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 ¨ No x

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

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

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

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

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

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

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

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

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

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

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

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

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, Autosite.com, AICAutoSite.com, Autoahorros.com and CarTV.com. Autobytel is also a leading provider of customer relationship management (CRM) products and programs, which consist of lead management products, customer loyalty and retention marketing programs, and data extraction services for dealers. Autobytel is also a provider of automotive marketing data and technology.

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

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

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

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

All intercompany transactions and balances have been eliminated in consolidation.

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 an original maturity of three months or less at the date of purchase to be cash equivalents. Domestic cash and cash equivalents represent amounts held by Autobytel for use by Autobytel.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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. The assets and liabilities of Autobytel.Europe were as follows:

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

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

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

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

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

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

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

Amortization expense for the remaining lives of the acquired 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. On October 13, 2004, the Court certified a class in six of the approximately 300 other nearly identical actions and noted that the decision is intended to provide strong guidance to all parties regarding class certification in the remaining cases. Plaintiffs have not yet moved to certify a class in the Autobytel case. Autobytel has approved a settlement agreement and related agreements which set forth the terms of a settlement between Autobytel, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. Among other provisions, the settlement provides for a release of Autobytel and the Autobytel Individual Defendants for the conduct alleged in the action to be wrongful. Autobytel would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims Autobytel may have against its underwriters. The settlement agreement also provides a guaranteed recovery of $1 billion to plaintiffs for the cases relating to all of the approximately 300 issuers. To the extent that the underwriter defendants settle all of the cases for at least $1 billion, no payment will be required under the issuers’ settlement agreement. To the extent that the underwriter defendants settle for less than $1 billion, the issuers are required to make up the difference. It is anticipated that any potential financial obligation of Autobytel to plaintiffs pursuant to the terms of the settlement agreement and related agreements will be directly covered and paid by its insurance carriers. Autobytel currently is not aware of any material limitations on the expected recovery of any potential financial obligation to plaintiffs from its insurance carriers. Its carriers are solvent, and Autobytel is not aware of any uncertainties as to the legal sufficiency of an insurance claim with respect to any recovery by plaintiffs. Therefore, Autobytel does not expect that the settlement will involve any payment by Autobytel. If material limitations on the expected recovery of any potential financial obligation to the plaintiffs from Autobytel’s insurance carriers should arise, Autobytel’s maximum financial obligation to plaintiffs pursuant to the settlement agreement would be less than $3.4 million. On February 15, 2005, the Court granted preliminary approval of the settlement agreement, subject to certain modifications consistent with its opinion. The Court ruled that the issuer defendants and the plaintiffs must submit a revised settlement agreement which provides for a mutual bar of all contribution claims by the settling and non-settling parties and does not bar the parties from pursuing other claims. The issuers and plaintiffs have negotiated a revised settlement agreement consistent with the Court’s opinion and are in the process of obtaining approval from those issuer defendants that are not in bankruptcy. At this point, all but one of the issuer defendants that are not in bankruptcy

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

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

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

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

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

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

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

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

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

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

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

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

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

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.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

In the first quarter of 2005, we experienced a net reduction in our number of retail dealer relationships. We cannot assure that we will be able to reduce 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 procurement, carrying or shipping costs and no inventory risk.

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

Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004 (Restated)

Revenues. Our revenues increased by $8.7 million, or 35%, to $33.3 million in the first quarter of 2005 compared to $24.6 million in the first quarter of 2004. The increase was due to growth in lead fees, CRM services and advertising. As a result of the acquisitions of iDriveonline and Stoneage on April 9, 2004 and April 15, 2004, respectively, revenues include $2.0 million from dealers using iDriveonline’s customer loyalty and retention marketing programs and $5.8 million from customers using Stoneage services in the first quarter of 2005.

