AUTOBYTEL INC - 10-Q Quarterly Report

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Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

As of April 30, 2004, there were 41,525,485 shares of the Registrant’s Common Stock outstanding.

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

Autobytel Inc. (Autobytel) is an automotive marketing services company that helps dealers sell cars and manufacturers build brands through efficient marketing, advertising and customer relationship management (CRM) products and programs primarily through the Internet. Autobytel owns and operates the automotive Web sites Autobytel.com, Autoweb.com, CarSmart.com and Autosite.com. Autobytel is also a leading provider of dealership lead management products and dealer management system data extraction services. Autobytel is also a provider of automotive marketing data and technology.

Autobytel provides products and programs to automotive dealers and manufacturers to help them increase marketing efficiency and reduce customer acquisition costs.

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 ABTL.

The accompanying interim consolidated financial statements as of March 31, 2004, and for the three months ended March 31, 2004 and 2003, are unaudited. 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, 2003 included in Autobytel’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 15, 2004.

Investments in entities in which Autobytel has the ability to exercise significant influence, but not control, are accounted for using the equity method. On March 31, 2004, Autobytel adopted FIN 46R and determined it was the primary beneficiary of Autobytel.Europe. As a result of this adoption, Autobytel consolidated Autobytel.Europe LLC (Autobytel.Europe) in its financial statements as of March 31, 2004. Autobytel owns 49% of Autobytel.Europe. (See Note 3.)

All intercompany transactions and balances have been eliminated in consolidation.

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.

For purposes of the consolidated balance sheets and the consolidated statements of cash flows, Autobytel considers all highly liquid investments with a 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. International cash and cash equivalents represent amounts held by Autobytel.Europe for use as directed by Autobytel.Europe. International cash and cash equivalents are not available to Autobytel. As of March 31, 2004, domestic and international cash and cash equivalents were $49,270 and $10,425, respectively.

Autobytel considers all investments with a remaining maturity of three months to one year to be short-term investments and those with a remaining maturity of more than one year to be long-term investments. In accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 115 “Accounting for Certain Investments in Debt and Equity Securities” and based on Autobytel’s intentions, all marketable debt securities and long-term debt investments are classified as held-to-maturity and reported at amortized cost. As of March 31, 2004, held-to-maturity debt securities with an amortized cost of $15,000 are due within one to two years.

As of March 31, 2004 and December 31, 2003, the amortized cost basis, aggregate fair value, unrealized gains and losses by security type were as follows:

Net income 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 per share is calculated by dividing the net income by the weighted average shares of common stock outstanding during the period. Diluted net income per share is calculated by dividing the net income by the weighted average shares of common stock outstanding during the period and potential shares of common stock. 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 the company from the exercise proceeds.

For the three months ended March 31, 2004 and 2003, there were 4,239,145 and 933,667 potential shares of common stock, respectively.

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 closing price over the exercise price on the grant date.

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 and net income per share for the three months ended March 31, 2004 and 2003, would approximate the pro forma amounts below:

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

In the three months ended March 31, 2004, Autobytel granted 550,000 stock options. The options granted were estimated to have a weighted average fair value of $3,741 based on the Black-Scholes option-pricing model on the date of grant and the following assumptions: (1) no dividend yield, (2) volatility of 66%, (3) weighted-average risk-free interest rate of approximately 2.21%, and (4) a weighted-average expected life of 3.5 years.

As of March 31, 2004, Autobytel had a total of 7,396,725 stock options outstanding, of which 6,304,929 stock options had exercise prices below the closing price per share of Autobytel’s common stock on that date.

Autobytel conducts its business within one business segment which is defined as providing automotive marketing services primarily through the Internet.

In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003) (FIN 46R), “Consolidation of Variable Interest Entities,” an Interpretation of Accounting Research Bulletin No. 51, which replaced the previously issued FIN 46. FIN 46R requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity (i) do not have sufficient equity at risk, (ii) do not have the characteristics of a controlling financial interest, or (iii) have voting rights that are disproportionate to their economic interests and the activities of the entity involve or are conducted on behalf of an investor with a disproportionately small voting interest. FIN 46R is effective no later than the first reporting period that ends after March 15, 2004.

As a result of the adoption of FIN 46R, Autobytel was determined to be the primary beneficiary of Autobytel.Europe and is required to consolidate Autobytel.Europe in its financial statements effective March 31, 2004. Autobytel has an ownership interest in Autobytel.Europe of 49%. The consolidation of Autobytel.Europe into Autobytel’s financial statements did not have an effect on Autobytel’s results of operations. (See Note 3.)

Effective January 1, 2004, Autobytel modified its revenue presentation to better align reported numbers and metrics with internal operations and to provide increased understanding and transparency for investors. Revenues are now classified as lead fees, advertising, customer relationship management (CRM) services and data, applications and other. Prior to January 1, 2004, Autobytel had reported revenue as program fees, enterprise sales, advertising and other products and services. Amounts for 2003 have been reclassified to conform to the 2004 presentation. There was no impact on total revenues as a result of the reclassification.

Lead fees consist of fees paid by retail dealers, enterprise dealers and automotive manufacturers who participate in the Autobytel.com, Autoweb.com and CarSmart.com online car buying referral networks. CRM services consist of fees paid by customers who use Autobytel’s customer retention and lead management products and services. Advertising revenues represent fees received from automotive manufacturers and other advertisers who target car-buyers during the research, consideration and decision making process on the Web sites. 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.

Also, certain other reclassifications have been made to prior year financial information to conform with the current year presentation.

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.

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. As a result of this adoption, Autobytel consolidated in its financial statements as of March 31, 2004, $10,425 in cash and cash equivalents, $940 in other assets, including a 46.4% investment in an equity investee held by Autobytel.Europe, $2,300 in liabilities, including accrued international licensee liabilities for payments to be made to Autobytel.Europe licensees, aggregating $1,541, under agreements entered into in March 2002, and $4,623 representing the 51% ownership in Autobytel.Europe belonging to Autobytel.Europe’s other shareholder. The accrued international licensee liabilities were paid in full by Autobytel.Europe in April 2004. The consolidation of Autobytel.Europe into Autobytel’s financial statements on March 31, 2004 did not have an effect on Autobytel’s results of operations. Autobytel will include the results of operations of Autobytel.Europe beginning April 1, 2004.

On June 4, 2003, Autobytel acquired all of the outstanding common stock of Applied Virtual Vision, Inc., now AVV, Inc., a provider of CRM and sales management products and dealer management system data extraction services, in exchange for cash and common stock. The acquisition of AVV complements Autobytel’s core business with its automotive customer relations management solutions and data extraction services. The acquisition has been accounted for using the purchase method of accounting.

The following summarized unaudited pro forma consolidated results of operations are presented as if the acquisition of AVV 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 acquisition been completed as presented.

On October 10, 2002, Morrison & Foerster LLP, a law firm that represented Autobytel, A.I.N. Corporation and Michael Gorun, former President of A.I.N., at various points in litigation which was settled in 2002, filed an action entitled Morrison & Foerster LLP v. Autobytel.com Inc. et al. in the Santa Clara Superior Court against Autobytel, A.I.N. and Mr. Gorun asserting claims for damages for breach of contract for failure to pay legal fees and expenses plus interest accrued

thereon in the aggregate amount of approximately $660. On July 15, 2003, Autobytel, A.I.N. and Morrison & Foerster LLP settled the matter described above. The settlement amount was paid in 2003.

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. Autobytel has approved a Memorandum of Understanding (“MOU”) 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 contemplated by the MOU provides for a release of Autobytel and the Autobytel Individual Defendants for the conduct alleged in the action to be wrongful and for Autobytel to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims Autobytel may have against its underwriters. It is anticipated that any potential financial obligation of Autobytel to plaintiffs pursuant to the terms of the MOU and related agreements will be covered by existing insurance. Therefore, Autobytel does not expect that the settlement will involve any payment by Autobytel. The MOU and related agreements are subject to a number of contingencies, including the negotiation of a settlement agreement and its approval by the court. Autobytel cannot determine whether or when a settlement will occur or be finalized and whether the outcome of the litigation will have a material impact on Autobytel’s results of operations or financial condition 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. Autoweb has approved the MOU 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 contemplated by the MOU provides for a release of Autoweb and the Autoweb Individual Defendants for the conduct alleged in the action to be wrongful and for Autoweb to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims Autoweb may have against its underwriters. It is anticipated that any potential financial obligation of Autoweb to plaintiffs pursuant to the terms of the MOU and related agreements will be covered by existing insurance. Therefore, Autoweb does not expect that the settlement will involve any payment by Autoweb. The MOU and related agreements are subject to a number of contingencies, including the negotiation of a settlement agreement and its approval by the court. Autobytel cannot determine whether or when a settlement will occur or be finalized and whether the outcome of the litigation will have a material impact on Autobytel’s results of operations or financial condition 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 financial statements.

From time to time, Autobytel is involved in other litigation matters relating to claims arising out of the ordinary course of business. Autobytel believes that there are no claims or actions pending or threatened against it, the ultimate disposition of which would have a material adverse effect on Autobytel’s business, results of operations and financial condition. However, if a court or jury rules against Autobytel and the ruling is ultimately sustained on appeal and damages are awarded against it, such ruling could have a material and adverse effect on Autobytel’s business, results of operations and financial condition.

