AUTOBYTEL INC - 10-Q Quarterly Report

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

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

As of July 31, 2004, there were 41,766,376 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 and advertising primarily through the Internet. Autobytel provides products and programs to automotive dealers and manufacturers to help them increase marketing efficiency and reduce customer acquisition costs. Autobytel owns and operates the automotive Web sites Autobytel.com, Autoweb.com, Car.com, CarSmart.com and Autosite.com. Autobytel is also a leading provider of customer relationship management (CRM) products and programs, consisting of lead management products, customer loyalty and retention marketing programs, and data extraction services for dealers. Autobytel is also a provider of automotive marketing data and technology.

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

The accompanying interim consolidated financial statements as of June 30, 2004, and for the three months and six months ended June 30, 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 LLC (Autobytel.Europe). As a result of this adoption, Autobytel consolidated Autobytel.Europe in its consolidated financial statements. 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 June 30, 2004, domestic and international cash and cash equivalents were $31,240 and $8,225, 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 June 30, 2004, held-to-maturity debt securities with an amortized cost of $15,000 are due within one to two years.

As of June 30, 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.

Dilutive potential shares of common stock, which have been included in the calculation of diluted net income per share, represent stock options with an exercise price equal to or less than the average market price for the three month or six month period ended June 30, 2004. For the three months and six months ended June 30, 2004, there were 3,571,555 and 3,909,521 dilutive potential shares of common stock, respectively, and for the three months and six months ended June 30, 2003, there were 2,136,143 and 1,612,625 dilutive potential shares of common stock, respectively.

Antidilutive potential shares of common stock, which have been excluded from the calculation of diluted net income per share, represent stock options with an exercise price greater than the average market price for the three month or six month period ended June 30, 2004. For the three months and six months ended June 30, 2004, there were 1,548,368 and 1,131,432 antidilutive 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 (loss) and net income (loss) per share for the three months and six months ended June 30, 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 six months ended June 30, 2004, Autobytel granted 988,000 stock options. The options granted were estimated to have a weighted average fair value of $6,300 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 2.34%, and (4) a weighted-average expected life of 3.5 years.

As of June 30, 2004, Autobytel had a total of 7,363,341 stock options outstanding, of which 5,469,719 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.

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.

As a result of the adoption of FIN 46R, Autobytel was determined to be the primary beneficiary of Autobytel.Europe and consolidated Autobytel.Europe in its financial statements effective March 31, 2004. Autobytel has an ownership interest in Autobytel.Europe of 49%. (See Note 3.)

In March 2004, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments” (EITF 03-1). EITF 03-1 provides accounting guidance regarding the determination of when an impairment (i.e., fair value is less than amortized cost) of debt and marketable equity securities and investments accounted for under the cost method should be considered other-than-temporary and recognized in earnings. EITF 03-1 also requires annual disclosures of certain quantitative and qualitative factors of debt and marketable equity securities classified as available-for-sale or held-to-maturity that are in an unrealized loss position at the balance sheet date, but for which an other-than-temporary impairment has not been recognized. Autobytel adopted the disclosure requirements of EITF 03-1 on December 31, 2003. The accounting guidance of EITF 03-1 will be effective on July 1, 2004. Autobytel does not expect the adoption of EITF 03-1 to have a material effect on Autobytel’s financial position or results of operations.

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 revenues 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, CarSmart.com and Car.com online car buying referral networks and fees paid by retail dealers and automotive finance companies who participate in the Car.com online finance referral network. 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. CRM services consist of fees paid by customers who use Autobytel’s lead management products, customer loyalty and retention marketing programs, and data extraction services. 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. Autobytel consolidated in its financial statements as of June 30, 2004, $8,225 in cash and cash equivalents, $996 in other assets, including a 46.4% investment in an equity investee held by Autobytel.Europe, $213 in

liabilities and $4,594 representing the 51% ownership in Autobytel.Europe belonging to Autobytel.Europe’s other shareholder. As of June 30, 2004, Autobytel’s 49% investment in Autobytel.Europe was calculated as follows:

Autobytel.Europe’s results of operations are included in Autobytel’s consolidated results of operations 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.

AVV’s financial position and results of operations from the date of acquisition on June 4, 2003 have been included in the accompanying consolidated financial statements.

On April 9, 2004, Autobytel acquired all of the outstanding common stock of iDriveonline, Inc. (iDriveonline), now Retention Performance Marketing, Inc., a provider of customer loyalty and retention marketing programs for the automotive industry, in exchange for cash and common stock. The acquisition combines iDriveonline’s leading applications, including an online prospecting and retention tool, enhanced data and segmentation tools, and improved dealer reporting capabilities with Autobytel’s existing customer retention product. The acquisition has been accounted for using the purchase method of accounting.

The aggregate purchase price was $12,287 and consisted of $5,021 in cash, 474,501 shares of common stock valued at $6,894 and transaction costs of $372. The value of the stock issued was determined based on the average market price of Autobytel’s common stock for the two days before through the two days after the date of the announcement of the

acquisition. The purchase price was allocated to the underlying net tangible and intangible assets based on their respective estimated fair values on the acquisition date as follows:

The excess of the purchase price over the estimated fair value of the net tangible and intangible assets acquired was recorded as goodwill in the amount of $11,541. The amount of goodwill is subject to adjustment as additional information regarding the estimated fair value of the net tangible and intangible assets becomes available. An increase in accounts payable and/or adjustments to estimated accrued expenses may be recorded as additional information becomes available. We expect that potential adjustments for these costs, if any, will be recorded by December 31, 2004. Goodwill is not amortized, rather it is evaluated on at least an annual basis for impairment. Goodwill is not deductible for income tax purposes. Intangible assets acquired consist of customer relationships and are amortized over an estimated useful life of three years.

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

On April 15, 2004, Autobytel acquired all of the outstanding common stock of Stoneage Corporation (Stoneage), now Car.com, Inc., a provider of Internet automotive buying services and owner of the Car.com Web site. The acquisition is anticipated to expand Autobytel’s market share of new car buyers, increase the number of purchase requests processed through Autobytel in 2004, and add retail and enterprise dealer relationships to Autobytel. The acquisition will also add the Car.com finance request business to Autobytel. The acquisition may modestly benefit Autobytel’s advertising business by adding the Car.com automotive portal to Autobytel’s advertising network of sites.

