, $421,000 of facility costs and $818,000 relatedto asset write-downs.

 

                During the third quarter, a total of$1,136,000 of costs was charged against the restructuring accrual of which$184,000 related to facility exit costs, $134,000 related to employeetermination benefits and the remainder to asset write-downs.

 

***Stock-basedCompensation***

 

                Our stock-based compensation expensesincreased to approximately $1.4 million for the three months ended September30, 2001 from approximately $1.3 million for the three months ended September30, 2000, an increase of $100,000 or 6%. For the nine months ended September30, 2001, stock based compensation expenses decreased to approximately $4.0million as compared to approximately $5.7 million for the nine months endedSeptember 30, 2000, a decrease of approximately $1.7 million or 30%.  The decrease is due to the reductions inworkforce.

 

                In connection with certain employee andnon-employee stock option grants during 1998 and 1999, we recorded unearnedstock-based compensation totaling approximately $13.8 million, which is beingamortized over the vesting periods of the related options, generally four yearsusing the method set out in FASB Interpretation No. 28, or "FIN28".  Under the FIN 28 method, eachvested tranche of options is accounted for as a separate option grant awardedfor past services. Accordingly, the compensation expense is recognized over theperiod during which the services have been provided. This method results inhigher compensation expense in the earlier vesting periods of the related options.Stock based compensation charges associated with employees who terminate theiremployment with us and have unvested options are reversed.

 

***InterestIncome***

 

                Our interest income decreased to $28,000 forthe three months ended September 30, 2001 from $817,000 for the three monthsended September 30, 2000, a decrease of $789,000 or 97%. For the nine monthsended September 30, 2001, interest income decreased to $675,000 as compared toapproximately $2.0 million for the nine months ended September 30, 2000, adecrease of approximately $1.3 million or 66%.

 

                The decrease in interest income isattributable to a decrease in our average invested cash balances. We expect adecline in our interest income during the remainder of 2001 due to the expecteddecline in our cash and cash

equivalents balances during theyear 2001.

***Income Taxes***

 

                We have recorded a 100% valuation allowanceagainst our net deferred tax assets, which arose primarily as a result of ouraggregate operating losses. The valuation allowance will remain at this leveluntil such time as we believe that the realization of the net deferred taxassets is more likely than not. Accordingly, our results of operations do notreflect any tax benefits for our reported losses.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

                Cash and cash equivalents totaledapproximately $12.0 million at September 30, 2001 a decrease of approximately$19.6 million or 62% from approximately $31.6 million at December 31, 2000. Thedecrease primarily came from the approximately $23.5 million cash used inoperating activities which largely reflected our net loss for the period.

 

                Since our inception, we have primarilyfinanced our operations through private sales of our convertible preferredstock and common stock. In March 2000, we closed our initial public offeringthat generated net cash proceeds of approximately $39.7 million. Our primarycapital needs have been to fund our operating losses; the prepayment of ourlarge media purchases and to make capital expenditures.

 

                Net cash used in operating activities wasapproximately $19.3 million in the nine months ended September 30, 2001, adecrease of approximately $21.1 million from approximately $40.4 million forthe nine months ended September 30, 2000, primarily due to a decrease in our netloss after adding back noncash stock-based compensation, other charges, anoverall decrease in accounts receivable, and prepaid expenses, partially offsetby a decrease in accounts payable and accrued liabilities.

 

                A result of our restructurings,  there has been a significant decrease in thepayroll expense and associated cash paid in comparison to the first nine monthsof 2000 as a result of the decrease in average headcount in the period from 276in 2000 to 121 in 2001.  In addition, inthe third quarter of 2001 additional resources have been focused on cashcollections procedures in order to improve our working capital management.

 

                Net cash used in investing activities was$274,000, a decrease of approximately $4.1 million from approximately $4.5million in the periods ended September 30, 2001 and 2000, respectively, due tothe focus of the business in restructuring operations in 2001, and necessarydecreases in capital expenditures. Net cash used in investing activities was aresult of purchase of property and equipment related to upgrading the leasedfacilities at our Oddstad Drive location in Redwood City.

 

                Net cash provided by financing activities hasdecreased by approximately $39.6 million from approximately $39.6 million to$20,000 in the nine month periods ended September 30, 2000 and 2001,respectively, due to the issuance of common stock in connection with ourinitial public offering in the period ended March 31, 2000.

 

                Our capital requirements depend on numerousfactors, including the success of our strategies for generating revenues andthe amount of resources we devote to operating activities, including sales,marketing and brand promotion and investments in our technology.   Our expenditures have substantiallyincreased since inception as our operations and staff have grown. Based on therealignment of our resources, we expect a decrease in most of our operatingexpenses categories detailed above for 2001 as compared to 2000. Additionally,we expect our capital expenditures for 2001 to decrease significantly. Weexpect to experience ongoing operating losses for the foreseeable future. Wecurrently anticipate that our operating expenses, primarily sales and marketingexpenditures, and payroll and related costs will constitute a significant useof our current cash resources.