Lead Fees. Lead fees increased by $4.4 million, or 26%, to $21.6 million in the first quarter of 2005 compared to $17.2 million in the first quarter of 2004. The increase in first quarter lead fee revenue was driven by 0.2 million purchase requests and 0.2 million finance requests delivered by Car.com, generating $5.3 million of revenue in the first quarter. This increase at Car.com was partially offset by a decline of 0.1 million purchase requests in our remaining properties, resulting in approximately a $0.9 million lead fee revenue decrease. Additionally, we increased our fees per purchase request for some dealers in the second half of 2004. The number of retail dealer relationships in our lead referral program was approximately 6,200 and 5,500 at March 31, 2005 and 2004, respectively. The number of enterprise dealer relationships with major dealer groups in our lead referral program was approximately 670 and 580 at March 31, 2005 and 2004, respectively. In addition, we had six direct relationships encompassing 16 brands with automotive manufacturers or their automotive buying service affiliates representing up to approximately 17,600 enterprise dealer relationships at March 31, 2005, compared to four direct relationships encompassing 15 brands representing up to approximately 18,200 enterprise dealer relationships at March 31, 2004. Our finance lead referral network at March 31, 2005 also included approximately 300 relationships with retail dealers, finance request intermediaries, and automotive finance companies who participate in the Car.com finance referral network. Lead fees and the number of purchase requests we delivered to our customers declined in the first quarter of 2005 compared to the fourth quarter of 2004. Management is taking actions to reverse this trend. However, we cannot assure that this trend will not continue.

Advertising. Advertising revenue increased by $1.7 million, or 53%, to $4.8 million in the first quarter of 2005 compared to $3.1 million in the first quarter of 2004. The increase was primarily due to higher spending by automotive manufacturers, additional Web site advertising sales to Car.com customers and the addition of new products, such as rich media and direct marketing offerings. With further selling of additional available advertising inventory, an increase in Internet advertising spending by automotive manufacturers, the acquisition of Stoneage in April 2004, and the addition of new and higher priced products, such as rich media and direct marketing offerings, we expect our advertising revenues to increase in 2005 compared to 2004.

CRM Services. CRM services increased by $2.7 million, or 91%, to $5.8 million in the first quarter of 2005 compared to $3.0 million in the first quarter of 2004. The increase was due to an increase in the number of WebControl and RPM customers, increase in RPM revenues, higher fees from iDriveonline’s customer loyalty

and retention marketing programs and fees from WebControl and ADS. The number of WebControl customers and RPM customers were 2,870 and 750, respectively, at March 31, 2005 compared to 2,540 and 450, respectively, at March 31, 2004. We expect revenues from our CRM services to increase in 2005 compared to 2004 due to the acquisition of iDriveonline in April 2004.

Data, Applications and Other. Revenues from data, applications and other decreased by $0.1 million or 10%, to $1.2 million in the first quarter of 2005 compared to $1.3 million in the first quarter of 2004. The decrease is primarily due to a decrease 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 2005 compared to 2004.

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

Cost of revenues increased by $2.9 million or 27% to $13.4 million in the first quarter of 2005 compared to $10.5 million in the first quarter of 2004. This represents 40% and 43% of total revenues for the first quarter of 2005 and 2004, respectively. The increase was due to a $2.6 million increase in the costs of purchase requests and finance requests acquired from third parties, a $0.6 million increase in printing, production, and postage costs for our customer loyalty and retention program, offset by a $0.1 million decrease in data content and license fees and a $0.2 million decrease in personnel and related costs. The increase in purchase request and finance request costs was primarily due to the increased delivery of purchase requests and finance requests, primarily as a result of the acquisition of Stoneage. The increase in printing, production and postage costs was due to the increase in customer loyalty and retention program volumes in our RPM business. We expect our costs of revenue to increase in 2005 compared to 2004.