Under the terms of the agreement, former Stoneage shareholders received 2,257,733 shares of Autobytel common stock and $15,251 in cash, subject to a post closing purchase price adjustment. In June 2004, the final purchase price adjustment was determined and resulted in Autobytel’s obligation to issue 47,511 additional shares of common stock. As of June 30, 2004, a $685 liability was recorded to reflect this obligation, using the value described below. The acquisition has been accounted for using the purchase method of accounting.

The aggregate purchase price was $49,464 and consisted of $15,251 in cash and 2,305,244 shares of common stock valued at $33,177 and transaction costs of $1,036. The value of the stock issued was determined based on the average market price of Autobytel’s common stock for the two days before through the two days after the date the announcement of the

acquisition. The purchase price was allocated to the net tangible and intangible assets based on their respective estimated fair values on the acquisition date as follows:

The excess of the purchase price over the estimated fair value of the net tangible and intangible assets acquired was recorded as goodwill in the amount of $41,105. The amount of goodwill is subject to adjustment as additional information regarding the estimated fair value of the net tangible and intangible assets becomes available. A decrease in accounts receivable, an increase in accounts payable and/or adjustments to estimated accrued expenses may be recorded as additional information becomes available. We expect that potential adjustments for these costs, if any, will be recorded by December 31, 2004. Goodwill is not amortized, rather it is evaluated on at least an annual basis for impairment. Goodwill is not deductible for income tax purposes. Intangible assets acquired consist of customer relationships which are amortized over an estimated useful life of three years and the Car.com domain name which is amortized over an estimated useful life of five years.

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

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

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

Amortization expense related to intangible assets was $402 and $447 for the three months and six months ended June 30, 2004, respectively, and $15 for the three months and six months ended June 30, 2003. Amortization expense for the remaining lives of the intangible assets is estimated to be as follows:

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 settlement agreement and related agreements which set forth the terms of a settlement between Autobytel, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. Among other provisions, the settlement provides for a release of Autobytel and the Autobytel Individual Defendants for the conduct alleged in the action to be wrongful 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 settlement agreement and related agreements will be directly covered and paid by its insurance carriers. Therefore, Autobytel does not expect that the settlement will involve any payment by Autobytel. The

settlement agreement has not yet been executed. The settlement agreement is subject to approval by the court, which cannot be assured. 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 a settlement agreement and related agreements which set forth the terms of a settlement between Autoweb, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. Among other provisions, the settlement provides for a release of Autoweb and the Autoweb Individual Defendants for the conduct alleged in the action to be wrongful 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 settlement agreement and related agreements will be directly covered and paid by its insurance carriers. Therefore, Autoweb does not expect that the settlement will involve any payment by Autoweb. The settlement agreement has not yet been executed. The settlement agreement is subject to approval by the court, which cannot be assured. 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.

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 June 30, 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 $168. Autobytel expects the remaining charges to be paid in 2004. The remaining accrued domestic restructuring liabilities related to the 2002 charges as of June 30, 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 assignees the amount that Mr. Grimes would have received for the remainder of the term of the agreement.

In July 2004, Autobytel’s Board of Directors approved the adoption of a stockholder rights plan under which all stockholders of record as of August 10, 2004 will receive rights to purchase shares of Series A Junior Participating Preferred Stock. The rights will be distributed as a non-taxable dividend and will expire July 30, 2014.

The rights will be exercisable only if a person or group acquires 15% or more of the common stock of Autobytel or announces a tender offer for 15% or more of the common stock. If a person or group acquires 15% or more of the common stock, all rightholders, except the acquiror, will be entitled to acquire at the then exercise price of a right that number of shares of Autobytel’s common stock which at the time will have a market value of two times the exercise price of the right. Under certain circumstances, all rightholders, other than the acquiror, will be entitled to receive at the then exercise price of a right that number of shares of common stock of the acquiring company which at the time will have a market value of two times the exercise price of the right.

The Board of Directors may terminate the rights plan at any time or redeem the rights prior to the time a person or group acquires more than 15% of Autobytel’s common stock.

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 and advertising 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 customer relationship management (CRM) products and programs, consisting of lead management products, customer loyalty and retention marketing programs, data extraction services and automotive marketing data and technology.

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. The total purchase price was $12.3 million and consisted of $5.0 million in cash, 474,501 shares of our common stock valued at $6.9 million and transaction costs of $0.4 million.

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. The total purchase price was $49.5 million and consisted of $15.3 million in cash, 2,305,244 shares of our common stock valued at $33.2 million and $1.0 million in transaction costs.

We continue experiencing growth in revenue from acquisitions. Revenues from our existing business were relatively flat in the second quarter of 2004 compared to the first quarter of 2004 and included a decline in lead fee revenues from our enterprise relationships due to a reduction in the number of purchase requests accepted by an automotive manufacturer and an increase in revenues from our CRM services business. We expect revenues from our existing business to grow in the second half of 2004. 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.

In the second quarter of 2004, we incurred approximately $1.0 million in costs related to the integration of the iDriveonline and Stoneage acquisitions primarily for transition salaries, severance, retention bonuses and travel. We expect to incur an additional $1.0 million in integration related costs in the second half of 2004, a majority of which is anticipated to be incurred in the third quarter of 2004. We expect most of the remaining costs to be related to the integration of technology.

As of June 30, 2004, we had $46.2 million in domestic cash, cash equivalents and long-term investments.

We generated $2.1 million in domestic cash from operations in the second quarter of 2004. Autobytel.Europe used $2.0 million of cash in operations in the second quarter of 2004. Cash used in operations by Autobytel.Europe was for $1.5 million in payments to Autobytel.Europe licensees, $0.3 million in payments to former shareholders for amounts due under agreements entered into in March 2002 and $0.2 million in other operating costs. For the six months ended June 30, 2004, we generated $2.7 million in domestic cash from operations. We expect to continue generating cash from operations for the remainder of 2004.

In the second quarter of 2004, we added approximately 1,400 retail dealer relationships, of which, approximately 1,300 were Car.com dealer relationships. We also added approximately 400 CRM dealer relationships, of which, approximately 200 were iDriveonline CRM relationships. We expect to continue to add retail dealer and CRM relationships for the remainder of 2004.

We had approximately 35,800 and 29,400 dealer relationships as of June 30, 2004 and March 31, 2004, respectively. As of June 30, 2004, our dealer relationships consisted of approximately 30,400 lead referral dealer relationships and 5,400 CRM dealer relationships. As of March 31, 2004, our dealer relationships consisted of approximately 24,400 lead referral dealer relationships and 5,000 CRM dealer relationships. A dealer who subscribes to the Autobytel.com new car program, the Autoweb.com new car program, WebControl and RPM accounts for four dealer relationships.

