**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

 

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**Form 10-Q**

 

**(MarkOne)**

 
| **ý** |   | **Quarterly Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934 for the quarterly period ended June 30, 2002.**                                                                                                                                                                                                      |
|------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                                                                                                                                                                                                            |
| **OR**     |
|       |   |                                                                                                                                                                                                                                                                                                                                            |
| **o**      |   | **Transition Report Pursuant to Section 13 or 15(d) of the  Securities Exchange Act of 1934 for the Transition Period from****                ****to****                ****.** |

 

 

**COMMISSION FILE NUMBER 000-29927**

 

 

**IMPROVENET, INC.**

(Exactname of registrant as specified in its charter)

 

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

 

**1286 Oddstad Drive**

**Redwood City, CA 94063-2469**

*(Address of principal executive offices)*

 

**(888) 777-2212**

(Registrant’stelephone number, including area code)

 

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

YES ý   NO o

 

 

The number of sharesoutstanding of the registrant’s common stock, $.001 par value, was 17,295,394as of July 31, 2002

 

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ImproveNet,Inc.

 

Form10-Q

 

Forthe Quarter Ended June 30, 2002

 

Index

 
| **PART I  FINANCIAL INFORMATION** |                                                                                                                    |   |
|----------------------------------------|-------------------------------------------------------------------------------------------------------------------------|--------|
|                                   |                                                                                                                    |   |   |
| Item 1                                 | Financial Statements:                                                                                                   |   |   |
|                                   | Condensed Consolidated Balance Sheets as of  June 30, 2002 and December 31, 2001 (Unaudited)                            |   |   |
|                                   | Condensed Consolidated Statements of  Operations for the three and six months ended June 30, 2002 and 2001  (Unaudited) |   |   |
|                                   | Condensed Consolidated Statements of Cash  Flows for the six months ended June 30, 2002 and 2001 (Unaudited)            |   |   |
|                                   | Notes to Unaudited Condensed Consolidated  Financial Statements                                                         |   |   |
|                                   |                                                                                                                    |   |   |
| Item 2                                 | Management’s Discussion and Analysis of  Financial Condition and Results of Operations                             |   |   |
|                                   |                                                                                                                    |   |   |
| Item 3                                 | Quantitative and Qualitative Disclosures  About Market Risk                                                             |   |   |
|                                   |                                                                                                                    |   |   |
| **PART II  OTHER INFORMATION**    |                                                                                                                    |   |
|                                   |                                                                                                                    |   |   |
| Item 1                                 | Legal Proceedings                                                                                                       |   |   |
|                                   |                                                                                                                    |   |   |
| Item 2                                 | Changes in Securities and Use of Proceeds                                                                               |   |   |
|                                   |                                                                                                                    |   |   |
| Item 3                                 | Defaults Upon Senior Securities                                                                                         |   |   |
|                                   |                                                                                                                    |   |   |
| Item 4                                 | Submission of Matters to a Vote of Security  Holders                                                                    |   |   |
|                                   |                                                                                                                    |   |   |
| Item 5                                 | Other Information                                                                                                       |   |   |
|                                   |                                                                                                                    |   |   |
| Item 6                                 | Exhibits and Reports on Form 8-K                                                                                        |   |   |
|                                   |                                                                                                                    |   |   |
| **SIGNATURES**                         |                                                                                                                    |   |

 

 

i

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**PART I- FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

** **

**IMPROVENET, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

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

**(UNAUDITED)**

 
|                                            |   | **June 30,  2002** |   | **December  31,  2001** |   |
|-------------------------------------------------|--------|--------------------|--------|-------------------------|--------|
| **Assets**                                      |   |               |   |                    |   |
|                                            |   |               |   |                    |   |
| Current assets:                                 |   |               |   |                    |   |
| Cash and cash equivalents                       |   | $                  | 3,147  |                    | $      | 9,612 |   |
| Accounts receivable, net                        |   | 673                |   | 1,000                   |   |
| Prepaid expenses                                |   | 790                |   | 549                     |   |
| Total current assets                            |   | 4,610              |   | 11,161                  |   |
|                                            |   |               |   |                    |   |
| Property and equipment, net                     |   | 260                |   | 1,496                   |   |
| Other assets                                    |   | 75                 |   | 478                     |   |
|                                            |   |               |   |                    |   |
| Total assets                                    |   | $                  | 4,945  |                    | $      | 13,135 |   |
|                                            |   |               |   |                    |   |
| **Liabilities & Stockholders’ Equity** |   |               |   |                    |   |
|                                            |   |               |   |                    |   |
| Current liabilities:                            |   |               |   |                    |   |
| Accounts payable                                |   | $                  | 317    |                    | $      | 636 |   |
| Accrued liabilities                             |   | 1,044              |   | 2,267                   |   |
| Accrual for restructuring                       |   | 318                |   | 1,026                   |   |
| Deferred revenue                                |   | 17                 |   | 180                     |   |
| Total current liabilitites                      |   | 1,696              |   | 4,109                   |   |
|                                            |   |               |   |                    |   |
| Long-term liabilities                           |   | —             |   | 10                      |   |
|                                            |   |               |   |                    |   |
| Total liabilities                               |   | 1,696              |   | 4,119                   |   |
|                                            |   |               |   |                    |   |
| Stockholders’ equity:                      |   |               |   |                    |   |
| Common stock                                    |   | 17                 |   | 17                      |   |
| Treasury stock                                  |   | (56                | )      | (56                     | )      |
| Additional paid-in-capital                      |   | 144,529            |   | 145,362                 |   |
| Unearned stock-based compensation               |   | —             |   | (5,711                  | )      |
| Accumulated deficit                             |   | (141,241           | )      | (130,596                | )      |
| Total stockholders’ equity                 |   | 3,249              |   | 9,016                   |   |
|                                            |   |               |   |                    |   |
| Total liabilities and stockholders’ equity |   | $                  | 4,945  |                    | $      | 13,135 |   |

 

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

 

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**IMPROVENET, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS**

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

**(UNAUDITED)**

** **

 
| ** **                                                                                                            | ** ** | **THREE  MONTHS ENDED  JUNE 30,** | ** ** | **SIX MONTHS  ENDED  JUNE 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|---------------------------------|------------|
|                                                                                                                  |       | **2002**                          |       | **2001**                        |       | **2002** |   | **2001** |   |
| REVENUES                                                                                                              |       |                              |       |                            |       |   |   |   |   |
| Service revenues                                                                                                      |       | $                                 | 1,094      |                            | $          | 1,827 |   | $ | 2,154 |   | $ | 2,965 |   |
| Marketing revenues                                                                                                    |       | 40                                |       | 372                             |       | 140 |   | 845 |   |
| Total revenues                                                                                                        |       | 1,134                             |       | 2,199                           |       | 2,294 |   | 3,810 |   |
| COST OF REVENUES                                                                                                      |       |                              |       |                            |       |   |   |   |   |
| Cost of service revenues (excludes  stock-based compensation of $20 and $58 in 2002 and $86 and $211 in 2001)         |       | 711                               |       | 1,111                           |       | 1,445 |   | 2,388 |   |
| Cost of marketing revenues (excludes  stock-based compensation of $8 and $24 in 2002 and $32 and $83 in 2001)         |       | 1                                 |       | 90                              |       | 60 |   | 226 |   |
| Total cost of revenues                                                                                                |       | 712                               |       | 1,201                           |       | 1,505 |   | 2,614 |   |
| Gross profit                                                                                                          |       | 422                               |       | 998                             |       | 789 |   | 1,196 |   |
| OPERATING EXPENSES                                                                                                    |       |                              |       |                            |       |   |   |   |   |
| Sales & marketing (excludes stock-based  compensation of $1,043 and $1,869 in 2002 and $1,053 and $2,143 in 2001) |       | 773                               |       | 4,514                           |       | 1,943 |   | 10,895 |   |
| Product development                                                                                                   |       | 438                               |       | 939                             |       | 1,077 |   | 1,996 |   |
| General & administrative (excludes  stock-based compensation of $2 and $6 in 2002 and $28 and $171 in 2001)       |       | 567                               |       | 1,060                           |       | 1,211 |   | 2,626 |   |
| Stock-based compensation and warrant  amortization                                                                    |       | 3,942                             |       | 1,199                           |       | 4,710 |   | 2,608 |   |
| Corporate restructuring                                                                                               |       | 975                               |       | 181                             |       | 2,562 |   | 2,173 |   |
| Total operating expenses                                                                                              |       | 6,695                             |       | 7,893                           |       | 11,503 |   | 20,298 |   |
| Operating loss                                                                                                        |       | (6,273                            | )          | (6,895                          | )          | (10,714 | ) | (19,102 | ) |
| Interest/Other income                                                                                                 |       | 31                                |       | 231                             |       | 68 |   | 647 |   |
| Net loss                                                                                                              |       | $                                 | (6,242     | )                               | $          | (6,664 | ) | $ | (10,646 | ) | $ | (18,455 | ) |
| Basic and diluted net loss per common share                                                                           |       | $                                 | (0.36      | )                               | $          | (0.38 | ) | $ | (0.62 | ) | $ | (1.05 | ) |
| Weighted average shares used in calculating  basic and diluted net loss per common share                              |       | 17,296                            |       | 17,585                          |       | 17,299 |   | 17,613 |   |

 

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

 

3

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**IMPROVENET, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS**