Sales and Marketing. Sales and marketing expense includes costs for developing our brand equity and personnel and other costs associated with dealer sales, CRM sales, Web site advertising sales, and dealer training and support. Sales and marketing expense increased by $2.0 million, or 33%, to $8.1 million in the first quarter of 2005 compared to $6.1 million in the first quarter of 2004. This represents 24% and 25% of total revenues for the first quarter of 2005 and 2004, respectively. The increase was due to a $1.3 million increase in costs associated with sales and customer relationship maintenance, and a $0.7 million increase in traditional advertising expenses. The increase in sales and customer relationship maintenance was due to higher personnel costs related to increased sales and headcount. The increase in traditional advertising expenses was partially a result of the acquisition of Stoneage and iDriveonline. We expect our sales and marketing expenses to increase in 2005 compared to 2004.

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, and costs related to data and technology development. Product and technology development expense increased by $1.7 million, or 39%, to $6.1 million in the first quarter of 2005 compared to $4.4 million in the first quarter of 2004. This represents 18% of total revenues for both the first quarter of 2005 and 2004. The increase was due to higher personnel and related costs of $1.3 million, a $0.1 million increase in telephone costs related to our voice communications and a $0.3 million increase in other expenses. The higher personnel and related costs are associated with the increase in headcount, largely from the acquisitions of iDriveonline and Stoneage. We expect our product and technology development expenses to increase in 2005 compared to 2004.

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 $5.3 million, or 176%, to $8.3 million in the first quarter of 2005 compared to $3.0 million in the first quarter of 2004. This represents 25% and 12% of total revenues for the first quarter of 2005 and 2004, respectively. The increase was primarily due to costs associated with the internal review and restatements of our consolidated financial statements of $3.2 million, a $1.2 million increase in public company expenses, a $0.4 million increase in legal fees associated with defending purported class action and derivative lawsuits filed against us and enforcing our intellectual property rights, higher personnel and related costs of $0.3 million, including $0.1 million in payments related to employment claims, a $0.1 million increase in the estimate of bad debt expense that could result from the inability or failure of our customers to pay for our services and a $0.1 million increase in depreciation primarily related to the property and equipment acquired from Stoneage and iDriveonline. We expect our general and administrative expenses to increase in 2005 compared to 2004 due to costs relating to compliance with the Sarbanes-Oxley Act of 2002, costs associated with the restatements of our consolidated financial statements, costs associated with remediation of material weaknesses in our internal controls identified in our internal review, costs associated with defending purported class action and derivative lawsuits filed against us and certain current directors and current and former officers relating to the restatements of our consolidated financial statements, and costs associated with enforcing our intellectual property rights, including the lawsuit filed against Dealix Corporation for patent infringement.

Amortization of Acquired Intangible Assets. Amortization of acquired intangible assets represents the amortization of customer relationships and domain name recorded as part of the AVV, iDriveonline and Stoneage acquisitions. Amortization of acquired intangible assets increased by $0.4 million in 2005 compared to 2004. The increase was due to the acquisitions of iDriveonline and Stoneage.

Interest Income. In the first quarter of 2005, interest income increased by $0.1 million, to $0.3 million compared to $0.2 million in the first quarter of 2004. The increase in interest income was due to the investment of our cash in accounts yielding higher interest rates.

Loss in Equity Investees. Loss in equity investee in the first quarter of 2004 represents our share of loss 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 first quarter of 2005, a $0.1 million provision for state income taxes has been recorded compared to a nominal amount in the first quarter of 2004. In the preparation of our consolidated 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. We have net operating loss carryforwards that expire in various years through 2024. We also have federal and state research tax credit carryforwards. The federal research tax credits expire in various years through 2022. The state research tax credits do not expire. 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 were not realizable at March 31, 2005, our assessment may change in future periods if we generate positive operating results and such adjustment would impact our provision for income taxes in the period of such change.

As of April 30, 2005, we had a total of 428 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 short-term and long-term investments totaled $52.2 million as of March 31, 2005, representing a decrease of $0.6 million in the first quarter of 2005. As of March 31, 2005, we had $25.2 million in domestic cash and cash equivalents. As of March 31, 2005, restricted international cash and cash equivalents held by Autobytel.Europe were $9.1 million for use as directed by Autobytel.Europe. Restricted international cash and cash equivalents are not unilaterally available to us.

