AUTOBYTEL INC (Form: 10-Q, Received: 05/31/2005 15:33:20)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2005

¨	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 0-22239

Autobytel Inc.

(Exact name of registrant as specified in its charter)


Delaware		33-0711569
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer identification number)

18872 MacArthur Boulevard, Irvine, California		92612
(Address of principal executive offices)		(Zip Code)

(949) 225-4500

(Registrant’s telephone number, including area code)

Check whether the registrant: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ¨ No x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨

As of April 30, 2005, there were 41,905,848 shares of the Registrant’s Common Stock outstanding.

EXPLANATORY NOTE

In addition to providing financial and other information for our fiscal quarter ended March 31, 2005, we are filing this Quarterly Report on Form 10-Q to restate our consolidated financial statements for the fiscal quarter ended March 31, 2004, as discussed in Note 3 to our consolidated financial statements. Our previously released financial statements for this period should not be relied upon.

On November 15, 2004, we announced that we expected to restate our consolidated financial statements for the second, third and fourth fiscal quarters of 2003, the full 2003 fiscal year and the first and second fiscal quarters of 2004, relating to credits issued to customers that were inappropriately reversed and recognized as revenue during the four fiscal quarters ended March 31, 2004, and outstanding checks issued by us that were voided and the corresponding obligations inappropriately reversed and recorded as an increase in revenue or a reduction of expenses in the second and third fiscal quarters of 2003 and the second fiscal quarter of 2004.

Upon a further review, we also determined to restate our consolidated financial statements for the full 2002 fiscal year and to include adjustments in our restated consolidated financial statements for the first, second, third and fourth fiscal quarters of 2003, the full 2003 fiscal year and the first and second fiscal quarters of 2004.

The Audit Committee of our Board of Directors, with the assistance of independent counsel and independent forensic accountants engaged by such independent counsel, undertook a seven-month internal review of the facts giving rise to the restatements described herein and our accounting policies and procedures related thereto. Independent counsel to the Audit Committee concluded that of the 31 items reviewed in the course of the internal investigation that were ultimately determined to have been improperly accounted for and that are the subject of the restatement of our financial statements, 26 of those items were the result of error or mistake and not the result of intentional conduct or fraud. With respect to the credits issued to customers that were inappropriately reversed and recognized as revenue and the outstanding checks issued by us that were voided and the corresponding obligations inappropriately reversed and recorded as an increase in revenue or a reduction of expenses, while there were some facts that may have supported different inferences, independent counsel could not conclude that the unapplied credit and stale check items were the result of intentional conduct for an improper or illegal purpose. With respect to the failure to make certain accruals in the second fiscal quarter of 2003, as well as the reversal of accruals for certain bonuses in the third and fourth fiscal quarters of 2002 (see description below), while inferences may be drawn from the facts, based on the evidence reviewed, independent counsel could not conclude that such accounting treatment was the result of intentional conduct for an improper or illegal purpose. Independent counsel to the Audit Committee also found that former senior management did not set an appropriate tone at the top that was conducive of an effective control environment. In addition, our financial staff undertook a review of the basis on which we document and prepare our financial statements under generally accepted accounting principles. The aggregate impact of all of the identified inappropriate accounting items and errors on our balance sheet is a reduction of $0.8 million in our stockholders’ equity at June 30, 2004, and the net impact on our statements of operations over the period from January 1, 2002 through June 30, 2004 is a reduction of net income of $3.1 million, of which $1.7 million impacted the first six months of 2004.

Independent counsel to the Audit Committee of the Board of Directors and the forensic accountants retained by such outside counsel have also identified internal control deficiencies, and have suggested changes, some of which we have begun to implement and others of which we intend to implement during the course of 2005, to our internal controls which are designed to remediate the deficiencies described in Management’s Report on Internal Control Over Financial Reporting set forth on page F-2 in our Annual Report on Form 10-K for the year ended December 31, 2004. Management has reviewed the internal control deficiencies with the Audit Committee of the Board of Directors, has discussed them with our independent registered public accounting firm, PricewaterhouseCoopers LLP, and has advised the Audit Committee that the deficiencies are indicative of material weaknesses in our internal control over financial reporting.

The remedial measures include, but are not limited to, the following:

•

Establishment of written policies and procedures relating to the access to, and control over, our financial accounting systems.

•

Development or revision of our written accounting policies and procedures relating to: (i) disbursement checks outstanding greater than 180 days, (ii) unapplied credits on customer accounts, to require review and approval by our controller or Chief Financial Officer of all debit memos and credit memos of $10,000 or more, (iii) voiding of purchase and disbursement transactions; and (iv) revenue recognition, accruals and reversals thereof, reclassifications of accruals, and back-up documentation related thereto, and to require review and approval by our Chief Financial Officer of all accruals, individually or in the aggregate, above $100,000.

•

Implementation of enhanced training for our finance and accounting personnel to familiarize them with our accounting policies.

•

Establishment of a quarterly and annual sub-certification process requiring written confirmation from business unit managers regarding communication of matters pertaining to their area of responsibility that are nonstandard or that would require disclosure.

•

Recruitment of additional personnel trained in financial reporting under accounting principles generally accepted in the United States to enhance supervision with regard to, among other things, account reconciliations and documentation supporting our quarterly and annual financial statements.

•

Implementation of formal training related to compliance with state escheat laws.

•

Revisions to, and improvement of, our contract management system and yield management system.

At the direction of, and in consultation with, the Audit Committee, management currently is implementing certain of the remedial measures and intends to implement the remaining remedial measures during the course of 2005. While this implementation is underway, we are relying on extensive manual procedures and the utilization of outside accounting professionals to assist us with meeting the objectives otherwise fulfilled by an effective controls environment. While we are implementing changes to our controls environment, there remains a risk that the transitional procedures on which we are currently relying will fail to be sufficiently effective under the criteria used to assess effectiveness identified in Management’s Report on Internal Control Over Financial Reporting. Please see Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors—Our internal controls and procedures need to be improved.”

In addition, we have (i) accepted the resignations of our Chief Executive Officer and President (from such positions), Chief Financial Officer and Executive Vice President, and Assistant Controller, (ii) appointed a new Chief Executive Officer and President, Chief Operating Officer and Executive Vice President, Chief Financial Officer and Executive Vice President, and Assistant Controller, and (iii) hired a new Director of Accounting.

The restatement of the consolidated financial statements for the first fiscal quarter of 2004 is reflected in this Quarterly Report on Form 10-Q, and principally make adjustments relating to the items set forth below, in addition to the adjustments related to customer credits and outstanding checks described above.

Revenue adjustments:

•

Certain revenue generated from the delivery of purchase requests for vehicles was inappropriately recognized in the first and second fiscal quarters of 2004;

•

Advertising credits earned by customers in the first and second fiscal quarters of 2004 were not recorded as a reduction of advertising revenue in the period earned by the customers and delivery or payment of these credits in subsequent periods was inappropriately recorded as a decrease in advertising revenue;

•

Inappropriate classification of revenue between lead fees and customer relationship management services revenue in the first and second fiscal quarters of 2004;

•

Website advertising revenue earned in the first and second fiscal quarters of 2004 that was not recognized in such periods;

•

Inappropriate recognition of revenue in the second fiscal quarter of 2004 for advertising services;

•

Inappropriate recognition of revenue during the four fiscal quarters ended June 30, 2004 relating to delivery of purchase requests to two customers; and

•

Inappropriate recognition of certain revenue from a multiple element arrangement in the first and second fiscal quarters of 2004.

Expense adjustments:

•

Credits issued to customers that were inappropriately reversed and recorded as a reduction of sales and marketing expense during 2002 and 2003 in connection with the cessation of operations of certain subsidiaries;

•

Expense provisions for our participation at an annual trade show that were inappropriately recorded throughout the annual fiscal period preceding the first fiscal quarter of the following annual fiscal period in which the trade show took place;

•

Inappropriate accrual of advertising costs in 2002 that was derecognized and recorded as a reduction of advertising expense in the first fiscal quarter of 2004;

•

Franchise tax expense was over-estimated in the first and second fiscal quarters of 2004;

•

Inappropriate accruals of subscription costs in 2003 that were subsequently derecognized and recorded as a reduction of sales and marketing expense in the first fiscal quarter of 2004;

•

Excess accrual of medical costs that should not have been recognized in 2002, but which was inappropriately derecognized and partially recorded as a reduction of online advertising costs in 2003, with the remaining excess recorded as a reduction of compensation costs in the first fiscal quarter of 2004;

•

Accrued liabilities that were prematurely derecognized and recorded as a reduction of expenses in the first fiscal quarter of 2004;

•

Inappropriate accrual of commissions expense in 2002;

•

Inappropriate excess accrual of commissions expense in 2003 that was derecognized and recorded as a reduction of commissions expense in the first fiscal quarter of 2004;

•

State income tax expenses were not recorded during the first and second fiscal quarters of 2004. The state tax expenses relate to two states where subsidiaries operate on a profitable basis;

•

The equity method of accounting was inappropriately applied for our investment in Autobytel.Europe; and

•

A series of loans made by Autobytel.Europe was inappropriately recorded at cost instead of net realizable value.

The restatements of the consolidated financial statements for the full 2002 and 2003 fiscal years are reflected in the Form 10-K for the fiscal year ended December 31, 2004 (the “Form 10-K”). The restatements of the consolidated financial statements for the second fiscal quarter of 2003 and the second fiscal quarter of 2004 are reflected in an amendment to the Form 10-Q for the fiscal quarter ended June 30, 2004 (the “Form 10-Q/A”). The restatement of the consolidated financial statements for the third fiscal quarter of 2003 is reflected in the Form 10-Q for the fiscal quarter ended September 30, 2004 (the “September 10-Q”).

Concurrently with the filing of this Quarterly Report on Form 10-Q, we are filing with the SEC the Form 10-K, the September 10-Q, and the Form 10-Q/A. No amendments have been or will be made to our Annual Reports on Form 10-K for the fiscal years 2002 or 2003, or our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2003, June 30, 2003, September 30, 2003, or March 31, 2004, as all relevant changes have been reflected in this Quarterly Report on Form 10-Q, the Form 10-K, the Form 10-Q/A, and the September 10-Q. Our previously filed Annual Reports on Form 10-K for the fiscal years ended 2002 and 2003, and our previously filed Quarterly Reports on Form 10-Q for the fiscal periods ended March 31, 2002, June 30, 2002, September 30, 2002, March 31, 2003, June 30, 2003, September 30, 2003, March 31, 2004, and June 30, 2004 should not be relied upon.