**(In thousands)**

**(UNAUDITED)**

 
| ** **                                                                   | ** ** | **SIX MONTHS  ENDED  JUNE 30,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------|------------|
|                                                                         |       | **2002**                        |       | **2001** |   |
| CASH FLOWS FROM OPERATING ACTIVITIES                                         |       |                            |       |   |   |
| Net loss                                                                     |       | $                               | (10,646    | ) | $ | (18,455 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities: |       |                            |       |   |   |
| Depreciation                                                                 |       | 388                             |       | 756 |   |
| Loss on disposal of property                                                 |       | —                          |       | 5 |   |
| Restructuring charges net of cash  expenditures                              |       |                            |       |   |   |
| Reduction in force                                                           |       | 208                             |       | 218 |   |
| Facilities exit costs                                                        |       | (916                            | )          | 607 |   |
| Asset write-downs                                                            |       | 848                             |       | 770 |   |
| Allowance for doubtful accounts                                              |       | (218                            | )          | 132 |   |
| Amortization of stock-based compensation                                     |       | 1,376                           |       | 2,608 |   |
| Accelerated warrant amortization                                             |       | 3,334                           |       | — |   |
| Warrant charges amortized                                                    |       | 169                             |       | 169 |   |
| Notes receivable from related party                                          |       | —                          |       | (60 | ) |
| Net change in operating assets and  liabilities:                             |       |                            |       |   |   |
| Accounts receivable                                                          |       | 545                             |       | (381 | ) |
| Prepaid expenses                                                             |       | (241                            | )          | 1,238 |   |
| Other assets                                                                 |       | 403                             |       | 2 |   |
| Accounts payable                                                             |       | (319                            | )          | (1,020 | ) |
| Accrued liabilities                                                          |       | (1,223                          | )          | (959 | ) |
| Deferred revenue                                                             |       | (163                            | )          | (30 | ) |
| Other long-term liabilities                                                  |       | —                          |       | 17 |   |
| Net cash used in operating activities                                        |       | (6,455                          | )          | (14,383 | ) |
|                                                                         |       |                            |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES                                         |       |                            |       |   |   |
| Purchase of property and equipment                                           |       | —                          |       | (187 | ) |
| Restricted cash                                                              |       | —                          |       | (61 | ) |
| Net cash used in investing activities                                        |       | —                          |       | (248 | ) |
|                                                                         |       |                            |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES                                         |       |                            |       |   |   |
| Proceeds from exercise of stock options/warrants/ESPP                        |       | —                          |       | 76 |   |
| Payment of long-term debt                                                    |       | (10                             | )          | — |   |
| Payment for treasury stock purchase                                          |       | —                          |       | (56 | ) |
| Net cash (used in) provided by financing  activities                         |       | (10                             | )          | 20 |   |
|                                                                         |       |                            |       |   |   |
| Net decrease in cash and cash equivalents                                    |       | (6,465                          | )          | (14,611 | ) |
| Cash and cash equivalents, beginning of  period                              |       | 9,612                           |       | 31,565 |   |
| Cash and cash equivalents, end of period                                     |       | $                               | 3,147      |   | $ | 16,954 |   |

 

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

 

4

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**IMPROVENET,INC.**

**NOTESTO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

                ***Natureof the business***

 

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

 

***                Basisof Presentation***

 

                The accompanying interim condensed consolidatedfinancial statements as of June 30, 2002 and December 31, 2001, and for thethree and six months ended June 30, 2002 and 2001, are unaudited. The unauditedinterim condensed consolidated financial statements have been prepared on thesame basis as the annual consolidated financial statements and, in the opinionof management, reflect all adjustments, which are of a normal recurring nature,necessary to present fairly the Company’s financial position as of June 30,2002, results of operations for the three and six months ended June 30, 2002and 2001, and cash flows for the six months ended June 30, 2002 and 2001. TheCompany’s results for an interim period are not necessarily indicative of theresults that may be expected for the year.

 

                Although the Company believes that all adjustmentsnecessary for a fair presentation of the interim periods presented are includedand that the disclosures are adequate, these condensed consolidated financialstatements and notes thereto are unaudited and should be read in conjunctionwith the audited consolidated financial statements and notes thereto for theyear ended December 31, 2001 included in the Company’s Form 10-K filed on April12, 2002, with the Securities and Exchange Commission. The balance sheet atDecember 31, 2001 has been derived from audited financial statements, but doesnot include all disclosures required by generally accepted accountingprinciples in the United States of America. Such disclosures are contained inour annual report on Form 10-K.

 

                The Company has completed several rounds of privateequity financing and raised, in its initial public offering, approximately$39.7 million, net of issuance costs, in March 2000. However, the Company hasincurred substantial negative cash flows from operations in every fiscal periodsince inception.  For the six monthperiod ended June 30, 2002, the Company incurred a loss from operations ofapproximately $10.6 million and negative cash flows from operations of approximately$6.5 million.  As of June 30, 2002, theCompany had an accumulated deficit of approximately $141.2 million.  Management expects operating losses andnegative cash flows to continue for the foreseeable future.

 

                The Company expects that losses will decrease fromfiscal year 2001 levels due primarily to reduced operations, includingdecreased marketing expenditures and reductions in workforce. Operationalrestructuring has already been initiated - the Company reduced its workforce by7% in 2000, 46% in 2001, and 95% for the six months ending June 30, 2002.  The Company has $3.1 million of cash andcash equivalents at June 30, 2002. Failure to generate sufficient revenues,raise additional capital or reduce discretionary spending could have a materialadverse effect on the Company’s ability to continue as a going concern and toachieve its intended business objectives.

 

                On June 25, 2002, the Company announced it wouldbegin the process of liquidating certain assets while it continues to reviewstrategic alternatives.  Subsequent tothe end of the quarter, the company announced a new agreement to merge witheTechLogix.  The Company continues tooperate its websites, provide referral services and remain active until furthernotice.  The Company is operating with aminimal level of staffing.

 

5

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**NOTE 2- NET LOSS PER SHARE**

 

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

 

                Options to purchase approximately 0.3 million sharesof common stock and warrants to purchase approximately 1.3 million shares ofcommon stock were outstanding as of June 30, 2002.

 

                The reconciliation of the numerator and denominatorused in the calculation of the basic and diluted net loss per common sharefollows (in thousands, except per share amounts):

 
|                                                  |   | **Three  Months Ended, June 30,** |   | **Six Months  Ended, June 30,** |   |
|-------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                  |   | **2002**                          |   | **2001**                        |   | **2002** |   | **2001** |   |
| Numerator:                                            |   |                              |   |                            |   |   |   |   |   |
| Net loss attributable to common  stockholders         |   | $                                 | (6,242 | )                               | $      | (6,664 | ) | $ | (10,646 | ) | $ | (18,455 | ) |
|                                                  |   |                              |   |                            |   |   |   |   |   |
| Denominator:                                          |   |                              |   |                            |   |   |   |   |   |
| Weighted average common shares                        |   | 17,296                            |   | 17,912                          |   | 17,301 |   | 18,128 |   |
| Weighted average common shares subject to  repurchase |   | (2                                | )      | (327                            | )      | (2 | ) | (515 | ) |
|                                                  |   |                              |   |                            |   |   |   |   |   |
| Denominator for basic and diluted  calculation        |   | 17,294                            |   | 17,585                          |   | 17,299 |   | 17,613 |   |
| Basic and diluted net loss per common share           |   | $                                 | (0.36  | )                               | $      | (0.38 | ) | $ | (0.62 | ) | $ | (1.05 | ) |

 

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

 

                Commencing in September 1999, the Company entered into multi–yearcommercial marketing contracts, some of which are with related parties. Thesecommercial contracts generally provided 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–Contractoror Powered by ImproveNet, plus a continuous presence, as defined, on theCompany’s Web sites. These commercial contracts were for periods rangingbetween 2 and 12 years, including renewal options. These commercial contractsalso include cooperative marketing arrangements under which the Company isobligated to fund, as defined, co–operative branding expenditures ontelevision and in the print media, with or on behalf of the commercial party.Most commercial contracts provide for the Company to spend 50% to 100% of thefees the Company expected to receive. In return, the Company is expected toreceive significant marketing and branding benefits including betteradvertising rates, stronger brand recognition, and access to customerdatabases, direct mail inserts and marketing resources—all designed to generatemore traffic to its sites and jobs to its proprietary matching services.

 

                As the Company does not have an established historical practice ofselling advertising for cash for similar multi–year commercial contracts,the Company has not assigned any value to the exchange of services or barterelement of these transactions and accordingly, the Company has not recordedeither revenue or sales and branding expense for the barter element. However,some of these multi–year commercial contracts do generate an overall netcash component to the Company, and in these cases, the Company has recordedrevenue based on the cash received or receivable under the contract, net of theobligation, if any, to reimburse the commercial party for the cooperativebranding and other marketing services. These revenues are recognized over theterm of the commercial contract once marketing and other services have beendelivered to the commercial party and collection of the resulting netreceivable is deemed probable.

 

                For the threeand six months ended June 30, 2002,the Company did not have any barter element amounts for these commercialcontracts.

 

                Furthermore,in connection with certain of these multi–year commercial contracts, theCompany also issued warrants to purchase shares of the Company’s common stockto the commercial parties. These warrants have been valued by the Company usingthe Black Scholes option-pricing model. As the fair value of these warrantsrepresent an additional rebate on the revenue otherwise recorded under thecontracts, the amortization of the warrants has been netted against the 

 

6

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related revenue over the term of the respective commercial contract. Tothe extent that there has been insufficient revenues, the remainingamortization of warrant stock–based compensation has been expensed, andcharacterized as sales and marketing expense. On June 25, 2002, the Company announced it would begin the process ofliquidating certain assets while it continues to review strategicalternatives.  Subsequent to the end ofthe quarter, the company announced a new agreement to merge witheTechLogix.  As a result, the Companybelieves that there is little benefit to be derived from the remaininglong-term multi-year commercial contracts and accordingly the remainingunamortized stock based compensation arising from the warrants associated withthese contracts has been expensed in the three months ended June 30, 2002.