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, 2004, 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 $212. Autobytel expects the remaining charges to be paid in 2004. The remaining accrued domestic restructuring liabilities related to the 2002 charges as of March 31, 2004 were as follows:

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. Mr. Grimes will make himself available to the executive officers of 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 assigns the amount that Mr. Grimes would have received for the remainder of the term of the agreement. Mr. Grimes has the right to terminate the agreement upon 90 days notice to Autobytel. Effective May 1, 2003, Mr. Grimes was not entitled to participate in Autobytel’s employee welfare benefit plans at Autobytel’s expense.

On April 9, 2004, Autobytel acquired iDriveonline, Inc. (iDriveonline), now Retention Performance Marketing, Inc., a provider of customer loyalty and retention marketing programs for the automotive industry. In connection with the acquisition, Autobytel issued 474,501 shares of Autobytel common stock and made payments of approximately $5,000 in cash, subject to a post closing purchase price adjustment.

On April 15, 2004, Autobytel acquired Stoneage Corporation (Stoneage), now Car.com, Inc., a provider of Internet automotive buying services and owner of the Car.com Web site. Under the terms of the agreement, former Stoneage shareholders received 2,257,733 shares of Autobytel common stock and approximately $15,300 in cash, subject to a post closing purchase price adjustment.

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.

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

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. In connection with the acquisition, we issued 474,501 shares of our common stock and made payments of approximately $5 million in cash, subject to a post closing purchase price adjustment.

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. Under the terms of the agreement, former Stoneage shareholders received 2,257,733 shares of our common stock and approximately $15.3 million in cash, subject to a post closing purchase price adjustment.

We continue experiencing growth in revenue, both in our existing business and from acquisitions. In addition, in the past several quarters 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 other revenue categories, in particular, CRM services. Our current business strategy is to grow our existing business and make acquisitions.

As of March 31, 2004, we had $64.3 million in domestic cash, cash equivalents and long-term investments. We generated $0.6 million in cash from operations during the first quarter of 2004. We expect to continue generating cash from operations for the remainder of 2004.

We continue to achieve net additions to our number of retail dealer relationships. We had approximately 5,500 retail dealer relationships as of March 31, 2004 compared to approximately 5,300 retail dealer relationships as of December 31, 2003. We expect to continue to add retail dealer relationships for the remainder of 2004.

We had approximately 29,400 and 29,000 dealer relationships as of March 31, 2004 and December 31, 2003, respectively. As of March 31, 2004, our dealer relationships consisted of approximately 18,900 enterprise dealer relationships, 5,500 retail dealer relationships and 5,000 CRM dealer relationships, including approximately 3,500 WebControl and ADS, 1,000 iManager (a lead management tool) and 450 RPM dealer relationships. As of December 31, 2003 our dealer relationships consisted of approximately 18,700 enterprise dealer relationships, 5,300 retail dealer relationships and 5,000 CRM dealer relationships, including approximately 3,400 WebControl and ADS, 1,200 iManager and 400 RPM dealer relationships. We are in the process of migrating iManager dealers to WebControl.

On March 31, 2004, we adopted the provisions of FIN 46R and determined we were the primary beneficiary of Autobytel.Europe. As a result of this adoption, as of March 31, 2004, we consolidated in our financial statements approximately $10.4 million in cash and cash equivalents, $0.9 million in other assets, including a 46.4% investment in an equity investee, $2.3 million in liabilities, including accrued international licensee liabilities for payments to be made to Autobytel.Europe licensees, aggregating $1.5 million, under agreements entered into in March 2002, and $4.6 million representing the 51% ownership in Autobytel.Europe belonging to Autobytel.Europe’s other shareholder. The accrued international licensee liabilities were paid in full by Autobytel.Europe in April 2004. The consolidation of Autobytel.Europe into our financial statements on March 31, 2004 did not have an effect on our results of operations. We will include the results of operations of Autobytel.Europe beginning April 1, 2004.

We had a 49%, or $2.7 million investment in Autobytel.Europe as of March 31, 2004, which was calculated as follows (in millions):

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

Effective January 1, 2004, we modified our revenue presentation to better align reported numbers and metrics with internal operations and to provide increased understanding and transparency for investors. Revenues are now classified as lead fees, customer relationship management (CRM) services, advertising, and data, applications and other. Prior to January 1, 2004, we had reported revenue as program fees, enterprise sales, advertising and other products and services. Amounts for 2003 have been reclassified to conform to the 2004 presentation. There was no impact on total revenue as a result of the reclassification.

Lead fees consist of fees paid by retail dealers, enterprise dealers and automotive manufacturers who participate in our Autobytel.com, Autoweb.com and CarSmart.com 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 manufacturers such as General Motors, Ford, Mercedes Benz 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 customers participating in our car buying referral networks each month. Beginning on April 15, 2004, lead fees will include fees paid by retail dealers, enterprise dealers and automotive manufacturers who participate in our Car.com online car buying referral network.

Generally, our dealer contracts have terms ranging from 90 days to one year and are terminable on 30 days’ notice by either party. As of March 31, 2004, we had a major manufacturer in our program that accounted for approximately 10,100 enterprise dealer relationships. The 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. We intend to strengthen the size and quality of our relationships with major dealer groups and automotive manufacturers. For the three months ended March 31, 2004 and 2003, lead fees were $16.8 million and $14.6 million, or 68% and 72% of total revenues, respectively. Average monthly lead fees per dealer were $849 and $768 in the first quarter of 2004 and 2003, respectively. We expect to be primarily dependent on our retail dealers for revenues in the foreseeable future.

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. Using the targeted nature of Internet advertising, manufacturers can advertise their brands effectively on any of our four Web sites by targeting advertisements to consumers who are researching vehicles, thereby increasing the likelihood of influencing their purchase decisions. Our customizable advertising products offer manufacturers the opportunity to present detailed, enhanced information about a specific vehicle model to millions of online car shoppers on our Web sites. Features can include image galleries, brochure requests and video. Revenues from advertising were $3.1 million and $2.8 million in the first quarter of 2004 and 2003, or 13% and 14% of total revenues, respectively. With further selling of our advertising inventory and an increase in Internet advertising spending by automotive manufacturers, we anticipate that our advertising business in 2004 will increase compared to 2003. Beginning on April 15, 2004, advertising revenues will include fees paid by automotive manufacturers who advertise on our Car.com Web site.

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 Retention Performance Marketing (RPM), our customer loyalty and retention marketing program, WebControl System (WebControl) and iManager, our customer lead management products, and Automobile Download Services (ADS), our data extraction service. CRM services include fees from WebControl and ADS beginning on June 4, 2003. 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 $3.5 million and $1.5 million, or 14% and 7% of total revenues, in the first quarter of 2004 and 2003, respectively. Beginning on April 9, 2004, customer loyalty and retention program revenue will include fees related to dealers using the iDriveonline product. We expect to combine the RPM and iDriveonline products into a new enhanced RPM product in 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. For the first quarter of 2004 and 2003, revenues from data, applications and other were $1.3 million for both periods.

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 strong purchase intent before delivering the purchase request to our retail and enterprise dealers. We have also implemented additional custom filters and validation processes to further enhance our existing process of validating consumer information. 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 0.9 million and 0.8 million purchase requests through our online systems to retail and enterprise dealers in the first quarter of 2004 and 2003, respectively. Of these, approximately 0.6 million and 0.6 million were delivered to retail dealers and approximately 0.3 million and 0.2 million were delivered to enterprise dealers in the first quarter of 2004 and 2003, respectively. Purchase requests delivered to retail dealers in the first quarter 2004 remained relatively unchanged compared to the first quarter of 2003. Purchase requests delivered to enterprise dealers in the first quarter of 2004 increased by 0.1 million, or 54%, compared to the first quarter of 2003, due to new enterprise relationships added as well as expansion of our existing relationships. We expect the number of purchase requests we deliver to our retail and enterprise dealers to increase in 2004 when compared to 2003.

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 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 our customers and to inform our retail dealers about their effectiveness using surveys completed by our purchase-intending customers.

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

In the first quarter of 2004, we continued to achieve net additions to our number of dealer relationships. However, we cannot assure that we will be able to continue to reduce our dealer turnover. Our inability or failure to reduce dealer turnover could have a material adverse effect on our business, results of operations and financial condition.

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 significant cost of goods sold, no procurement, carrying or shipping costs and no inventory risk.

Our Internet marketing and advertising costs, including annual, monthly and variable fees, were $8.5 million and $7.4 million in the first quarter of 2004 and 2003, respectively. Also included in sales and marketing expenses are the costs related to signing up new dealers and their ongoing training and support, costs to support our advertising, costs for printing production and postage for RPM and costs associated with traditional media, such as television, radio and print advertising. Sales and marketing costs are recorded as an expense in the period the service is provided.

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

Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003

Revenues. Our revenues increased by $4.5 million, or 22%, to $24.8 million in the first quarter of 2004 compared to $20.3 million in the first quarter of 2003. The increase was due to growth in lead fees, CRM services and advertising. As a result of the acquisition of AVV, Inc. (AVV) on June 4, 2003, revenues include $1.8 million from dealers using our WebControl products and ADS services in the first quarter of 2004.

Lead Fees. Lead fees increased by $2.2 million, or 15%, to $16.8 million in the first quarter of 2004 compared to $14.6 million in the first quarter of 2003. The increase was due to the delivery of an additional 0.1 million purchase requests to our retail and enterprise dealers in the first quarter of 2004 when compared to the first quarter of 2003, coupled with the increase in revenue per purchase request to $19.59 in the first quarter of 2004 from $18.38 in the first quarter of 2003. We expect lead

fees to increase in 2004 compared to 2003 as we have added retail and enterprise dealers, including retail and enterprise dealers relating to the acquisition of Car.com, Inc. in April 2004. We also expect to continue our efforts to increase the number of purchase requests we send to our dealers and the fees paid per purchase request.