INDEX


		Page
	PART I. FINANCIAL INFORMATION

ITEM 1.	Consolidated Financial Statements (unaudited):

	Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004	7

	Consolidated Statements of Operations for the Three Months Ended March 31, 2005 and 2004 (restated)	8

	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004 (restated)	9

	Notes to Consolidated Financial Statements	10

ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	32

ITEM 4.	Controls and Procedures	58

	PART II. OTHER INFORMATION

ITEM 1.	Legal Proceedings	60

ITEM 6.	Exhibits	62

Signatures		63

PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

AUTOBYTEL INC.

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share and per share data)

(unaudited)


	March 31, 2005			December 31, 2004
Current assets:
Domestic cash and cash equivalents	$	25,180		$	24,287
Restricted international cash and cash equivalents		9,053			9,053
Short-term investments		15,000			16,500
Accounts receivable, net of allowances for bad debts and customer credits of $1,247 and $1,037, respectively		18,665			17,920
Prepaid expenses and other current assets		2,172			2,344

Total current assets		70,070			70,104
Long-term investments		12,000			12,000
Property and equipment, net		3,407			3,389
Capitalized internal use software, net		120			225
Goodwill		70,697			70,697
Acquired intangible assets, net		3,688			4,187
Other assets		111			115

Total assets	$	160,093		$	160,717

LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	7,860		$	5,812
Accrued expenses		8,314			7,990
Current portion of deferred revenues		4,026			4,029
Accrued domestic restructuring		27			74
Other current liabilities		2,140			2,216

Total current liabilities		22,367			20,121
Long-term deferred revenues		4			8

Total liabilities		22,371			20,129
Minority interest		4,530			4,521

Commitments and contingencies (Note 7.)

Stockholders’ equity:
Preferred stock, $0.001 par value; 11,445,187 shares authorized; none outstanding		—			—
Common stock, $0.001 par value; 200,000,000 shares authorized; 41,905,848 shares issued and outstanding for both periods		42			42
Additional paid-in capital		282,287			282,287
Accumulated other comprehensive income		2,034			2,099
Accumulated deficit		(151,171	)		(148,361	)

Total stockholders’ equity		133,192			136,067

Total liabilities, minority interest and stockholders’ equity	$	160,093		$	160,717

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

AUTOBYTEL INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except share and per share data)

(unaudited)


	Three Months Ended March 31,
	2005			2004
				(Restated)
Revenues	$	33,328		$	24,618

Costs and expenses:
Cost of revenues		13,387			10,525
Sales and marketing		8,082			6,085
Product and technology development		6,071			4,360
General and administrative		8,328			3,019
Amortization of acquired intangible assets		460			27

Total costs and expenses		36,328			24,016

Income (loss) from operations		(3,000	)		602
Interest income		349			186
Loss in equity investees		—			(84	)
Other income		2			1
Minority interest		(17	)		—

Income (loss) before income taxes		(2,666	)		705
Provision for income taxes		(144	)		(29	)

Net income (loss)	$	(2,810	)	$	676

Net income (loss) per share:
Basic	$	(0.07	)	$	0.02

Diluted	$	(0.07	)	$	0.02

Shares used in computing net income (loss) per share:
Basic		41,905,848			38,343,958

Diluted		41,905,848			42,592,070

Comprehensive income (loss):
Net income (loss)	$	(2,810	)	$	676
Translation adjustment		65			144

Comprehensive income (loss)	$	(2,745	)	$	820

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

AUTOBYTEL INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(unaudited)


	Three Months Ended March 31,
	2005			2004
				(restated)
Cash flows from operating activities:
Net income (loss)	$	(2,810	)	$	676
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Non-cash charges:
Depreciation and amortization		420			373
Amortization of capitalized internal use software		145			270
Amortization of acquired intangible assets		499			45
Provision for bad debt		210			77
Provision for customer credits		814			33
Loss in equity investee		—			84
Minority interest		17			—
Changes in assets and liabilities:
Accounts receivable		(1,769	)		330
Prepaid expenses and other current assets		172			23
Other assets		4			(399	)
Accounts payable		2,048			642
Accrued expenses		324			(1,365	)
Deferred revenues		(7	)		(178	)
Accrued domestic restructuring		(47	)		(46	)
Other current liabilities		(76	)		9

Net cash (used in) provided by operating activities		(56	)		574

Cash flows from investing activities:
Sales and maturities of short-term investments		7,500			10,991
Purchases of short-term and long-term investments		(6,000	)		(27,000	)
Purchases of property and equipment		(438	)		(357	)
Changes in restricted cash and cash equivalents		(73	)		—
Capitalized internal use software costs		(40	)		—

Net cash provided by (used in) investing activities		949			(16,366	)

Cash flows from financing activities:
Net proceeds from sale of common stock		—			2,419

Net cash provided by financing activities		—			2,419

Net increase (decrease) in cash and cash equivalents		893			(13,373	)
Cash and cash equivalents, beginning of period		24,287			45,643

Cash and cash equivalents, end of period	$	25,180		$	32,270

Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes	$	407		$	—

Cash refunded during the period for interest	$	—		$	(1	)

Supplemental disclosure of non-cash investing activities:

•

In March 2004, Autobytel consolidated Autobytel.Europe due to the adoption of FIN 46R. As a result of this adoption, Autobytel recorded $10,459 (including $10,425 of restricted international cash and cash equivalents) in assets, $2,300 in liabilities and $4,161 in minority interest. (See Note 4.)

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

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in thousands, except per share data)

(unaudited)

1. Organization and Operations of Autobytel

Autobytel Inc. (Autobytel) is an automotive marketing services company that helps dealers sell cars and manufacturers build brands through efficient marketing and advertising primarily through the Internet. Autobytel provides products and programs to automotive dealers and manufacturers to help them increase marketing efficiency and reduce customer acquisition costs. Autobytel owns and operates the automotive Web sites Autobytel.com, Autoweb.com, Car.com, CarSmart.com, Autosite.com, AICAutoSite.com, Autoahorros.com and CarTV.com. Autobytel is also a leading provider of customer relationship management (CRM) products and programs, which consist of lead management products, customer loyalty and retention marketing programs, and data extraction services for dealers. Autobytel is also a provider of automotive marketing data and technology.

Autobytel is a Delaware corporation incorporated on May 17, 1996. Its principal corporate offices are located in Irvine, California. Autobytel completed an initial public offering in March 1999 and its common stock is listed on the Nasdaq National Market under the symbol ABTLE.

2. Summary of Significant Accounting Policies

Unaudited Interim Financial Statements

The accompanying interim consolidated financial statements as of March 31, 2005, and for the three months ended March 31, 2005 are unaudited. The accompanying unaudited consolidated financial statements for the three months ended March 31, 2004 have been restated (see Note 3). The unaudited interim consolidated financial statements have been prepared on the same basis as the audited annual consolidated financial statements and, in the opinion of Autobytel’s management, reflect all adjustments, which are of a normal recurring nature, necessary to fairly state Autobytel’s consolidated balance sheets and statements of operations and cash flows for the periods presented in accordance with accounting principles generally accepted in the United States. Autobytel’s results for an interim period are not necessarily indicative of the results that may be expected for the year.

Although Autobytel believes that all adjustments necessary for a fair presentation of the interim periods presented are included and that the disclosures are adequate, these consolidated financial statements and related notes are unaudited and should be read in conjunction with the audited consolidated financial statements and related notes for the year ended December 31, 2004 included in Autobytel’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission on May 31, 2005.

Principles of Consolidation

On March 31, 2004, Autobytel adopted FIN 46R and determined it was the primary beneficiary of Autobytel.Europe LLC (Autobytel.Europe). As a result of adopting FIN 46R, Autobytel consolidated Autobytel.Europe in its consolidated financial statements. Autobytel owns 49% of Autobytel.Europe. (See Note 4.)

All intercompany transactions and balances have been eliminated in consolidation.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with generally accepted accounting principles requires Autobytel to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

Cash and Cash Equivalents

For purposes of the consolidated balance sheets and the consolidated statements of cash flows, Autobytel considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents. Domestic cash and cash equivalents represent amounts held by Autobytel for use by Autobytel.

Restricted Cash and Cash Equivalents

Restricted international cash and cash equivalents represent amounts held for Autobytel.Europe’s current operations use as directed by Autobytel.Europe. Restricted international cash and cash equivalents are not available to Autobytel.

Short-Term and Long-Term Investments

Autobytel categorized its debt securities as either held-to-maturity or available-for-sale investments in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” All held-to-maturity securities with remaining maturities of less than one year are classified as short-term investments and all held-to-maturity securities with remaining maturities greater than one year are classified as long-term investments and are reported at amortized cost. Autobytel categorized auction rate securities as available-for-sale short-term investments. Auction rate securities are reported at cost, which approximates fair market value due to the interest rate reset feature of these securities. As such, no unrealized gains or losses related to these securities were recognized during the three months March 31, 2005 and 2004. The cost of securities sold is based on the specific identification method.

Autobytel reviews its investments in debt securities for potential impairment on a regular basis. As part of the evaluation process, Autobytel considers the credit ratings of these securities and Autobytel’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated improvement of the investee financial condition. Autobytel will record an impairment loss on investments for any other-than-temporary decline in fair value of these debt securities below their cost basis. For the three months ended March 31, 2005 and 2004, Autobytel did not record any impairment losses that were related to other-than-temporary decline in fair value of its debt securities.