Net cash used in operating activities was $0.1 million for the three months ended March 31, 2005 compared to net cash provided by operating activities of $0.6 million for the same period in 2004. Net cash used in operating activities for the three months ended March 31, 2005 resulted from a net loss of $2.8 million for the period and a $1.8 million increase in accounts receivable which were partially offset by non-cash charges, and a $2.4 million increase in accounts payable and accrued expenses. The $1.8 million increase in accounts receivable was primarily due to the increase in days sales outstanding metric from 51 days during the three months ended December 31, 2004 to 54 days for the three months ended March 31, 2005. The $2.4 million increase in accounts payable and accrued expenses was primarily due to professional fees incurred related to the restatements of our consolidated financial statements, internal review, and defending purported class action and derivative lawsuits filed against us and certain current directors and current and former officers.

Net cash provided by operating activities was $0.6 million for the three months ended March 31, 2004, resulting from net income of $0.7 million for the period, non-cash charges, an increase in accounts payable, and a decrease in accounts receivable, which were partially offset by a decrease in accrued expenses. A $0.3 million decrease in accounts receivable was primarily due to an improvement in our collection effort. A $1.4 million decrease in accrued expenses was primarily due to the payout of accrued compensation costs in the first quarter of 2004.

Net cash provided by investing activities was $1.0 million for the three months ended March 31, 2005 compared to net cash used by investing activities of $16.4 million for the same period in 2004. Cash provided by investing activities for the three months ended March 31, 2005 was related to the sale and maturities of short-term investment in government sponsored agency bonds and auction rate securities, offset by purchases of short-term and long-term investments in government sponsored agency bonds and auction rate securities and purchases of property and equipment. Cash used in investing activities in the first quarter of 2004 was related to the purchase of short-term and long-term investments in government sponsored agency bonds and auction rate securities, and purchases of property and equipment, offset by the maturity of short-term investments.

There were no cash flow from financing activities for the three months ended March 31, 2005 compared to $2.4 million of net cash provided by financing activities for the same period in 2004. Cash provided by financing activities for the three months ended March 31, 2004 was due to proceeds received from the sale of common stock through our employee stock purchase plan and the exercise of stock options.

We estimate and record allowances 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 allowance for bad debts is our estimate of bad debt expense that could result from the inability or refusal of our customers to pay for our services. Additions to the estimated reserve for bad debts are recorded as an increase in general and administrative expenses. Reductions in the estimated reserve for bad debts are recorded as a decrease in sales and marketing 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 allowance 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 ended March 31, 2005, we added $1.0 million to our domestic allowances for bad debts and customer credits. Also during the three months March 31, 2005, we wrote-off $0.8 million from our previously established allowances for bad debts and customer credits. The write-offs had no impact on our revenues or operating expenses. As of March 31, 2005, our estimated allowances for domestic bad debts and customer credits have increased to $1.2 million, or 6% of gross accounts receivable from $1.0 million, or 5%, of gross accounts receivable as of December 31, 2004.

With the adoption of FIN 46R on March 31, 2004, we consolidated Autobytel.Europe into our consolidated financial statements. As of March 31, 2004, Autobytel.Europe had an estimated allowance for bad debt of $0.8 million. In the second quarter of 2004, Autobytel.Europe wrote-off the majority of the estimated uncollectible accounts receivable 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 allowances 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.

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 from the fourth quarter of 2002 through the fourth quarter of 2004 and otherwise have a history of net losses. We incurred a loss in the first quarter of 2005 and cannot assure that we will be profitable in the future. If we are unable to achieve profitability in the future 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 and have achieved profitability from the fourth quarter of 2002 through the fourth quarter of 2004. We incurred a loss in the first quarter of 2005, primarily because of the costs related to the restatements of our financial statements and the internal review related to those restatements. We cannot assure that we will be profitable in the future. We had an accumulated deficit of $151.2 million as of March 31, 2005 and $148.4 million as of December 31, 2004.