Advertising. Advertising revenue increased by $0.3 million, or 10%, to $3.1 million in the first quarter of 2004 compared to $2.8 million in the first quarter of 2003. The increase was primarily due to higher spending by automotive manufacturers. With further selling of our available advertising inventory and an increase in Internet advertising spending by automotive manufacturers, we expect our advertising revenues to increase in 2004 compared to 2003.

CRM Services. CRM services increased by $2.0 million, or 138%, to $3.5 million in the first quarter of 2004 compared to $1.5 million in the first quarter of 2003. The increase was due to an increase in RPM revenues partially offset by a decrease in iManager revenues as a result of our migration of dealers from iManager to RPM and fees from WebControl products and ADS services. In connection with the acquisition of AVV in June 2003, we added 3,400 dealer relationships that use our WebControl products and/or ADS services. We expect our CRM services to increase in 2004 compared to 2003 due to an increase in RPM revenues, the addition of iDriveoline dealers in April 2004 and the benefit of WebControl and ADS for a full year.

Data, Applications and Other. Revenues from data, applications and other were $1.3 million in the first quarter of 2004, relatively unchanged from the first quarter of 2003. We continue to focus our efforts on offering marketing services to dealers and automotive manufacturers. We expect data, applications and other to decline slightly in 2004 compared to 2003.

Sales and Marketing. Sales and marketing expense includes advertising and marketing expenses paid to our purchase request providers and for developing our brand equity, as well as 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 $2.0 million, or 15%, to $14.8 million in the first quarter of 2004 compared to $12.9 million in the first quarter of 2003. This represents 60% and 64% as a percent of total revenues for the first quarter of 2004 and 2003, respectively. The increase was primarily due to a $1.1 million increase in online advertising as a result of an increase in the number of purchase requests delivered to dealers participating in our car buying referral networks and higher costs for each purchase request, a $0.3 million increase in costs associated with sales and customer relationship maintenance, including AVV, which was acquired on June 4, 2003, a $0.2 million increase in sales personnel and compensation costs and a $0.3 million increase in printing, production and postage costs related to our growing RPM program. We expect our sales and marketing expenses as a percentage of revenues to remain flat in 2004 compared to 2003.

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 communications platform, costs associated with our telecommunications and computer infrastructure, costs related to data and technology development and amortization of software development costs. Product and technology development expense increased by $1.2 million, or 32%, to $5.1 million in the first quarter of 2004 compared to $3.9 million in the first quarter of 2003. This represents 20% and 19% of total revenues for the first quarter of 2004 and 2003, respectively. The increase was primarily due to higher personnel and related costs of $1.0 million associated with the increase in headcount, coupled with a $0.2 million increase in telephone and connectivity costs related to our voice and data communications. We expect our product and technology development expenses as a percentage of revenues to slightly decline in 2004 compared to 2003.

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 $0.1 million, or 5%, to $2.9 million in the first quarter of 2004 compared to $2.8 million in the first quarter of 2003. This represents 12% and 14% of total revenues for the first quarter of 2004 and 2003, respectively. The increase was primarily due to higher personnel and related costs of $0.2 million associated with the increase in headcount and a $0.1 million increase in public company expenses. Such increases were offset by a decrease of $0.2 million in insurance, legal costs and other costs. We expect our general and administrative expenses as a percentage of revenues to slightly increase in 2004 compared to 2003 due to fees associated with regulatory requirements for public companies, in particular, compliance costs associated with the Sarbanes-Oxley Act of 2002.

Interest Income. In the first quarter of 2004, interest income increased by $0.1 million, to $0.2 million compared to $0.1 million in the first quarter of 2003. The increase in interest income was due to higher cash generated from operations, coupled with the sale of five million shares of common stock in a private placement for net proceeds of $25.6 million in June 2003 and the investment of our cash in accounts yielding higher interest rates.

Income (Loss) in Equity Investee. Income (loss) in equity investee represents our share of income or loss in Autobytel.Europe prior to the adoption of FIN 46R.

Income Taxes. No provision for federal income taxes has been recorded as we generated taxable losses through December 31, 2002 and had nominal taxable income for the year ended December 31, 2003, which will be offset by net operating loss carryforwards. As of December 31, 2003, we had approximately $63.0 million of federal and $34.0 million of state net operating loss carryforwards available to offset future taxable income. These net operating loss carryforwards expire in various years through 2022. We also have federal and state research tax credit carryforwards of $0.7 million and $0.5 million, respectively. These research tax credits expire in various years through 2022. Utilization of these carryforwards is subject to an annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. The annual limitation may result in the expiration of the carryforwards before utilization. Additionally, the state of California suspended the deduction for net operating loss carryovers for the 2003 tax year. At the end of each reporting period, we evaluate whether it is more likely than not that our deferred tax assets are not realizable. While we believe that such deferred tax assets are not realizable at March 31, 2004, our assessment may change in future periods as we continue to generate positive operating results.

From January 1, 2004 through March 31, 2004, we granted stock options to purchase 550,000 shares of common stock under our 1999 Employee and Acquisition Related Stock Option Plan and Amended and Restated 2001 Restricted Stock and Option Plan. The stock options were granted at our common stock closing price on the date of grant. As of March 31, 2004, we had approximately 7.4 million outstanding stock options.

As of March 31, 2004, we had a total of 328 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.

As of March 31, 2004, we had $49.3 million in domestic cash and cash equivalents. Our domestic cash, cash equivalents and short and long-term investments totaled $64.3 million as of March 31, 2004, an increase of $2.6 million in the first quarter of 2004. As of March 31, 2004, international cash and cash equivalents held by Autobytel.Europe were $10.4 million for use as directed by Autobytel.Europe. International cash and cash equivalents are not available to us. In April 2004, we used approximately $20.3 million in cash and cash equivalents in connection with the acquisitions of Retention Performance Marketing, Inc. and Car.com, Inc., excluding transaction costs.

Net cash provided by operating activities was $0.6 million for the three months ended March 31, 2004 compared to $1.1 million for the same period in 2003. Net cash provided by operating activities for the three months ended March 31, 2004 resulted from net income for the period before non-cash charges, partially offset by an increase in prepaid expenses and other assets coupled with a decrease in accrued expenses. A $0.7 million increase in prepaid expenses and other assets was primarily due to the payment of insurance premiums and acquisition costs during the first quarter of 2004. A $1.7 million decrease in accrued expenses was primarily due to the payout of accrued compensation costs in the first quarter of 2004.

Net cash provided by operating activities for the three months ended March 31, 2003 primarily resulted from the net income for the period before non-cash charges and a decrease in prepaid expenses and other current assets partially offset by a decrease in accrued expenses. A $1.1 million decrease in prepaid expenses and other current assets was primarily due to the amortization of prepaid fees related to a marketing agreement and the settlement of escrow funds in the first quarter of 2003. A $1.4 million decrease in accrued expenses was primarily due to the payout of accrued compensation costs in the first quarter of 2003.

Net cash provided by investing activities was $5.1 million for the three months ended March 31, 2004 and nominal for the same period in 2003. Cash provided by investing activities in the first quarter of 2004 was related to the consolidation of Autobytel.Europe’s cash balance in accordance with FIN 46R and the maturity of short-term investments, offset by the purchase of long-term investments in government sponsored agency bonds and purchases of property and equipment.

Net cash provided by financing activities was $2.4 million for the three months ended March 31, 2004 and $0.1 million for the same period in 2003. Cash provided by financing activities in the first quarter of 2004 and 2003 was due to

proceeds received from the sale of common stock through our employee stock purchase plan and the exercise of stock options.

We maintain reserves for bad debts and customer credits. The allowance for bad debts is our estimate of bad debt expense that could result from the inability or refusal of our customers to pay for our services. The estimated provision for bad debts is charged to operating expenses. The allowance for customer credits is our estimate of adjustments for purchase requests or other services that do not meet our customers’ quality expectations. The estimated provision for customer credits is recorded as a reduction in revenue. Our estimates are based on our historical bad debt expense and customer credit experience.

In prior periods, significant increases in required reserves for domestic bad debts and customer credits have been recorded. We experienced an improvement in our collection of accounts receivable due to vigorous collection efforts and the improved quality of our products and services. Based on this improvement, we have reduced our reserves for domestic bad debts and customer credits to $1.3 million, or 11% of total accounts receivable, as of March 31, 2004 from $1.8 million, or 16% of total accounts receivable as of December 31, 2003. If we continue to improve the quality of our accounts receivable, we may further reduce our reserves for domestic bad debts and customer credits. Reductions in the estimated provisions for bad debts and customer credits are recorded as a decrease in operating expenses and an increase in revenues, respectively. As of March 31, 2004, Autobytel.Europe had $0.8 million in reserves for bad debt.

However, if there is 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, additional reserves for bad debts and customer credits may be required and the impact on our business, results of operations or financial condition could be material.

We do not have debt. We believe our current cash and cash equivalents are sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months.

Car.com’s contractual obligations include an operating lease for its facility. As of April 15, 2004, the aggregate minimum lease payments were $0.5 million expiring on various dates through June 2005.