 

                Our limited operating history and operatinglosses have limited our ability to obtain vendor credit or extended paymentterms and bank financing on favorable terms; accordingly, we depend on our cashand cash equivalent balances to fund our operations.

                We currentlybelieve that our available cash resources will be sufficient to meet ouranticipated needs for operations and capital expenditures for the next 12months.  We will strive to make ongoingrealignments, as required, to achieve positive cash flow with ourexisting cash resources. We restructured our operations and we have reduced ourheadcount during the year ended December 31, 2000 and also in the first andthird quarters of 2001.  We areadditionally decreasing our marketing expenditures to assist us in maintainingour available cash resources. We may need to raise additional funds, however,in order to fund more rapid expansion, to develop new or enhance existingservices, to respond to competitive pressures or to acquire complementarybusinesses, services or technologies. If we raise additional funds by sellingequity securities, the percentage ownership of our stockholders will bereduced. We cannot be sure that additional financing will be available on termsfavorable to us, or at all. If adequate funds are not available on acceptableterms, our ability to fund expansion, react to competitive pressures, or takeadvantage of unanticipated opportunities would be substantially limited. Ifthis occurred, our business would be significantly harmed. We will continue toevaluate our needs for funds based on our assessment of access to public orprivate capital markets and the timing of our need for funds. Although we haveno present intention to conduct additional public equity offerings, we may seekto raise these additional funds through private or public debt or equityfinancings.

 

**RISK FACTORS THAY MAY AFFECT OUR RESULTS OFOPERATIONS AND FINANCIAL CONDITION**

 

                This document contains certainforward-looking statements. These statements relate to future events or ourfuture financial performance. In some cases, you can identify forward-lookingstatements by terminology such as "anticipates', "believes","continue", "could", "estimates","expects", "intends", "plans", "potential","predicts", "should" or "will" or the negative ofthese terms or other comparable terminology which are intended to identifycertain of these forward-looking statements. The cautionary statements made inthis document should be read as being applicable to all related forward-lookingstatements wherever they appear in this document. The Company's actual resultscould differ materially from those discussed in this document. Factors thatcould cause or contribute to such differences include those discussed below, aswell as those discussed in the Company's Annual Report on Form 10-K.

 

**We have large accumulated losses, we expectfuture losses, and we may not achieve or maintain 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, 2001, our accumulated loss was approximately $125.6 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 March 2001 andin September 2001. We will continue to lose money unless we significantlyincrease our revenues. We cannot predict when, if ever, we will operateprofitably.

 

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

 

                We were incorporated in January 1996;however, we did not begin offering home improvement services on the Internetuntil August 1997. In December 1998, we began selling Web site advertising.Until March 1999, we focused primarily on building our network of serviceproviders and refining our matching services processes. In March 1999, we hiredour Chief Executive Officer and commenced recruiting our senior management. InApril 1999, we introduced Powered by ImproveNet, a service that allows thirdparties to offer the ImproveNet matching services and content on their Websites, for national suppliers of home improvement and repair products. InNovember 1999, we launched our customized Web site for service providers. Wecompleted the acquisition of two regional contractor referral companies,Contractor Referral Service, LLC and The J.L. Price Corporation, in Septemberand November 1999. We experienced reductions in force in July 2000. In thesecond half of 2000 we significantly reduced our marketing expenditures. In thefirst and third quarters of 2001, we implemented cost restructuring initiativesthat included a reduction in force of approximately 106 people. Furthermore,even if our business is successful, we may change our business to enter intonew business areas such as our Premeire Services offerings which are in theprocess of launching into selected geographic regions.  These and other new business initiatives areareas in which we do not have extensive experience.

 

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

 

                On June 29, 2001, we received a NasdaqQualification Panel Decision indicating that we have failed to comply with theminimum bid price requirement for continued listing, and were delisted from theNasdaq National Market. Our stock is currently being traded on the Nasdaqover-the-counter bulletin board, however, we believe that our liquidity will besignificantly lower than when it was on the Nasdaq National Market.

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

 

                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 to fund brandpromotions, develop new or enhanced services or respond to competitivepressures. We cannot be certain that we will be able to obtain additionalfinancing on favorable terms, or at all. If we need additional capital andcannot raise it on acceptable terms, we may not be able, among other things,to:

•      developor enhance our services;

•      developor acquire new technologies, products or businesses;

•      expandoperations in the United States or internationally;

•      hire,train and retain employees; or

•      respondto competitive pressures or unanticipated capital requirements.

