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

The Securities and Exchange Commission (“SEC”) encourages companies to disclose forward-looking information so that investors can better understand a company’s future prospects and make informed investment decisions. This Quarterly Report on Form 10-Q contains such forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “anticipate,” “estimate,” “expects,” “projects,” “intends,” “plans,” “believes” and words of similar substance used in connection with any discussion of future operations or financial performance identify forward-looking statements. In particular, statements regarding expectations and opportunities, new product expectations and capabilities, and our outlook regarding our performance and growth are forward-looking statements. This Quarterly Report on Form 10-Q also contains statements regarding plans, goals and objectives. There is no assurance that we will be able to carry out such plans or achieve such goals and objectives or that we will be able to successfully do so on a profitable basis. These forward-looking statements are just predictions and involve risks and uncertainties such that actual results may differ materially from these statements. Important factors that could cause actual results to differ materially from those reflected in forward-looking statements made in this Quarterly Report on Form 10-Q are set forth under Part II “Item 1A. Risk Factors.” Investors are urged not to place undue reliance on forward-looking statements, which speak only as of the date hereof. We are under no obligation, and expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise. All forward-looking statements contained herein are qualified in their entirety by the foregoing cautionary statements. Unless specified otherwise, as used herein, the terms “we,” “us” or “our” refer to Autobytel Inc. and its subsidiaries.

You should read the following discussion of our results of operations and financial condition in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q.

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 automotive Web sites, including 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 services. In the second quarter of 2006 we began, and plan to continue, to implement certain strategic initiatives, including transitioning us toward a media-centric business model, focusing on providing best-of-class marketing and media services for our dealer and manufacturer customers, and capturing integration opportunities within our business.

On June 12, 2006, our Board of Directors, at the recommendation of management, approved a realignment of our workforce, which included a reduction of our workforce by approximately 10%. The realignment was effected in order to generate operational efficiencies across our product lines and to enable new investment in key growth areas. As a result, we recorded a $0.3 million charge in the second quarter of 2006, consisting of severance costs.

Effective August 9, 2006, PricewaterhouseCoopers LLP (“PwC”) will cease being our independent registered public accounting firm. We expect to select an independent registered public accounting firm to replace PwC in the third quarter of 2006.

We announced on May 1, 2006 that Michael Schmidt, our Chief Financial Officer, is expected to transition from his position upon the completion of our search for a new chief financial officer.

Richard Walker resigned as Executive Vice President and Chief Operating Officer and all other officer titles he holds with us or any of our subsidiaries effective May 31, 2006.

Our results of operations have been affected in the second quarter of 2006, and may continue to be affected in the future, by various factors, including, but not limited to, the following:

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Also, our results of operations may be affected in the future by the implementation of certain strategic initiatives, including those described above. We anticipate these strategic initiatives will require an investment of approximately $3 million to $4 million in operating expenses and approximately $3 million to $4 million in capital expenditures over the remainder of 2006. There will also be further investments over the course of 2007.

For the year ending December 31, 2006, we expect that revenue from leads and advertising will both decline when compared to the same period in 2005. CRM revenues are expected to increase in 2006 when compared to 2005. Cost of revenue is expected to increase as a percentage of total revenue for the year ending December 31, 2006 when compared to the same period in 2005. Operating expenses, excluding cost of revenue, are expected to increase in 2006 when compared to 2005. Operating expenses include the previously mentioned costs associated with the implementation of our strategic initiatives, stock-based compensation expense due to the implementation of FAS 123(R) and costs associated with enforcing our intellectual property rights.

On January 1, 2006, we adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payments,” which is a revision to SFAS No. 123, “Accounting for Stock-Based Compensation” issued in 1995 using the modified prospective application method. Under this transition method, compensation cost of $1.2 million was recognized in the second quarter of 2006, which includes the applicable amounts of: (a) compensation cost of all stock-based payments granted prior to, but not yet vested as of December 31, 2005 (based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123 and previously presented in the pro forma footnote disclosures), and (b) compensation cost for all stock-based payments granted subsequent to December 31, 2005 (based on the grant-date fair value estimated in accordance with the new provisions of SFAS No. 123(R)). See Note 4, Stock-Based Compensation, in the accompanying notes to the condensed consolidated financial statements.

As of June 30, 2006, we had $38.1 million in domestic cash, cash equivalents, and short-term investments.

Net cash used in operations was $5.2 million in the second quarter of 2006. For the remainder of 2006, we expect to continue to use cash in excess of cash generated from operations.