In April 2004, accrued international licensee liabilities aggregating $1.5 million were paid in full by Autobytel.Europe.

While we forecast and budget cash requirements, assumptions underlying the estimates may change and could have a material impact on our cash requirements. If our uses of funds vary materially from those currently planned, we may require additional financing sooner than anticipated. We have no commitments for any additional financing, and there can be no assurance that any such commitments can be obtained on favorable terms, if at all.

Any additional equity financing may be dilutive to our stockholders, and debt financing, if available, may involve restrictive covenants with respect to dividends, raising capital and other financial and operational matters which could restrict our operations or finances. If we are unable to obtain additional financing as needed or on terms favorable to us, we may be required to reduce the scope of or discontinue our operations or delay or discontinue any expansion, which could have a material adverse effect on our business, results of operations and financial condition.

involve or are conducted on behalf of an investor with a disproportionately small voting interest. FIN 46R is effective no later than the first reporting period that ends after March 15, 2004.

Under FIN 46R, we determined we were the primary beneficiary of Autobytel.Europe and are required to consolidate Autobytel.Europe in our financial statements effective March 31, 2004. We have an ownership interest in Autobytel.Europe of 49%. The consolidation of Autobytel.Europe into our financial statements did not have an effect on our results of operations.

In addition to the factors discussed in the “Overview” and “Liquidity and Capital Resources” sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Quarterly Report on Form 10-Q, the following additional factors may affect our future results.

We have only been profitable for the last six quarters and otherwise have a history of net losses and cannot assure that we will continue to be profitable. If we are unable to sustain our recent profitability and we lose money, our operations will not be financially viable.

Because of the relatively recent emergence of the Internet-based vehicle information and purchasing industry, none of our senior executives has long-term experience in the industry. This limited operating history contributes to our difficulty in predicting future operating results.

We have incurred losses every quarter through the third quarter of 2002. Having achieved profitability in the fourth quarter of 2002, we might fail to sustain or increase that profitability in the future. We cannot assure that we will continue to be profitable. We had an accumulated deficit of $151.7 million as of March 31, 2004 and $153.8 million as of December 31, 2003.

Our potential for future profitability must be considered in light of the risks, uncertainties, expenses and difficulties frequently encountered by companies in emerging and rapidly evolving markets, such as the market for Internet commerce. We believe that to achieve and sustain profitability, we must, among other things:

We cannot be certain that we will be successful in achieving these goals or that if we are successful in achieving these goals, that we will continue to be profitable.

If our dealer attrition increases, our dealer networks and revenues derived from these networks may decrease.

The majority of our revenues are derived from fees paid by our networks of participating retail and enterprise dealers. A few agreements account for all of our enterprise dealer relationships. 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. If dealer attrition increases and we are unable to add new dealers to mitigate the attrition, our revenues will decrease. A material factor affecting dealer attrition is our ability to provide dealers with high quality purchase requests. 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. If the number of dealers in our networks declines, our revenues will decrease and our business, results of operations and financial condition will be materially and adversely affected. In addition, if automotive manufacturers or major dealer groups force us to decrease the fees we charge for our services, our revenues will decline which could have a material adverse effect on our business, results of operations and financial condition.

Generally, our retail dealer agreements have a stated term ranging from 90 days to one year, but such dealer agreements are cancelable by either party upon 30 days notice. Participating retail dealers may terminate their relationship with us for any reason, including an unwillingness to accept our subscription terms or as a result of joining alternative marketing programs. We cannot assure that retail dealers will not terminate their agreements with us. Our business is dependent upon our ability to attract and retain qualified new and used vehicle retail dealers, major dealer groups and automotive manufacturers. In order for us to grow or maintain our dealer networks, we need to reduce our dealer attrition. We cannot assure that we will be able to reduce the level of dealer attrition, and our failure to do so could materially and adversely affect our business, results of operations and financial condition.

We may lose participating retail dealers because of the reconfiguration or elimination of exclusive dealer territories. We will lose the revenues associated with any reductions in participating retail dealers resulting from such changes.

We may reduce, reconfigure or eliminate exclusive territories currently assigned to Autobytel, CarSmart or Car.com retail dealers. If a retail dealer is unwilling to accept a reduction, reconfiguration or elimination of its exclusive territory, it may terminate its relationship with us. A retail dealer also could sue to prevent such reduction, reconfiguration or elimination, or collect damages from us. We have experienced one such lawsuit. A material decrease in the number of retail dealers participating in our networks or litigation with retail dealers could have a material adverse effect on our business, results of operations and financial condition.

We send some individual purchase requests to multiple retail dealers. As a result, we may lose participating retail dealers and may be subject to pressure on the fees we charge such dealers for such purchase requests. We will lose the revenues associated with any reductions in participating retail dealers or fees.

We send some individual purchase requests to multiple retail dealers to enhance consumer satisfaction and experience. If a retail dealer perceives such requests as having less value, it may request that fees be reduced or may terminate its relationship with us. A material decrease in the number of retail dealers participating in our networks or the fees such dealers pay us could have a material adverse effect on our business, results of operations and financial condition.

We rely heavily on our participating dealers to promote our brand value by providing high quality services to our consumers. If dealers do not provide our consumers high quality services, our brand value will diminish and the number of consumers who use our services may decline causing a decrease in our revenues.

Promotion of our brand value depends on our ability to provide consumers a high quality experience for purchasing vehicles throughout the purchasing process. If our dealers do not provide consumers with high quality service, the value of our brands could be damaged and the number of consumers using our services may decrease. We devote significant efforts to train participating retail dealers in practices that are intended to increase consumer satisfaction. Our inability to train retail dealers effectively, or the failure by participating dealers to adopt recommended practices, respond rapidly and professionally to vehicle inquiries, or sell and lease vehicles in accordance with our marketing strategies, could result in low consumer satisfaction, damage our brand names and materially and adversely affect our business, results of operations and financial condition.

Competition could reduce our market share and harm our financial performance. Our market is competitive not only because the Internet has minimal technical barriers to entry, but also because we compete directly with other companies in the offline environment.

Our vehicle purchasing services compete against a variety of Internet and traditional vehicle purchasing services, automotive brokers and classified advertisement providers. Therefore, we are affected by the competitive factors faced by both Internet commerce companies as well as traditional, offline companies within the automotive and automotive-related industries. The market for Internet-based commercial services is relatively new, and competition among commercial Web sites may increase significantly in the future. Our business is characterized by minimal technical barriers to entry, and new competitors can launch a competitive service at relatively low cost. To compete successfully, we must significantly increase awareness of our services and brand names. Failure to compete successfully will cause our revenues to decline and would have a material adverse effect on our business, results of operations and financial condition.

We compete with other entities which maintain similar commercial Web sites including AutoUSA, Microsoft Corporation’s MSN Autos, CarsDirect.com, Cars.com, eBayMotors.com, AutoNation and AutoTrader.com. We also compete with vehicle dealers that are not part of our networks. Such companies may already maintain or may introduce Web sites which compete with ours. We also compete indirectly against vehicle brokerage firms and affinity programs offered by several companies, including Costco Wholesale Corporation and Wal-Mart Stores, Inc. In addition, all major automotive manufacturers have their own Web sites and many have launched online buying services, such as General Motors Corporation’s BuyPower and Ford Motor Company in its partnership with its dealers through FordDirect.com. The WebControl product competes with products from companies such as Reynolds and Reynolds and Cobalt Systems Corporation. Our customer relationship management products, RPM and iDriveonline, compete with companies that provide marketing services to automotive manufacturers and dealers, including Reynolds and Reynolds, TVI Inc., Minacs, Online Administrators and Teletech.

We cannot assure that we can compete successfully against current or future competitors, many of which have substantially more capital, existing brand recognition, resources and access to additional financing. In addition, competitive pressures may result in increased marketing costs, decreased Web site traffic or loss of market share or otherwise may materially and adversely affect our business, results of operations and financial condition.

Our quarterly financial results are subject to significant fluctuations which may make it difficult for investors to predict our future performance.

Our quarterly operating results have fluctuated in the past and may fluctuate in the future due to many factors. Our expense levels are based in part on our expectations of future revenues which may vary significantly. If revenues do not increase faster than expenses, our business, results of operations and financial condition will be materially and adversely affected. Other factors that may adversely affect our quarterly operating results include:

Seasonality is likely to cause fluctuations in our operating results. Investors may not be able to predict our annual operating results based on a quarter to quarter comparison of our operating results.

The seasonal patterns of Internet usage and vehicle purchasing do not completely overlap. Historically, Internet usage typically declines during summer and certain holiday periods, while vehicle purchasing in the United States is strongest in the spring and summer months. In addition, purchase request volume usually declines in the summer because of the model year change over, as some consumers defer purchases until information regarding the new model year is available, and many manufacturers do not make their data available for publication until later in the year. As seasonality occurs, investors may not be able to predict our annual operating results based on a quarter to quarter comparison of our operating results. Seasonality in the automotive industry, Internet and commercial online service usage and advertising expenditures is likely to cause fluctuations in our operating results and could have a material adverse effect on our business, results of operations and financial condition.

We may be particularly affected by general economic conditions due to the nature of the automotive industry.