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 be profitable in the future.

Management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. In making its assessment of internal control over financial reporting as of December 31, 2004, management used the criteria described in Internal Control—Integrated Framework

issued by the Committee of Sponsoring Organizations of the Treadway Commission. A material weakness is a control deficiency, or combination of control deficiencies, that results in a more than remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.

Management determined that we had material weaknesses in our internal control over financial reporting as of December 31, 2004, and these material weaknesses led to the restatement of our consolidated financial statements for the full 2002 fiscal year, the first, second, and third fiscal quarters of 2003, the full 2003 fiscal year and the first and second fiscal quarters of 2004. The material weaknesses relate to the lack of (1) effective controls over the financial reporting process due to an insufficient complement of personnel with a level of accounting knowledge, experience and training in the application of generally accepted accounting principles commensurate with our financial reporting requirements, and (2) an effective control environment based on criteria established in the Internal Control—Integrated Framework. Because of these material weaknesses, management was unable to conclude that we maintained effective internal control over financial reporting as of December 31, 2004 based on the criteria in the Internal Control—Integrated Framework. Further, the material weaknesses identified resulted in an adverse opinion by our independent registered public accounting firm on the effectiveness of our internal control over financial reporting.

If we are unable to substantially improve our internal controls, our ability to report our financial results on a timely and accurate basis will continue to be adversely affected, which could have a material adverse affect on our ability to operate our business. Please see Item 9A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2004 for more information regarding the measures we have commenced to implement, and which we intend to implement during the course of 2005, which are designed to remediate the deficiencies in our internal controls described in our Management’s Report On Internal Control Over Financial Reporting set forth on page F-2 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2004. The costs of remediating such deficiencies in our internal controls will adversely affect our financial condition and results of operations. In addition, even after the remedial measures discussed in Item 9A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2004 are fully implemented, our internal controls will not prevent all potential error and fraud, because any control system, no matter how well designed, can only provide reasonable and not absolute assurance that the objectives of the control system will be achieved.

The impact of ongoing purported class action and derivative litigation may be material. We are also subject to the risk of additional litigation and regulatory action in connection with the restatement of our consolidated financial statements and the potential liability from any such litigation or regulatory action could harm our business.

We recently restated our consolidated financial statements for the full 2002 fiscal year, the full 2003 fiscal year, the first, second and third fiscal quarters of 2003, and the first and second fiscal quarters of 2004. We, and certain of our present directors and present and former officers, are defendants in certain purported class action litigations pending in the United States District Court for the Central District of California. The claims were brought on behalf of our stockholders who purchased shares during the period July 24, 2003 through October 21, 2004. The claims in all of these purported class actions are virtually identical, and purport to allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. In this regard, the plaintiffs allege that we misrepresented and omitted material facts with respect to our financial results and operations during the time period between July 24, 2003 and October 20, 2004. The complaint seeks unspecified compensatory damages, and attorneys’ fees and costs, as well as accountants’ and experts’ fees.

On January 28, 2005, the court ordered the consolidation of the currently pending class actions into a single case pursuant to a stipulation for consolidation signed by all parties. On March 14, 2005, the court appointed a lead plaintiff and approved the selection of lead counsel and liaison counsel. Additional lawsuits asserting the same or similar claims may be filed as well. We intend to defend the claims vigorously. However, we cannot currently predict the impact or outcome of this litigation, which could be material, and the initiation, continuation and outcome of these lawsuits may have a material impact on our results of operations and financial condition.