 

                Our failure to do any of these things couldresult in lower revenues and could harm our business or cause us to discontinueoperations.

 

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

 

**Our financial results will be affected byseasonality and cyclical fluctuations in the home improvement industry.**

 

                Our limited operating history and rapidgrowth make it difficult to assess the impact of seasonal factors on ourbusiness. However, our business is dependent upon the home improvementindustry. As a result, we expect that our revenues may be lower during thefirst and fourth quarters since more homeowners commit to home improvementprojects during the spring and summer months. Being dependent on the homeimprovement industry exposes us to cyclical movements in the economy ingeneral, especially as they relate to consumers willingness to make largeexpenditures that are mostly discretionary. Our limited operating history andthe state of the economy for most of our existence make it difficult to assessthe impact of cyclical factors on our business.

 

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

 

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

 

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

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

 

                Currently most homeowners use traditionalmeans including word-of-mouth referrals, Yellow Pages and local contractormatching services to obtain service providers for their home improvementprojects. In addition, many service providers do not use the Internet forbusiness purposes and may be reluctant to become part of a network of service providerson an Internet-based service provider matching service. If homeowners do notuse our matching service or service providers do not join our network, we willnot be able to generate significant revenues from either services or branding,or be able to enter into new multi-year commercial contracts.

 

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

 

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

 

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

 

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

 

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

 

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

 

                We depend on our service providers andhomeowners to report that they have won a job and pay us our win fee. We relyon our relationship with our service providers and the incentive to receivefuture leads from us to encourage service providers to report wins and pay winfees. If service providers do not report wins or pay us win fees, we will loseservice revenues and our business will be harmed.

 

**We depend on third-party relationships toattract visitors to our Web sites.**

 

                We have entered into multi-year 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 site from their Web sites toallow their customers to visit our Web site if the customers are interested inobtaining home improvement information or searching for a service provider. Webelieve that increasing the number of visitors to our Web sites will increasethe number of job submissions. We cannot assure you that these contracts willlead to increased visits to our Web sites or that increased visits to our Websites will result in increased job submissions. If we do not maintain ourexisting multi-year commercial 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 for a multi-yearcommercial contract may offer services competitive with suppliers with which wecurrently have multi-year contracts. As a result, these suppliers may bereluctant to enter into multi-year commercial contracts with us.

**We depend on third-party relationships toprovide software tools and infrastructure.**

 

                We integrate third-party software into ourservice offerings on our Web sites. We would be harmed if the providers fromwhich we license software ceased to deliver and support reliable products, toenhance their current products, or to respond to emerging industry standards.In addition, third-party software may not continue to be available to us oncommercially reasonable terms or at all. The loss of, or inability to maintainor obtain, this software could limit the features available on our Web sites,which could harm our business.

 

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

 

                We depend on the continued service of our keytechnical, sales and senior management personnel. In particular, the loss ofthe services of Ronald B. Cooper, our President and Chief Executive Officer, orother senior management personnel, individually or as a group, could cause usto incur increased operating expenses and divert other senior management timein searching for their replacements. We do not have employment agreements withany employee, except Mr. Cooper, and we do not maintain any key person lifeinsurance policies for any of our key employees, except for Mr. Cooper. Theloss of any of our key technical, sales or senior management personnel couldharm our business.

 

                In addition, we must attract, retain andmotivate highly skilled employees. Given the fact that we had majorrestructurings during March and September 2001, we face significant challengesto retain individuals with the skills required to develop, market and supportour services. We may not be able to recruit and retain sufficient numbers ofhighly skilled employees, and as a result our business could suffer.

 

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

 

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

 

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

 

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

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

 

                We depend on the efficient and uninterruptedoperation of our computer and communications hardware and software systems.Substantially all of our computer hardware for operating our Web sites iscurrently located at Qwest Communications in Sunnyvale, California, withbackups located at our facility in Redwood City, California. These systems andoperations are vulnerable to damage or interruption from earthquakes, floods,fires, power loss, telecommunication failures and similar events. They are alsosubject to break-ins, sabotage, intentional acts of vandalism and similarmisconduct. We do not have fully redundant systems, a formal disaster recoveryplan or alternative providers of hosting services, and we do not carry businessinterruption insurance to compensate us for losses that could occur. Despiteany precautions we may take, the occurrence of a natural disaster or otherunanticipated problems either at Qwest or at our facility could result ininterruptions in our services. Any damage to or failure of our systems couldresult in interruptions in our service. In addition to placing an increasedburden on our engineering staff, any system failure could create user questionsand complaints that must be responded to by our customer support personnel. Thesystem failures of various third-party Internet service providers, onlineservice providers and other Web site operators could result in interruptions inour service to those users who require the services of these third-partyproviders and operators to access our Web sites. These interruptions couldreduce our revenues and profits, and our future revenues and profits will beharmed if our users believe that our system is unreliable. Since we have beenkeeping logs of our Web sites, our ImproveNet.com Web site has beenunintentionally interrupted for periods ranging from two minutes to one hour,the latter prior to February 2000. On one occasion, prior to February 2000,some users experienced interruptions in part of our service for a period of 48hours.