The economic strength of the automotive industry significantly impacts the revenues we derive from our dealers, automotive manufacturers and other strategic partners, advertising revenues and consumer traffic to our Web sites. The automotive industry is cyclical, with vehicle sales fluctuating due to changes in national and global economic forces. Purchases of vehicles are typically discretionary for consumers and may be particularly affected by negative trends in the general economy. The success of our operations depends to a significant extent upon a number of factors relating to discretionary consumer spending, including economic conditions (and perceptions of such conditions by consumers) affecting disposable consumer income (such as employment, wages and salaries, business conditions and interest rates in regional and local markets). In addition, because the purchase of a vehicle is a significant investment and is relatively discretionary, any reduction in disposable income in general or a general increase in interest rates or a general tightening of lending may affect us more significantly than companies in other industries.

Zero percent financing offered by manufacturers in 2002 and 2003 may negatively affect vehicle sales in 2004. Consumers may have shifted their planned vehicle purchases from 2004 to 2003 and 2002. At some point in the future, manufacturers may decrease current levels of incentive spending on new vehicles, which has served to drive sales volume in the past. Such a reduction in incentives could lead to a decline in demand for new vehicles. A decline in vehicle purchases may result in a decline in demand for our services which could adversely affect our business, financial condition and results of operations.

Threatened terrorist acts and the ongoing military action have created uncertainties in the automotive industry and domestic and international economies in general. These events may have an adverse impact on general economic conditions, which may reduce demand for vehicles and consequently our services and products which could have an adverse effect on our business, financial condition and results of operations. At this time, however, we are not able to predict the nature, extent and duration of these effects on overall economic conditions on our business, financial condition and results of operations.

We cannot assure that our business will not be materially adversely affected as a result of an industry or general economic downturn.

If any of our relationships with Internet search engines or online automotive information providers terminates, our purchase request volume or quality could decline. If our purchase request volume or quality declines, our participating dealers may not be satisfied with our services and may terminate their relationships with us or force us to decrease the fees we charge for our service. If this occurs, our revenues would decrease.

We depend on a number of strategic relationships to direct a substantial amount of purchase requests and traffic to our Web sites. The termination of any of these relationships or any significant reduction in traffic to Web sites on which our services are advertised or offered, or the failure to develop additional referral sources, could cause our purchase request volume or quality to decline. If this occurs, dealers may no longer be satisfied with our service and may terminate their relationships with us or force us to decrease the fees we charge for our services. If our dealers terminate their relationships with us or force us to decrease the fees we charge for our services, our revenues will decline which could have a material adverse effect on our business, results of operations and financial condition. We receive a significant number of purchase requests through a limited number of Internet search engines, online automotive information providers, and other auto related Internet sites. We periodically negotiate revisions to existing agreements and these revisions could increase our costs in future periods. A number of our agreements with online service providers may be terminated without cause. We may not be able to maintain our relationship with our online service providers or find alternative, comparable marketing sponsorships and alliances capable of originating significant numbers of purchase requests on terms satisfactory to us. If we cannot maintain or replace our relationships with online service providers, our revenues may decline which could have a material adverse effect on our business, results of operations and financial condition.

If any of our relationships with advertising manufacturers terminates, our revenues would decrease.

We depend on a number of manufacturer relationships for substantially all of our advertising revenues. The termination of any of these relationships or any significant failure to develop additional sources of advertising would cause our revenues to decline which could have a material adverse effect on our business, results of operations and financial condition. We periodically negotiate revisions to existing agreements and these revisions could decrease our advertising revenues in future periods. A number of our agreements with such manufacturers may be terminated without cause. We may not be able to maintain our relationship with such manufacturers on favorable terms or find alternative comparable relationships capable of replacing advertising revenues on terms satisfactory to us. If we cannot do so, our revenues would decline which could have a material adverse effect on our business, results of operations and financial condition.

If we cannot build and maintain strong brand loyalty our business may suffer.

We believe that the importance of brand recognition will increase as more companies engage in commerce over the Internet. Development and awareness of the Autobytel.com, Autoweb.com, Car.com and CarSmart.com brands will depend largely on our ability to obtain a leadership position in Internet commerce. If dealers and manufacturers do not perceive us as an effective channel for increasing vehicle sales, or consumers do not perceive us as offering reliable information concerning new and used vehicles, as well as referrals to high quality dealers, in a user-friendly manner that reduces the time spent for vehicle purchases, we will be unsuccessful in promoting and maintaining our brands. Our brands may not be able to gain widespread acceptance among consumers or dealers. Our failure to develop our brands sufficiently would have a material adverse effect on our business, results of operations and financial condition.

If we lose our key personnel or are unable to attract, train and retain additional highly qualified sales, marketing, managerial and technical personnel, our business may suffer.

Our future success depends on our ability to identify, hire, train and retain highly qualified sales, marketing, managerial and technical personnel. In addition, as we introduce new services we may need to hire additional personnel. We may not be able to attract, assimilate or retain such personnel in the future. The inability to attract and retain the necessary managerial, technical, sales and marketing personnel could have a material adverse effect on our business, results of operations and financial condition.

Our business and operations are substantially dependent on the performance of our executive officers and key employees. The loss of the services of one or more of our executive officers or key employees could have a material adverse effect on our business, results of operations and financial condition.

We are a relatively new business in an emerging industry and need to manage our growth and our entry into new business areas in order to avoid increased expenses without corresponding revenues.

We have been introducing new services to consumers and dealers in order to establish ourselves as a leader in the evolving market for automotive marketing services. The growth of our operations requires us to increase expenditures before we generate revenues. For example, we may need to hire personnel to oversee the introduction of new services before we generate revenues from these services. Our inability to generate satisfactory revenues from such expanded services to offset costs could have a material adverse effect on our business, results of operations and financial condition.

If federal or state franchise laws apply to us we may be required to modify or eliminate our marketing programs. If we are unable to market our services in the manner we currently do, our revenues may decrease and our business may suffer.

We believe that neither our relationship with our dealers nor our dealer subscription agreements constitute “franchises” under federal or state franchise laws. A federal court of appeals in Michigan has ruled that our dealer subscription agreement is not a “franchise” under Michigan law. However, if any state’s regulatory requirements relating to franchises or our method of business impose additional requirements on us or include us within an industry-specific regulatory scheme, we may be required to modify our marketing programs in such states in a manner which undermines the program’s attractiveness to consumers or dealers. If our relationship or written agreement with our dealers were found to be a “franchise” under federal or state franchise laws, we could be subject to other regulations, such as franchise disclosure and registration requirements and limitations on our ability to effect changes in our relationships with our dealers, which may negatively impact our ability to compete and cause our revenues to decrease and our business to suffer. If we become subject to fines or other penalties or if we determine that the franchise and related requirements are overly burdensome, we may elect to terminate operations in such state. In each case, our revenues may decline and our business, results of operations and financial condition could be materially and adversely affected.

We also believe that our dealer marketing service generally does not qualify as an automobile brokerage activity and, therefore, state motor vehicle dealer or broker licensing requirements do not apply to us. Through a subsidiary, we are licensed as a motor vehicle dealer and broker. In response to Texas Department of Transportation concerns, we modified our marketing program in that state to make our program open to all dealers who wish to apply. In addition, we modified the program to include a pricing model under which all participating dealers, regardless of brand, in a given zip code in Texas are charged uniform fees. If other states’ regulatory requirements relating to motor vehicle dealers or brokers are deemed applicable to us, we may become subject to fines, penalties or other requirements and may be required to modify our marketing programs in such states in a manner that undermines the attractiveness of the program to consumers or dealers. If we determine that the licensing or other requirements, in a given state are overly burdensome, we may elect to terminate operations in such state. In each case, our revenues may decline and our business, results of operations and financial condition could be materially and adversely affected.

If financial broker and insurance licensing requirements apply to us in states where we are not currently licensed, we will be required to obtain additional licenses and our business may suffer.

If we are required to be licensed as a financial broker, it may result in an expensive and time-consuming process that could divert the effort of management away from day-to-day operations. In the event states require us to be licensed and we are unable to do so, or are otherwise unable to comply with regulations required by changes in current operations or the introduction of new services, we could be subject to fines or other penalties or be compelled to discontinue operations in such states, and our business, results of operations and financial condition could be materially and adversely affected.

We provide links on our Web sites so consumers can receive real time quotes for insurance coverage from third parties and submit quote applications online through such parties’ Web sites. We receive fees from such participants in connection with this advertising activity. We do not believe that such activities require us to be licensed under state insurance laws. The use of the Internet in the marketing of insurance products, however, is a relatively new practice. It is not clear whether or to what extent state insurance licensing laws apply to activities similar to ours. Given these uncertainties, we currently hold, through a wholly-owned subsidiary, insurance agent licenses or are otherwise authorized to transact insurance in numerous states.

If we are unable to be licensed to comply with additional regulations, or are otherwise unable to comply with regulations required by changes in current operations or the introduction of new services, we could be subject to fines or other penalties or be compelled to discontinue operations in such states, and our business, results of operations and financial condition could be materially and adversely affected.

There are many risks associated with consummated and potential acquisitions.

We intend to continue to evaluate potential acquisitions which we believe will complement or enhance our existing business. If we acquire other companies in the future, it may dilute the value of existing stockholders’ ownership. The impact of dilution may restrict our ability or otherwise not allow us to consummate acquisitions. Issuance of equity securities may restrict utilization of net operating loss carryforwards because of an annual limitation due to ownership change limitations under the Internal Revenue Code. We may also incur debt and losses related to the impairment of goodwill and other intangible assets if we acquire another company, and this could negatively impact our results of operations. We currently do not have any definitive agreements to acquire any company or business, and we may not be able to identify or complete any acquisition in the future.