 

**NOTE 4— SEGMENT INFORMATION**

 

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

 

Summary of the Company’srevenue by service offerings is as follows (in thousands):

 
|                                 |   | **Three  Months Ended, March 31,** |   | **Six Months  Ended, June 30,** |   |
|--------------------------------------|--------|------------------------------------|--------|---------------------------------|--------|
|                                 |   | **2002**                           |   | **2001**                        |   | **2002** |   | **2001** |   |
| Service revenues:                    |   |                               |   |                            |   |   |   |   |   |
| Lead fees                            |   | $                                  | 436    |                            | $      | 348 |   | $ | 999 |   | $ | 811 |   |
| Win fees                             |   | 348                                |   | 1,401                           |   | 568 |   | 1,978 |   |
| Other fees                           |   | 310                                |   | 78                              |   | 587 |   | 176 |   |
| Total service revenues               |   | 1,094                              |   | 1,827                           |   | 2,154 |   | 2,965 |   |
| Marketing revenues                   |   | 40                                 |   | 372                             |   | 140 |   | 845 |   |
| Total service and marketing revenues |   | $                                  | 1,134  |                            | $      | 2,199 |   | $ | 2,294 |   | $ | 3,810 |   |

 

                For the three and six month periods ended June 30,2002 and 2001, no customers represented over 10% of service or marketingrevenues.

 

**NOTE 5— COMPREHENSIVE LOSS**

 

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

 

**NOTE 6— RECENT PRONOUNCEMENTS**

 

                In July 2001, the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 141, “Business Combinations” and SFAS No. 142,“Goodwill and Other Intangible Assets”. Under SFAS No. 141, all business combinations initiated after June 30,2001 must be accounted for using the purchase method.  SFAS No. 142 requires, among other things, the discontinuance ofgoodwill amortization.  In addition, thestatement includes provisions upon adoption for the reclassification of certainexisting recognized intangibles as goodwill, reassessment of the useful livesof existing recognized intangibles and the testing for impairment of existinggoodwill and other intangibles.  TheCompany has adopted the provisions of SFAS No. 142 and SFAS No. 141 effectiveJanuary 1, 2002.  The implementation ofSFAS No. 142 and SFAS No. 141 did not have a material effect on the Company’sfinancial position and results of operations.

 

                In October 2001, the FASB issued SFAS No. 144,“Accounting for the Impairment or Disposal of Long-Lived Assets”, whichaddresses financial accounting and reporting for the impairment or disposal oflong-lived assets.  This statementsupersedes SFAS No. 121 and the accounting and reporting provisions ofAccounting Principles Board ("APB"), Opinion No. 30 “Reporting theResults of Operations-Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions”, for the disposal of a segment of a business.  

 

 

7

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The Company adopted theprovisions of SFAS No. 144 effective January 1, 2002. The implementation ofSFAS No. 144 did not have a material effect on the Company’s financial positionand results of operations.

 

                In November 2001, the Emerging Issues Task Force(“EITF”) reached a consensus on EITF Issue No. 01-09, “Accounting forConsideration Given by a Vendor to a Customer or a Reseller of the Vendor’sProducts,” (“EITF No. 01-09”).  EITF No.01-09 requires recording certain consideration paid to distributors of theCompany’s products as a reduction of revenue. The Company adopted the provisions of EITF No. 01-09 effective January1, 2002. The implementation of EITF No. 01-09 did not have a material effect onthe Company’s financial position and results of operations.

 

                In April of 2002, FASB issued SFAS No. 145, “Rescissionof FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, andTechnical Corrections,”**which iseffective for fiscal years beginning after May 15, 2002.  Under SFAS No.145, gains and losses from theextinguishment of debt should be classified as extraordinary items only if theymeet the criteria of APB Opinion No. 30. SFAS No. 145 also addresses financial accounting and reporting forcapital leases that are modified in such a way as to give rise to a newagreement classified as an operating lease. The Company believes that the adoption of SFAS No. 145 will not have amaterial impact on the consolidated financial position or results of theoperations of the Company.

 

                In June 2002, the FASB issued SFAS No. 146,“Accounting for Exit or Disposal Activities”. SFAS No. 146 addresses significant issues regarding the recognition,measurement, and reporting of costs that are associated with exit and disposalactivities, including restructuring activities that are currently accounted forunder EITF No. 94-3, “Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit and Activity (including Certain Costs Incurredin a Restructuring).” The scope of the SFAS No.146 also includes cots relatedto terminating a contract that is not a capital lease and termination benefitsthat employees who are involuntarily terminated receive under the terms of aone-time benefit arrangement that is not an ongoing benefit arrangement or anindividual deferred-compensation contract. SFAS No.146 will be effective forexit or disposal activities that are initiated after December 31, 2002, butearly application is encouraged.  Theprovisions of EITF No. 94-3 shall continue to apply for an exit activityinitiated under an exit plan that met the criteria of EITF No. 94-3 prior tothe adoption of SFAS No.146. Adopting the provisions of SFAS No. 146 willchange, on a prospective basis, the timing of when restructuring charges arerecorded from a commitment date approach to when the liability is incurred.

 

**NOTE 7- RESTRUCTURING ACCRUAL**

 

                During 2001, the Company announced severalrestructuring plans to reduce costs and to improve productivity.  These related to facilities costs, workforcereductions and asset write-downs.

 

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

 

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

 

                In the second quarter of 2002, the Company announcedrestructuring plans to further reduce costs, which included the termination of27 employees, the write-down of fixed assets, and terminating facility leases.

 

                In the second quarter of 2002, $50,000 wasreallocated from other unused facility exits costs to restructuring chargesrelating to the exit costs of the Oddstad Road, California facility.  After subtracting rental payments andsettlement fees made of $1.1 million, the balance at June 30, 2002, is $90,000,of which approximately $50,000 relates to the Oddstad Road facility and theremainder relates to the facilities closed as part of the restructurings in theprior year.

 

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                The Company recorded $689,000 of costsrelating to employee termination benefits, of which $844,000 was utilized inthe period.  The remaining liability of$228,000 is expected to be fully utilized, by the fourth quarter of 2002.  Under the restructuring plan, the Companytook a charge of $286,000 in the second quarter, for the write-down of assetsincluded in property and equipment. This was fully utilized in the period.

 

                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 ultimately incur may change as therestructuring initiatives are executed.

 

                The activity impacting the accrual forrestructuring charges through the second quarter ended June 30, 2002 aresummarized in the table below (in thousands):

 
|                                                                      |   | **Facilities** |   | **Workforce  reductions** |   | **Asset  write-  downs** |   | **Total** |   |
|---------------------------------------------------------------------------|--------|----------------|--------|---------------------------|--------|--------------------------|--------|-----------|--------|
| Balance at December 31, 2001                                              |   | $              | 1,006  |                      | $      | 20                       |   | $         | — |   | $ | 1,026 |   |
|                                                                      |   |           |   |                      |   |                     |   |      |   |
| Restructuring charges to operations in  three months ended March 31, 2002 |   | 391            |   | 634                       |   | 562                      |   | 1,587     |   |
| Cash payments made during the three months  ended June 30, 2002           |   | (241           | )      | (271                      | )      | —                   |   | (512      | )      |
| Non cash write-offs during the three months  ended June 30, 2002          |   | —         |   | —                    |   | (562                     | )      | (562      | )      |
| Balance at March 31, 2002                                                 |   | 1,156          |   | 383                       |   | —                   |   | 1,539     |   |
|                                                                      |   |           |   |                      |   |                     |   |      |   |
| Restructuring charges to operations in  three months ended June 30, 2002  |   | —         |   | 689                       |   | 286                      |   | 975       |   |
| Cash payment made during the three months  ended June 30, 2002            |   | (1,066         | )      | (844                      | )      | —                   |   | (1,910    | )      |
| Non cash write-offs during the three months  ended June 30, 2002          |   | —         |   | —                    |   | (286                     | )      | (286      | )      |
| Balance at June 30, 2002                                                  |   | $              | 90     |                      | $      | 228                      |   | $         | — |   | $ | 318 |   |

 

**NOTE 8— SUBSEQUENT EVENTS**

 

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

 

                As part of our restructuring efforts RonCooper has stepped down as President and Chief Executive Officer.  Mr. Cooper will provide management support,as well as remain ImproveNet’s Chairman of the Board until the merger iscompleted.  Upon completion of themerger, Mr. Cooper will serve as a board member of the merged company.

 

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

 

                The following discussion and analysis of ourfinancial condition and results of operation should be read with “SelectedCondensed Consolidated Financial Data” and our condensed consolidated financialstatements and notes included elsewhere in this Report on Form 10-Q.  The discussion in this Report on Form 10-Qcontains forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended, including statements using terminology such as “can,”“may,” “believe,” “designated to,” “will,” “expect,” “plan,” “anticipate,”“estimate,” “potential,” or “continue,” or the negative thereof or othercomparable terminology regarding beliefs, plans, expectations or intentionsregarding the future.  Forward-lookingstatements involve risks and uncertainties and actual results could differmaterially from those discussed in the forward-

 

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looking statements.  All forward-looking statements and riskfactors included in this document are made as of the date hereof, based oninformation available to the Company as of the date thereof, and the Company assumesno obligation to update any forward-looking statement or risk factors, unlesswe are required to do so by law.  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 those discussedelsewhere.