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, we consolidated in our financial statements approximately $8.2 million in cash and cash equivalents, $1.0 million in other assets, including a 46.4% investment in an equity investee, $0.2 million in liabilities and $4.6 million representing the 51% ownership in Autobytel.Europe belonging to Autobytel.Europe’s other shareholder.

We had a 49%, or $2.8 million investment in Autobytel.Europe as of June 30, 2004, which was calculated as follows (in millions):

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

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 revenues 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.

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

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 June 30, 2004, a major manufacturer in our program accounted for approximately 9,811 enterprise dealer relationships. This program with a major manufacturer automatically extends in one-month increments until terminated by us or the manufacturer. From time to time, a major dealer group or automotive manufacturer may significantly increase or decrease the number of enterprise dealers participating in our dealer networks or the number of purchase requests accepted from us. We intend to strengthen the size and quality of our relationships with major dealer groups and automotive manufacturers.

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

For the three months ended June 30, 2004 and 2003, lead fees were $21.5 million and $15.5 million, or 68% and 71% of total revenues, respectively. Average revenue per purchase request was $18.10 and $19.52 in the second quarter of 2004 and 2003, respectively, including revenue from Car.com in the second quarter of 2004. Revenue per purchase request in the

second quarter of 2004 decreased compared to the second quarter of 2003 due to the addition of Car.com purchase requests at a lower price. Revenue per finance request was $10.26 in the second quarter of 2004. We expect to derive a majority of our revenues in the foreseeable future from retail dealers, enterprise dealers and automotive manufacturers who participate in our online car buying referral networks.

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 five Web sites by targeting advertisements to consumers who are researching vehicles, thereby increasing the likelihood of influencing their purchase decisions. Beginning on April 15, 2004, advertising revenues include fees paid by automotive manufacturers who advertise on our Car.com Web site.

Revenues from advertising were $3.4 million and $3.0 million in the second quarter of 2004 and 2003, or 11% and 14% of total revenues, respectively. With further selling of our advertising inventory, an increase in Internet advertising spending by automotive manufacturers and the acquisition of Stoneage in April 2004, we anticipate that our advertising revenues in 2004 will increase compared to 2003.

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) and iDriveonline, our customer loyalty and retention marketing programs, 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, and fees from dealers using the iDriveonline program beginning on April 9, 2004. Customers using our CRM services pay transaction fees based on the specified service, or ongoing monthly subscription fees based on the level of functionality selected from our suite of lead management products. Revenues from CRM services were $5.3 million and $2.1 million, or 17% and 10% of total revenues, in the second quarter of 2004 and 2003, respectively. We expect to develop new RPM product technology in 2005.

Revenues from data, applications and other include fees from automotive marketing data and technology, classified listings for used cars, international licensing agreements, internet sales training and other products and services. Revenues from data, applications and other were $1.3 million and $1.1 million, or 4% and 5% of total revenues, in the second quarter of 2004 and 2003, respectively. We continue to focus our efforts on offering marketing services to dealers and automotive manufacturers. We expect revenues from data, applications and other to decline in 2004 compared to 2003.

To enhance the quality of purchase requests, each purchase request is passed through our Quality Verification System (QVS)^SM which uses filters and validation processes to identify consumers with valid purchase intent before delivering the purchase request to our retail and enterprise dealers. 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 expect to apply QVS and custom filters and validation processes to Car.com purchase requests by the end of 2004.

We delivered approximately 1.1 million and 0.8 million purchase requests through our online systems to retail and enterprise dealers in the second quarter of 2004 and 2003, respectively, including 0.3 million purchase requests delivered by Car.com in the second quarter of 2004. Of these, approximately 0.7 million and 0.6 million were delivered to retail dealers and approximately 0.4 million and 0.2 million were delivered to enterprise dealers in the second quarter of 2004 and 2003, respectively. Purchase requests delivered to retail dealers in the second quarter of 2004 increased by 0.1 million, or 24%, compared to the second quarter of 2003, due to the addition of new retail dealer relationships, including Car.com relationships. Purchase requests delivered to enterprise dealers in the second quarter of 2004 increased by 0.2 million, or 84%, compared to the second quarter of 2003, due to the addition of new enterprise relationships, the expansion of our existing relationships and the addition of Car.com relationships. We expect the number of purchase requests we deliver to our retail and enterprise dealers to increase in 2004 when compared to 2003.

We also delivered approximately 0.1 million finance requests in the second quarter of 2004 as a result of the Car.com acquisition.

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 second 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 $10.5 million and $7.7 million in the second 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, 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 June 30, 2004 Compared to Three Months Ended June 30, 2003

Revenues. Our revenues increased by $9.8 million, or 45%, to $31.5 million in the second quarter of 2004 compared to $21.7 million in the second quarter of 2003. The increase was due to growth in lead fees, CRM services and advertising, coupled with the benefit of WebControl and ADS for a full quarter. As a result of the acquisitions of iDriveonline and Stoneage on April 9, 2004 and April 15, 2004, respectively, revenues include $1.4 million from dealers using iDriveonline’s customer loyalty and retention marketing programs and $5.4 million from dealers using Stoneage services in the second quarter of 2004.

Lead Fees. Lead fees increased by $6.0 million, or 38%, to $21.5 million in the second quarter of 2004 compared to $15.5 million in the second quarter of 2003. The increase was due to the delivery of an additional 0.3 million purchase requests to our retail and enterprise dealers and 0.1 million in finance requests delivered to dealers and automotive finance companies in the second quarter of 2004 when compared to the second quarter of 2003. The increase in purchase requests was primarily delivered to Car.com retail and enterprise dealers. We expect lead fees to increase in 2004 compared to 2003 as we have added retail and enterprise dealers, including Car.com retail and enterprise dealers. We also expect to increase the number of purchase requests we send to our dealers. We also believe that we may be able to increase fees paid per purchase request.

Advertising. Advertising revenue increased by $0.4 million, or 14%, to $3.4 million in the second quarter of 2004 compared to $3.0 million in the second quarter of 2003. The increase was primarily due to higher spending by automotive manufacturers and additional web site advertising sales to Car.com customers. With further selling of our available advertising inventory, an increase in Internet advertising spending by automotive manufacturers and the acquisition of Stoneage in April 2004, we expect our advertising revenues to increase in 2004 compared to 2003.