We recently acquired Retention Performance Marketing, Inc. and Car.com, Inc. Acquisitions involve numerous risks. For example:

Internet commerce has yet to attract significant regulation. Government regulations may result in increased costs that may reduce our future earnings.

There are currently few laws or regulations that apply directly to the Internet. Because our business is dependent on the Internet, the adoption of new local, state or national laws or regulations may decrease the growth of Internet usage or the acceptance of Internet commerce which could, in turn, decrease the demand for our services and increase our costs or otherwise have a material adverse effect on our business, results of operations and financial condition.

Tax authorities in a number of states are currently reviewing the appropriate tax treatment of companies engaged in Internet commerce. New state tax regulations may subject us to additional state sales, use and income taxes.

Evolving government regulations may require future licensing which could increase administrative costs or adversely affect our revenues.

In a regulatory climate that is uncertain, our operations may be subject to direct and indirect adoption, expansion or reinterpretation of various laws and regulations. Compliance with these future laws and regulations may require us to obtain appropriate licenses at an undeterminable and possibly significant initial monetary and annual expense. These additional monetary expenditures may increase future overhead, thereby potentially reducing our future results of operations.

We have identified what we believe are the areas of domestic government regulation, which if changed, would be costly to us. These laws and regulations include franchise laws, motor vehicle brokerage licensing laws, motor vehicle dealership licensing laws, insurance licensing laws and financial services laws, which are or may be applicable to aspects of our business. There could be laws and regulations applicable to our business which we have not identified or which, if changed, may be costly to us.

Our success is dependent on keeping pace with advances in technology. If we are unable to keep pace with advances in technology, consumers may stop using our services and our revenues will decrease.

The Internet and electronic commerce markets are characterized by rapid technological change, changes in user and customer requirements, frequent new service and product introductions embodying new technologies and the emergence of new industry standards and practices that could render our existing Web sites and technology obsolete. These market characteristics are exacerbated by the emerging nature of the market and the fact that many companies are expected to introduce new Internet products and services in the near future. If we are unable to adapt to changing technologies, our business, results of operations and financial condition could be materially and adversely affected. Our performance will depend, in part, on our ability to continue to enhance our existing services, develop new technology that addresses the increasingly sophisticated and varied needs of our prospective customers, license leading technologies and respond to technological advances and emerging industry standards and practices on a timely and cost-effective basis. The development of our Web sites and CRM systems and other proprietary technology entails significant technical and business risks. We may not be successful in using new technologies effectively or adapting our Web sites and CRM systems, or other proprietary technology to customer requirements or to emerging industry standards.

We are vulnerable to electricity blackouts and communications system interruptions. The majority of our primary servers are located in a single location. If electricity or communications to that location or to our headquarters were interrupted, our operations would be adversely affected.

We presently host our production Web sites and certain systems, including Autobytel.com, Autoweb.com, CarSmart.com, AutoSite.com, Car.com, AVV.com, iDriveonline and RPM, at secure hosting facilities. Although backup servers are available, our primary servers are vulnerable to interruption by damage from fire, earthquake, flood, power loss, telecommunications failure, break-ins and other events beyond our control. In the event that we experience significant system disruptions, our business, results of operations and financial condition would be materially and adversely affected. We have, from time to time, experienced periodic systems interruptions and anticipate that such interruptions will occur in the future.

Our main production systems and our accounting, finance and contract management systems are hosted in a secure facility with generators and other alternate power supplies in case of a power outage. However, our corporate offices, where we have the users and applications for our accounting, finance and contract management systems, are vulnerable to wide-scale power outages. To date, we have not been significantly affected by blackouts or other interruptions in service. In the event we are affected by interruptions in service, our business, results of operations and financial condition could be materially and adversely affected.

We maintain business interruption insurance which pays up to $8.6 million for the actual loss of business income sustained due to the suspension of operations as a result of direct physical loss of or damage to property at our offices. However, in the event of a prolonged interruption, this business interruption insurance may not be sufficient to fully compensate us for the resulting losses.

Internet commerce is relatively new and evolving with few profitable business models. We cannot assure that our business model will continue to be profitable.

The market for Internet-based purchasing services has only recently begun to develop and is rapidly evolving. While many Internet commerce companies have grown in terms of revenues, few are profitable. We cannot assure that we will continue to be profitable. As is typical for a new and rapidly evolving industry, demand and market acceptance for recently introduced services and products over the Internet are subject to a high level of uncertainty and there are few proven services and products. Moreover, since the market for our services is new and evolving, it is difficult to predict the future growth rate, if any, and size of this market. The extent to which other participants in the automotive industry will accept the role of third party all make, all model services like us is not yet known.

If consumers do not continue to adopt Internet commerce as a mainstream medium of commerce or if automotive industry participants resist the role of third party online services, our revenues may not grow and our earnings may suffer.

The success of our services will continue to depend upon the adoption of the Internet by consumers and dealers as a mainstream medium for commerce and/or the willingness of automotive manufacturers to cooperate with third party services. While we believe that our services offer significant advantages to consumers and dealers, there can be no assurance that widespread acceptance of Internet commerce in general, or of our services in particular, will occur or that automotive companies will continue to accept a role for third party services such as ours. Our success assumes that consumers and dealers who have historically relied upon traditional means of commerce to purchase or lease vehicles, and to procure vehicle financing and insurance, will accept new methods of conducting business and exchanging information and that automotive manufacturers will accept, rather than resist, a role for all make, all model third party sites such as ours that allow for comparisons. In addition, dealers must be persuaded to adopt new selling models and be trained to use and invest in developing technologies. If the market for Internet-based vehicle marketing services fails to develop, develops slower than expected, faces opposition or becomes saturated with competitors, or if our services do not achieve market acceptance, our business, results of operations and financial condition may be materially and adversely affected.

Internet-related issues may reduce or slow the growth in the use of our services in the future.

Critical issues concerning the commercial use of the Internet, such as ease of access, security, privacy, reliability, cost, and quality of service, remain unresolved and may impact the growth of Internet use. If Internet usage continues to increase rapidly, the Internet infrastructure may not be able to support the demands placed on it by this growth, and its performance and reliability may decline. The recent growth in Internet traffic has caused frequent periods of decreased performance, outages and delays. Our ability to increase the speed with which we provide services to consumers and to increase the scope and quality of such services is limited by and dependent upon the speed and reliability of the Internet, which is beyond our control. If periods of decreased performance, outages or delays on the Internet occur frequently or other critical issues concerning the Internet are not resolved, overall Internet usage or usage of our Web sites could increase more slowly or decline, which would cause our business, results of operations and financial condition to be materially and adversely affected.

The public market for our common stock may continue to be volatile, especially since market prices for Internet-related and technology stocks have often been unrelated to operating performance.

Prior to the initial public offering of our common stock in March 1999, there was no public market for our common stock. We cannot assure that an active trading market will be sustained or that the market price of the common stock will not decline. Recently, the stock market in general and the shares of emerging companies in particular have experienced significant price fluctuations. The market price of our common stock is likely to continue to be highly volatile and could be subject to wide fluctuations in response to factors such as:

Further, the stock markets, and in particular the Nasdaq National Market, have experienced extreme price and volume fluctuations that have particularly affected the market prices of equity securities of many technology companies and have

often been unrelated or disproportionate to the operating performance of such companies. These broad market factors have and may adversely affect the market price of our common stock. In addition, general economic, political and market conditions, such as recessions, interest rates, international currency fluctuations, terrorist acts, military actions or wars, may adversely affect the market price of the common stock. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against companies with publicly traded securities. Such litigation could result in substantial costs and a diversion of management’s attention and resources, which would have a material adverse effect on our business, results of operations and financial condition.

Changing legislation affecting the automotive industry could require increased regulatory and lobbying costs and may harm our business.

Our services may result in changing the way vehicles are sold which may be viewed as threatening by new and used vehicle dealers who do not subscribe to our programs. Such businesses are often represented by influential lobbying organizations, and such organizations or other persons may propose legislation which could impact the evolving marketing and distribution model which our services promote. Should current laws be changed or new laws passed, our business, results of operations and financial condition could be materially and adversely affected. As we introduce new services, we may need to comply with additional licensing regulations and regulatory requirements.

To date, we have not spent significant resources on lobbying or related government affairs issues but we may need to do so in the future. A significant increase in the amount we spend on lobbying or related activities could have a material adverse effect on our results of operations and financial condition.

International activities may adversely affect our results of operations and financial condition.

Our licensees currently have Web sites in the United Kingdom, Sweden, The Netherlands and Japan. Revenue from our licensees may be adversely affected by risks in conducting business in their markets, such as regulatory requirements, changes in political conditions, potentially weaker intellectual property protections and educating consumers and dealers who may be unfamiliar with the benefits of online marketing and commerce. In addition, our investment in licensees may be impaired. We may expand our brand into other foreign markets primarily through licensing our trade names. In the past we incurred losses in our international activities. We cannot be certain that we will be successful in introducing or marketing our services abroad. Our results of operations and financial condition may be adversely affected by our international activities.

Our computer infrastructure may be vulnerable to security breaches. Any such problems could jeopardize confidential information transmitted over the Internet, cause interruptions in our operations or cause us to have liability to third persons.