Our lead referral dealer relationships represent domestic and imported makes of vehicles and light trucks sold in the United States. As of June 30, 2006, our lead referral dealer relationships, excluding dealer enterprise relationships attributable to automotive manufacturers or their automotive buying service affiliates, totaled approximately 6,330, encompassing approximately 5,570 retail dealer relationships (including approximately 140 suspended dealers) and relationships with major dealer groups representing approximately 760 enterprise dealer relationships. Additionally, our lead referral dealer relationships include 10 direct relationships encompassing 20 brands with automotive manufacturers or their automotive buying service affiliates through our enterprise sales initiatives representing up to approximately 21,350 enterprise dealer relationships. As of June 30, 2006, approximately 660 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 June 30, 2006, our finance lead referral network included approximately 370 relationships with retail dealers, finance request intermediaries, and automotive finance companies who participate in our Car.com finance referral network. Participants in the finance referral network receive requests to arrange for financing the purchase of an automobile. As of June 30, 2006, the CRM customer relationships consisted of approximately 2,940 Web Control ^® , our lead management product (“Web Control”), and approximately 900 RPM ^® , 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 Web Control 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. Web Control customer relationships are accounted for based on the number of customers using Web Control, rather than the number of franchises owned by a given customer. We no longer include iManager ^® (our

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legacy lead management tool) product relationships within CRM customer relationships, as we are offering dealers who use iManager the opportunity to migrate to our Web Control product.

Suspended dealer relationships are relationships with dealers to whom the delivery of purchase requests or performance of services has been suspended. The suspension may be initiated by us or the dealers for various reasons, including, but not limited to nonpayment by dealers or dealers temporarily not having an Internet manager. The number of dealer relationships and customer relationships as of June 30, 2006 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 automotive buying service affiliates who participate in our online car buying referral networks. 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 General Motors and Ford. Fees paid by customers participating in our car buying referral networks are comprised of monthly subscription and/or 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 June 30, 2006, a major manufacturer in our program accounted for up to approximately 8,000 enterprise dealer relationships. This program with such 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.

Revenues from lead fees were $17.8 million and $19.7 million, or 60% and 63% of total revenues in the second quarter of 2006 and 2005, 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 finance referral network.

To enhance the quality of purchase requests, each purchase request is passed through our Quality Verification System ^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 0.8 million and 0.9 million purchase requests through our online systems to retail and enterprise dealers in the second quarter of 2006 and 2005, respectively. Of these, approximately 0.5 million and 0.6 million were delivered to retail dealers in the second quarter of 2006 and 2005, respectively, and approximately 0.3 million were delivered to enterprise dealers in both the second quarter of 2006 and 2005. The number of purchase requests we delivered to our retail dealers in the second quarter of 2006 reflects a decline from the same period in 2005. We are taking actions to reverse this trend. However, we cannot assure that this trend will not continue for the remainder of 2006.

Additionally, we delivered approximately 0.2 million finance requests in both the second quarter of 2006 and 2005 to retail dealers, finance request intermediaries, and automotive finance companies.

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.

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Revenues from advertising were $4.3 million and $4.5 million, or 15% and 14% of total revenues in the second quarter of 2006 and 2005, respectively.

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 Web Control, our customer lead management product, RPM, and Automotive Download Services (“ADS”), our data extraction service. 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 $6.3 million and $6.0 million, or 22% and 19% of total revenues in the second quarter of 2006 and 2005, respectively.

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 $1.0 million and $1.1 million, or 3% and 4% of total revenues in the second quarter of 2006 and 2005, respectively. We develop 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.

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 using surveys completed by purchase-intending consumers.

Our relationship with retail dealers may terminate for various reasons including:

From time to time as we sign major dealer groups to receive purchase requests, dealers that are part of such groups and previously represented retail dealer relationships are counted as enterprise dealer relationships. In the second quarter of 2006, we had a slight increase in our number of retail dealer relationships. We cannot assure that we will be able to continue to increase or maintain our number of retail dealer relationships. If we are unable to maintain our number of retail dealer relationships, our business, results of operations and financial condition could be materially and adversely affected.

Because our primary revenue source is from lead fees, our business model is different from many other Internet commerce sites. The automobiles requested through our Web sites are sold by dealers; therefore, we derive no direct revenues from the sale of a vehicle and have no procurement, carrying or shipping costs and no inventory risk.