CRM Services. CRM services increased by $3.2 million, or 157%, to $5.3 million in the second quarter of 2004 compared to $2.1 million in the second quarter of 2003. The increase was due to an increase in RPM revenues, higher fees from iDriveonline’s customer loyalty and retention marketing programs and fees from WebControl and ADS partially offset by a decrease in iManager fees as a result of our migration of dealers from iManager to WebControl. We expect revenues from 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 increased by $0.2 million or 15%, to $1.3 million in the second quarter of 2004 compared to $1.1 million in the second quarter of 2003. The increase is primarily due to an increase in fees from customers who use our automotive marketing data and technology through our Automotive Information Center (AIC) division and training. We continue to focus our efforts on offering marketing services to dealers and automotive manufacturers. We expect data, applications and other to decline in 2004 compared to 2003.

Sales and Marketing. Sales and marketing expense includes advertising and marketing expenses paid to our purchase request and finance 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 $5.7 million, or 43%, to $18.8 million in the second quarter of 2004 compared to $13.1 million in the second quarter of 2003. This represents 60% of total revenues for both the second quarter of 2004 and 2003. The increase was due to a $2.9 million increase in the cost of purchase requests and finance requests acquired from third parties, a $1.4 million increase in costs associated with sales and customer relationship maintenance, a $0.5 million increase in traditional advertising expenses, a $0.5 million increase in printing, production and postage costs, a $0.1 million increase in sales personnel and compensation costs and a $0.3 million increase in other marketing costs, including data and licensing expense. The increase in purchase request and finance request costs was due to the delivery of purchase requests and finance requests to dealers added as a result of the acquisition of Stoneage, offset by a decline in the organic cost of each purchase request to $8.23 in the second quarter of 2004 compared to $8.74 in the second quarter of 2003. The increase in sales and customer relationshiop maintenance, traditional advertising expenses, printing, production and postage costs, sales personnel and compensation costs, and other marketing costs was partially a result of the acquisition of Stoneage and iDriveonline. We expect our sales and marketing expenses as a percentage of revenues to slightly decline 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 $1.9 million, or 44%, to $6.4 million in the second quarter of 2004 compared to $4.5 million in the second quarter of 2003. This represents 20% and 21% of total revenues for the second quarter of 2004 and 2003, respectively. The increase was due to higher personnel and related costs of $1.6 million, a $0.2 million increase in telephone and connectivity costs related to our voice and data communications and a $0.1 million increase in other expenses. The higher personnel and related costs is associated with the increase in headcount, largely from the acquisitions of iDriveonline and Stoneage. Also included in this increase are integration related expenses, such as transition salaries, severance and retention bonuses. 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 $2.1 million, or 67%, to $5.2 million in the second quarter of 2004 compared to $3.1 million in the second quarter of 2003. This represents 16% and 14% of total revenues for the second quarter of 2004 and 2003, respectively. The increase was primarily due to $0.9 million in higher compensation and related costs and an increase in headcount, $0.1 million in severance costs associated with the separation of an employee from us, a $0.4 million increase in public company expenses related to compliance with the Sarbanes-Oxley Act, a $0.3 million increase in other professional fees, a $0.3 million increase in amortization costs primarily related to intangible assets acquired from Stoneage and $0.3 million related to an abandoned acquisition. These increases were offset by $0.4 million charged to rent expense in the second quarter of 2003 related to the relocation of our AIC operations from Westborough, Massachusetts to our corporate office. We expect our general and administrative expenses as a percentage of revenues to remain flat in 2004 compared to 2003.

Interest Income. In the second quarter of 2004, interest income increased by $0.1 million, to $0.2 million compared to $0.1 million in the second quarter of 2003. The increase in interest income was due to higher cash balances in 2004 as a result of 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 in Equity Investee. Income in equity investee in the second quarter of 2004 represents 46.4% share of income in an equity investee held by Autobytel.Europe. Income in equity investee in the second quarter of 2003 represents our share of income in Autobytel.Europe prior to the adoption of FIN 46R.

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

Income Taxes. In the preparation of our financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate, including estimating both our actual current tax exposure and assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. A nominal provision for alternative minimum 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 partially offset by net operating loss carryforwards. Our net operating loss carryforwards expire in various years through 2022. We also have federal and state research tax credit carryforwards that 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. To the extent that we have deferred tax assets, we must assess the likelihood that our deferred tax assets will be recovered from taxable temporary differences, tax strategies or future taxable income and to the extent that we believe that recovery is not likely, we must establish a valuation allowance. 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 June 30, 2004, our assessment may change in future periods if we continue to generate positive operating results and such adjustment would impact our provision for income taxes in the period of such change.

Revenues. Our revenues increased by $14.3 million, or 34%, to $56.3 million in the six months ended June 30, 2004 compared to $42.0 million for the same period in 2003. The increase was due to growth in lead fees, CRM services and advertising, coupled with the benefit of WebControl and ADS for a full six months. As a result of the acquisitions of iDriveonline and Stoneage, revenues include $1.4 million from dealers using iDriveonline’s customer loyalty and retention marketing programs and $5.4 million from dealers using Stoneage services in the six months ended June 30, 2004.

Lead Fees. Lead fees increased by $8.2 million, or 27%, to $38.3 million in the six months ended June 30, 2004 compared to $30.1 million for the same period in 2003. The increase was due to the delivery of an additional 0.4 million purchase requests to our retail and enterprise dealers and 0.1 million finance requests delivered to dealers and automotive finance companies in the six months ended June 30, 2004 when compared to the same period in 2003. The increase in purchase requests was primarily delivered to Car.com retail and enterprise dealers. We expect lead fees to increase in 2004 compared to 2003 as we have added retail and enterprise dealers, including Car.com retail and enterprise dealers. We also expect to increase the number of purchase requests we send to our dealers. We believe that we may be able to increase fees paid per purchase request.

Advertising. Advertising revenue increased by $0.7 million, or 12%, to $6.6 million in the six months ended June 30, 2004 compared to $5.9 million for the same period in 2003. The increase was primarily due to higher spending by automotive manufacturers and the additional web site advertising sales to Car.com customers. With further selling of our available advertising inventory, an increase in Internet advertising spending by automotive manufacturers and the acquisition of Stoneage in April 2004, we expect our advertising revenues to increase in 2004 compared to 2003.