Our computer infrastructure is potentially vulnerable to physical or electronic computer break-ins, viruses and similar disruptive problems and security breaches. Any such problems or security breaches could cause us to have liability to one or more third parties and disrupt all or part of our operations. A party who is able to circumvent our security measures could misappropriate proprietary information, jeopardize the confidential nature of information transmitted over the Internet or cause interruptions in our operations. Concerns over the security of Internet transactions and the privacy of users could also inhibit the growth of the Internet in general, particularly as a means of conducting commercial transactions. To the extent that our activities or those of third party contractors involve the storage and transmission of proprietary information such as personal financial information, security breaches could expose us to a risk of financial loss, litigation and other liabilities. Our current insurance program may protect us against some, but not all, of such losses. Any of these events could have a material adverse effect on our business, results of operations and financial condition.

We depend on continued technological improvements in our systems and in the Internet overall. If we are unable to handle an unexpectedly large increase in volume of consumers using our Web sites, we cannot assure our consumers or dealers that purchase requests will be efficiently processed and our business may suffer.

If the Internet continues to experience significant growth in the number of users and the level of use, then the Internet infrastructure may not be able to continue to support the demands placed on it by such potential growth. The Internet may not prove to be a viable commercial medium because of inadequate development of the necessary infrastructure, timely development of complementary products such as high speed modems, delays in the development or adoption of new standards and protocols required to handle increased levels of Internet activity or increased government regulation.

An unexpectedly large increase in the volume or pace of traffic on our Web sites or the number of orders placed by customers may require us to expand and further upgrade our technology, transaction-processing systems and network infrastructure. We may not be able to accurately project the rate or timing of increases, if any, in the use of our Web sites or

expand and upgrade our systems and infrastructure to accommodate such increases. In addition, we cannot assure that our dealers will efficiently process purchase requests.

Any of such failures regarding the Internet in general or our Web sites, technology systems and infrastructure in particular, or with respect to our dealers, would have a material and adverse affect on our business, results of operations and financial condition.

Misappropriation of our intellectual property and proprietary rights could impair our competitive position.

Our ability to compete depends upon our proprietary systems and technology. While we rely on trademark, trade secret, patent and copyright law, confidentiality agreements and technical measures to protect our proprietary rights, we believe that the technical and creative skills of our personnel, continued development of our proprietary systems and technology, brand name recognition and reliable Web site maintenance are more essential in establishing and maintaining a leadership position and strengthening our brands. As part of our confidentiality procedures, we generally enter into confidentiality agreements with our employees and consultants and limit access to our trade secrets and technology. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our services or to obtain and use information that we regard as proprietary. Policing unauthorized use of our proprietary rights is difficult. We cannot assure that the steps taken by us will prevent misappropriation of technology or that the agreements entered into for that purpose will be enforceable. Effective trademark, service mark, copyright and trade secret protection may not be available in every country in which our products and services are made available online. In addition, litigation may be necessary in the future to enforce or protect our intellectual property rights or to defend against claims or infringement or invalidity. Misappropriation of our intellectual property or potential litigation could have a material adverse effect on our business, results of operations and financial condition.

We face risk of claims from third parties relating to intellectual property. In addition, we may incur liability for retrieving and transmitting information over the Internet. Such claims and liabilities could harm our business.

As part of our business, we make Internet services and content available to our customers. This creates the potential for claims to be made against us, either directly or through contractual indemnification provisions with third parties. We could face liability for information retrieved from or transmitted over the Internet and liability for products sold over the Internet. We could be exposed to liability with respect to third-party information that may be accessible through our Web sites, links or car review services. Such claims might, for example, be made for defamation, negligence, patent, copyright or trademark infringement, personal injury, breach of contract, unfair competition, false advertising, invasion of privacy or other legal theories based on the nature, content or copying of these materials. Such claims might assert, among other things, that, by directly or indirectly providing links to Web sites operated by third parties, we should be liable for copyright or trademark infringement or other wrongful actions by such third parties through such Web sites. It is also possible that, if any third-party content information provided on our Web sites contains errors, consumers could make claims against us for losses incurred in reliance on such information. Any claims could result in costly litigation, divert management’s attention and resources, cause delays in releasing new or upgrading existing services or require us to enter into royalty or licensing agreements.

We also enter into agreements with other companies under which any revenue that results from the purchase of services through direct links to or from our Web sites is shared. Such arrangements may expose us to additional legal risks and uncertainties, including disputes with such parties regarding revenue sharing, local, state and federal government regulation and potential liabilities to consumers of these services, even if we do not provide the services ourselves. We cannot assure that any indemnification provided to us in our agreements with these parties, if available, will be adequate.

Even to the extent such claims do not result in liability to us, we could incur significant costs in investigating and defending against such claims. The imposition upon us of potential liability for information carried on or disseminated through our system could require us to implement measures to reduce our exposure to such liability, which might require the expenditure of substantial resources or limit the attractiveness of our services to consumers, dealers and others.

Litigation regarding intellectual property rights is common in the Internet and software industries. We expect that Internet technologies and software products and services may be increasingly subject to third-party infringement claims as the number of competitors in our industry segment grows and the functionality of products in different industry segments overlaps. There can be no assurance that our services do not infringe on the intellectual property rights of third parties.

In the past, plaintiffs have brought these types of claims and sometimes successfully litigated them against online services. Our general liability insurance may not cover all potential claims to which we are exposed and may not be adequate to indemnify us for all liability that may be imposed. Any imposition of liability that is not covered by insurance or is in excess of our insurance coverage could have a material adverse effect on our business, results of operations and financial condition.

We could be adversely affected by litigation. If we were subject to a significant adverse litigation outcome, our financial condition could be materially adversely affected.

We are a defendant in certain proceedings which are described in “Part II. Item 1. Legal Proceedings” herein.

From time to time, we are involved in other litigation matters arising from the normal course of our business activities. The actions filed against us 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 our business, results of operations and financial condition.

We are uncertain of our ability to obtain additional financing for our future capital needs. If we are unable to obtain additional financing we may not be able to continue to operate our business.

We currently anticipate that our cash, cash equivalents and short-term and long-term investments will be sufficient to meet our anticipated needs for working capital and other cash requirements at least for the next 12 months. We may need to raise additional funds sooner, however, in order to fund more rapid expansion, to develop new or enhance existing services or products, to respond to competitive pressures or to acquire complementary products, businesses or technologies. There can be no assurance that additional financing will be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, our ability to fund our expansion, take advantage of potential acquisition opportunities, develop or enhance services or products or respond to competitive pressures would be significantly limited. In addition, our ability to continue to operate our business may also be materially adversely affected in the event additional financing is not available when required. Such limitation could have a material adverse effect on our business, results of operations, financial condition and prospects.

Sales or the perception of future sales of our common stock may depress our stock price. Because the market prices for Internet related stocks are likely to remain volatile, our stock price may be more adversely affected than other companies by such future sales.

Sales of substantial numbers of shares of our common stock in the public market, or the perception that significant sales are likely, could adversely affect the market price of our common stock. Other than 283,763 shares that are held in escrow until at least April 2005, all of the shares issued in connection with the acquisitions of iDriveonline and Stoneage, subject to certain limitations, will be available for sale upon and during the effectiveness of a registration statement that we plan to file with the Securities and Exchange Commission in the second quarter of 2004, and this number of shares is greater than the average daily trading volume for our shares. Although no prediction can be made as to the effect, if any, that market sales of such shares will have on the market price of our common stock, sales of substantial amounts of such shares in the public market could adversely affect the market price of our common stock.

Our certificate of incorporation and bylaws and Delaware law contain provisions that could discourage a third party from acquiring us or limit the price third parties are willing to pay for our stock.

Provisions of our amended and restated certificate of incorporation and bylaws relating to our corporate governance could make it difficult for a third party to acquire us, and could discourage a third party from attempting to acquire control of us. These provisions allow us to issue preferred stock with rights senior to those of the common stock without any further vote or action by the stockholders. These provisions provide that the board of directors is divided into three classes, which may have the effect of delaying or preventing changes in control or change in our management because less than a majority of the board of directors are up for election at each annual meeting. In addition, these provisions impose various procedural and other requirements which could make it more difficult for stockholders to effect corporate actions such as a merger, asset sale or other change of control of us. Such charter provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock and may have the effect of delaying or preventing a change in control. The issuance of preferred stock also could decrease the amount of earnings and assets available for distribution to the holders of common stock or could adversely affect the rights and powers, including voting rights, of the holders of the common stock.

We are also subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law. In general, the statute prohibits a publicly held Delaware corporation from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. For purposes of Section 203, a “business combination” includes a merger, asset sale or other transaction resulting in a financial benefit to the interested stockholder, and an “interested stockholder” is a person who, together with affiliates and associates, owns or did own 15% or more of the corporation’s voting stock.

Our actual results could differ from forward-looking statements in this report.

This report contains forward-looking statements based on current expectations which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors, including the risk factors set forth above and elsewhere in this Quarterly Report on Form 10-Q. The cautionary statements made in this report should be read as being applicable to all forward-looking statements wherever they appear in this Quarterly Report on Form 10-Q.

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of March 31, 2004. Based on their evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in alerting our management, including our principal executive officer and principal financial officer, to material information required to be included in our periodic reports filed with the Securities and Exchange Commission. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

On a regular basis, we review and modify our internal controls and procedures. There have been no changes in our internal controls and procedures during our fiscal quarter ended March 31, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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. Autobytel has approved a Memorandum of Understanding (“MOU”) 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 contemplated by the MOU provides for a release of Autobytel and the Autobytel Individual Defendants for the conduct alleged in the action to be wrongful and for Autobytel to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims Autobytel may have against its underwriters. It is anticipated that any potential financial obligation of Autobytel to plaintiffs pursuant to the terms of the MOU and related agreements will be covered by existing insurance. Therefore, we do not expect that the settlement will involve any payment by Autobytel. The MOU and related agreements are subject to a number of contingencies, including the negotiation of a settlement agreement and its approval by the court. We cannot determine whether or when a settlement will occur or be finalized and whether the outcome of the litigation will have a material impact on our results of operations or financial condition in any future period.