Critical Accounting Policies

Stock Based Compensation Expense. Effective January 1, 2006, we adopted SFAS No. 123(R) using the modified prospective method and therefore have not restated prior periods’ results. Under the fair value recognition provisions of SFAS No. 123R, we recognize stock-based compensation net of an estimated forfeiture rate and therefore only recognize compensation cost for those shares expected to vest over the service period of the award. Prior to SFAS No. 123(R) adoption, we accounted for share-based payments under APB Opinion No. 25 and, accordingly, generally recognized no

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compensation expense related to share-based awards as awards were generally granted at fair value at the date of grant and accounted for forfeitures as they occurred.

Calculating stock-based compensation expense requires the input of highly subjective assumptions, including the expected term of the stock-based awards, stock price volatility, and pre-vesting option forfeitures. We estimate the expected life of options granted based on historical exercise patterns, which we believe are representative of future behavior, using a lattice expected term model. We estimate the volatility of our common stock at the date of grant based on historical volatility of our common stock for a period equal to the expected term of the awards. The assumptions used in calculating the fair value of stock-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. We estimate the forfeiture rate based on historical experience of our stock-based awards that are granted, exercised and cancelled. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period. See Note 4 — “Stock-Based Compensation” in the condensed consolidated financial statements for additional information.

Revenue Recognition. We recognize revenues when earned as defined by Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” and Emerging Issues Task Force (“EITF”) Issue 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” SAB No. 104 considers revenue realized after all four of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the seller’s price to the buyer is fixed or determinable and (iv) collectibility is reasonably assured.

In accounting for multiple-element arrangements, one of the key judgments to be made is the accounting value that is attributable to the different contractual elements. The appropriate allocation of value not only impacts which revenue stream is credited with the revenue, it also impacts the amount and timing of revenue recorded in the consolidated statement of operations during a given period due to the differing methods of recognizing revenue. Revenue is allocated to each element based on the accounting determination of the relative fair value of that element to the aggregate fair value of all elements. The fair values must be reliable, verifiable and objectively determinable. When available, such determination is based principally on the pricing of similar cash arrangements with unrelated parties that are not part of a multiple-element arrangement. When sufficient evidence of the fair values of the individual elements does not exist, revenue is not allocated among them until that evidence exists. Instead, the revenue is recognized as earned using revenue recognition principles applicable to the entire arrangement as if it were a single element arrangement.

Results of Operations

The following table sets forth our results of operations as a percentage of revenues:

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Revenues by groups of similar services are as follows (in thousands):

Three Months Ended June 30, 2006 Compared to the Three Months Ended June 30, 2005

Revenues.  Our revenues decreased by $2.0 million, or 6%, to $29.4 million in the second quarter of 2006 compared to $31.4 million in the second quarter of 2005.

Lead Fees. Lead fees decreased by $1.9 million, or 10%, to $17.8 million in the second quarter of 2006 compared to $19.7 million in the second quarter of 2005. The decrease was primarily due to a decline in the (i) purchase requests delivered to our retail dealers of 0.1 million, primarily due to a lower average monthly delivery of purchase requests per dealer coupled with a decline in our retail dealer relationships and (ii) average sales price per retail lead.

Advertising. Advertising revenue decreased by $0.2 million, or 4%, to $4.3 million in the second quarter of 2006 compared to $4.5 million in the second quarter of 2005. The decrease in advertising revenue was primarily due to lower spending by automotive manufacturers with our properties.

CRM Services. CRM services increased by $0.3 million, or 5%, to $6.3 million in the second quarter of 2006 compared to $6.0 million in the second quarter of 2005. The increase was due to an increase in fees from Web Control products as a result of an increase in the average fee per customer coupled with an increase in the number of customers from approximately 2,900 at June 30, 2005 to approximately 2,940 at June 30, 2006.

Data, Applications and Other. Revenues from data, applications and other decreased by $0.2 million or 16%, to $1.0 million in the second quarter of 2006 compared to $1.1 million in the second quarter of 2005. The decrease was primarily due to a decrease in fees from classified advertising that was discontinued in the second quarter of 2005 and international license fees as a result of the substantially complete liquidation of Autobytel.Europe in the fourth quarter of 2005, coupled with a decline in fees from training.

Cost of Revenues. Cost of revenues consists of traffic acquisition costs (“TAC”) and other cost of revenues. TAC consists of payments made to our internet consumer request providers, including Internet portals and online automotive information providers. Other cost of revenues consists of printing, production, and postage for our customer loyalty and retention programs, fees paid to third parties for data and content included on our properties, connectivity costs, technology license fees, server equipment depreciation and technology amortization and compensation related expense.