 

 

## ***CRITICAL ACCOUNTING POLICIES ANDESTIMATES***

 

                ImproveNet,Inc.’s discussion and analysis of its financial condition and results ofoperations are based upon ImproveNet, Inc. consolidated financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires ImproveNet to make estimates and judgments that affect the reportedamounts of assets, liabilities, revenues and expenses, and related disclosureof contingent assets and liabilities. On an on-going basis, ImproveNetevaluates its estimates, including those related to customer programs, baddebts, intangible assets, income taxes, restructuring, and contingencies andlitigation. ImproveNet bases its estimates on historical experience and onvarious other assumptions that are believed to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. Actual results may differ from these estimates underdifferent assumptions or conditions.

 

                ImproveNetbelieves the following critical accounting policies affect its more significantjudgments and estimates used in the preparation of its consolidated financialstatements. ImproveNet records estimated reductions to revenue for customerallowances and incentive offerings including special pricing agreements, andpromotions.  ImproveNet recognizesrevenue, profit and potential losses on fixed price contracts using thecompleted contract method. Provisions for estimated losses on uncompletedcontracts are made in the period in which such losses are determined.  Costs in excess of amounts billed on uncompletedcontracts are classified as deferred costs. Billings in excess of costs on uncompleted contracts are classified asdeferred revenue.  ImproveNet maintainsallowances for doubtful accounts for estimated losses resulting from theinability of its customers to make required payments. If the financialcondition of ImproveNet’s customers were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired.  ImproveNet records avaluation allowance to reduce its deferred tax assets to the amount that ismore likely than not to be realized. While ImproveNet has considered futuretaxable income and ongoing prudent and feasible tax planning strategies inassessing the need for the valuation allowance, in the event ImproveNet were todetermine that it would be able to realize its deferred tax assets in thefuture in excess of its net recorded amount, an adjustment to the deferred taxasset would increase income in the period such determination was made.Likewise, should ImproveNet determine that it would not be able to realize allor part of its net deferred tax asset in the future, an adjustment to thedeferred tax asset would be charged to income in the period such determinationwas made.

 

 

**OVERVIEW**

 

                Our businessstarted in January 1996 as a regional contractor matching service.  We spent most of 1996 and 1997 building ourservice provider database, developing our services and technology, recruitingpersonnel and raising capital. We launched our Web site and homeowner/serviceprovider matching service on a national scale in August 1997. In December 1998,we began selling Web site advertising and direct marketing services tosuppliers of home improvement products as a way to send targeted messages abouttheir products, including product promotions, to homeowners at the time ofpurchase, as well as to our network of service providers. In March 1999, webegan to hire our senior management team, including our chief executiveofficer. In April 1999, we introduced Powered by ImproveNet, a service that allowsthird parties to offer the ImproveNet matching services and content on theirWeb sites. We completed the acquisition of two regional contractor referralcompanies, Contractor Referral Service, LLC and The J.L. Price Corporation, inSeptember and November 1999, respectively. These entities were integrated into our operations during the course ofcalendar year 2000.  In March 2000, wecompleted our IPO.  From January throughJune 2000 we spent substantial amounts primarily on marketing and 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%.  In March2001, we restructured our operations again resulting in a staff reduction of25% and we closed our largest facility 

 

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at Bay Road, in Redwood City, California.  In September 2001, we further reduced our staff by 29% and closedour Camarillo, California facility.  AtDecember 31, 2001, we employed 111 full-time employees and had our Ft.Lauderdale, Florida and Oddstad Road, California facilities operating.  In the first quarter 2002, we reduced staffby an additional 69% and closed our Ft Lauderdale, Florida facility.  In the second quarter 2002, we reduced staffby an additional 82%. We currently have 6 full-time employees.

 

                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 also 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.  In the second quarterwe completed our contract with Home Depot and do not expect installed salesrevenue in the future.  We generatemarketing revenues from the sale of banner, button and other advertising on ourWeb sites, from the sale of SmartLeads generated from the traffic of homeownersvisiting our Web sites and from the sale of Find-A-Contractor or Powered byImproveNet products.  Our marketingrevenues are generally derived from suppliers of home improvement products.

 

OnJune 25, 2002, the Company announced it would begin the process of liquidatingcertain assets while it continues to review strategic alternatives.  On July 30, 2002, subsequent to the end ofthe quarter, the Company entered into an Agreement and Plan of Merger witheTechLogix.  The Company continues tooperate its websites, provide referral services and remain active until furthernotice.  The Company is operating with aminimal level of staffing.  As a resultthe Company believes that there is little benefit to be delivered from theremaining long-term multi-year commercial contracts and accordingly theremaining unamortized stock based compensation arising from the warrantsassociated with these contracts have been expensed in the three months endedJune 30, 2002.

 

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

 

 

**RESULTSOF OPERATIONS**

 

***REVENUES***

 

                Our revenues decreased to approximately $1.1 millionfor the three months ended June 30, 2002, from approximately $2.2 million forthe three months ended June 30, 2001, a decrease of approximately $1.1 millionor 50%.  For the six months ended June 30,2002, revenues decreased to approximately $2.3 million as compared toapproximately $3.8 million for the six months ended June 30, 2001, a decreaseof approximately $1.5 million or 39%

 

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

 
|               |   | **Three  Months Ended, June 30,** |   | **Six Months  Ended, June 30,** |   |
|--------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|               |   | **2002**                          |   | **2001**                        |   | **%****Change** |   | **2002** |   | **2001** |   | **%****Change** |   |
| Revenues:          |   |                              |   |                            |   |   |   |   |   |   |   |   |   |
| Service revenues   |   | $                                 | 1,094  |                            | $      | 1,827 |   | -40 | % | 2,154 |   | 2,965 |   | -27 | % |
| Marketing revenues |   | 40                                |   | 372                             |   | -89 | % | 140 |   | 845 |   | -83 | % |
|               |   |                              |   |                            |   |   |   |   |   |   |   |   |   |
| Total revenues     |   | $                                 | 1,134  |                            | $      | 2,199 |   | -48 | % | $ | 2,294 |   | $ | 3,810 |   | -40 | % |
|                    |        |                                   |        |                                 |        |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Service Revenues***

 

                Service revenues decreased to approximately$1,094,000 for the three months ended June 30, 2002, from approximately$1,827,000 for the three months ended June 30, 2001, a decrease ofapproximately $733,000 or 40%.  For 

 

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the six months endedJune 30, 2002, revenues decreased to approximately $2,154,000 as compared toapproximately $2,965,000 for the six months ended June 30, 2001, a decrease ofapproximately $811,000 or 27%.  Thedecrease in service revenues was primarily due to a decrease in match rate andwin rate as a result of the restructuring of operations during the quarter.

 

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

 

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

 
|                  |   | **Three  Months Ended, June 30,** |   | **Six Months  Ended, June 30,** |   |
|-----------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                  |   | **2002**                          |   | **2001**                        |   | **2002** |   | **2001** |   |
| Lead fees             |   | 40                                | %      | 19                              | %      | 47 | % | 27 | % |
| Win fees              |   | 32                                | %      | 77                              | %      | 26 | % | 67 | % |
| Other fees            |   | 28                                | %      | 4                               | %      | 27 | % | 6 | % |
|                  |   |                              |   |                            |   |   |   |   |   |
| Total service revenue |   | 100                               | %      | 100                             | %      | 100 | % | 100 | % |

 

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

 

•                    The numberof job submissions;

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

•                    The successof the service provider to win a job; and

•                    The amountwe charge the service provider for a lead or a win.

 

                The following table provides information on some ofour key business metrics (in thousands):

 
| Key Metrics                            |   | **Three Months Ended, June 30,** |   | **Six Months Ended, June 30,** |   |
|----------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                   |   | **2002**                         |   | **2001**                       |   | **2002** |   | **2001** |   |
| Job submissions                        |   | 28.2                             |   | 31.3                           |   | 53.6 |   | 69.9 |   |
| Matched jobs                           |   | 13.7                             |   | 20.5                           |   | 21.1 |   | 45.7 |   |
| Won jobs                               |   | 1.5                              |   | 3.2                            |   | 2.5 |   | 6 |   |
|                                   |   |                             |   |                           |   |   |   |   |   |
| Matched jobs as a % of job submissions |   | 48.6                             | %      | 65.4                           | %      | 39.4 | % | 65.3 | % |
|                                   |   |                             |   |                           |   |   |   |   |   |
| Won jobs as a % of job submissions     |   | 5.3                              | %      | 10.3                           | %      | 4.7 | % | 8.6 | % |

 

                The decrease in Match Rate and Win Rate for the threemonths ended June 30, 2002, was due to reductions in staff and the transitionof closing our Florida facility, which is where we processed all of ourjobs.  The decrease in Match Rate andWin Rate for the six months ended June 30, 2002, was due to the economic downturn during the two quarters of 2002 and a change in the pricing schedule oflead fees and win fees in the fourth quarter of 2001.  Match Rate and Win Rate increased from the first quarter of 2002to the second quarter 2002 due to another pricing change.

 

                Revenues from new service provider enrollment feesare recognized as revenue ratably over the expected period they participate inour contractor matching service, which is initially estimated to be one year.Revenues from premium service fees to homeowners are recognized at the time theservice is provided.

 

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***Marketing Revenues***

 

                Marketing revenues decreased to approximately $40,000for the three months ended June 30, 2002, from approximately $372,000 for thethree months ended June 30, 2001, a decrease of approximately $332,000 or 89%.For the six months ended June 30, 2002, revenues decreased to approximately$140,000 as compared to approximately $845,000 for the six months ended June30, 2001, a decrease of approximately $705,000 or 83%. The decline in marketingrevenues reflects the overall softening of the market for online advertisingand marketing services due to current economic conditions.  ImproveNet also completed certain commercialcontracts in the fourth quarter 2001 that were not renewed this year.

 

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

 

Revenuesfrom banner, button and other advertising are largely a function of:

 

•     The numberof Web pages that we serve;

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

•     The amountwe charge per advertisement.