 

**We may have capacity restraints that could limitthe growth of or reduce our revenues.**

 

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

 

                We use internally developed systems foroperating our services and processing our transactions, including billing andcollections processing. We must continually improve these systems in order toaccommodate the level of use of our Web sites. In addition, 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 held liable for products andservices referred by means of our Web site.**

 

                We could be subject to claims relating toproducts and services that we refer through our Web site. Homeowners may bringclaims against us for referring service providers who may have, among otherthings, provided them with poor workmanship or caused bodily injury or damageto property. Our existing insurance coverage may not cover all potentialclaims, may not adequately cover all costs incurred in defense of potentialclaims, may not indemnify us for all liability that may be imposed or may notbe renewable in future periods or renewable on terms and conditionssatisfactory to us. In addition, claims, with or without merit, would result indiversion of our financial resources and management resources.

 

**We could be held liable for general contracting services we perform.**

 

                We could be subject to claims related togeneral contractor services we provide to homeowners.  Homeowners may bring claims against us for providing generalcontractor services that, among other things, result in poor workmanship orcause bodily injury or damage to property. Our existing insurance coverage may not cover all potential claims,  may not adequately cover all costs incurredin defense of potential claims, may not indemnify us for all liability that maybe imposed or may not be renewable in future periods or renewable on terms andconditions satisfactory to us.  Inaddition, claims, with or without merit, would result in diversion of ourfinancial resources and management resources.

**We depend on the increasing use of theInternet. If the use of the Internet does not grow, our revenues may not growand could decline and our business could be harmed.**

 

                We depend on increased acceptance and use ofthe Internet. In particular, our matching service depends upon serviceproviders being willing to use the Internet to find jobs through our service.We believe that service providers generally have not traditionally usedcomputers or the Internet to operate their businesses. Demand and 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.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

                We file state tax returns as required by lawbased on principles applicable to traditional businesses. However, one or morestates could seek to impose additional income tax obligations or sales and usetax collection obligations on out-of-state companies such as ours that engagein or facilitate Internet-based commerce. A number of proposals have been madeat state and local levels that could impose taxes on the sale of products andservices through the Internet or the income derived from those sales. Theseproposals, if adopted, could substantially impair the growth of Internet-basedcommerce and harm our ability to become profitable.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

***InterestRate Risk***

 

                The primary objective of our 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 ininterest rates relates primarily to increases or decreases in the amount ofinterest income we earn on our investment portfolio and on increases ordecreases in the amount of interest expense we must pay with respect to anyoutstanding debt instruments. We mitigate default risk by investing in onlyhigh credit quality securities that we believe to be low risk and bypositioning our portfolio to respond appropriately to a significant reductionin a credit rating of any investment issuer or guarantor.

 

                We do not hold derivative financialinstruments as of September 30, 2001, and have never held such instruments inthe past. In addition, we had no debt instruments outstanding as of September30, 2001. We currently transact all of our revenues, which are all traded inthe United States in U.S. dollars.

 

**PARTII. OTHER INFORMATION**

 

**Item1.    Legal Proceedings**

 

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

 

** **

**Item 2.    ChangesIn Securities and Use of Proceeds**

 

                None

 

 

**Item 3.    DefaultsUpon Senior Securities**

 

                None

 

 

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

 

                None

 

 

**Item5.    Other Information**

 

                Due to regulatory requirements associatedwith being delisted, our repurchase program has been suspended.

 

**Item 6.    Exhibitsand Reports on Form 8-K**

 

(a)           Exhibits

 
| Exhibit Number |   | Description  of Document    |
|----------------|--------|-----------------------------|
| 10.36          |   | Stock  Repurchase Agreement |

 

 

(b)           A current report on Form 8-K wasfiled with the Securities and Exchange Commission on July 9, 2001, regardingImproveNet's delisting from the Nasdaq National Market.

 

**Signatures**

 

                Pursuant to the requirements of theSecurities and Exchange Act of 1934, the Registrant has duly caused this reportto be signed, November 13, 2001 on its behalf by the undersigned dulyauthorized.

 

IMPROVENET,INC.

(Registrant)

 

 

By:/s/ RonaldCooper

 

Ronald Cooper

Chairman, CEO& President

Date: November13, 2001