Cost of revenues increased by $1.7 million or 14% to $14.4 million in the second quarter of 2006 compared to $12.7 million in the second quarter of 2005. This represents 49% and 41% of total revenues for the second quarter of 2006 and 2005, respectively. The increase was primarily due to a $1.8 million increase in TAC as a result of our increased spending with third parties who direct search queries to our Web sites and an increase in the costs of finance requests acquired from third parties, partially offset by a decrease in the number of purchase requests acquired directly from third parties. This increase was offset by a $0.1 million decline in other costs.

Sales and Marketing.  Sales and marketing expense includes costs for developing our brand equity and personnel and other costs associated with dealer sales, CRM sales, Web site advertising sales, and dealer training and support. Sales and marketing expense increased by $0.3 million, or 4%, to $7.3 million in the second quarter of 2006 compared to $7.0 million in the second quarter of 2005. This represents 25% and 22% of total revenues for the second quarter of 2006 and 2005, respectively. The increase was primarily due to a $0.3 million increase in stock compensation expense as a result of adopting the provisions of SFAS No. 123(R) on January 1, 2006.

Product and Technology Development. Product and technology development expense includes personnel costs related to developing new products, enhancing the features, content and functionality of our Web sites and our Internet-based

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communications platform, costs associated with our telecommunications and computer infrastructure, and costs related to data and technology development. Product and technology development expense decreased by $0.1 million, or 2%, to $6.2 million in the second quarter of 2006 compared to $6.3 million in the second quarter of 2005. This represents 21% and 20% of total revenues for the second quarter of 2006 and 2005, respectively. The decrease was primarily due to lower personnel and related costs of $0.6 million associated with the decrease in headcount, offset by a $0.3 million charge associated with the write-off of a capitalized internal use software no longer being developed or expected to be placed in service for its intended use, and a $0.2 million increase in stock compensation expense as a result of adopting the provisions of SFAS No. 123(R) on January 1, 2006.

General and Administrative. General and administrative expense consists of executive, financial and legal personnel expenses and costs related to being a public company. General and administrative expense increased by $0.9 million, or 11%, to $9.5 million in the second quarter of 2006 compared to $8.5 million in the second quarter of 2005. This represents 32% and 27% of total revenues for the second quarter of 2006 and 2005, respectively. The increase was primarily due to:

These increases were offset by a:

Interest Income.  In the second quarter of 2006, interest income increased by $0.1 million, to $0.5 million compared to $0.4 million in the second quarter of 2005. The increase in interest income was due to the investment of our cash in accounts yielding higher interest rates.

Minority Interest.  Minority interest represents the portion of Autobytel.Europe’s net income allocable to Autobytel.Europe’s other shareholder.

Income Taxes.  We recorded zero for the provision for state income taxes for the second quarter of 2006 compared to $0.1 million for the second quarter of 2005.

Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005

Revenues. Our revenues decreased by $6.3 million, or 10%, to $58.4 million for the six months ended June 30, 2006 compared to $64.7 million for the same period in 2005.

Lead Fees. Lead fees decreased by $5.6 million, or 13%, to $35.7 million for the six months ended June 30, 2006 compared to $41.3 million for the same period in 2005. The increase was primarily due to a decline in the (i) purchase requests delivered to our retail dealers of 0.2 million, primarily due to a lower average monthly delivery of purchase requests per dealer coupled with a decline in our retail dealer relationships and (ii) average sales price per retail lead.

Advertising. Advertising revenue decreased by $1.2 million, or 13%, to $8.1 million for the six months ended June 30, 2006 compared to $9.3 million for the same period in 2005. The decrease was primarily due to lower spending by automotive manufacturers with our properties.

CRM Services. CRM services increased by $0.9 million, or 7%, to $12.7 million for the six months ended June 30, 2006 compared to $11.8 million for the same period in 2005. The increase was due to a $0.8 million increase in fees from Web Control products as a result of an increase in the average fee per customer coupled with an increase in the number of customers from approximately 2,900 at June 30, 2005 to approximately 2,940 at June 30, 2006 and a $0.1 million increase in RPM revenue.