In addition, our directors and a former officer are defendants in a derivative suit pending in the Superior Court of Orange County, California, and we are named as a nominal defendant in this suit. This suit purports to allege that the defendants breached numerous duties to us, including breach of fiduciary duty and misappropriation of information, abuse of control, gross mismanagement, waste of corporate assets, and unjust enrichment, as well as violations of California Corporations Code 25402 (trading with material non-public information), and that these breaches and violations caused losses to us, including damages to our reputation and goodwill. Plaintiffs’ claims are based on allegations that the defendants disseminated false and misleading statements concerning our results of operations and that these results were inflated at all relevant times due to violations of generally accepted accounting principals and Securities and Exchange Commission rules. The complaint seeks unspecified compensatory damages, treble damages, equitable and/or injunctive relief, restitution, and attorneys’ fees and costs, as well as accountants’ and experts’ fees.

We intend to defend this suit vigorously. However, we cannot currently predict the impact or outcome of this litigation, which could be material, and the continuation and outcome of this lawsuit, as well as the initiation of similar suits may have a material impact on our results of operations and financial condition.

As a result of the restatement of our consolidated financial statements described above, we could become subject to additional purported class action, derivative, or other securities litigation. In addition, regulatory agencies, such as the Securities and Exchange Commission, could commence an investigation relating to the restatement of our consolidated financial statements. As of the date hereof, we are not aware of any additional litigation or investigation having been commenced against us related to these matters, but we cannot predict whether any such litigation or regulatory investigation will be commenced or, if it is, the outcome of any such litigation or investigation. If any such investigation were to result in a regulatory proceeding or action against us, our business and financial condition could be harmed. The initiation of any additional securities litigation, together with the lawsuits described above, may also harm our business and financial condition.

Until the existing purported class action and derivative litigation or any additional litigation or regulatory investigation is resolved, it may be more difficult for us to raise additional capital or incur indebtedness or other obligations. If an unfavorable result occurred in any such action, our business and financial condition could be further harmed.

We will incur substantial expenses in connection with ongoing purported class action and derivative litigation and possible related regulatory investigations which will materially and adversely affect our financial condition, results of operations, and cash flows.

We will incur substantial expenses in connection with purported class action and derivative litigation and possible related regulatory investigations in connection with the restatement of our consolidated financial statements, including substantial fees for attorneys and other professional advisors. We are also obligated to indemnify our current and former officers and current directors named as defendants in such actions. These expenses, to the extent not covered by available insurance, will materially and adversely affect our financial condition, results of operations, and cash flows.

We will incur substantial expenses relating to remediation of material weaknesses in our internal controls identified in our internal review, which will materially and adversely affect our financial condition, results of operations, and cash flows.

We will incur substantial expenses relating to the remediation of material weaknesses in our internal controls identified in our internal review. These expenses will materially and adversely affect our financial condition, results of operations, and cash flows.

Our failure to comply with certain conditions required for our common stock to be listed on The Nasdaq National Market could result in the delisting of our common stock from The Nasdaq National Market.

As a result of our failure to timely file our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2004, our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, our

Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2005, and certain required restatements of our financial statements for prior periods, from November 2004 to May 2005 we were not in full compliance with Nasdaq Marketplace Rule 4310(c)(14), which requires us to make, on a timely basis, all filings with the Securities and Exchange Commission required by the Securities Exchange Act of 1934, as amended. We are required to comply with Nasdaq Marketplace Rule 4310(c)(14) as a condition for our common stock to continue to be listed on The Nasdaq National Market.

We have requested and received from a Nasdaq Listing Qualifications Panel (the “Panel”) several extensions within which to comply with Nasdaq Marketplace Rule 4310(c)(14). Recently, on April 7, 2005, we received an extension to the deadline to come into full compliance with Nasdaq Marketplace Rule 4310(c)(14) to May 15, 2005, which deadline was subsequently extended by the Panel to May 31, 2005. The Panel’s decision to continue the listing of our shares on The Nasdaq National Market was subject to the condition that we file, on or before May 31, 2005, our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2004, our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, our Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2005, and certain required restatements of our financial statements for prior periods. We have now complied with this condition. In addition, our continued listing is conditioned on us timely filing all periodic reports with the Securities and Exchange Commission and The Nasdaq Stock Market for all reporting periods ending on or before December 31, 2006. The filing of a Form 12b-25 extension request will not result in an automatic extension of these filing deadlines.