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

As of March 31, 2005 and December 31, 2004, the amortized cost basis, aggregate fair value, unrealized gains and losses by security type were as follows:


	Amortized Cost Basis		Aggregate Fair Value		Unrealized Gains		Unrealized Losses
March 31, 2005:

Short-term investments, available for sale:
Auction rate securities	$	6,000	$	6,000	$	—	$	—
Short-term investments, held-to-maturity:
Government sponsored agency bonds		9,000		8,935		—		65

		15,000		14,935		—		65

Long-term investments, held-to-maturity:
Government sponsored agency bonds	$	12,000	$	11,858	$	—	$	142

Total as of March 31, 2005	$	27,000	$	26,793	$	—	$	207

December 31, 2004:

Short-term investments, available for sale:
Auction rate securities	$	10,500	$	10,500	$	—	$	—
Short-term investments, held-to-maturity:
Government sponsored agency bonds		6,000		5,976		—		24

		16,500		16,476		—		24

Long-term investments, held-to-maturity:
Government sponsored agency bonds		12,000		11,905		—		95

Total as of December 31, 2004	$	28,500	$	28,381	$	—	$	119

The following represents the contractual maturities of investments as of March 31, 2005:


	Amortized Cost Basis
Due within one year	$	9,000
Due after one through five years		12,000
Due after five years		6,000

	$	27,000

Certain auction rate securities have been reclassified from cash equivalents to short-term investments. Auction rate securities are variable rate bonds tied to short-term interest rates with maturities on the face of the securities in excess of 90 days. Auction rate securities have interest rate resets through a modified Dutch auction, at pre-determined short-term intervals, usually every 7, 28 or 35 days. They trade at par and are callable at par on any interest payment date at the option of the issuer. Interest paid during a given period is based upon the interest rate determined during the prior auction.

Although these securities are issued and rated as long-term bonds, they are priced and traded as short-term instruments because of the liquidity provided through the interest rate reset. Based on Autobytel’s ability either to liquidate its holdings or to roll its investment over to the next reset period, Autobytel has historically classified some or all of these instruments as cash equivalents if the period between interest rate resets was 90 days or less.

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

Autobytel accounts for these marketable securities in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Such investments are classified as “available for sale” and are reported at fair value in Autobytel’s consolidated balance sheets. The short-term nature and structure, the frequency with which the interest rate resets and the ability to sell auction rate securities at par and at Autobytel’s discretion indicates that such securities should more appropriately be classified as short-term investments with the intent of meeting Autobytel’s short-term working capital requirements.

Based upon Autobytel’s evaluation of these securities, Autobytel has classified as short-term investments any auction rate securities.

Purchases of short-term and long-term investments and sales of short-term investments included in the accompanying consolidated statement of cash flows for 2004 have been reclassified to reflect the purchase and sale of auction rate securities. Total purchases of auction rate securities were $18,000 for the three months ended March 31, 2004 and total sales of auction rate securities were $7,000 for the three months ended March 31, 2004.

Revenues

Autobytel classifies revenues as lead fees, advertising, customer relationship management (CRM) services, and data, applications and other. Revenues by groups of similar services are as follows for the three months ended March 31, 2005 and 2004, respectively:


	Three Months Ended March 31,
	2005		2004
			Restated
Revenues:
Lead fees	$	21,625	$	17,192
Advertising		4,761		3,102
CRM services		5,758		3,009
Data, applications and other		1,184		1,315

Total revenues	$	33,328	$	24,618

Computation of Basic and Diluted Net Income (Loss) per share

Net income (loss) per share has been calculated under SFAS No. 128, “Earnings per Share.” SFAS No. 128 requires companies to compute earnings per share under two different methods, basic and diluted. Basic net income (loss) per share is calculated by dividing the net income by the weighted average shares of common stock outstanding during the period. Diluted net income (loss) per share is calculated by dividing the net income by the weighted average shares of common stock outstanding during the period and dilutive potential shares of common stock. Dilutive potential shares of common stock, as determined under the treasury stock method, consist of shares of common stock issuable upon exercise of stock options net of shares of common stock assumed to be repurchased by Autobytel from the exercise proceeds.

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

The following table sets forth the computation of basic and diluted net income (loss) per share:


	Three Months Ended March 31,
	2005			2004
				(Restated)
Numerator:
Net income (loss)	$	(2,810	)	$	676

Denominator:
Weighted average common shares and denominator for basic calculation		41,905,848			38,343,958
Weighted average effect of dilutive securities:
Employee stock options		—			4,239,145
Employee stock purchase plan		—			8,967

Denominator for diluted calculation		41,905,848			42,592,070
Net income (loss) per share—basic	$	(0.07	)	$	0.02
Net income (loss) per share—diluted	$	(0.07	)	$	0.02

For the three months ended March 31, 2005, 7,788,941 antidilutive potential shares of common stock have been excluded from the calculation of diluted net income (loss) per share, as Autobytel incurred a net loss for the period. For the three months ended March 31, 2004, 759,926 antidilutive potential shares of common stock have been excluded from the calculation of diluted net income per share which represent stock options with an exercise price greater than the average market price for the period.

Stock-Based Compensation

As permitted under SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” which amended SFAS No. 123, “Accounting for Stock-Based Compensation”, Autobytel has elected to continue to account for its stock-based compensation using the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees.” Under APB 25, compensation expense is recognized over the vesting period based on the excess of the market closing price over the exercise price on the grant date.

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

For disclosure purposes, stock compensation expense has been estimated using the Black-Scholes option-pricing model on the date of grant and assumptions related to dividend yield, stock price volatility, weighted-average risk free interest rate and expected life of the stock options, which is a fair value based method. Had the provisions of SFAS No. 123 been applied to Autobytel’s stock option grants for its stock-based compensation plans, Autobytel’s net income (loss) and net income (loss) per share for the three months ended March 31, 2005 and 2004, would approximate the pro forma amounts below:


	Three Months Ended March 31,
	2005			2004
				(Restated)
Net income (loss):
As reported	$	(2,810	)	$	676
Less: Employee stock-based compensation determined under the fair value based method		(1,593	)		(1,271	)

Pro forma	$	(4,403	)	$	(595	)

Net income (loss) per share—basic:
As reported	$	(0.07	)	$	0.02
Pro forma	$	(0.11	)	$	(0.01	)
Net income (loss) per share—diluted:
As reported	$	(0.07	)	$	0.02
Pro forma	$	(0.11	)	$	(0.01	)

The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts.

Autobytel did not grant any stock options during the three months ended March 31, 2005. Autobytel granted 550,000, stock options to employees and directors during the three months ended March 31, 2004. The options granted were estimated to have a weighted average fair value per share of $6.81 for the three months ended March 31, 2004, based on the Black-Scholes option-pricing model on the date of grant and the following assumptions:


Dividend yield	—	%
Volatility	65.98	%
Weighted-average risk-free interest rate	2.21	%
Weighted-average expected life	3.5 years

No awards were issued under the employee stock purchase plan during the three months ended March 31, 2005. Awards issued under the employee stock purchase plan were estimated to have a weighted average fair value per award of $3.06 for the three months ended March 31, 2004, based on the Black-Scholes option-pricing model on the date of grant and the following assumptions:


Dividend yield	—	%
Volatility	66.06 - 73.86	%
Weighted-average risk-free interest rate	1.03 - 1.05	%
Weighted-average expected life	6 months

As of March 31, 2005, Autobytel had a total of 7,754,443 stock options outstanding, of which 3,022,684 stock options had exercise prices below the closing price per share of Autobytel’s common stock on that date.

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

Business Segment

Autobytel conducts its business within one business segment, which is defined as providing automotive marketing services.

3. Restatement

On November 15, 2004, Autobytel announced that Autobytel expected to restate its consolidated financial statements for the second, third and fourth fiscal quarters of 2003, the full 2003 fiscal year and the first and second fiscal quarters of 2004, relating to credits issued to customers that were inappropriately reversed and recognized as revenue during the four fiscal quarters ended March 31, 2004, and outstanding checks issued by Autobytel that were voided and the corresponding obligations inappropriately reversed and recorded as an increase in revenue or a reduction of expenses primarily in the second fiscal quarter of 2003. In the course of preparing these consolidated financial statements to properly reflect the credits issued to customers and the outstanding checks issued, Autobytel identified other items and errors for which accounting adjustments were necessary; which resulted in further restatement adjustments to its consolidated financial statements for 2003 and 2002 and in subsequent periods.

The revenue restatement adjustments recorded in this restatement primarily result in revenue being deferred and recognized in subsequent periods, although certain adjustments result in permanent reductions in revenue. These adjustments include (i) credits issued to certain customers that were inappropriately recognized, (ii) errors previously made in the application of the revenue recognition principles under EITF 00-21, and (iii) errors previously made in the application of the revenue recognition principles under SAB 104. The net effect of these revenue adjustments is to decrease total revenue by $139 for the three months ended March 31, 2004. Autobytel also made certain deferrals and other adjustments to its expenses and other accounts in connection with these revenue adjustments and has made certain other adjustments to its expenses. These expense adjustments include errors previously made in the application of SFAS No. 5, “Accounting for Contingencies” and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” related to the recognition and derecognition of accrued expenses. The net effect of these expense adjustments is to increase total expenses by $1,250 for the three months ended March 31, 2004.

The following table is a reconciliation of revenue as previously reported to amounts as restated for the periods indicated:


	Three Months Ended March 31, 2004
Total revenue, as previously reported	$	24,757
Total revenue restatement adjustments:
Unapplied credits		(43	)
Multiple element arrangements		(10	)
Delivery of purchase requests		(25	)
Advertising		(20	)
Other		(41	)

Total revenue restatement adjustments		(139	)

Total revenue, as restated	$	24,618

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

The following table is a reconciliation of net income as previously reported to amounts as restated for the periods indicated:


	Three Months Ended March 31, 2004
Net income, as previously reported	$	2,065
Restatement adjustments to revenue (see above)		(139	)
Expense adjustments:
Accrued expenses		(941	)
Commission expense		(249	)
Equity investments		(31	)
Other		(29	)

Total restatement expense adjustments		(1,250	)

Net restatement adjustments		(1,389	)

Restated net income	$	676

Classifications

Effective with the filing of this Quarterly Report on Form 10-Q, Autobytel has modified its statement of operations presentation to better align reported results with internal operational measures and to provide increased understanding and transparency for investors. Operating expenses are now classified as cost of revenues, sales and marketing, product and technology development, general and administrative, and amortization of acquired intangible assets. Amounts which have been reclassified as a result of the new presentation are indicated in the following table in the column titled “Reclassifications.” Cost of revenues contain costs previously classified as sales and marketing including traffic acquisition and related compensation costs, printing, production and postage for Autobytel’s customer loyalty and retention program, and fees paid to third parties for data and content included on Autobytel’s properties. Cost of revenues also contain costs previously classified as product and technology development including connectivity costs, technology license fees, amortization of acquired technology, amortization of internally developed technology, fees paid to third parties for data and content included on Autobytel’s properties, and server equipment depreciation. Other costs which have been reclassified are: (1) bad debt expense, which was previously classified as sales and marketing expense, is now classified as general and administrative expense, (2) credit balances of customers, which were previously classified as accounts receivable, are now classified as other current liabilities, and (3) auction rate securities previously classified as cash equivalents are now classified as short-term investments.