CRM Services. CRM services increased by $5.3 million, or 149%, to $8.8 million in the six months ended June 30, 2004 compared to $3.5 million for the same period in 2003. The increase was due to an increase in RPM revenues, higher fees from iDriveonline’s customer loyalty and retention marketing programs and fees from WebControl products and ADS services partially offset by a decrease in iManager fees as a result of our migration of dealers from iManager to WebControl. We expect revenues from 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 increased by $0.1 million or 6%, to $2.6 million in the six months ended June 30, 2004 compared to $2.5 million for the same period in 2003. The increase is primarily due to the consolidation of Autobytel.Europe beginning April 1, 2004. We continue to focus our efforts on offering marketing services to dealers and automotive manufacturers. We expect data, applications and other to decline in 2004 compared to 2003.

Sales and Marketing. Sales and marketing expense increased by $7.6 million, or 29%, to $33.6 million in the six months ended June 30, 2004 compared to $26.0 million for the same period in 2003. This represents 60% and 62% as a percent of total revenues for the six months ended June 30, 2004 and 2003, respectively. The increase was due to a $4.0 million increase in the cost of purchase requests and finance requests acquired from third parties, a $1.7 million increase in costs associated with sales and customer relationship maintenance, a $0.8 million increase in printing, prodution and postage costs, a $0.4 million increase in traditional advertising expenses, a $0.3 million increase in sales personnel and compensation costs, and a $0.4 million increase in other marketing costs, including data and licensing expense. The increase in purchase request and finance request costs was primarily due to the delivery of purchase requests and finance requests to dealers added as a result of the acquisition of Stoneage. The increase in sales and customer relationship maintenance, printing, production and postage costs, traditional advertising expenses, sales personnel and compensation costs and other marketing costs was partially a result of the acquisition of Stoneage and iDriveonline. We expect our sales and marketing expenses as a percentage of revenues to slightly decline in 2004 compared to 2003.

Product and Technology Development. Product and technology development expense increased by $3.2 million, or 39%, to $11.5 million in the six months ended June 30, 2004 compared to $8.3 million for the same period in 2003. This represents 21% and 20% of total revenues for the six months ended June 30, 2004 and 2003, respectively. The increase was due to higher personnel and related costs of $2.6 million, a $0.4 million increase in telephone and connectivity costs related to our voice and data communications and a $0.2 million in other expenses. The higher personnel and related costs is associated with the increase in headcount, largely from the acquisition of iDriveonline and Stoneage. Also included in this increase are integration related expenses, such as transition salaries, severance and retention bonuses. 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 increased by $2.2 million, or 38%, to $8.1 million in the six months ended June 30, 2004 compared to $5.9 million for the same period in 2003. This represents 14% of total revenues for the six months ended June 30, 2004 and 2003, respectively. The increase was due to $1.1 million in higher compensation and related costs and an increase in headcount, $0.1 million in severance costs associated with the separation of an employee from us, a $0.5 million increase in public company expenses related to compliance with the Sarbanes-Oxley Act, a $0.2 million increase in other professional fees, a $0.4 million increase in amortization costs primarily related to intangible assets acquired from Stoneage and $0.3 million related to an abandoned acquisition. These increases were offset by $0.4 million charged to rent expense in 2003 related to the relocation of our AIC operations from Westborough, Massachusetts to our corporate office. We expect our general and administrative expenses as a percentage of revenues to remain flat in 2004 compared to 2003.

Interest Income. In the six months ended June 30, 2004, interest income increased by $0.3 million, to $0.4 million compared to $0.1 million for the same period in 2003. The increase in interest income was due to higher cash balances as a result of 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 in Equity Investee. Income in equity investee in the six months ended June 30, 2004 represents 46.4% share of income in an equity investee held by Autobytel.Europe and our share of income in Autobytel.Europe prior to April 1, 2004. Income in equity investee in the six months ended June 30, 2003 represents our share of income in Autobytel.Europe.

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

From January 1, 2004 through June 30, 2004, we granted stock options to purchase 988,000 shares of common stock under our 1996 Stock Incentive Plan, 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 June 30, 2004, we had approximately 7.4 million outstanding stock options.

As of June 30, 2004, we had a total of 402 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.

Our domestic cash, cash equivalents and long-term investments totaled $46.2 million as of June 30, 2004, a decrease of $18.0 million in the second quarter of 2004 primarily due to the acquisitions of Stoneage and iDriveonline in April 2004. As of June 30, 2004, we had $31.2 million in domestic cash and cash equivalents. As of June 30, 2004, international cash and cash equivalents held by Autobytel.Europe were $8.2 million for use as directed by Autobytel.Europe. International cash and cash equivalents decreased by $2.2 million in the second quarter of 2004 primarily due to payments made in April 2004 by Autobytel.Europe aggregating $1.5 million to Autobytel.Europe licensees and $0.4 million to former shareholders for amounts due under agreements entered into in March 2002. International cash and cash equivalents are not available to us.

Net cash provided by operating activities was $0.7 million for the six months ended June 30, 2004 compared to $3.4 million for the same period in 2003. Net cash provided by operating activities for the six months ended June 30, 2004 resulted from net income for the period before non-cash charges and an increase in accounts payable, partially offset by an increase in accounts receivable, prepaid expenses and other assets coupled with a decrease in accrued expenses, deferred revenues and accrued international licensee liabilities. A $1.5 million increase in accounts receivable was due to higher billing as a result of increased revenues. A $0.7 million increase in prepaid expenses and other assets was primarily due to the payment of insurance premiums during the first half of 2004, offset by the amortization of the insurance premiums. A $1.6 million decrease in accrued expenses was primarily due to the payout of accrued compensation costs in the first half of 2004. A $0.6 million decrease in deferred revenue is primarily due to revenue recognized for our services provided to Stoneage dealers that were billed prior to the acquisition of Stoneage and international license fees for the first half of 2004 that were billed in December 31, 2003. A $1.5 million decrease in accrued international licensee liabilities was due to payments made in April 2004 by Autobytel.Europe to Autobytel.Europe licensees for amounts due under agreements entered into in March 2002.

Net cash provided by operating activities for the six months ended June 30, 2003 primarily resulted from the net income for the period before non-cash charges, a decrease in prepaid expenses and other current assets and an increase in accounts payable, partially offset by a decrease in accrued expenses and an increase in accounts receivable. The $1.5 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. A $1.0 million decrease in accrued expenses was primarily due to the payout of accrued compensation costs in the first quarter of 2003. The $2.3 million increase in accounts receivable was due to higher billing as a result of increased revenues and significant accounts with certain customers which were collected subsequent to June 30, 2003.