 

                Advertisers pay us to display their banner, buttonand other advertisements on the Web pages we serve when a user is visiting ourWeb sites. Our marketing revenues historically have been derived fromshort-term advertising contracts based on either a guaranteed minimum number ofimpressions or a fixed fee per thousand impressions.

 

***Multi-year Commercial Contracts***

 

                CommencingSeptember 1999, we entered into multi-year commercial contracts, some of whichare with related parties. These commercial contracts generally provide for afixed annual fee, an advertising or branding package that includes a mix ofbuttons, banners, SmartLeads and other marketing or branding services,including Find-A-Contractor or Powered by ImproveNet, plus a continuouspresence, on our Web sites. These commercial contracts are for periods rangingbetween 2 and 12 years, including renewal options. These commercial contractsalso include cooperative marketing arrangements under which we are obligated tofund cooperative branding expenditures on television and in the print media,with or on behalf of the commercial party. Most commercial contracts providefor us to spend 50% to 100% of the fees that we expect to receive. In return,we expect to receive significant marketing and branding benefits includingbetter advertising rates, stronger brand recognition, and access to customer databases,direct mail inserts and marketing resources - all of which are designed togenerate more traffic to sites 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 of thesemulti-year commercial contracts do generate an overall net cash component, andin these cases we have recorded revenue based on the cash received orreceivable under the contract, net of the obligation, if any, to reimburse thecommercial party for the cooperative branding and other marketing services.These revenues are recognized over the term of the commercial contract onceadvertising and other services have been delivered to the commercial party andcollection of the resulting net receivable is deemed probable. There was norevenue generated by multi-year commercial contracts, net of warrant charges,for the three months and six months ended June 30, 2002, compared with revenueof approximately $324,000 for the three months and approximately $749,000 forthe six months ended June 30, 2001.

 

                Furthermore,in connection with certain of these multi–year commercial contracts, theCompany also issued warrants to purchase shares of the Company’s common stockto the commercial parties. These warrants have been valued by the Company usingthe Black Scholes option-pricing model. As the fair value of these warrantsrepresent an additional rebate on the revenue otherwise recorded under thecontracts, the amortization of the warrants netted against the revenue over theterm of the respective commercial contract. To the extent that there has beeninsufficient revenues, the remaining amortization of warrant stock–basedcompensation is expensed and characterized as sales and marketing expense.  On June 25, 2002, the Company announced itwould begin the process of liquidating certain assets while it continues toreview strategic alternatives. Subsequent to the end of the quarter, the company announced a newagreement to merge 

 

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with eTechLogix.  The Companycontinues to operate its websites, provide referral services and remain activeuntil further notice.  The Company isoperating with a minimal level of staffing. As a result,  the Companybelieves that there is little benefit to be derived from the remaininglong-term multi-year commercial contracts and accordingly the remainingunamortized stock based compensation arising from the warrants associated withthese contracts has been expensed in the three months ended June 30, 2002.

 

                Totalrevenues may be analyzed as follows (in thousands):

 
|                                                                                                  |   | **Three  Months Ended, June 30,** |   | **Six Months  Ended, June 30,** |   |
|-------------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                                                                                                  |   | **2002**                          |   | **2001**                        |   | **2002** |   | **2001** |   |
| Service revenues                                                                                      |   | $                                 | 1,094  |                            | $      | 1,827 |   | $ | 2,154 |   | $ | 2,965 |   |
| Marketing revenues                                                                                    |   | 40                                |   | 846                             |   | 140 |   | 1,722 |   |
| Less:   Amounts invoiced and accrued under multi-year commercial contracts  with related parties |   | —                            |   | (390                            | )      | — |   | (708 | ) |
| Less:   Amortization of warrant stock-based compensation                                         |   | —                            |   | (84                             | )      | — |   | (169 | ) |
| Total marketing revenues                                                                              |   | 40                                |   | 372                             |   | 140 |   | 845 |   |
|                                                                                                  |   |                              |   |                            |   |   |   |   |   |
| Total revenues                                                                                        |   | $                                 | 1,134  |                            | $      | 2,199 |   | $ | 2,294 |   | $ | 3,810 |   |

 

 

**OPERATINGEXPENSES**

 

***Cost of Revenues***

 

                Our cost ofrevenues decreased to approximately $712,000 for the three months ended June30, 2002, from approximately $1,201,000 for the three months ended June 30,2001, a decrease of approximately $489,000 or 41%.  For the six months ended June 30, 2002, cost of revenuesdecreased to approximately $1,505,000 as compared to approximately $2,614,000 forthe six months ended June 30, 2001, a decrease of approximately $1,109,000 or42%.

 

                Cost of revenues consists of materials and relatedsubcontractor labor costs for premiere kitchen and bath remodels, employeepayroll and related costs and occupancy, telecommunications and otheradministrative costs for our project service group, which is responsible forall phases of our proprietary matching services and includes our projectadvisors. In addition, cost of revenues includes an allocation of direct Website operations costs, consisting of payroll and related costs, datatransmission costs and equipment depreciation.

 

***Cost of Service Revenues***

 

                Our cost of service revenues decreased toapproximately $711,000 for the three months ended June 30, 2002, fromapproximately $1,111,000 for the three months ended June 30, 2001, a decreaseof approximately $400,000 or 36%. For the six months ended June 30, 2002, costof service revenues decreased to approximately $1,445,000 as compared toapproximately $2,388,000 for the six months ended June 30, 2001, a decrease ofapproximately $943,000 or 39%.

 

                The decrease in the cost of service revenueswas primarily a result of restructurings during the six months of 2002, whichreduced payroll and related costs and facilities and related costs.

 

***Cost of Marketing Revenues***

 

                Our cost of marketing revenues decreased toapproximately $1,000 for the three months ended June 30, 2002, fromapproximately $90,000 for the three months ended June 30, 2001, a decrease ofapproximately $89,000 or 99%. For the six months ended June 30, 2002, cost ofmarketing revenues decreased to approximately $60,000 as compared toapproximately $226,000 for the six months ended June 30, 2001, a decrease ofapproximately $166,000 or 73%.

 

 

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                Cost ofmarketing revenue includes an allocation of direct Web site operations costs,consisting of payroll and related costs, data transmission costs and equipmentdepreciation. The decrease in the cost of marketing revenue was a result of the restructurings during the first quarter andsecond quarter of 2002.

 

***Sales and Marketing***

 

                Our sales and marketing expense decreased toapproximately $773,000 for the three months ended June 30, 2002, fromapproximately $4.5 million for the three months ended June 30, 2001, a decreaseof approximately $3.7 million or 83%. For the six months ended June 30, 2002, sales and marketing expensedecreased to approximately $1.9 million as compared to approximately $10.9million for the six months ended June 30, 2001, a decrease of $9.0 million or83%.

 

                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, support staff expenses, travel costs and other general expensesof our marketing, professional services and partnership services departments.

 

                The decrease in sales and marketing expenses wasprimarily attributable to:

 

•                    Renegotiating or transitioning newand existing agreements from a high fixed cost formula to a variableperformance based formula based on jobs won;

•                    Reduced online and offline brandadvertising spending; and

•                    Reduced staffing related expensesas a result of our restructurings during the first and second quarters.

 

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

 

***Product Development***

 

                Our product development expenses decreased toapproximately $438,000 for the three months ended June 30, 2002, fromapproximately $939,000 for the three months ended June 30, 2001, a decrease ofapproximately $501,000 or 53%.  For thesix months ended June 30, 2002, product development expense decreased toapproximately $1.1 million as compared to approximately $2.0 million for thesix months ended June 30, 2001, a decrease of approximately $919,000 or 46%.

 

                Our product development costs include the payroll andrelated costs of our technology staff, fees for contract content providers,other costs of Web site design and new technologies required to enhance theperformance of our Web sites.  Thedecrease in product development expenses was primarily attributable todecreased payroll and related costs and decreased usage of contract contentproviders.  We expect productdevelopment costs to continue to be minimal until the close of the merger.

 

***General and Administrative***

 

                Our general and administrative expenses decreased toapproximately $567,000 for the three months ended June 30, 2002, fromapproximately $1,060,000 for the three months ended June 30 2001, a decrease ofapproximately $493,000 or 47%.  For thesix months ended June 30, 2002, general and administrative expense decreased toapproximately $1.2 million as compared to approximately $2.6 million for thesix months ended June 30, 2001, a decrease of approximately $1.4 million or54%.

 

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

 

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

 

                Our stock-based compensation expenses increased toapproximately $3,942,000 for the three months ended June 30, 2002, fromapproximately $1,199,000 for the three months ended June 30, 2001, an increaseof approximately $2,743,000 or 229%.  For the six months ended June 30, 2002, stock-based compensationincreased to approximately $4,710,000 as compared to approximately $2,608,000for the six months ended June 30, 2001, an increase of approximately $2,102,000or 81%.  The increase of stock-basedcompensation was primarily due to the acceleration of approximately $3,334,000of warrant amortization that we charged in the second quarter of 2002.

 

                The Company believes that there is little benefit tobe delivered from the remaining long-term multi-year commercial contracts andaccordingly the remaining unamortized stock-based compensation arising from thewarrants associated with these contracts have been expensed in the three monthsended June 30, 2002.  Due to thisacceleration, there will be no additional stock-based compensation expensearising from these warrants in the future. In addition, no employee stock based compensation expense remains to berecognized relating to pre-IPO employee stock options.