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

The consolidated financial statements for the three months ended March 31, 2004 have been restated to incorporate all the restatement adjustments, as described herein. The following table sets forth selected consolidated statement of operations data for Autobytel, showing previously reported amounts and restated amounts for the three months ended March 31, 2004:

Consolidated Statement of Operations for the Three Months Ended


	March 31, 2004
	As Previously Reported			Reclassifications			Adjustments			As Restated
Revenues	$	24,757		$	—		$	(139	)	$	24,618

Costs and expenses:
Cost of revenues		—			10,525			—			10,525
Sales and marketing		14,809			(9,706	)		982			6,085
Product and technology development		5,088			(896	)		168			4,360
General and administrative		2,929			50			40			3,019
Amortization of acquired intangible assets		—			27			—			27

Total costs and expenses		22,826			—			1,190			24,016

Income from operations		1,931			—			(1,329	)		602
Interest income		186			—			—			186
Loss in equity investee		(53	)		—			(31	)		(84	)
Other income		1			—			—			1

Income before income taxes		2,065			—			(1,360	)		705
Provision for income taxes		—			—			(29	)		(29	)

Net income	$	2,065		$	—		$	(1,389	)	$	676

Net income per share:
Basic	$	0.05		$	—		$	(0.03	)	$	0.02

Diluted	$	0.05		$	—		$	(0.03	)	$	0.02


Shares used in computing net income per share:
Basic		38,343,958			—			—			38,343,958

Diluted		42,583,103			—			8,967			42,592,070


Comprehensive income:
Net income	$	2,065		$	—		$	(1,389	)	$	676
Translation adjustment		—			—			144			144

Comprehensive income	$	2,065		$	—		$	(1,245	)	$	820

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

The following table sets forth selected consolidated statement of cash flows data for Autobytel, showing previously reported amounts and restated amounts for the three months ended March 31, 2004:

Consolidated Statement of Cash Flows for the Three Months Ended


	March 31, 2004
	As Previously Reported			As Restated
Cash flows from operating activities:
Net income	$	2,065		$	676
Adjustments to reconcile net income to net cash provided operating activities:
Non-cash charges:
Depreciation and amortization		688			373
Amortization of capitalized internal use software		—			270
Amortization of acquired intangible assets		—			45
Provision for bad debt		77			77
Provision for customer credits		33			33
Loss in equity investee		53			84
Changes in assets and liabilities, excluding effect of acquisitions and consolidation of Autobytel.Europe:
Accounts receivable		268			330
Prepaid expenses and other current assets		(284	)		23
Other assets		(399	)		(399	)
Accounts payable		87			642
Accrued expenses		(1,722	)		(1,365	)
Deferred revenues		(208	)		(178	)
Accrued domestic restructuring		(46	)		(46	)
Other current liabilities		(38	)		9

Net cash provided by operating activities		574			574

Cash flows from investing activities:
Maturities of short-term investments		3,991			10,991
Purchases of short-term and long-term investments		(9,000	)		(27,000	)
Consolidation of Autobytel.Europe cash balance		10,425			—
Purchases of property and equipment		(357	)		(357	)

Net cash provided by (used in) investing activities		5,059			(16,366	)

Cash flows from financing activities:
Net proceeds from sale of common stock		2,419			2,419

Net cash provided by financing activities		2,419			2,419

Net increase (decrease) in cash and cash equivalents		8,052			(13,373	)
Cash and cash equivalents, beginning of period		51,643			45,643

Cash and cash equivalents, end of period	$	59,695		$	32,270

Supplemental disclosure of cash flow information:
Cash refunded during the period for interest	$	(1	)	$	(1	)

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

The following describes restatement items which affects the consolidated financial statements for the three months ended March 31, 2004.

Unapplied credits

•

Credits issued to certain inactive customers were inappropriately reversed and recognized as revenue during the four fiscal quarters ended March 31, 2004. As a result, Autobytel decreased lead fees for the three months ended March 31, 2004.

Multiple element arrangements

•

Certain revenue from a multiple element arrangement was inappropriately recognized upon completion of the services. Autobytel determined that such revenue should be recognized over the period of the license agreement. As a result, Autobytel decreased data, applications and other revenue for the three months ended March 31, 2004.

Delivery of purchase requests

•

Certain revenue generated from the delivery of purchase requests for vehicles were inappropriately recognized. Autobytel determined that these revenues should not be recognized because collectibility cannot be reasonably assured and the amount is not fixed or determinable and that such revenue should be recorded when Autobytel receives payment. As a result, Autobytel decreased lead fee revenue for the three months ended March 31, 2004.

Advertising

•

Advertising credits earned by Autobytel’s customers were not recorded as a reduction of advertising revenue in the period earned by the customer and delivery or payment of these credits in subsequent periods were inappropriately recorded as a decrease in advertising revenue. As a result, Autobytel decreased advertising revenue for the three months ended March 31, 2004.

•

Advertising revenue was not recognized in the period when earned and as a result deferred website advertising revenue was overstated at March 31, 2004. As a result, Autobytel increased advertising revenue for the three months ended March 31, 2004.

Reclassification

•

Autobytel recognized CRM services revenue for iManager, a CRM product that was combined with the sale of purchase requests. Autobytel cannot determine the fair value of the CRM product in a reliable, verifiable and objective manner and determined that the CRM service revenue should be reclassified as lead fees. As a result, Autobytel decreased CRM services revenue and increased lead fees revenue for the three months ended March 31, 2004.

Accrued expenses

•

Expense provisions for our participation at an annual trade show were inappropriately recorded throughout annual fiscal periods preceding Autobytel’s attendance at the trade show in the first fiscal quarter of the following annual fiscal period. As a result, Autobytel increased sales and marketing expense for the three months ended March 31, 2004.

•

Autobytel recorded an accrual for advertising costs in 2002 that was subsequently derecognized and recorded as a reduction of expenses in the first fiscal quarter of 2004. Autobytel determined that the

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

liability should not have been recorded, and no amounts have been paid. As a result, Autobytel increased sales and marketing expense for the three months ended March 31, 2004.

•

Franchise tax expense was under-estimated in 2003 and over-estimated in the first fiscal quarter of 2004. As a result, Autobytel decreased general and administrative expenses for the three months ended March 31, 2004.

•

Autobytel recorded accruals for subscription costs during 2003 that were subsequently derecognized and recorded as a reduction of expense in the first fiscal quarter of 2004. Autobytel determined that the liability should not have been recorded, and no amounts have been paid. As a result, Autobytel increased sales and marketing expense for the three months ended March 31, 2004.

•

In 2002, there was an excess accrual for medical costs that was inappropriately derecognized with a corresponding reduction of online advertising costs in 2003 and a reduction of compensation costs in first fiscal quarter of 2004. As a result, Autobytel increased sales and marketing, product and technology development, and general and administrative expenses for the three months ended March 31, 2004.

•

Accrued liabilities associated with two inactive vendors were prematurely derecognized and recorded as a reduction of expenses in the first fiscal quarter of 2004. As a result, Autobytel increased sales and marketing, product and technology development and general and administrative expenses for the three months ended March 31, 2004.

Commission expense

•

The accrual for commissions expense was incorrectly calculated during the six fiscal quarters ended June 30, 2004. As a result, Autobytel increased sales and marketing expense for the three months ended March 31, 2004.

Equity investment

•

A series of loans made by Autobytel.Europe was inappropriately recorded at cost instead of net realizable value. As a result, Autobytel increased the loss in equity investee and comprehensive income for the three months ended March 31, 2004.

Other

•

Autobytel inappropriately recognized as revenue certain purchase requests delivered to two customers during the four fiscal quarters ended June 30, 2004. The overpayment amount constitute a liability for Autobytel. As a result, Autobytel decreased lead fees revenue for the three months ended March 31, 2004.

•

State income tax expense was under-estimated in the first fiscal quarter of 2004. As a result, Autobytel increased the provision for income taxes for the three months ended March 31, 2004 and accrued expenses at March 31, 2004.

•

The shares used in computing diluted net income per share inappropriately excluded the weighted average effect of awards to be issued under the employee stock purchase plan for the three months ended March 31, 2004. As a result, Autobytel increased the number of shares used in computing diluted net income per share.

4. Autobytel.Europe LLC

Autobytel.Europe was organized in August 1997 and began operations in the fourth quarter of 1999. Autobytel.Europe was formed to expand the Autobytel business model and operations throughout Europe.

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

On March 28, 2002, Autobytel.Europe completed a recapitalization, which reduced Autobytel’s ownership of Autobytel.Europe from 76.5% to 49%. As a result of the reduction in Autobytel’s ownership interest, Autobytel accounted for its investment in Autobytel.Europe under the equity method subsequent to March 28, 2002.

On March 31, 2004, Autobytel adopted the provisions of FIN 46R and determined it was the primary beneficiary of Autobytel.Europe. The assets and liabilities of Autobytel.Europe were as follows:


	As of
	March 31, 2005			December 31, 2004
Restricted international cash and cash equivalents	$	9,053		$	9,053
Other current and non-current assets		93			75
Current liabilities		(264	)		(264	)
Minority interest		(4,530	)		(4,521	)

	$	4,352		$	4,343

Autobytel.Europe’s revenue and expenses are included in Autobytel’s consolidated results of operations beginning April 1, 2004. Total revenue for the three months ended March 31, 2005 was $45.

5. Acquisitions

Acquisition of Stoneage Corporation

On April 15, 2004, Autobytel acquired all of the outstanding common stock of Stoneage Corporation (Stoneage), now Car.com, Inc., a provider of Internet automotive buying services and owner of the Car.com Web site. Stoneage was acquired to expand Autobytel’s market share of new car buyers, increase the number of purchase requests processed through Autobytel, and add retail and enterprise dealer relationships to Autobytel. The acquisition also added the Car.com finance request business to Autobytel. Autobytel believes that the combined assets will further position it as a leader in the internet automotive business services sector. The aggregate purchase price was $50,767 and consisted of $15,251 in cash and 2,305,244 shares of common stock valued at $34,480 and transaction costs of $1,036.