Net cash used in investing activities was $16.1 million for the six months ended June 30, 2004 and $5.1 million for the same period in 2003. Cash used in investing activities in the six months ended June 30, 2004 was related to the acquisitions of Stoneage and iDriveonline, net purchases of long-term investments in government sponsored agency bonds and purchases of property and equipment, offset by the consolidation of Autobytel.Europe’s cash balance in accordance with FIN 46R and the maturity of short-term investments. Cash used in investing activities in 2003 was related to the acquisition of AVV and the purchase of property and equipment.

Net cash provided by financing activities was $3.4 million for the six months ended June 30, 2004 and $25.8 million for the same period in 2003. Cash provided by financing activities in the six months ended June 30, 2004 was due to proceeds received from the sale of common stock through our employee stock purchase plan and the exercise of stock options, offset by payments of capital lease obligations assumed in the Stoneage acquisition. Cash provided by financing activities in 2003 was due to proceeds received from the sale of common stock in a private placement, through our employee stock purchase plan and the exercise of stock options.

We estimate and record reserves for potential bad debts and customer credits based on our historical bad debt and customer credit experience, which is consistent with our past practice.

The reserve 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. Additions to the estimated reserve for bad debts are recorded as an increase in operating expenses. Reductions in the estimated reserve for bad debts are recorded as a decrease in operating expenses. As specific bad debts are identified, they are written-off against the previously established estimated reserve for bad debts and have no impact on operating expenses.

The reserve for customer credits is our estimate of adjustments for services that do not meet our customers’ perceived expectations. Additions to the estimated reserve for customer credits are recorded as a reduction in revenues. Reductions in the estimated reserve for customer credits are recorded as an increase in revenues. As specific customer credits are identified, they are written-off against the previously established estimated reserve for customer credits and have no impact on revenues.

During the three months and six months ended June 30, 2004, we added $0.2 million and $0.3 million, respectively, to our domestic reserves for bad debts and customer credits. Also during the three months and six months ended June 30, 2004, we wrote-off $0.8 million and $1.3 million, respectively, from our previously established reserves for bad debts and customer credits. The write-offs had no impact on our revenues or operating expenses. As of June 30, 2004, our estimated reserves for domestic bad debts and customer credits have declined to $0.8 million, or 5% of gross accounts receivable from $1.3 million, or 11%, of gross accounts receivable, as of March 31, 2004 and from $1.8 million, or 14%, of gross accounts receivable as of December 31, 2003. We have experienced improvement in the collectibility of our accounts receivable due to vigorous collection efforts and improved quality of our products and services.

With the adoption of FIN 46R on March 31, 2004, we consolidated Autobytel.Europe into our financial statements. As of March 31, 2004, Autobytel.Europe had an estimated reserve for bad debt of $0.8 million. In the second quarter of 2004, Autobytel.Europe wrote-off the majority of the estimated bad debt reserve balance which had no impact on Autobytel.Europe’s or our operating expenses.

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 estimated 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.

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.

Car.com’s contractual obligations include an operating lease for its facility. As of June 30, 2004, the aggregate minimum lease payments were $0.3 million expiring on various dates through June 2005.

Under FIN 46R, we determined we were the primary beneficiary of Autobytel.Europe and were required to consolidate Autobytel.Europe in our financial statements effective March 31, 2004. We have an ownership interest in Autobytel.Europe of 49%.

In March 2004, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments” (EITF 03-1). EITF 03-1 provides accounting guidance regarding the determination of when an impairment (i.e., fair value is less than amortized cost) of debt and marketable equity securities and investments accounted for under the cost method should be considered other-than-temporary and recognized in earnings. EITF 03-1 also requires annual disclosures of certain quantitative and qualitative factors of debt and marketable equity securities classified as available-for-sale or held-to-maturity that are in an unrealized loss position at the balance sheet date, but for which an other-than-temporary impairment has not been recognized. We adopted the disclosure requirements of EITF 03-1 on December 31, 2003. The accounting guidance of EITF 03-1 will be effective on July 1, 2004. We do not expect the adoption of EITF 03-1 to have a material effect on our financial position or 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 seven 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 $150.4 million as of June 30, 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 or the number of purchase requests accepted from us. If dealer attrition increases or the number of purchase requests accepted from us decreases and we are unable to add new dealers to mitigate the attrition or decrease in number of accepted requests, 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 AutoNation’s AutoUSA, Microsoft Corporation’s MSN Autos, CarsDirect.com, Cars.com, eBayMotors.com 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 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 services. 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 services 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 dealer 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 filed with the Securities and Exchange Commission in June 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, stockholder rights plan 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 and provisions in our stockholder rights plan 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. Under the stockholder rights plan, if a person or group acquires 15% or more of the common stock, all rightsholders, except the acquiror, will be entitled to acquire at the then exercise price of a right that number of shares of Autobytel’s common stock which at the time will have a market value of two times the exercise price of the right. In addition, under certain circumstances, all rightholders, other than the acquiror, will be entitled to receive at the then exercise price of a right that number of shares of common stock of the acquiring company which at the time will have a market value of two times the exercise price of the right. The initial exercise

price of a right is $65. Such charter and rights 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 June 30, 2004. Based on their evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective at the reasonable assurance level 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 June 30, 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 settlement agreement and related agreements which set forth the terms of a settlement between Autobytel, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. Among other provisions, the settlement provides for a release of Autobytel and the Autobytel Individual Defendants for the conduct alleged in the action to be wrongful 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 settlement agreement and related agreements will be directly covered and paid by its insurance carriers. Therefore, we do not expect that the settlement will involve any payment by Autobytel. The settlement agreement has not yet been executed. The settlement agreement is subject to approval by the court, which cannot be assured. 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.

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 a settlement agreement and related agreements which set forth the terms of a settlement between Autoweb, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. Among other provisions, the settlement provides for a release of Autoweb and the Autoweb Individual Defendants for the conduct alleged in the action to be wrongful 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 settlement agreement and related agreements will be directly covered and paid by its insurance carriers. Therefore, we do not expect that the settlement will involve any payment by Autoweb. The settlement agreement has not yet been executed. The settlement agreement is subject to approval by the court, which cannot be assured. 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.

On April 9, 2004, in connection with, and as partial consideration for, our acquisition of iDriveonline, Inc., we issued 474,501 shares of common stock to the then current shareholders of such entity. The offers and sales were exempt from registration pursuant to Regulation D under the Securities Act of 1933, as amended.