 

***CorporateRestructuring***

 

                During the first quarter ended March 31, 2002, theCompany announced restructuring plans which resulted in a total charge ofapproximately $1.6 million of which approximately $634,000 related to reductionin workforce costs, approximately $391,000 related to facility exit costs, andapproximately $562,000 related to asset write-downs.  During the firstquarter of 2002, a total of approximately $1,074,000 of costs was chargedagainst the restructuring accrual of which approximately $271,000 related toreduction in workforce costs, approximately $241,000 related to facility exitcosts, and approximately $562,000 related to asset write-downs.

 

                During the second quarter ended June 30,2002, the Company announced additional restructuring plans, which resulted in atotal charge of approximately $975,000, of which approximately $689,000 relatedto reduction in workforce costs, and approximately $286,000 related to asset write-downs.  During the second quarter of 2002, a totalof approximately $2,196,000 of costs was charged against the restructuringaccrual of which approximately $844,000 related to reduction in workforcecosts, approximately $1,066,000 related to facility exit costs, andapproximately $286,000 related to asset write-downs.

 

***Interest/Other Income***

 

                Our Interest/Other Income decreased to approximately$31,000 for the three months ended June 30, 2002 from approximately $231,000for the three months ended June 30, 2001, a decrease of approximately $200,000or 87%.  For the six months ended June30, 2002, interest income decreased to approximately $68,000 as compared toapproximately $647,000 for the six months ended June 30, 2001, a decrease ofapproximately $579,000 or 89%.

 

                Thedecrease in interest income is attributable to a decrease in our averageinvested cash balances. We expect the decline in our interest income tocontinue during the remainder of 2002 due to the expected decline in our cashand cash equivalents balances during the year.

 

***Income Taxes***

 

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

 

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

                Cash and cash equivalents totaled approximately $3.1million at June 30, 2002, a decrease of approximately $6.5 million or 67% fromapproximately $9.6 million at December 31, 2001. The decrease primarily camefrom the $6.5 million cash used in operating activities and restructuringcosts.

 

                Since our inception, we have primarily financed ouroperations through private sales of our convertible preferred stock and commonstock. In March 2000, we closed our initial public offering that generated netcash proceeds of 

 

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approximately $39.7million. Our primary capital uses have been funding our operating losses, theprepayment of our large media purchases and capital expenditures.

 

                Net cash used in operating activities for the six monthsended June 30, 2002, decreased approximately $7.9 million or 55% fromapproximately $14.4 million for the six months ended June 30, 2001.  Net cash used in operating activitiesresults primarily from our net loss before non-cash charges for amortization ofstock-based compensation, warrant amortization, restructuring charges net ofcash expenditures and depreciation, offset by changes in operating assets andliabilities and allowances for doubtful accounts.

 

                Net cash used in investing activities was nil in thesix months ended June 30, 2002, a decrease of approximately $248,000 or 100%from net cash used of approximately $248,000 for the six months ended June 30,2001.

 

                Net cash used in financing activities wasapproximately $10,000 in the six months ended June 30, 2002, a decrease ofapproximately $30,000 or 150% from the net cash provided by financingactivities of approximately $20,000 at June 20, 2001.  In 2002, the net cash used in financing activities was related todebt repayment. In 2001, the net cash provided by financing activities was fromthe exercise of stock options.

 

                Our capitalrequirements depend on numerous factors, including the success of ourstrategies for generating revenues and the amount of resources we devote tooperating activities.  Our expenditureshave substantially decreased as a result of our restructuring. Based on therealignment of our resources, we expect a decrease in most of our operatingexpense categories detailed above for the year 2002 as compared to year 2001. Wedo expect to experience ongoing operating losses for the foreseeable future.Pursuant to the agreement with Microsoft that we entered into during December1999 and renegotiated in April 2002, an annual fee of $400,000 is due andpayable to Microsoft in 2002 for services through April 2003.  Pursuant to the two-year agreement withAT&T that we entered into in December 2000, the minimum payment of $1.4million is due at the end of the contract, December 2002.  The Company is in the process of disputingthe commitment based on a provision withinthe agreement that allowed for revision of commitment levels based on actualexperience.  No resolution has beenreached as of the filing of this document. As at June 30, 2002, operating lease commitments of approximately$225,000 are payable over the next four years.

 

                Our limitedoperating history and operating losses have limited our ability to obtainvendor credit or extended payment terms and bank financing on favorable terms;accordingly, we depend on our cash and cash equivalent balances to fund ouroperations.

 

                We currently believe that our available cashresources will be sufficient to meet our anticipated needs for operations andcapital expenditures until the merger is complete.  We will strive to make ongoing realignments, as required, toachieve positive cash flow with our existing cash resources. We areadditionally decreasing our marketing expenditures to assist us in maintainingour available cash resources.  We willcontinue to evaluate our needs for funds based on our assessment of access topublic or private capital markets and the timing of our need for funds.Although we have no present intention to conduct additional public equityofferings, we may seek to raise these additional funds through private orpublic debt or equity financings.  If weraise additional funds by selling equity securities, the percentage ofownership of our stockholders will be reduced. We cannot be sure that additional financing will be available on termsfavorable to us, or at all.  Failure togenerate sufficient revenues, raise additional capital or reduce discretionaryspending could have a material adverse effect on the Company's ability tocontinue as a going concern and to achieve its intended business objectives.

 

 

**RECENTPRONOUNCEMENTS**

 

                In July 2001, the Financial Accounting StandardsBoard (“FASB”) issued SFAS No. 141, “Business Combinations” and SFAS No. 142,“Goodwill and Other Intangible Assets”. Under SFAS No. 141, all business combinations initiated after June 30,2001 must be accounted for using the purchase method.  SFAS No. 142 requires, among other things, the discontinuance ofgoodwill amortization.  In addition, thestatement includes provisions upon adoption for the reclassification of certainexisting recognized intangibles as goodwill, reassessment of the useful livesof existing recognized intangibles and the testing for impairment of existinggoodwill and other intangibles.  TheCompany has adopted the provisions of SFAS No. 142 effective January 1, 2002.  The implementation of SFAS No. 141 and SFASNo. 142 did not have a material effect on the Company’s financial position andresults of operations.

 

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                In October 2001, the FASB issued SFAS No. 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets”, which addresses financialaccounting and reporting for the impairment or disposal of long-livedassets.  This statement supersedes SFASNo. 121 and the accounting and reporting provisions of Accounting PrinciplesBoard, Opinion No. 30 “Reporting the Results of Operations-Reporting theEffects of Disposal of a Segment of a Business, and Extraordinary, Unusual andInfrequently Occurring Events and Transactions”, for the disposal of a segmentof a business.  The Company adopted theprovisions of SFAS No. 144 effective January 1, 2002. The implementation ofSFAS No. 144 did not have a material effect on the Company’s financial positionand results of operations.

 

                In November 2001, the Emerging Issues Task Force(“EITF”) reached a consensus on EITF Issue No. 01-09, “Accounting forConsideration Given by a Vendor to a Customer or a Reseller of the Vendor’sProducts,” (“EITF No. 01-09”). EITF No. 01-09 requires recording certainconsideration paid to distributors of the Company’s products as a reduction ofrevenue.  The Company adopted theprovisions of EITF No. 01-09 effective January 1, 2002. The implementation ofEITF No. 01-09 did not have a material effect on the Company’s financialposition and results of operations.

 

                In April of 2002, FASB issued SFAS No. 145 (“SFAS145”), “*Rescission of FASB Statements No. 4,44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections,”*whichis effective for fiscal years beginning after May 15, 2002.  Under SFAS No.145, gains and losses from theextinguishment of debt should be classified as extraordinary items only if theymeet the criteria of APB Opinion No. 30. SFAS No. 145 also addresses financial accounting and reporting forcapital leases that are modified in such a way as to give rise to a newagreement classified as an operating lease. The Company believes that the adoption of SFAS No. 145 will not have amaterial impact on the consolidated financial position or results of theoperations of the Company.

 

                In June 2002, the FASB issued SFAS No. 146,“Accounting for Exit or Disposal Activities”. SFAS No. 146 addresses significant issues regarding the recognition,measurement, and reporting of costs that are associated with exit and disposalactivities, including restructuring activities that are currently accounted forunder EITF No. 94-3, “Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit and Activity (including Certain Costs Incurredin a Restructuring).” The scope of the SFAS No.146 also includes cots relatedto terminating a contract that is not a capital lease and termination benefitsthat employees who are involuntarily terminated receive under the terms of aone-time benefit arrangement that is not an ongoing benefit arrangement or anindividual deferred-compensation contract. SFAS No.146 will be effective forexit or disposal activities that are initiated after December 31, 2002, butearly application is encouraged.  Theprovisions of EITF No. 94-3 shall continue to apply for an exit activityinitiated under an exit plan that met the criteria of EITF No. 94-3 prior tothe adoption of SFAS No.146. Adopting the provisions of SFAS No. 146 willchange, on a prospective basis, the timing of when restructuring charges arerecorded from a commitment date approach to when the liability is incurred.

 

 

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

 

                This document contains certain forward-lookingstatements. These statements relate to future events or our future financialperformance. In some cases, you can identify forward-looking statements byterminology such as “anticipates’, “believes”, “continue”, “could”,“estimates”, “expects”, “intends”, “plans”, “potential”, “predicts”, “should”or “will” or the negative of these terms or other comparable terminology whichare intended to identify certain of these forward-looking statements. Thecautionary statements made in this document should be read as being applicableto all related forward-looking statements wherever they appear in thisdocument. The Company’s actual results could differ materially from thosediscussed in this document. Factors that could cause or contribute to suchdifferences include those discussed below, as well as those discussed in theCompany’s Annual Report on Form 10-K.