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Data, Applications and Other. Revenues from data, applications and other decreased by $0.4 million, or 17%, to $1.9 million for the six months ended June 30, 2006 compared to $2.3 million for the same period in 2005. The decrease was primarily due to a $0.2 million decrease in fees from classified advertising that was discontinued in the second quarter of 2005, a $0.1 million decrease in international licensing fees as a result of the substantially complete liquidation of Autobytel.Europe in the fourth quarter of 2005 and a $0.1 million decline in fees from training.

Cost of Revenues. Cost of revenues increased by $3.1 million or 12% to $29.2 million for the six months ended June 30, 2006 compared to $26.1 million for the same period in 2005. This represents 50% and 40% of total revenues for the six months ended June 30, 2006 and 2005, respectively. The increase was primarily due to a $2.7 million increase in TAC and a $0.7 million increase in printing, production and postage costs. The increase was offset by a $0.3 million decrease in amortization of capitalized internal use software and acquired intangible assets. The increase in TAC was primarily due to our increased spending with third parties who direct search queries to our Web sites and an increase in the costs of finance requests acquired from third parties, partially offset by a decrease in the number of purchase requests acquired directly from third parties. The increase in printing, production and postage costs was primarily due to the increase in customer loyalty and retention program volume in our RPM business. The decrease in amortization of capitalized internal use software and acquired intangible assets was due to certain costs that were fully amortized in 2005.

Sales and Marketing. Sales and marketing expense decreased by $0.3 million, or 2%, to $14.8 million for the six months ended June 30, 2006 compared to $15.1 million for the same period in 2005. This represents 26% and 24% of total revenues for the six months ended June 30, 2006 and 2005, respectively. The decrease was primarily due to a $0.8 million decline in advertising spending and a $0.1 million decrease in other costs, offset by $0.6 million increase in stock compensation expense as a result of adopting the provisions of SFAS No. 123(R) on January 1, 2006.

Product and Technology Development. Product and technology development expense decreased by $0.5 million, or 4%, to $11.8 million for the six months ended June 30, 2006 compared to $12.4 million for the same period in 2005. This represents 20% and 19% of total revenues for the six months ended June 30, 2006 and 2005, respectively. The decrease was primarily due to lower personnel and related costs of $1.1 million associated with the decrease in headcount and a $0.1 million decrease in telephone costs related to our voice communications, offset by a $0.4 million increase in stock compensation expense as a result of adopting the provisions of SFAS No. 123(R) on January 1, 2006 and a $0.3 million charge associated with the write-off of a capitalized internal use software no longer being developed or expected to be placed in service for its intended use.

General and Administrative. General and administrative expense increased by $2.3 million, or 14%, to $19.2 million for the six months ended June 30, 2006 compared to $16.9 million for the same period in 2005. This represents 33% and 26% of total revenues for the six months ended June 30, 2006 and 2005, respectively. The increase was primarily due to:

These increases were offset by a:

Interest Income. For the six months ended June 30, 2006, interest income increased by $0.2 million, to $0.9 million compared to $0.7 million for the same period in 2005. The increase in interest income was due to the investment of our cash in accounts yielding higher interest rates.

Minority Interest. Minority interest represents the portion of Autobytel.Europe’s net income allocable to Autobytel.Europe’s other shareholder.

Income Taxes.  We recorded zero for the provision for state income taxes for the six months ended June 30, 2006 compared to $0.3 million for the same period in 2005.

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Stock Options Granted in 2006

From January 1, 2006 through June 30, 2006, we granted (i) stock options to purchase 590,500 shares of common stock under our 1996 Stock Incentive Plan, 1998 Stock Option Plan, 1999 Stock Option Plan, 1999 Employee and Acquisition Related Stock Option Plan, 2004 Restricted Stock and Option Plan, and 2006 Inducement Stock Option Plan and (ii) an inducement stock option to purchase 1,000,000 shares of common stock to Mr. Riesenbach. The stock options were granted at our common stock closing price on the date of grant. Of the 1,000,000 inducement stock options granted to Mr. Riesenbach, 400,000 performance-based options were granted with the performance criteria to be defined at a later date. These 400,000 options are not reflected in outstanding stock options at June 30, 2006. As of June 30, 2006, excluding these 400,000 options, we had 9,081,186 outstanding stock options.

Employees

As of July 31, 2006, we had a total of 397 employees. We also utilize independent contractors as required. None of our employees are represented by a labor union. We have not experienced any work stoppages and consider our employee relations to be good.