On April 15, 2004, in connection with, and as partial consideration for, our acquisition of Stoneage Corporation., we issued 2,257,733 shares of common stock to the then current and certain former shareholders of such entity. In addition, on July 6, 2004, in connection with certain post-closing adjustment provisions, we issued 47,511 shares of common stock to such persons. All such offers and sales were exempt from registration pursuant to Regulation D under the Securities Act of 1933, as amended.

Autobytel held its Annual Meeting of Stockholders on June 24, 2004. The following is a brief description of each matter voted upon at the meeting and the number of votes cast for, withheld or against and, if applicable, the number of abstentions and broker non-votes with respect to each matter. Each director proposed by Autobytel was elected and the other three matters submitted for stockholder vote were approved.

The term of office as director for Mark N. Kaplan, Richard A. Post, Mark R. Ross and Jeffrey A. Schwartz continued after the meeting.

The following reports on Form 8-K were furnished or filed, as applicable, during the quarter covered by this Quarterly Report on Form 10-Q:

On April 20, 2004, we filed a Form 8-K under items 2 and 7 announcing our acquisitions of iDriveonline and Stoneage.

On April 27, 2004, we furnished a Form 8-K under Item 12 announcing our financial results for the quarter ended March 31, 2004.

On June 28, 2004, we filed a Form 8-K/A under item 7 providing financial statements and pro forma financial information relating to the acquisition of Stoneage.

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)

By:

/s/ MATTHEW MCDOWELL

Matthew McDowell

Vice President and Controller

(Principal Accounting Officer)


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


		Page
PART I. FINANCIAL INFORMATION

ITEM 1.	Consolidated Financial Statements (unaudited):

	Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003	3

	Consolidated Statements of Operations for the Three Months and Six Months Ended June 30, 2004 and 2003	4

	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2004 and 2003	5

	Notes to Consolidated Financial Statements	7

ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17

ITEM 4.	Controls and Procedures	39

PART II. OTHER INFORMATION

ITEM 1.	Legal Proceedings	40

ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41

ITEM 4.	Submission of Matters to a Vote of Security Holders	41

ITEM 6.	Exhibits and Reports on Form 8-K	41

Signatures		43


	June 30, 2004			December 31, 2003
	(unaudited)
ASSETS
Current assets:
Domestic cash and cash equivalents	$	31,240		$	51,643
International cash and cash equivalents (Note 3.)		8,225			—
Short-term investments		—			3,991
Accounts receivable, net of reserves for bad debts and customer credits of $850 and $1,764, respectively		17,213			10,889
Prepaid expenses and other current assets		2,677			833

Total current assets		59,355			67,356
Long-term investments		15,000			6,000
Property and equipment, net		3,141			2,138
Capitalized software, net		484			1,024
Investment in equity investee (Note 3.)		827			2,810
Goodwill		69,477			16,830
Intangible assets, net		5,168			315
Other assets		121			155

Total assets	$	153,573		$	96,628

LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	6,906		$	4,063
Accrued expenses		6,143			5,034
Deferred revenues		3,709			4,022
Accrued domestic restructuring		168			258
Other current liabilities		587			441

Total current liabilities		17,513			13,818
Common stock due to former Stoneage shareholders		685			—

Total liabilities		18,198			13,818

Minority interest (Note 3.)		4,594			—
Commitments and contingencies (Note 6.)
Stockholders’ equity:
Preferred stock, $0.001 par value; 11,445,187 shares authorized; none outstanding		—			—
Common stock, $0.001 par value; 200,000,000 shares authorized; 41,642,176 and 37,786,767 shares issued and outstanding, respectively		42			38
Additional paid-in capital		279,584			236,544
Accumulated other comprehensive income		1,597			—
Accumulated deficit		(150,442	)		(153,772	)

Total stockholders’ equity		130,781			82,810

Total liabilities, minority interest and stockholders’ equity	$	153,573		$	96,628


	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Revenues:
Lead fees	$	21,478		$	15,508		$	38,325		$	30,131
Advertising		3,441			3,024			6,563			5,863
Customer relationship management (CRM) services		5,312			2,068			8,775			3,520
Data, applications and other		1,284			1,121			2,609			2,460

Total revenues		31,515			21,721			56,272			41,974

Operating expenses:
Sales and marketing		18,773			13,109			33,582			25,967
Product and technology development		6,431			4,454			11,519			8,316
General and administrative		5,172			3,106			8,101			5,891

Total operating expenses		30,376			20,669			53,202			40,174

Income from operations		1,139			1,052			3,070			1,800
Interest income		219			61			405			130
Income (loss) in equity investees		18			14			(35	)		67
Foreign currency exchange gain		20			—			20			—
Other income		—			—			1			—
Minority interest		(62	)		—			(62	)		—

Income before income taxes		1,334			1,127			3,399			1,997
Provision for income taxes		(69	)		(5	)		(69	)		(7	)

Net income	$	1,265		$	1,122		$	3,330		$	1,990

Net income per share:
Basic	$	0.03		$	0.04		$	0.08		$	0.06

Diluted	$	0.03		$	0.03		$	0.08		$	0.06

Shares used in computing net income per share:
Basic		41,123,593			31,814,364			39,733,775			31,525,905

Diluted		44,695,148			33,950,507			43,643,296			33,138,530

Comprehensive income:
Net income	$	1,265		$	1,122		$	3,330		$	1,990
Translation adjustment		(88	)		36			(88	)		63

Comprehensive income	$	1,177		$	1,158		$	3,242		$	2,053


	Six Months Ended June 30,
	2004			2003
Cash flows from operating activities:
Net income	$	3,330		$	1,990
Adjustments to reconcile net income to net cash provided by operating activities:
Non-cash charges:
Depreciation and amortization		1,788			1,228
Reserve for (recovery of) bad debt		(240	)		314
Reserve for customer credits		584			1,294
Loss on disposal of property and equipment		20			—
Stock based compensation		—			51
(Income) loss in equity investees		35			(67	)
Minority interest		62			—
Changes in assets and liabilities:
Accounts receivable		(1,457	)		(2,289	)
Prepaid expenses and other current assets		(722	)		1,536
Other assets		13			23
Accounts payable		1,082			449
Accrued expenses		(1,639	)		(1,022	)
Deferred revenues		(594	)		66
Customer deposits		—			(76	)
Accrued domestic restructuring		(90	)		(126	)
Accrued international licensee liabilities		(1,541	)		—
Other current liabilities		60			24

Net cash provided by operating activities		691			3,395

Cash flows from investing activities:
Acquisitions of businesses, net of cash acquired		(20,630	)		(4,952	)
Maturities of short-term investments		3,991			—
Purchases of long-term investments		(18,000	)		—
Redemptions of long-term investments		9,000			—
Consolidation of Autobytel.Europe cash balance (Note 3.)		10,425			—
Purchases of property and equipment		(923	)		(145	)