 

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

 

                We have incurred substantial losses and usedsubstantial cash to support our operations as we have expanded our sales andmarketing programs, funded the development of our services, promoted our Websites and matching service and expanded our operations infrastructure. As ofJune 30, 2002, our accumulated loss was approximately $141 million. We expectour expenditures on sales and marketing activities, support field services andthe development of new products, services and technologies to continue at areduced rate, as we restructured our business in June 2002. This restructuringincluded operational efficiencies caused by headcount reductions ofapproximately 82% during the second quarter. We 

 

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will continue to losemoney unless we significantly increase our revenues. We cannot predict when, ifever, we will operate profitably.

 

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

 

                We were incorporated inJanuary 1996; however, we did not begin offering home improvement services onthe Internet until August 1997. In December 1998, we began selling Web siteadvertising. Until March 1999, we focused primarily on building our network ofservice providers and refining our matching services processes. In March 1999,we hired our Chief Executive Officer and commenced recruiting our seniormanagement team. In April 1999, we introduced Powered by ImproveNet, a servicethat allows third parties to offer the ImproveNet matching services and contenton their Web sites, for national suppliers of home improvement and repairproducts. In November 1999, we launched our customized Web site for serviceproviders. We completed the acquisition of two regional contractor referralcompanies, Contractor Referral Service, LLC and The J.L. Price Corporation, inSeptember and November 1999. We experienced reductions in force in July 2000.In the second half of 2000 we significantly reduced our marketing expenditures.In the first and third quarters of 2001, first quarter of 2002, and mostrecently as of June 2002, we implemented cost restructuring initiatives thatincluded a reduction in workforce. Furthermore, even if our business issuccessful, we may change our business to enter into new business areas such asour Premiere Services offerings, which are in the process of launching intoselected geographic regions.  These andother new business initiatives are areas in which we do not have extensiveexperience.

 

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

 

                On June 29, 2001, we received a Nasdaq QualificationPanel Decision indicating that we have failed to comply with the minimum bidprice requirement for continued listing, and were delisted from the NasdaqNational 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.**

 

                Weexpect that currently available funds will be sufficient to meet our workingcapital and capital expenditure needs until the merger is completed; however, if we are unable to generate sufficient cash flowsfrom operations to meet our anticipated needs for working capital and capitalexpenditures, we will need to raise additional funds.  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.

 

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

 

                In addition, we may seek to raise additional funds, finance acquisitionsor develop commercial relationships by issuing equity or convertible debtsecurities, which would reduce the percentage ownership of existingstockholders. Furthermore, any new securities could have rights, preferences orprivileges senior to those of our common stock.

 

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

 

                The market for our services is intensely competitive, evolving andsubject to rapid technological change. To remain competitive, we must continueto enhance and improve the ease of use, responsiveness, functionality andfeatures of our online and offline services in order to attract homeowners toour Web site and maintain our service provider network. We expect the intensityof competition to increase in the future. Increased competition may result inchanges in our pricing model, fewer homeowners visiting our Web site, serviceproviders leaving our network, less marketing revenue, reduced gross marginsand loss of market share, any one of which could significantly reduce anyfuture profitability. In addition, technological barriers to entry arerelatively low. As a result, current competitors, including local referralbusinesses and online referral companies including ServiceMagic.com, iMandi,Bid Express, and Contractor.com as well as potential competitors such as TheHome Depot, Lowe’s and Sears Roebuck & Company who have launched Web sitessimilar to ours that could gain broader market acceptance based on content,products and services.

 

                Some of our competitors have more resources and broader and deepercustomer access than we do. In addition, several of these competitors have orcan readily obtain extensive knowledge of the home improvement industry. Ourcompetitors may be able to respond more quickly than we can to new technologiesor changes in Internet user preferences and devote greater resources than wecan to the development, promotion and sale of their services. We may not beable to maintain our competitive position against current and futurecompetitors, especially those with significantly greater resources and brandrecognition.

 

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

 

                Currently most homeowners use traditional means including word–of–mouthreferrals, Yellow Pages and local contractor matching services to obtainservice providers for their home improvement projects. In addition, manyservice providers do not use the Internet for business purposes and may bereluctant to become part of a network of service providers on an Internet–basedservice provider matching service. If homeowners do not use our matchingservice or service providers do not join our network, we will not be able togenerate significant revenues from either services or advertising.

 

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

 

                We expect to derive the majority of our revenues from our network ofservice providers in the form of payments for each homeowner referral that weprovide to them and for each home improvement project that they win. Ourbusiness is highly dependent on homeowners’ use of our Web site to find serviceproviders for their home improvement projects so that service providers willachieve a satisfactory return on their participation in the ImproveNet program.

 

                A key element of the growth of our business is the pace at whichservice providers adopt the ImproveNet matching process. This adoption includesresponding to homeowner inquiries within 72 hours, providing a competitive,firm quote to homeowners quickly, and paying the service fees to ImproveNet. Wedevote significant effort and resources to screening and supportingparticipating service providers and to developing programs that monitor serviceproviders’ job wins and that collect service fees from service providers forthese wins. Our inability to screen and support service providers effectively,or the failure of our service providers to respond professionally and in atimely manner to homeowner inquiries, could result in low homeownersatisfaction and harm our business. In addition, the failure of our serviceproviders to win home improvement projects, report their wins to us, or pay usservice fees could harm our business.

 

                We must actively recruit new service providers and retain and motivateour current service providers to ensure that we continually have adequatecoverage. We believe that service providers in the home improvement industrysuffer from a relatively high failure or turnover rate that makes it difficultfor us to retain service providers. Accordingly, we expect that not all of ourservice providers will remain active participants in our network. If we areunable to achieve low turnover among our network of service providers ourbusiness 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 for paying us a win fee for eachjob that they obtain from us. We ask service providers not to pass on the costof the win fee to the homeowner. However, we do not currently provide anyguarantee to the homeowner that our service providers have not raised theirrates to cover the win fee nor do we audit or plan to audit our serviceproviders to confirm that they have not raised their rates. Homeowners maybelieve that they are indirectly paying us our win fee through the higher ratesof service providers and, therefore, choose to select service providers through

 

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word–of–mouth referrals, YellowPages, local contractor matching services or other means rather than using ourmatching service. If homeowners choose not to use our service, we will loseservice revenues and visitors to our Web sites and our business will be harmed.

 

                We depend on our service providers to report that they have won a joband pay us our win fee. We rely on our relationships with our service providersand the incentive to receive future leads from us to encourage serviceproviders to report wins and pay win fees. Currently, we do not have a controlor an oversight mechanism in place with either service providers or homeownersto ensure that they report wins and pay win fees. If service providers do notreport wins or pay us win fees, we will lose service revenues and our businesswill be harmed.

 

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

 

                We have entered into commercial contracts with suppliers of homeimprovement products and services to generate revenues and increase the numberof visitors to our Web sites. Under these contracts, suppliers have placedlinks to our Web site from their Web sites to allow their customers to visitour Web site if the customers are interested in obtaining home improvementinformation or searching for a service provider. We believe that increasing thenumber of visitors to our Web sites will increase the number of jobsubmissions. We cannot assure you that these contracts will lead to increasedvisits to our Web sites or that increased visits to our Web sites will resultin increased job submissions. If we do not maintain our existing contracts onterms as favorable as currently in effect or if we are not able to establishnew contracts on commercially reasonable terms, our business could be harmed.

 

                Companies that we may pursue for a commercial contract may offerservices competitive with suppliers with which we currently have contracts. Asa result, these suppliers may be reluctant to enter into commercial contractswith us.

 

                We purchase preferential placement on high–traffic Web sites. Webelieve these Web sites can help us to increase the number of visitors toImproveNet.com. Web site traffic originated from AltaVista, Lycos, MicrosoftHomeAdvisor and Yahoo! There is intense competition for preferential placementson these Web sites. If we lose our relationships with any one of these Websites, job submissions on ImproveNet.com may decrease and we may not be able toenter into commercially reasonable contracts with replacement high–trafficWeb sites, if at all.

 

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

 

                We integrate third–party software into our service offerings onour Web sites. We would be harmed if the providers from which we licensesoftware ceased to deliver and support reliable products, to enhance theircurrent 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 retain qualified personnel, ourability to continue to operate could be harmed.**

 

                We depend on the continued service of our key technical, operationaland administrative personnel. In particular, the loss of the services of any ofthe remaining personnel, individually or as a group, could cause us to incurincreased operating expenses and divert other personnel time in searching fortheir replacements. We do not have employment agreements with any employee, andwe do not maintain any key person life insurance policies for any of ouremployees. The loss of any of our remaining personnel could harm our business.

 

**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 and protect our intellectualproperty rights, including our databases of homeowners and service providersand our internally–developed matching criteria and algorithms, todistinguish our services from our competitors’ services. We rely on acombination 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. 