Stoneage’s financial position and results of operations from the date of acquisition on April 15, 2004 have been included in the accompanying consolidated financial statements.

Acquisition of iDriveonline, Inc.

On April 9, 2004, Autobytel acquired all of the outstanding common stock of iDriveonline, Inc. (iDriveonline), now Retention Performance Marketing, Inc., a provider of customer loyalty and retention marketing programs for the automotive industry, in exchange for cash and common stock. The acquisition combines iDriveonline’s leading applications, including an online prospecting and retention tool, enhanced data and segmentation tools, and improved dealer reporting capabilities with Autobytel’s existing customer retention program. Through this acquisition, Autobytel gained a meaningful presence in the automotive CRM marketplace. The aggregate purchase price was $12,168 and consisted of $5,021 in cash, 474,501 shares of common stock valued at $6,775 and transaction costs of $372.

iDriveonline’s financial position and results of operations from the date of acquisition on April 9, 2004 have been included in the accompanying consolidated financial statements.

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

Proforma Consolidated Results of Operations

The following summarized unaudited pro forma consolidated results of operations are presented as if the acquisitions of iDriveonline and Stoneage had occurred on January 1, 2003. The unaudited pro forma results are not necessarily indicative of future earnings or earnings that would have been reported had the acquisitions been completed as presented.


	Three months ended March 31, 2004
	(Restated Pro Forma)
Revenue	$	33,294
Net income	$	1,077
Net income per share:
Basic	$	0.03
Diluted	$	0.02

6. Acquired Intangible Assets

Acquired intangible assets recorded as a part of the AVV, iDriveonline and Stoneage acquisitions are amortized over their estimated useful lives and consist of the following:


	As of March 31, 2005
	Average Estimated Useful Lives	Gross Carrying Amount		Accumulated Amortization			Impairment Charge			Net Amount
Developed technology	2 years	$	820	$	(395	)	$	—		$	425
Customer relationships	3 years		4,375		(1,478	)		(200	)		2,697
Domain name	5 years		700		(134	)		—			566

Total		$	5,895	$	(2,007	)	$	(200	)	$	3,688


	As of December 31, 2004
	Average Estimated Useful Lives	Gross Carrying Amount		Accumulated Amortization			Impairment Charge			Net Amount
Developed technology	2 years	$	820	$	(289	)	$	—		$	531
Customer relationships	3 years		4,375		(1,120	)		(200	)		3,055
Domain name	5 years		700		(99	)		—			601

Total		$	5,895	$	(1,508	)	$	(200	)	$	4,187

Amortization expense for the remaining lives of the acquired intangible assets is estimated to be as follows:


	Amortization Expense
Nine months ending December 31, 2005	$	1,413
2006	$	1,579
2007	$	515
2008	$	140
2009	$	41

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

7. Commitments and Contingencies

Litigation

In August 2001, a purported class action lawsuit was filed in the United States District Court for the Southern District of New York against Autobytel and certain of Autobytel’s current and former directors and officers (the “Autobytel Individual Defendants”) and underwriters involved in Autobytel’s initial public offering. The complaints against Autobytel have been consolidated with two other complaints that relate to its initial public offering but do not name it as a defendant, and a Consolidated Amended Complaint, which is now the operative complaint, was filed on April 19, 2002. This action purports to allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. Plaintiffs allege that the underwriter defendants agreed to allocate stock in Autobytel’s initial public offering to certain investors in exchange for excessive and undisclosed commissions and agreements by those investors to make additional purchases of stock in the aftermarket at pre-determined prices. Plaintiffs allege that the prospectus for Autobytel’s initial public offering was false and misleading in violation of the securities laws because it did not disclose these arrangements. The action seeks damages in an unspecified amount. The action is being coordinated with approximately 300 other nearly identical actions filed against other companies. A motion to dismiss addressing issues common to the companies and individuals who have been sued in these actions was filed on July 15, 2002. On October 9, 2002, the Court dismissed the Autobytel Individual Defendants from the case without prejudice based upon Stipulations of Dismissal filed by the plaintiffs and the Autobytel Individual Defendants. On February 19, 2003, the Court denied the motion to dismiss the complaint against Autobytel. On October 13, 2004, the Court certified a class in six of the approximately 300 other nearly identical actions and noted that the decision is intended to provide strong guidance to all parties regarding class certification in the remaining cases. Plaintiffs have not yet moved to certify a class in the Autobytel case. Autobytel has approved a settlement agreement and related agreements which set forth the terms of a settlement between Autobytel, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. Among other provisions, the settlement provides for a release of Autobytel and the Autobytel Individual Defendants for the conduct alleged in the action to be wrongful. Autobytel would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims Autobytel may have against its underwriters. The settlement agreement also provides a guaranteed recovery of $1 billion to plaintiffs for the cases relating to all of the approximately 300 issuers. To the extent that the underwriter defendants settle all of the cases for at least $1 billion, no payment will be required under the issuers’ settlement agreement. To the extent that the underwriter defendants settle for less than $1 billion, the issuers are required to make up the difference. It is anticipated that any potential financial obligation of Autobytel to plaintiffs pursuant to the terms of the settlement agreement and related agreements will be directly covered and paid by its insurance carriers. Autobytel currently is not aware of any material limitations on the expected recovery of any potential financial obligation to plaintiffs from its insurance carriers. Its carriers are solvent, and Autobytel is not aware of any uncertainties as to the legal sufficiency of an insurance claim with respect to any recovery by plaintiffs. Therefore, Autobytel does not expect that the settlement will involve any payment by Autobytel. If material limitations on the expected recovery of any potential financial obligation to the plaintiffs from Autobytel’s insurance carriers should arise, Autobytel’s maximum financial obligation to plaintiffs pursuant to the settlement agreement would be less than $3.4 million. On February 15, 2005, the Court granted preliminary approval of the settlement agreement, subject to certain modifications consistent with its opinion. The Court ruled that the issuer defendants and the plaintiffs must submit a revised settlement agreement which provides for a mutual bar of all contribution claims by the settling and non-settling parties and does not bar the parties from pursuing other claims. The issuers and plaintiffs have negotiated a revised settlement agreement consistent with the Court’s opinion and are in the process of obtaining approval from those issuer defendants that are not in bankruptcy. At this point, all but one of the issuer defendants that are not in bankruptcy

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

have approved the revised settlement agreement, which has been submitted to the Court. The underwriter defendants will have an opportunity to object to the revised settlement agreement. There is no assurance that the Court will grant final approval to the settlement. If the settlement agreement is not approved and Autobytel is found liable, Autobytel is unable to estimate or predict the potential damages that might be awarded, whether such damages would be greater than its insurance coverage, or whether such damages would have a material impact on its results of operations, financial condition or cash flows in any future period.

Between April and June 2001, eight separate purported class actions virtually identical to the one filed against Autobytel were filed against Autoweb.com, Inc. (“Autoweb”), certain of Autoweb’s current and former directors and officers (the “Autoweb Individual Defendants”) and underwriters involved in Autoweb’s initial public offering. The complaints against Autoweb have been consolidated into a single action, and a Consolidated Amended Complaint, which is now the operative complaint, was filed on April 19, 2002. The foregoing action purports to allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. Plaintiffs allege that the underwriter defendants agreed to allocate stock in Autoweb’s initial public offering to certain investors in exchange for excessive and undisclosed commissions and agreements by those investors to make additional purchases of stock in the aftermarket at pre-determined prices. Plaintiffs allege that the prospectus for Autoweb’s initial public offering was false and misleading in violation of the securities laws because it did not disclose these arrangements. The action seeks damages in an unspecified amount. The action is being coordinated with approximately 300 other nearly identical actions filed against other companies. A motion to dismiss addressing issues common to the companies and individuals who have been sued in these actions was filed on July 15, 2002. On October 9, 2002, the Court dismissed the Autoweb Individual Defendants from the case without prejudice based upon Stipulations of Dismissal filed by the plaintiffs and the Autoweb Individual Defendants. On February 19, 2003, the Court dismissed the Section 10(b) claim without prejudice and with leave to replead but denied the motion to dismiss the claim under Section 11 of the Securities Act of 1933 against Autoweb. On October 13, 2004, the Court certified a class in six of the approximately 300 other nearly identical actions and noted that the decision is intended to provide strong guidance to all parties regarding class certification in the remaining cases. Plaintiffs have not yet moved to certify a class in the Autoweb case. Autoweb has approved a settlement agreement and related agreements which set forth the terms of a settlement between Autoweb, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. Among other provisions, the settlement provides for a release of Autoweb and the Autoweb Individual Defendants for the conduct alleged in the action to be wrongful. Autoweb would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims Autoweb may have against its underwriters. The settlement agreement also provides a guaranteed recovery of $1 billion to plaintiffs for the cases relating to all of the approximately 300 issuers. To the extent that the underwriter defendants settle all of the cases for at least $1 billion, no payment will be required under the issuers’ settlement agreement. To the extent that the underwriter defendants settle for less than $1 billion, the issuers are required to make up the difference. It is anticipated that any potential financial obligation of Autoweb to plaintiffs pursuant to the terms of the settlement agreement and related agreements will be directly covered and paid by its insurance carriers. Autoweb currently is not aware of any material limitations on the expected recovery of any potential financial obligation to plaintiffs from its insurance carriers. Its carriers are solvent, and Autoweb is not aware of any uncertainties as to the legal sufficiency of an insurance claim with respect to any recovery by plaintiffs. Therefore, Autobytel does not expect that the settlement will involve any payment by Autoweb. If material limitations on the expected recovery of any potential financial obligation to the plaintiffs from Autoweb’s insurance carriers should arise, Autoweb’s maximum financial obligation to plaintiffs pursuant to the settlement agreement would be less than $3.4 million. On February 15, 2005, the Court granted preliminary approval of the settlement agreement, subject to certain modifications consistent with its opinion. The Court ruled that the issuer

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

defendants and the plaintiffs must submit a revised settlement agreement which provides for a mutual bar of all contribution claims by the settling and non-settling parties and does not bar the parties from pursuing other claims. The issuers and plaintiffs have negotiated a revised settlement agreement consistent with the Court’s opinion and are in the process of obtaining approval from those issuer defendants that are not in bankruptcy. At this point, all but one of the issuer defendants that are not in bankruptcy have approved the revised settlement agreement, which has been submitted to the Court. The underwriter defendants will have an opportunity to object to the revised settlement agreement. There is no assurance that the Court will grant final approval to the settlement. If the settlement agreement is not approved and Autoweb is found liable, Autobytel is unable to estimate or predict the potential damages that might be awarded, whether such damages would be greater than Autobytel’s insurance coverage, or whether such damages would have a material impact on Autobytel’s results of operations, financial condition or cash flows in any future period.