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

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 substantially 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 at prices acceptable to 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. If the number of dealers in our networks declines or dealers reduce the services they receive from us, 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 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 and deliver satisfactory value to our customers. 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, Dealix.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 product, RPM, competes 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 and other incentives offered by manufacturers in 2003 and 2004 may negatively affect vehicle sales in 2005. Consumers may have accelerated their planned vehicle purchases from 2005 to 2004 and 2003. 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, CarSmart.com and other 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 may evaluate potential acquisitions which we believe will complement or enhance our existing business. However, currently we do not expect to consummate acquisitions in the near future as we focus on our business and remedial actions necessary to address material weaknesses in our internal controls identified in our internal review. 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 acquired 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 iDriveonline, Inc., which we renamed Retention Performance Marketing, Inc., and Stoneage Corporation, which we renamed 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. If we are required to invest substantial amounts in technology, our results of operations will suffer.

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. In addition, if we are required to invest substantial amounts in technology in order to keep pace with technological advances, our results of operations will suffer.

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.

With the exception of the Car.com Web site and certain related systems, our production Web sites and certain systems, including Autobytel.com, Autoweb.com, CarSmart.com, AutoSite.com, AVV.com, iDriveonline and RPM are currently hosted at secure third-party hosting facilities. We host the Car.com Web site and certain related systems at Car.com’s 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 limited 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 be profitable in the future.

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 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.

If consumers do not continue to adopt Internet commerce as a mainstream medium of commerce or if automotive industry participants do not continue to accept 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 of continued acceptance of our services by consumers, dealers or automotive companies. 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 continue to accept new methods of conducting business and exchanging information and that automotive manufacturers will continue to accept a role for all make, all model third-party sites such as ours that allow for comparisons. In addition, dealers must continue 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 continue to be accepted, 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 able to circumvent our security measures could misappropriate proprietary information, customer information or consumer 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 continue to be a viable commercial medium because of inadequate development of the necessary infrastructure, timely development of complementary products, 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, patent, 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 to enforce or protect our intellectual property rights or to defend against claims or infringement or invalidity. We filed one such lawsuit, which is currently pending, to protect our patent. Such litigation, even if successful, could result in substantial costs and diversion of resources and management attention and could materially adversely affect our business, results of operations and financial condition. Misappropriation of our intellectual property or potential litigation could also 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 I. 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 develop new or enhance existing services or products or to respond to competitive pressures. 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 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.

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 our 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, has 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, has 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.

As more fully described in the Explanatory Note, as well as in Note 3 to the Consolidated Financial Statements of our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, we have restated our financial statements for the full 2002 fiscal year, the first, second, and third fiscal quarters of 2003, the full 2003 fiscal year, and the first and second fiscal quarters of 2004.

As described more fully in our Management’s Report On Internal Control Over Financial Reporting set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004, management assessed the effectiveness of our internal control over financial reporting as of December 31, 2004, and this assessment identified internal control deficiencies that individually or collectively are indicative of a material weakness in our internal control over financial reporting. Management currently is implementing certain remedial measures identified in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2004, and intends to implement the remaining remedial measures during the course of 2005. While this implementation is underway, we are relying on extensive manual procedures and the utilization of outside accounting professionals to assist us with meeting the objectives otherwise fulfilled by an effective controls environment. While we are implementing changes to our controls environment, there remains a risk that the transitional procedures on which we are currently relying will fail to be sufficiently effective to address the internal control deficiencies identified in

Management’s Report On Internal Control Over Financial Reporting. Please see Part I, Item 2. “Management’s Discussion and Analysis—Risk Factors—Our internal controls and procedures need to be improved.”