 

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Accordingly, we may not be able to protectour intellectual property rights against unauthorized third–party copyingor use. Furthermore, policing the unauthorized use of our intellectual propertyis difficult, and expensive litigation may be necessary in the future toenforce our intellectual property rights. The use by others of our proprietaryrights could 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 have infringed their intellectualproperty rights by claiming that our matching service infringes their patents,trade secrets or copyrights. In the ordinary course of business, we havereceived, and may receive in the future, notices from third parties claiminginfringement of their proprietary rights. In addition, providers of goods andservices over the Internet are increasingly subject to claims that they infringepatents that cover basic elements of electronic commerce. The resolution of anyclaims could be time–consuming, result in costly litigation, delay orprevent us from offering our services or require us to enter into royalty orlicensing agreements, any of which could harm our business. In the event aninfringement claim against us is successful and we cannot obtain a license onacceptable terms, license a substitute technology or redesign our services, ourbusiness would be harmed. Furthermore, former employers or our current andfuture employees may assert that our employees have improperly disclosed to usor are using confidential or proprietary 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 uninterrupted operation of our computerand communications hardware and software systems. Substantially all of ourcomputer hardware for operating our Web sites is currently located at QwestCommunications in Sunnyvale, California, with backups located at our facilityin Redwood City, California. These systems and operations are vulnerable todamage or interruption from earthquakes, floods, fires, power loss,telecommunication failures and similar events. They are also subject to break–ins,sabotage, intentional acts of vandalism and similar misconduct. We do not havefully redundant systems, a formal disaster recovery plan or alternativeproviders of hosting services, and we do not carry business interruptioninsurance to compensate us for losses that could occur. Despite any precautionswe may take, the occurrence of a natural disaster or other unanticipatedproblems either at Qwest or at our facility could result in interruptions inour services. Any damage to or failure of our systems could result ininterruptions in our service. In addition to placing an increased burden on ourengineering staff, any system failure could create user questions and complaintsthat must be responded to by our customer support personnel. The systemfailures of various third–party Internet service providers, onlineservice providers and other Web site operators could result in interruptions inour service to those users who require the services of these third–partyproviders and operators to access our Web sites. These interruptions couldreduce our revenues and profits, and our future revenues and profits will beharmed if our users believe that our system is unreliable. Since we have beenkeeping logs of our Web sites, our ImproveNet.com Web site has beenunintentionally interrupted for periods ranging from two minutes to one hour,the latter prior to February 2000.

 

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

 

                The satisfactory performance, reliability and availability of our Websites, processing systems and network infrastructure are critical to ourreputation and our ability to attract and retain large numbers of users. If thevolume of traffic, including at peak times, on our Web sites increases, we mayneed to expand and upgrade our technology, transaction processing systems andnetwork infrastructure. We may not be able to accurately project the rate ortiming of these increases, if any, in the use of our services or to expand orupgrade our systems and infrastructure in a timely manner to accommodate theseincreases.

 

                We use internally developed systems for operating our services andprocessing our transactions, including billing and collections processing. Wemust continually improve these systems in order to accommodate the use of ourWeb sites. If we add new features and functionality to our services, we couldbe required to develop or license additional technologies. Our inability to addadditional software and hardware or upgrade our technology, transactionprocessing systems or network infrastructure could cause unanticipated systemdisruptions, slower response times, degradation in levels of customer support,impaired quality of the users’ experience, delays in accounts receivablecollection or losses of recorded financial information. Our failure to providenew features or functionality also could result in these consequences. Therequired hardware may not be readily available or affordable and we may beunable to effectively upgrade and/or expand our systems 

 

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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.**

 

                We could be subject to claims relating to products and services that weperform on behalf of homeowners or referrals to selected contractors throughour Web site. Homeowners may bring claims against us or our service providers,who may have among other things, provided them with poor workmanship or causedbodily injury or damage to property. Our existing insurance coverage may notcover all potential claims, may not adequately cover all costs incurred indefense of potential claims, may not indemnify us for all liability that may beimposed or may not be renewable in future periods or renewable on terms andconditions satisfactory to us. In addition, claims, with or without merit,would result in diversion of our financial resources and management resources.

 

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

 

                We depend on increased acceptance and use of the Internet. Inparticular, our matching service depends upon service providers being willingto use the Internet to find jobs through our service. We believe that serviceproviders generally have not traditionally used computers or the Internet tooperate their businesses. Demand and market acceptance for recently introducedproducts and services over the Internet are subject to a high level ofuncertainty. As a result, acceptance and use of the Internet may not develop ora sufficiently broad base of users may not adopt or continue to use theInternet as a medium of commerce.

 

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

 

                To succeed, we will need to adapt effectively to rapidly changingtechnologies and continually improve the performance features and reliabilityof our services. We could incur substantial costs in modifying our products,services or infrastructure to adapt to these changes, and we may also losecustomers and revenues if our services fail to adapt to the rapid changescharacteristic of the Internet.

 

                Conversely, if the Internet experiences increased growth in number ofusers, frequency of use and bandwidth requirements, the Internet infrastructuremay be unable to support the demands placed on it. The success of our businesswill rely on the Internet providing a convenient means of interaction andcommerce. Our business depends on the ability of users to access informationwithout significant delays or aggravation.

 

**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, an increasing number of lawsand regulations pertaining to the Internet. These laws and regulations mayrelate to liability for information retrieved from or transmitted over theInternet, online content, user privacy, taxes or the quality of services. Anynew law or regulation pertaining to the Internet, or the adverse application orinterpretation of existing laws, could decrease the demand for our services orincrease our cost of doing business.

 

                We are not certain how our business may be affected by the applicationof existing laws governing issues such as property ownership, copyrights,encryption and other intellectual property issues, taxation, libel, obscenityand export or import matters. The vast majority of these laws were adoptedprior to the advent of the Internet. As a result, they do not contemplate oraddress the unique issues created by the Internet and related technologies.Changes in laws intended to address these issues could create uncertainty foror adversely affect companies doing business on the Internet. This could reducedemand for our services or increase the cost of doing business.

 

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

 

                General economic conditions, which affect consumer confidence and homeimprovement and home-building spending, including interest rates, the overalllevel of economic activity, the availability of consumer credit and mortgagefinancing and unemployment rates may change dramatically and impact our abilityto operate.

 

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

 

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

 

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

 

                Current computing and Internet technology allows us to collect personalinformation about our users. In the past, the Federal Trade Commission hasinvestigated companies that have sold personal information to third partieswithout permission or in violation of a stated privacy policy. Currently, wecollect personal information only with the users’ consent and under our privacypolicy. If we begin collecting or selling personal information withoutpermission or in violation of our privacy policy, we could face potentialliability for compiling and providing information to third parties.

 

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

 

                We file 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 oursthat engage in or facilitate Internet–based commerce. A number ofproposals have been made at state and local levels that could impose taxes onthe sale of products and services through the Internet or the income derivedfrom those sales. These proposals, if adopted, could substantially impair thegrowth of Internet–based commerce and harm our ability to becomeprofitable.

 

                United States of America federal law limits the ability of the statesto impose taxes on Internet-based transactions.  Until October 21, 2001, state and local taxes on Internet-basedcommerce that are discriminatory against Internet access are prohibited, unlessthe taxes were generally imposed and actually enforced before October 1,1998.  It is possible that this taxmoratorium will not be renewed by October 21, 2001 or at all.  Failure to renew this legislation wouldallow various states to impose taxes on Internet-based commerce.  The imposition of state and local taxescould harm our ability to become profitable.

 

**Wedepend on the very reduced staff.**

 

                We areoperating on a very reduced staff.  Wecurrently have one person in engineering and operating our website.  If the website goes down or any part of ournetwork breaks, it could greatly effect our revenue source. We also only haveone person in marketing and operations. If we were to lose that person is could greatly effect our operationsand job flow, which could greatly reduce our source of revenue.

 

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

 

**InterestRate Risk**

 

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

 

                Our exposure to market risk for changes in interestrates relates primarily to increases or decreases in the amount of interestincome we earn on our investment portfolio and on increases or decreases in theamount of interest expense we 

 

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must pay with respect toany outstanding 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 financial instruments as ofJune 30, 2002, and have never held such instruments in the past. In addition,we had no debt instruments outstanding as of June 30, 2002. We currentlytransact all of our revenues, which are all traded in the United States ofAmerica, in U.S. dollars.

 

 

**PART II- OTHER INFORMATION**

 

**Item1.  Legal Proceedings**

 

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

 

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

 

                None

 

**Item3.  Defaults Upon Senior Securities**

 

                None

 

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

 

The Company heldits annual meeting of stockholders on June 6, 2002. At such meeting thefollowing actions were voted upon:

 

(a)                                      Election of two directors, Charles Brownand Garrett Gruener, to hold office until the 2005 annual meeting ofstockholders. 

 
|            |   | **Votes in  Favor** |   | **Votes  Withheld** |   |
|-----------------|--------|---------------------|--------|---------------------|--------|
| Charles Brown   |   | 11,018,234          |   | 197,115             |   |
| Garrett Gruener |   | 11,141,234          |   | 74,115              |   |

 

(b)                                     Ratification of PricewaterhouseCoopers LLPas the Company’s independent auditors for the fiscal year ending December 31,2002.

 
| **Votes in  Favor** |   | **Votes  Against** |   | **Abstentions** |   | **Broker Non  Votes** |
|---------------------|--------|--------------------|--------|-----------------|--------|-----------------------|
| 11,071,372          |   | 142,578            |   | 1,399           |   | —                |

 

Based on these voting results, each of thedirectors nominated was elected and the second matter was approved.

 

**Item5.  Other Information**

 

None.

 

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

 

(a)                                  Exhibits

 

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

 

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(1)                                  Incorporatedby reference to the Registrant’s Form 10-Q for the period ended March 31, 2002filed on April 15, 2002.

(2)                                  Incorporatedby reference to the Registrant’s Form 8-K filed on August 6, 2002.

(3)                                  Filed herewith.

 

 

(b)                                 Reports on Form 8-K

 

OnJune 11, 2002, the Registrant filed a Current Report on Form 8-K relating tothe execution of a Letter of Intent to enter into an Agreement and Plan ofMerger with eTechLogix, Inc.

OnJune 18, 2002, the Registrant filed a Current Report on Form 8-K relating tothe amendment of the Letter of Intent to enter into an Agreement and Plan ofMerger with eTechLogix, Inc.

OnJune 24, 2002, the Registrant filed a Current Report on Form 8-K relating tothe cancellation of its intent to merge with eTechLogix, Inc.

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

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**Signatures**

 

Pursuant tothe requirements of the Securities and Exchange Act of 1934, the Registrant hasduly caused this report to be signed, August 14, 2002 on its behalf by theundersigned duly authorized.

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

 

Date: August 20, 2002

 

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