Net cash used in investing activities		(16,137	)		(5,097	)

Cash flows from financing activities:
Payments of capital lease obligations		(225	)		(8	)
Net proceeds from sale of common stock		3,657			25,809

Net cash provided by financing activities		3,432			25,801

Effect of exchange rates on cash		(164	)		63

Net increase (decrease) in cash and cash equivalents		(12,178	)		24,162
Cash and cash equivalents, beginning of period		51,643			27,571

Cash and cash equivalents, end of period (Note 3.)	$	39,465		$	51,733

Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes	$	69		$	7

Cash paid (refunded) during the period for interest	$	(1	)	$	2


	Amortized Cost Basis		Aggregate Fair Value		Unrealized Gains		Unrealized Losses
June 30, 2004:
Long-term investments, held-to-maturity:
Government sponsored agency bonds	$	15,000	$	14,896	$	—	$	104

Total as of June 30, 2004	$	15,000	$	14,896	$	—	$	104

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		—

Total as of December 31, 2003	$	9,991	$	10,011	$	20	$	—


	Three Months Ended June 30,						Six Months Ended June 30,
	2004			2003			2004			2003
Net income (loss):
As reported	$	1,265		$	1,122		$	3,330		$	1,990
Add: Stock-based compensation included in reported net income, net of tax		—			51			—			51
Less: Stock-based compensation determined under the fair value based method, net of tax		(1,464	)		(858	)		(2,671	)		(1,822	)

Pro forma	$	(199	)	$	315		$	659		$	219

Net income (loss) per share—basic:
As reported	$	0.03		$	0.04		$	0.08		$	0.06
Pro forma	$	0.00		$	0.01		$	0.02		$	0.01
Net income (loss) per share—diluted:
As reported	$	0.03		$	0.03		$	0.08		$	0.06
Pro forma	$	0.00		$	0.01		$	0.02		$	0.01


	As of June 30, 2004
Cash and cash equivalents	$	8,225
Other current assets		168
Non-current assets		828
Current liabilities		(213	)
Other investor’s investment in Autobytel.Europe		(4,594	)
Cumulative translation adjustment		(1,597	)

Autobytel’s investment in Autobytel.Europe	$	2,817


Purchase price:
Cash	$	5,021
Common stock (474,501 shares at $14.53 per share)		6,894
Transaction costs incurred by Autobytel		372

Total purchase price	$	12,287

Allocation of purchase price:
Assets:
Cash	$	266
Accounts receivable		542
Other current assets		48
Non-current assets		60
Goodwill		11,541
Intangible assets		600
Liabilities:
Current liabilities		(770	)

Total purchase price	$	12,287


Purchase price:
Cash	$	15,251
Common stock (2,305,244 shares at $14.40 per share)		33,177
Transaction costs incurred by Autobytel		1,036

Total purchase price	$	49,464

Allocation of purchase price:
Assets:
Cash	$	599
Accounts receivable		4,584
Other current assets		1,045
Non-current assets		888
Goodwill		41,105
Intangible assets		4,700
Liabilities:
Current liabilities		(3,231	)
Non-current liabilities		(226	)

Total purchase price	$	49,464


	As of June 30, 2004
	Estimated Useful Lives	Gross Carrying Amount		Accumulated Amortization			Net Amount
Developed technology	3 years	$	220	$	(80	)	$	140
Customer relationships	1 to 3 years		4,800		(443	)		4,357
Domain name	5 years		700		(29	)		671

Total		$	5,720	$	(552	)	$	5,168


	As of December 31, 2003
	Estimated Useful Lives	Gross Carrying Amount		Accumulated Amortization			Net Amount
Developed technology	3 years	$	220	$	(43	)	$	177
Customer relationships	1 to 3 years		200		(62	)		138

Total		$	420	$	(105	)	$	315


	Amortization Expense
Six months ending December 31, 2004	$	901
2005	$	1,787
2006	$	1,720
2007	$	579
2008	$	140
2009	$	41


	As of December 31, 2003		Cash Payments			As of June 30, 2004
Rent	$	258	$	(90	)	$	168


Director	For	Withheld Authority
Jeffrey H. Coats	32,746,628	1,542,283
Michael J. Fuchs	32,732,751	1,556,160
Robert S. Grimes	32,936,577	1,352,334


For	Against	Abstain	Broker Non-Votes
17,289,657	8,715,655	150,273	8,133,326


10.1		Acquisition Agreement, dated as of April 15, 2004, among Autobytel Inc., Autobytel Bedrock Corp., Stoneage Corporation and current and former shareholders of Stoneage Corporation is incorporated herein by reference to Exhibit 2.1 of the Form 8-K/A filed with the Securities and Exchange Commission on June 28, 2004 (the “Form 8-K/A”).

10.2		Acquisition Agreement, dated as of April 7, 2004, among Autobytel Inc., Autobytel Lonestar Corp., iDriveonline, Inc. and shareholders of iDriveoline, Inc. is incorporated herein by reference to Exhibit 2.2 of the Form 8-K/A.

31.1		Chief Executive Officer Section 302 Certification of Periodic Report, dated August 5, 2004.



31.2		Chief Financial Officer Section 302 Certification of Periodic Report, dated August 5, 2004.

32.1		Chief Executive Officer and Chief Financial Officer Section 906 Certification of Periodic Report, dated August 5, 2004.


Exhibit Number

10.1		Acquisition Agreement, dated as of April 15, 2004, among Autobytel Inc., Autobytel Bedrock Corp., Stoneage Corporation and current and former shareholders of Stoneage Corporation is incorporated herein by reference to Exhibit 2.1 of the Form 8-K/A filed with the Securities and Exchange Commission on June 28, 2004 (the “Form 8-K/A”).

10.2		Acquisition Agreement, dated as of April 7, 2004, among Autobytel Inc., Autobytel Lonestar Corp., iDriveonline, Inc. and shareholders of iDriveoline, Inc. is incorporated herein by reference to Exhibit 2.2 of the Form 8-K/A.

31.1		Chief Executive Officer Section 302 Certification of Periodic Report, dated August 5, 2004.

31.2		Chief Financial Officer Section 302 Certification of Periodic Report, dated August 5, 2004.

32.1		Chief Executive Officer and Chief Financial Officer Section 906 Certification of Periodic Report, dated August 5, 2004.