Autobytel has reviewed the above class action matters and does not believe that it is probable that a loss contingency has occurred, therefore, no amounts have been recorded in the accompanying consolidated financial statements.

On September 24, 2004, Autobytel filed a lawsuit in the United States District Court for the Eastern District of Texas against Dealix Corporation. In that lawsuit, Autobytel asserted infringement of U.S. Patent No. 6,282,517, entitled “Real Time Communication of Purchase Requests,” against Dealix Corporation, asserted that Dealix Corporation is infringing Autobytel’s patent by virtue of Dealix Corporation’s software system for the distribution of purchase requests, asserted damages, and sought a preliminary injunction. Dealix Corporation filed answers to this lawsuit on January 28, 2005 and February 1, 2005, in which it asserts typical defensive counterclaims denying infringement and challenging the validity of the patent. Dealix Corporation also seeks attorney’s fees and costs. Autobytel expects to incur attorneys’ fees and costs in this matter as are customary in the prosecution of patent litigation, and could be liable for Dealix Corporation’s attorneys’ fees and costs if Dealix Corporation is successful in its counterclaims.

Between October and December 2004, five separate purported class actions were filed in the United States District Court for the Central District of California against Autobytel and certain of its current directors and current and former officers. The claims were brought on behalf of stockholders who purchased shares during the period July 24, 2003 through October 21, 2004. The claims alleged in all of these purported class actions are virtually identical, and purport to allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. In this regard, the plaintiffs allege that Autobytel misrepresented and omitted material facts with respect to its financial results and operations during the time period between July 24, 2003 and October 20, 2004. The complaint seeks unspecified compensatory damages, and attorneys’ fees and costs, as well as accountants’ and experts’ fees. On January 28, 2005, the court ordered the consolidation of the currently pending class actions into a single case pursuant to a stipulation for consolidation signed by all parties. On March 14, 2005, the court appointed a lead plaintiff and approved the selection of lead counsel and liaison counsel. Additional lawsuits asserting the same or similar claims may be filed as well. Autobytel intends to defend the claims vigorously. However, Autobytel cannot currently predict the impact or outcome of this litigation, which could be material, and the initiation, continuation and outcome of these lawsuits may have a material impact on Autobytel’s results of operations, financial condition and cash flows.

In addition, Autobytel’s directors and a former officer are defendants in a derivative suit pending in the Superior Court of Orange County, California, and Autobytel is named as a nominal defendant in this suit. This suit purports to allege that the defendants breached numerous duties to Autobytel, including breach of fiduciary

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

duty and misappropriation of information, abuse of control, gross mismanagement, waste of corporate assets, and unjust enrichment, as well as violations of California Corporations Code 25402 (trading with material non-public information), and that these breaches and violations caused losses to Autobytel, including damages to its reputation and goodwill. Plaintiffs’ claims are based on allegations that the defendants disseminated false and misleading statements concerning Autobytel’s results of operations and that these results were inflated at all relevant times due to violations of generally accepted accounting principles and Securities and Exchange Commission rules. The complaint seeks unspecified compensatory damages, treble damages, equitable and/or injunctive relief, restitution, and attorneys’ fees and costs, as well as accountants’ and experts’ fees.

Autobytel intends to defend this suit vigorously. However, Autobytel cannot currently predict the impact or outcome of this litigation, which could be material, and the continuation and outcome of this lawsuit, as well as the initiation of similar suits may have a material impact on Autobytel’s results of operations, financial condition and cash flows

From time to time, Autobytel is involved in other litigation matters arising from the normal course of its business activities. The actions filed against Autobytel and other litigation, even if not meritorious, could result in substantial costs and diversion of resources and management attention and an adverse outcome in litigation could materially adversely affect Autobytel’s business, results of operations, financial condition and cash flows.

8. Accrued Domestic Restructuring Liability

In 2002, Autobytel recorded a total of $769 for charges related to the restructuring of Autobytel’s operations to reduce costs and enhance efficiencies. The charges included severance costs affecting approximately 15% of Autobytel’s employees in sales, marketing and information technology, and Autobytel’s lease obligation on the vacant portion of office facilities in Westborough, Massachusetts.

As of March 31, 2005, the remaining accrued domestic restructuring liabilities related to the 2002 restructuring charges for Autobytel’s lease obligation on the vacant portion of office facilities in Westborough, Massachusetts were $27. Autobytel expects the remaining charges to be paid in the second quarter of 2005. The remaining accrued domestic restructuring liabilities related to the 2002 charges as of March 31, 2005 were as follows:


	As of December 31, 2004		Cash Payments			As of March 31, 2005
Lease obligation	$	74	$	(47	)	$	27

9. Related Party Transactions

Consulting Agreement

Autobytel and Robert Grimes, a current director and a former Executive Vice President of Autobytel, are parties to a consulting services agreement dated April 1, 2000. The agreement was extended through September 30, 2004 and then on a month to month basis until notice of termination by either party. During the term of the consulting agreement, Mr. Grimes will receive $50 per year payable on a monthly basis and a $2.5 monthly office expense allowance. These costs are included in product and technology development expenses in the consolidated statements of operations. Mr. Grimes will make himself available to the executive officers of

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

Autobytel for up to 16 hours a month for consultation and other activities related to formulating and implementing business strategies and relationships. Autobytel may terminate the agreement upon Mr. Grimes’ breach of contract. If Mr. Grimes’ agreement is terminated without breach, Mr. Grimes is entitled to either a pro rated or a lump sum payment equal to the amount that would have been received by Mr. Grimes if he had remained a consultant for the remaining balance of the term. In the event of death or disability, Autobytel will pay to Mr. Grimes or his successors and assignees the amount that Mr. Grimes would have received for the remainder of the term of the agreement.

10. Subsequent Events

Resignation of Principal Accounting Officer

Effective April 1, 2005, Matthew McDowell, Autobytel’s Vice President and Controller and principal accounting officer, resigned as an employee of Autobytel. Michael F. Schmidt, Autobytel’s Chief Financial Officer, assumed the functions of principal accounting officer, pending appointment of a Controller.

Resignation of Chief Executive Officer; Appointment of New Chief Executive Officer

Effective April 27, 2005, Jeffrey Schwartz resigned as Autobytel’s Chief Executive Officer and President (but remains an employee in the role of Vice Chairman). Effective April 27, 2005, Richard A. Post, a director, was appointed as Autobytel’s Chief Executive Officer and President.

Appointment of Chief Operating Officer

Effective April 27, 2005, Richard G. Walker, formerly Autobytel’s Executive Vice President, Corporate Development and Strategy, was appointed as Autobytel’s Executive Vice President and Chief Operating Officer.

Appointment of Chief Financial Officer

Effective May 30, 2005, Michael F. Schmidt, formerly Autobytel’s Senior Vice President, Finance, was appointed as Autobytel’s Executive Vice President and Chief Financial Officer.

Employment Agreements

In connection with the management changes described above, Autobytel entered into an employment agreement with Mr. Post and amended and restated employment agreements with each of Mr. Schwartz and Mr. Walker. The agreement with Mr. Post is for a one year term and may be terminated by Autobytel with thirty days’ prior written notice, or by Mr. Post with sixty days’ prior written notice. Autobytel may renew the agreement by delivering written notice to Mr. Post at least sixty days prior to the expiration of the agreement, in which case, the term of the agreement shall extend for additional one month terms until the second anniversary thereof, unless Autobytel delivers thirty days’ written notice or Mr. Post delivers sixty (60) days’ written notice of its or his intention not to renew. The agreement with Mr. Schwartz is for a one year term and may be terminated by Autobytel at any time, or by Mr. Schwartz, with thirty days prior written notice. Autobytel may renew the agreement by delivering written notice to Mr. Schwartz at least ninety days prior to the expiration of the agreement, in which case, the term of the agreement shall extend for an additional one year term. If the agreement is not renewed, Autobytel is required to pay Mr. Schwartz his base salary for three months after the expiration of the agreement and to continue his benefits during such period. If the Company terminates

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

Mr. Schwartz’ employment during the term, he is entitled to continue to receive his base salary and benefits until ninety days following the date on which the agreement would have expired by its terms. The agreement with Mr. Walker is for a one year term and automatically renews for an additional one year period unless either party notifies the other of its intent not to renew no later than sixty days prior to the expiration of the one year term. If Autobytel does not renew or terminates Mr. Walker’s employment during the term, Mr. Walker is entitled to twelve months of base salary plus a bonus of 50% of his annual base salary, and to receive benefits for twelve months after such expiration.

If, during the one year following the termination of employment (and in the case of Mr. Schwartz, the longer of such period and July 2006), each individual complies with the non-competition and non-solicitation provisions of the agreement, any unvested stock options (i) that were granted after the date of the agreement, with respect to Mr. Post and Mr. Walker, or (ii) held as of the date of termination, with respect to Mr. Schwartz, will be deemed to have vested during such period as if he was an employee during that time.

In the event of a change of control during the term of employment or at any time during the six month period following such term, each individual is entitled to a lump sum payment equal to two times the sum of his annual base salary plus a bonus of 65% of annual base salary in the case of Mr. Post and 50% of annual base salary in the case of each of Mr. Schwartz and Mr. Walker. In the case of Mr. Walker, such payment is conditioned on Mr. Walker agreeing, if requested, to continue with Autobytel or any successor for no longer than ninety days after the change of control. In addition, if employment was terminated prior to a change of control that occurs during the six month period following such termination, any unvested stock options (i) that were granted after the date of the agreement, with respect to Mr. Post and Mr. Walker, or (ii) held as of the date of termination, with respect to Mr. Schwartz, shall vest in full immediately prior to such change of control, assuming the individual complies with the non-compete and non-solicitation provisions of the agreement. Each agreement provides that if compensation is deemed to be parachute payments under the Internal Revenue Code, then Autobytel will make additional payments to compensate for additional tax obligations. The agreement also requires Autobytel to indemnify Mr. Schwartz under certain circumstances.