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. Autoweb has approved the MOU 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 contemplated by the MOU provides for a release of Autoweb and the Autoweb Individual Defendants for the conduct alleged in the action to be wrongful and for Autoweb to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims Autoweb may have against its underwriters. It is anticipated that any potential financial obligation of Autoweb to plaintiffs pursuant to the terms of the MOU and related agreements will be covered by existing insurance. Therefore, we do not expect that the settlement will involve any payment by Autoweb. The MOU and related agreements are subject to a number of contingencies, including the negotiation of a settlement agreement and its approval by the court. We cannot determine whether or when a settlement will occur or be finalized and whether the outcome of the litigation will have a material impact on our results of operations or financial condition in any future period.

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

From time to time, we are involved in other litigation matters relating to claims arising out of the ordinary course of business. We believe that there are no claims or actions pending or threatened against us, the ultimate disposition of which would have a material adverse effect on our business, results of operations and financial condition. However, if a court or jury rules against us and the ruling is ultimately sustained on appeal and damages are awarded against us, such ruling could have a material and adverse effect on our business, results of operations and financial condition.

The following report on Form 8-K was furnished during the quarter covered by this Quarterly Report on Form 10-Q:

On February 3, 2004, we furnished a Form 8-K under Item 12 announcing our financial results for the quarter and year ended December 31, 2003.

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


AUTOBYTEL INC.
By:		/s/ HOSHI PRINTER
		Hoshi Printer *Executive Vice President and Chief Financial Officer* (Duly Authorized Officer and Principal Financial Officer)


		Page
PART I. FINANCIAL INFORMATION

ITEM 1.	Consolidated Financial Statements (unaudited):

	Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003	3

	Consolidated Statements of Operations for the three months ended March 31, 2004 and 2003	4

	Consolidated Statements of Cash Flows for the three months ended March 31, 2004 and 2003	5

	Notes to Consolidated Financial Statements	6

ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

ITEM 4.	Controls and Procedures	32

PART II. OTHER INFORMATION

ITEM 1.	Legal Proceedings	32

ITEM 6.	Exhibits and Reports on Form 8-K	33

Signatures		34


	March 31, 2004			December 31, 2003
ASSETS		(unaudited)
Current assets:
Domestic cash and cash equivalents	$	49,270		$	51,643
International cash and cash equivalents (Note 3.)		10,425			—
Short-term investments		—			3,991
Accounts receivable, net of reserves for bad debts and customer credits of $2,117 and $1,764, respectively		10,597			10,889
Prepaid expenses and other current assets		1,146			833

Total current assets		71,438			67,356
Long-term investments		15,000			6,000
Property and equipment, net		2,123			2,138
Capitalized software, net		754			1,024
Investment in equity investee (Note 3.)		824			2,810
Goodwill		16,830			16,830
Other assets		824			470

Total assets	$	107,793		$	96,628


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,255		$	4,063
Accrued expenses		3,964			5,034
Deferred revenues		3,814			4,022
Accrued domestic restructuring		212			258
Accrued international licensee liabilities (Note 3.)		1,541			—
Other current liabilities		405			441

Total current liabilities		14,191			13,818

Minority interest (Note 3.)		4,623			—

Commitments and contingencies (Note 5.)

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; 38,570,537 and 37,786,767 shares issued and outstanding, respectively		39			38
Additional paid-in capital		238,962			236,544
Accumulated other comprehensive income		1,685			—
Accumulated deficit		(151,707	)		(153,772	)

Total stockholders’ equity		88,979			82,810

Total liabilities and stockholders’ equity	$	107,793		$	96,628


	Three Months Ended March 31,
	2004			2003
Revenues:
Lead fees	$	16,847		$	14,623
Advertising		3,122			2,839
CRM services		3,463			1,452
Data, applications and other		1,325			1,339

Total revenues		24,757			20,253

Operating expenses:
Sales and marketing		14,809			12,858
Product and technology development		5,088			3,862
General and administrative		2,929			2,785

Total operating expenses		22,826			19,505

Income from operations		1,931			748
Interest income		186			69
Income (loss) in equity investees		(53	)		53
Other income		1			—

Income before income taxes		2,065			870
Provision for income taxes		—			2

Net income	$	2,065		$	868

Net income per share:
Basic	$	0.05		$	0.03

Diluted	$	0.05		$	0.03

Shares used in computing net income per share:
Basic		38,343,958			31,234,243

Diluted		42,583,103			32,167,910

Comprehensive income:
Net income	$	2,065		$	868
Translation adjustment		—			27

Comprehensive income	$	2,065		$	895


	Three Months Ended March 31,
	2004			2003
Cash flows from operating activities:
Net income	$	2,065		$	868
Adjustments to reconcile net income to net cash provided by operating activities:
Non-cash charges:
Depreciation and amortization		688			608
Provision for bad debt		77			242
Customer credits		33			851
(Income) loss in equity investees		53			(53	)
Changes in assets and liabilities:
Accounts receivable		268			(1,289	)
Prepaid expenses and other current assets		(284	)		1,093
Other assets		(399	)		11
Accounts payable		87			375
Accrued expenses		(1,722	)		(1,441	)
Deferred revenues		(208	)		(47	)
Customer deposits		—			(7	)
Accrued domestic restructuring		(46	)		(68	)
Other current liabilities		(38	)		(18	)

Net cash provided by operating activities		574			1,125

Cash flows from investing activities:
Maturities of short-term investments		3,991			—
Purchases of long-term investments		(9,000	)		—
Consolidation of Autobytel.Europe cash balance (Note 3.)		10,425			—
Purchases of property and equipment		(357	)		(31	)

Net cash provided by (used in) investing activities		5,059			(31	)

Cash flows from financing activities:
Net proceeds from sale of common stock		2,419			136

Net cash provided by financing activities		2,419			136

Effect of exchange rates on cash		—			27

Net increase in cash and cash equivalents		8,052			1,257
Cash and cash equivalents, beginning of period		51,643			27,571

Cash and cash equivalents, end of period (Note 3.)	$	59,695		$	28,828

Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes	$	—		$	2

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


	Amortized Cost Basis		Aggregate Fair Value		Unrealized Gains		Unrealized Losses
March 31, 2004:
Long-term investments, held-to-maturity:
Government sponsored agency bonds		15,000		15,009		9		—

	$	15,000	$	15,009	$	9	$	—

December 31, 2003:
Short-term investments, held-to-maturity:
Commercial paper	$	3,991	$	3,991	$	—	$	—
Long-term investments, held-to-maturity:
Government sponsored agency bonds		6,000		6,020		20		—

	$	9,991	$	10,011	$	20	$	—

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	Three Months Ended March 31,
	2004			2003
Net income (loss):
As reported	$	2,065		$	868
Add: Stock-based compensation included in reported net income, net of tax		—			—
Less: Stock-based compensation determined under the fair value based method, net of tax		(1,206	)		(965	)

Pro forma	$	859		$	(97	)

Net income (loss) per share—basic:
As reported	$	0.05		$	0.03
Pro forma	$	0.02		$	0.00
Net income (loss) per share—diluted:
As reported	$	0.05		$	0.03
Pro forma	$	0.02		$	0.00


	Three Months Ended March 31, 2003
Revenues	$	21,690
Net income	$	953
Net income per share:
Basic	$	0.03
Diluted	$	0.03


	As of March 31, 2004
Cash and cash equivalents	$	10.4
Other assets		0.9
Liabilities		(2.3	)
Other investor’s investment in Autobytel.Europe		(4.6	)
Cumulative translation adjustment		(1.7	)

Autobytel’s investment in Autobytel.Europe	$	2.7


	Three Months Ended March 31,
	2004		2003
Revenues
Lead fees	68	%	72	%
Advertising	13		14
CRM services	14		7
Data, applications and other	5		7

Total revenues	100		100

Operating expenses:
Sales and marketing	60		63
Product and technology development	20		19
General and administrative	12		14

Total operating expenses	92		96

Income from operations	8		4
Other income (expense)	—		—

Income before income taxes	8		4
Provision for income taxes	—		—

Net income	8	%	4	%


10.1		Letter agreement, dated March 31, 2004 between Autobytel Inc. and Robert S. Grimes.

31.1		Chief Executive Officer Section 302 Certification of Periodic Report, dated May 6, 2004.

31.2		Chief Financial Officer Section 302 Certification of Periodic Report, dated May 6, 2004.

32.1		Chief Executive Officer and Chief Financial Officer Section 906 Certification of Periodic Report, dated May 6, 2004.


Exhibit Number
10.1		Letter agreement, dated March 31, 2004 between Autobytel Inc. and Robert S. Grimes.

31.1		Chief Executive Officer Section 302 Certification of Periodic Report, dated May 6, 2004.

31.2		Chief Financial Officer Section 302 Certification of Periodic Report, dated May 6, 2004.

32.1		Chief Executive Officer and Chief Financial Officer Section 906 Certification of Periodic Report, dated May 6, 2004.