Liquidity and Capital Resources

Our working capital decreased by $9.4 million, to $39.1 million at June 30, 2006 compared to $48.4 million at December 31, 2005. The decrease was primarily related to cash used by operations and purchases of property and equipment, offset in part by cash proceeds received from the maturity of long-term investments and the issuances of common stock in connection with the exercise of employee stock options and pursuant to our employee stock purchase plan.

Our domestic cash, cash equivalents and short-term investments totaled $38.1 million as of June 30, 2006 compared to domestic cash, cash equivalents, short-term and long-term investments of $48.4 million as of December 31, 2005. As of June 30, 2006, we had $29.2 million in domestic cash and cash equivalents and $9.0 million in short-term investments.

Net Cash Used In Operating Activities

Net cash used in operating activities was $9.5 million and $6.4 million for the six months ended June 30, 2006 and 2005, respectively. Net cash used in operating activities for the six months ended June 30, 2006 resulted primarily from the net loss of $16.3 million for the period, which was partially offset by a $0.9 million increase in accounts payable and accrued expenses, a $0.3 million increase in deferred revenues, and non-cash charges. The increase in accounts payable and accrued expenses was primarily due to professional fees incurred related to enforcing our intellectual property rights, offset in part by payments of accrued compensation costs in the first half of 2006. The increase in deferred revenues was primarily due to the deferral of revenue related to the two multiple-element arrangements mentioned above.

Net cash used in operating activities for the six months ended June 30, 2005 resulted from a net loss of $6.1 million for the period, a $3.1 million increase in accounts receivable, $0.7 million increase in prepaid expenses and other current assets and a $0.5 million decrease in accounts payable and accrued expenses, which were partially offset by non-cash charges. The $3.1 million increase in accounts receivable was primarily due to the increase in days sales outstanding from 51 days during the three months ended December 31, 2004 to 57 days for the six months ended June 30, 2005. The $0.7 million increase in prepaid expenses and other current assets was primarily due to the payment of insurance premiums during the first half of 2005, offset by the amortization of the insurance premiums. The $0.5 million decrease in accounts payable and accrued expenses was primarily due to payout of accrued compensation costs in the first half of 2005, offset by professional fees incurred related to the restatements of our consolidated financial statements, internal review, and defending purported class action and derivative lawsuits filed against us and certain current directors and current and former officers.

Net Cash Provided By Investing Activities

Net cash provided by investing activities was $4.7 million and $9.2 million for the six months ended June 30, 2006 and 2005, respectively. Cash provided by investing activities for the six months ended June 30, 2006 was related to the maturity of investments in government sponsored agency bonds, offset by purchases of short-term investment in commercial paper and purchases of property and equipment. Cash provided by investing activities for the six months ended June 30, 2005 was related to the sale and maturities of short-term investments in government sponsored agency bonds and auction rate securities, offset by purchases of short-term and long-term investments in government sponsored agency bonds and auction rate securities and purchases of property and equipment.

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Net Cash Provided By Financing Activities

Net cash provided by financing activities was $0.7 million for the six months ended June 30, 2006 and nominal for the six months ended June 30, 2005. Cash provided by financing activities for the six months ended June 30, 2006 and 2005 was due to proceeds received from the sale of common stock through our employee stock purchase plan and the exercise of stock options.

Prospective Capital Needs

A decline in the general economic environment that negatively affects the financial condition of our customers or an increase in the number of customers that are dissatisfied with our services could have a material impact on our business, results of operations or financial condition.

We do not have debt. Although we forecast and budget cash requirements, assumptions underlying the estimates may change and could have a material impact on our cash requirements. If capital requirements vary materially from those currently planned, we may require additional financing sooner than anticipated. We have no commitments for any additional financing. Should we need financing, there can be no assurance that any such commitments can be obtained on favorable terms, if at all.

Although we believe that we have sufficient capital to fund our activities for at least the next 12 months, our future capital requirements may vary materially from those now planned. We anticipate that the amount of capital we will need in the future will depend on many factors, including but not limited to:

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements as defined in Regulation S-K Item 303(a)(4)(ii).

Recent Accounting Pronouncements

In May 2005, FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle. It also requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings for that period rather than being reported in an income statement. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We adopted SFAS No. 154 on January 1, 2006, and its adoption did not have a material effect on our consolidated financial position or results of operations.

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In July 2006, FASB issued FIN 48 “Accounting for Uncertainty in Income Taxes” which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. It also provides guidance on the derecognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The accounting provisions of FIN 48 will be effective for us beginning January 1, 2007. We are currently evaluating the impact of adopting FIN 48 on our consolidated financial statements.