In connection with the appointment of Michael Schmidt to the position of Executive Vice President and Chief Financial Officer, on May 30, 2005, Autobytel and Mr. Schmidt amended and restated the March 9, 2004 letter agreement between them in an Employment Agreement (as amended and restated, the “Schmidt Employment Agreement”).

The Schmidt Employment Agreement is for a one year term and automatically renews for an additional one year period unless either party notifies the other of its intent not to renew no later than sixty days prior to the expiration of the one year term. Mr. Schmidt is entitled to an annual base salary of $250,000 during the term, and is eligible for a bonus of 50% of his annual base salary in the board’s discretion. In addition, Mr. Schmidt may participate in any benefit plans generally afforded to executive officers. If Mr. Schmidt’s employment is terminated without “cause”, is not renewed or if Mr. Schmidt terminates his employment with “good reason” (each as defined in the Schmidt Employment Agreement), Mr. Schmidt is entitled to a lump sum payment equal to his annual base salary plus bonus, as well as benefits for one year following such termination.

In the event of a change of control during the term of his employment or at any time during the six month period following such term, Mr. Schmidt is entitled to a lump sum payment equal to two times the sum of his annual base salary plus a bonus of 50% of annual base salary, so long as Mr. Schmidt agrees, if requested, to continue with Autobytel or any successor for no longer than six months after the change of control. If Mr. Schmidt’s

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

compensation is deemed to be parachute payments under the Internal Revenue Code, then Autobytel has agreed to make additional payments to him to compensate for his additional tax obligations.

Mr. Schmidt will also be granted stock options to purchase 150,000 shares of Autobytel’s common stock, which shall vest, as to 50,000 of the options, on the one year anniversary of the date of grant, and thereafter 4,166 of the options shall vest on each monthly anniversary of the date of grant, provided that the vesting of such options shall accelerate upon a change of control.

Costs Associated with Closing of Facility

On April 19, 2005, Autobytel took steps to commit itself to integrate the business operations of its customer loyalty and retention marketing program, Retention Performance Marketing, with its customer lead management product, WebControl, (the “Integration”). Autobytel determined to proceed with the Integration in order to increase efficiency and respond to market demand for integrated customer relationship management solutions. As part of the Integration, Autobytel intends to close its Houston office and to move the operations of such office to its offices in Irvine, California and/or Westerville, Ohio. Certain employees in the Houston office may relocate to Autobytel’s offices in Irvine, California and/or Westerville, Ohio. Autobytel expects to complete the Integration by December 31, 2005. Autobytel estimates that the total expenses relating to the Integration, primarily consisting of retention, severance and relocation costs, will be between $175 and $300.

Resolution of Contract Dispute

In May 2005, Autobytel incurred $1,100 in expense relating to the resolution of a contract dispute whereby parties to a certain contract alleged that Autobytel breached certain representations and warranties in connection with a contract entered into by Autobytel. The alleged breach was triggered by Autobytel’s announcement on November 15, 2004 that it expected to restate its consolidated financial statements for the second, third, and fourth quarters of 2003, the full 2003 fiscal year and the first and second fiscal quarters 2004, relating to credits issued to customers that were inappropriately reversed and recognized as revenue during the four fiscal quarters ended March 31, 2004, and outstanding checks issued by Autobytel that were voided and the corresponding obligations inappropriately reversed and recorded as an increase in revenue or a reduction of expenses primarily in the second fiscal quarter of 2003. For more details on Autobytel’s restatement, see Note 3.

Although the settlement for the contract dispute was reached in May 2005, Autobytel is required to accrue and incur the settlement expense in the three months ended December 31, 2004 as (1) the underlying cause of the event occurred during the three months ended December 31, 2004 and (2) the financials statements for that period were not yet issued at the time the settlement was reached.

Nasdaq

As a result of Autobytel’s failure to timely file its Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2004, its Annual Report on Form 10-K for the fiscal year ended December 31, 2004, its Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2005, and certain required restatements of its financial statements for prior periods (“Required Filings”), from November 2004 to May 2005 Autobytel was not in full compliance with Nasdaq Marketplace Rule 4310(c)(14), which requires Autobytel to make, on a timely basis, all filings with the Securities and Exchange Commission required by the Securities Exchange Act of 1934, as amended. Autobytel is required to comply with Nasdaq Marketplace Rule 4310(c)(14) as a condition for its common stock to continue to be listed on The Nasdaq National Market.

AUTOBYTEL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Amounts in thousands, except per share data)

(unaudited)

Autobytel requested and received from a Nasdaq Listing Qualifications Panel (the “Panel”) several extensions within which to comply with Nasdaq Marketplace Rule 4310(c)(14). On April 7, 2005, Autobytel received an extension to the deadline to come into full compliance with Nasdaq Marketplace Rule 4310(c)(14) to May 15, 2005, which deadline was subsequently extended by the Panel to May 31, 2005. The Panel’s decision to continue the listing of Autobytel’s shares on The Nasdaq National Market was subject to the condition that Autobytel files the Required Filings on or before May 31, 2005. Autobytel has now complied with this condition. In addition, Autobytel’s continued listing is conditioned on timely filing all periodic reports with the Securities and Exchange Commission and The Nasdaq Stock Market for all reporting periods ending on or before December 31, 2006. The filing of a Form 12b-25 extension request will not result in an automatic extension of these filing deadlines.

On May 20, 2005, Autobytel received notice from The Nasdaq Stock Market that the Nasdaq Listing and Hearing Review Council (the “Listing Council”) has called for a review of the Panel’s April 7, 2005 decision. Autobytel has until June 20, 2005 to submit information for the Listing Council’s consideration. Autobytel cannot give any assurances as to what actions the Listing Council may take, but such actions could include delisting its shares from The Nasdaq National Market. In addition, if Autobytel is unable to comply with the conditions for continued listing required by the Panel, then its shares of common stock are subject to immediate delisting from The Nasdaq National Market. If its shares of common stock are delisted from The Nasdaq National Market, they may not be eligible to trade on any national securities exchange or the over-the-counter market. If its common stock is no longer traded through a market system, it may not be liquid, which could affect its price.

Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

You should read the following discussion of our results of operations and financial condition in conjunction with our consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements based on current expectations that involve risks and uncertainties. Actual results and the timing of certain events may differ significantly from those projected in such forward-looking statements due to a number of factors, including those discussed in the section entitled “Risk Factors” below in this Quarterly Report on Form 10-Q.

The following discussion and analysis gives effect to the restatement described above in the Explanatory Note to this Form 10-Q and in Note 3 to our consolidated financial statements. Accordingly, some of the data set forth in this section is not comparable to discussions and data in our previously filed annual and quarterly reports for the corresponding periods.

Overview

We are an automotive marketing services company that helps dealers sell cars and manufacturers build brands through efficient marketing and advertising primarily through the Internet. We own and operate the automotive Web sites Autobytel.com, Autoweb.com, Car.com, CarSmart.com, AutoSite.com, AICAutoSite.com, Autoahorros.com, and CarTV.com. We are also a leading provider of customer relationship management (CRM) products and programs, consisting of lead management products, customer loyalty and retention marketing programs, data extraction services and automotive marketing data and technology.

We have recently restated our consolidated financial statements for the full 2002 fiscal year, the full 2003 fiscal year, the first, second, and third fiscal quarters of 2003, and the first and second fiscal quarters of 2004. In connection with those restatements, there are currently pending against us and certain of our current directors and current and former officers certain purported class action and derivative lawsuits, as more fully described in “Part II. Item 1. Legal Proceedings”.

In September 2004, we filed a lawsuit for patent infringement against Dealix Corporation in order to protect certain of our intellectual property, as more fully described in “Part II. Item 1. Legal Proceedings”.

We expect our results of operations and financial condition during 2005 to be adversely affected by higher than expected operating costs, including an increase in customer acquisition costs and costs relating to compliance with the Sarbanes-Oxley Act of 2002, as well as costs associated with the restatements of our consolidated financial statements, the internal review, and the remediation of material weaknesses in our internal controls identified in our internal review. In addition, costs associated with defending purported class action and derivative lawsuits filed against us and certain current directors and current and former officers relating to the restatements of our consolidated financial statements, and costs associated with enforcing our intellectual property rights, including the lawsuit filed against Dealix Corporation for patent infringement, are also expected to increase our operating costs and adversely affect our results of operations and financial condition.

As we previously announced, on April 27, 2005, (i) Jeffrey Schwartz resigned as our Chief Executive Officer and President (but remains an employee in the role of Vice Chairman), (ii) Richard Post, a director, was elected as Chief Executive Officer and President, and (iii) Richard Walker, former Executive Vice President, Corporate Development and Strategy, was elected as Executive Vice President and Chief Operating Officer.

As we previously announced on November 15, 2004, Hoshi Printer resigned as our Executive Vice President and Chief Financial Officer effective November 15, 2004. Michael F. Schmidt, our Senior Vice President, Finance, assumed the functions of Chief Financial Officer pending our appointment of a Chief Financial Officer. On May 30, 2005, Mr. Schmidt was appointed as our Chief Financial Officer.

As previously announced, on April 1, 2005, Matthew McDowell, our Vice President and Controller and principal accounting officer, resigned as an employee of Autobytel. Michael F. Schmidt, our Chief Financial Officer, assumed the functions of principal accounting officer, pending our appointment of a Controller.

On April 19, 2005, we took steps to commit to integrate the business operations of our customer loyalty and retention marketing program, Retention Performance Marketing, with our customer lead management product, WebControl, (the “Integration”). We determined to proceed with the Integration in order to increase efficiency and respond to market demand for integrated customer relationship management solutions. As part of the Integration, we intend to close our Houston office and to move the operations of such office to our offices in Irvine, California and/or Westerville, Ohio. Certain employees in the Houston office may relocate to our offices in Irvine, California and/or Westerville, Ohio. We expect to complete the Integration by December 31, 2005. We estimate that the total expenses relating to the Integration, primarily consisting of retention, severance and relocation costs, will be between $175 and $300.

On April 9, 2004, we acquired iDriveonline, Inc. (iDriveonline), now Retention Performance Marketing, Inc., a provider of customer loyalty and retention marketing programs for the automotive industry. On April 15, 2004, we acquired Stoneage Corporation (Stoneage), now Car.com, Inc., a provider of Internet automotive buying services and owner of the Car.com Web site.

We expect revenue from our business to continue growing for the remainder of 2005. In addition, we have been able to better diversify our revenue mix. We reduced the percentage of revenue from lead fees and increased the percentage of revenue from CRM services.

As of March 31, 2005, we had $52.2 million in domestic cash, cash equivalents, and short-term and long-term investments.

Net cash used in operations was $0.1 million in the first quarter of 2005. We may continue to use cash from operations for the remainder of 2005.

Our lead referral dealer relationships represent every major domestic and imported make of vehicle and light truck sold in the United States. As of March 31, 2005, our lead referral dealer relationships consisted of approximately 6,200 retail dealer relationships (including 273 suspended dealers), relationships with major dealer groups representing approximately 670 enterprise dealer relationships, and six direct relationships encompassing 16 brands with automotive manufacturers or their automotive buying service affiliates through our enterprise sales initiatives representing up to approximately 17,600 enterprise dealer relationships. As of March 31, 2005, approximately 850 retail dealers had more than one retail lead referral dealer relationship with us. A majority of our revenue from lead referral dealer relationships is derived from retail dealer relationships and enterprise dealer relationships with major dealer groups. In addition, as of March 31, 2005, our finance lead referral network includes approximately 300 relationships with retail dealers, finance request intermediaries, and automotive finance companies who participate in our Car.com finance referral network. As of March 31, 2005, CRM customer relationships consisted of approximately 2,870 WebControl ^® , our lead management product, and approximately 750 Retention Performance Marketing ^SM (RPM ^SM) , our customer loyalty and retention marketing program, relationships. As an example of how we calculate these relationships, a dealer that subscribes to the Autobytel.com new car program and the Autoweb.com new car program accounts for two retail dealer relationships, and a dealer that subscribes to our WebControl product and RPM program accounts for two CRM customer relationships. As a further example, a dealer group that owns three different franchises and that subscribes to the Autoweb.com new car program for all such franchises accounts for three retail dealer relationships. WebControl customer relationships are accounted for based on the number of customers using WebControl, rather than the number of franchises owned by a given customer. We no longer include iManager ^SM (our legacy lead management tool) product relationships within CRM customer relationships, as we are offering dealers who use iManager the opportunity to migrate to WebControl. Suspended dealer relationships are relationships with dealers to whom the delivery of purchase requests or performance of services has been suspended. The number of dealer relationships and customer relationships as of March 31, 2005 referred to above was determined in conformity with the methodology described above.

We conduct our business within one business segment, which is defined as providing automotive marketing services.

Lead fees consist of car buying purchase request fees for new and used cars, and finance request fees.

Fees for car buying purchase requests are paid by retail dealers, enterprise dealers and automotive manufacturers or their buying service affiliates who participate in our online car buying referral networks. Beginning April 15, 2004, lead fees include fees paid by retail dealers, enterprise dealers and automotive manufacturers who participate in our Car.com online car buying referral network. Enterprise dealers consist of (i) dealers that are part of major dealer groups with more than 25 dealerships with whom we have a single agreement and (ii) dealers that are eligible to receive purchase requests from us as part of a single agreement with an automotive manufacturer or its automotive buying service affiliate. Major dealer groups include AutoNation and automotive manufacturers include manufacturers such as General Motors, Ford and Mazda. Fees paid by customers participating in our car buying referral networks are comprised of monthly subscription and transaction fees for consumer leads, or purchase requests, which are directed to participating dealers. These monthly subscription and transaction fees are recognized in the period service is provided. Ongoing fixed monthly subscription fees are based, among other things, on the size of territory, demographics and, indirectly, the transmittal of purchase requests to customers participating in our car buying referral networks. Transaction fees are based on the number of purchase requests provided to retail and enterprise dealers and automotive manufacturers each month.

Generally, our dealer contracts are terminable on 30 days’ notice by either party. As of March 31, 2005, a major manufacturer in our program accounted for up to approximately 8,200 enterprise dealer relationships. This program with a major manufacturer automatically extends in one-month increments until terminated by us or the manufacturer. From time to time, a major dealer group or automotive manufacturer may significantly increase or decrease the number of enterprise dealers participating in our dealer networks or the number of purchase requests accepted from us. We intend to strengthen the size and quality of our relationships with major dealer groups and automotive manufacturers.

Beginning April 15, 2004, lead fees also include fees paid by retail dealers, finance request intermediaries, and automotive finance companies who participate in our Car.com finance referral network. Customers participating in our Car.com finance referral network pay ongoing monthly subscription fees or transaction fees based on the number of finance requests provided to them each month. The fees are recognized in the period service is provided.

For the three months ended March 31, 2005 and 2004, lead fees were $21.6 million and $17.2 million, or 65% and 70% of total revenues in the first quarter of 2005 and 2004, respectively. We expect to derive a majority of our revenues in the foreseeable future from retail dealers, enterprise dealers and automotive manufacturers that participate in our online car buying referral networks and dealers, finance request intermediaries, and automotive finance companies that participate in our Car.com finance referral network.

Advertising revenues represent fees from automotive manufacturers and other advertisers who target car buyers during the research, consideration and decision making process on our Web sites, as well as through direct marketing offerings. Using the targeted nature of Internet advertising, manufacturers can advertise their brands effectively on any of our Web sites by targeting advertisements to consumers who are researching vehicles, thereby increasing the likelihood of influencing their purchase decisions. Beginning April 15, 2004, advertising revenues include fees paid by automotive manufacturers who advertise on our Car.com Web site.

Revenues from advertising were $4.8 million and $3.1 million, or 14% and 13% of total revenues, in the first quarter of 2005 and 2004, respectively. With further selling of additional advertising inventory, an increase in Internet advertising spending by automotive manufacturers, the acquisition of Stoneage in April 2004 and the addition of new and higher priced products, such as rich media and direct marketing offerings, we anticipate that our advertising revenues in 2005 will increase compared to 2004.

CRM services consist of fees paid by customers who use our customer retention and lead management products. Customer retention and lead management products consist of WebControl System (WebControl), our customer lead management product, Retention Performance Marketing (RPM) and iDriveonline, our customer loyalty and retention marketing programs, and Automotive Download Services (ADS), our data extraction service. CRM services include fees from WebControl and ADS and fees from dealers using the iDriveonline program beginning April 9, 2004. Customers using our CRM services pay transaction fees based on the specified service, or ongoing monthly subscription fees based on the level of functionality selected from our suite of lead management products. Revenues from CRM services were $5.8 million and $3.0 million, or 17% and 12% of total revenues, in the first quarter of 2005 and 2004, respectively. We expect revenues from our CRM services to increase in 2005 compared to 2004 primarily due to the acquisition of iDriveonline in April 2004.

Revenues from data, applications and other include fees from automotive marketing data and technology, classified listings for used cars, international licensing agreements, internet sales training and other products and services. Revenues from data, applications and other were $1.2 million and $1.3 million, or 4% and 5% of total revenues, in the first quarter of 2005 and 2004, respectively. We develop our own data for use on our Web sites, and also make it available to third parties, such as automotive manufacturers and internet portals. We continue to focus our efforts on offering marketing services to dealers and automotive manufacturers. We expect revenues from data, applications and other to decline in 2005 compared to 2004.

Effective with the filing of this Quarterly Report on Form 10-Q, we modified our statement of operations presentation to better align reported results with internal operational measures and to provide increased understanding and transparency for investors. Operating expenses are now classified as cost of revenues, sales and marketing, product and technology development, general and administrative, and amortization of acquired intangible assets. Cost of revenues contain costs previously classified as sales and marketing, including traffic acquisition and related compensation costs, printing, production and postage for our customer loyalty and retention program, and fees paid to third parties for data and content included on our properties. Cost of revenues also contain costs previously classified as product and technology development including connectivity costs, technology license fees, amortization of acquired technology, amortization of internally developed technology, fees paid to third parties for data and content included on our properties, and server equipment depreciation. Other costs which have been reclassified are: (1) bad debt expense, which was previously classified as sales and marketing expense, is now classified as general and administrative expense and (2) credit balances of customers, which were previously classified as accounts receivable, are now classified as other current liabilities.

To enhance the quality of purchase requests, each purchase request is passed through our Quality Verification System (QVS) ^SM which uses filters and validation processes to identify consumers with valid purchase intent before delivering the purchase request to our retail and enterprise dealers. We believe the implementation of these quality enhancing processes allows us to deliver high quality purchase requests to our retail and enterprise dealers. High quality purchase requests are those that result in high closing ratios. Closing ratio is the ratio of the number of vehicles purchased at a dealer generated from purchase requests to the total number of purchase requests sent to that dealer.

We delivered approximately 1.0 million and 0.9 million purchase requests through our online systems to retail and enterprise dealers in the first quarter of 2005 and 2004, respectively, including 0.2 million purchase requests delivered by Car.com in the first quarter of 2005. Of these, approximately 0.6 million were delivered to retail dealers for both the first quarter of 2005 and 2004 and approximately 0.4 million and 0.3 million were delivered to enterprise dealers in the first quarter of 2005 and 2004, respectively. The number of purchase requests we delivered to our retail and enterprise dealers in the first quarter of 2005 declined by 0.2 million compared to the fourth quarter of 2004. Management is taking actions to reverse this trend. However, we cannot assure that this trend will not continue.

Additionally, we delivered approximately 0.2 million finance requests in the first quarter of 2005 to retail dealers, finance request intermediaries, and automotive finance companies as a result of the Car.com acquisition.

We expect that the number of finance requests we deliver to retail dealers, finance request intermediaries, and automotive finance companies will increase in 2005 compared to 2004.

To enhance our retail dealers’ ability to sell cars using our programs, we developed and implemented various products and processes that allow us to provide high quality dealer support. We contact all retail dealers new to our programs to confirm their initiation on our programs and train their designated personnel on the use of our programs and products. We also contact our retail dealers on a regular basis to identify retail dealers who are not using our programs effectively, develop relationships with retail dealer principals and their personnel responsible for calling consumers and to inform our retail dealers about their effectiveness u

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