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. In light of the internal control deficiencies referenced in the Management’s Report On Internal Control Over Financial Reporting, our Chief Executive Officer and our Chief Financial Officer, believe that, as of the period covered by this report, our disclosure controls and procedures were not effective in alerting our management, including our principal executive officer and principal financial officer, to material information required to be included in our periodic reports filed with the Securities and Exchange Commission. However, our Chief Executive Officer and our Chief Financial Officer believe that the remedial measures described in Item 9A of our Annual Report on Form 10-K for the year ended December 31, 2004, when implemented, will be designed to address the internal control deficiencies described in the Management’s Report On Internal Control Over Financial Reporting and should allow us to conclude that our disclosure controls and procedures are effective at a reasonable level of assurance at future filing dates.

As of the end of the period covered by this report there were no changes in internal control over financial reporting that occurred during the last fiscal quarter of such period that materially affected, or were 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. On October 13, 2004, the Court certified a class in six of the approximately 300 other nearly identical actions and noted that the decision is intended to provide strong guidance to all parties regarding class certification in the remaining cases. Plaintiffs have not yet moved to certify a class in the Autobytel case. Autobytel has approved a settlement agreement and related agreements which set forth the terms of a settlement between Autobytel, the plaintiff class and the vast majority of the other approximately 300 issuer defendants. Among other provisions, the settlement provides for a release of Autobytel and the Autobytel Individual Defendants for the conduct alleged in the action to be wrongful. Autobytel would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims Autobytel may have against its underwriters. The settlement agreement also provides a guaranteed recovery of $1 billion to plaintiffs for the cases relating to all of the approximately 300 issuers. To the extent that the underwriter defendants settle all of the cases for at least $1 billion, no payment will be required under the issuers’ settlement agreement. To the extent that the underwriter defendants settle for less than $1 billion, the issuers are required to make up the difference. It is anticipated that any potential financial obligation of Autobytel to plaintiffs pursuant to the terms of the settlement agreement and related agreements will be directly covered and paid by its insurance carriers. Autobytel currently is not aware of any material limitations on the expected recovery of any potential financial obligation to plaintiffs from its insurance carriers. Its carriers are solvent, and Autobytel is not aware of any uncertainties as to the legal sufficiency of an insurance claim with respect to any recovery by plaintiffs. Therefore, we do not expect that the settlement will involve any payment by Autobytel. If material limitations on the expected recovery of any potential financial obligation to the plaintiffs from Autobytel’s insurance carriers should arise, Autobytel’s maximum financial obligation to plaintiffs pursuant to the settlement agreement would be less than $3.4 million. On February 15, 2005, the Court granted preliminary approval of the settlement agreement, subject to certain modifications consistent with its opinion. The Court ruled that the issuer defendants and the plaintiffs must submit a revised settlement agreement which provides for a mutual bar of all contribution claims by the settling and non-settling parties and does not bar the parties from pursuing other claims. The issuers and plaintiffs have negotiated a revised settlement agreement consistent with the Court’s opinion and are in the process of obtaining approval from those issuer defendants that are not in bankruptcy. At this point, all but one of the issuer defendants that are not in bankruptcy have approved the revised settlement agreement, which has been submitted to the Court. The underwriter defendants will have an opportunity to object to the revised settlement agreement. There is no assurance that the Court will grant final approval to the settlement. If the settlement agreement is not approved and Autobytel is found liable, we are unable to estimate or predict the potential damages that might be awarded, whether such damages would be greater than our insurance coverage, or whether such damages would have a material impact on our results of operations, financial condition or cash flows in any future period.

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

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

Between October and December 2004, five separate purported class actions were filed in the United States District Court for the Central District of California against us and certain of our current directors and current and former officers. The claims were brought on behalf of stockholders who purchased shares during the period July 24, 2003 through October 21, 2004. The claims alleged in all of these purported class actions are virtually identical, and purport to allege violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. In this regard, the plaintiffs allege that we misrepresented and omitted material facts with respect to our financial results and operations during the time period between July 24, 2003 and October 20, 2004. The complaint seeks unspecified compensatory damages, and attorneys’ fees and costs, as well as accountants’ and experts’ fees.

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/ MICHAEL F. SCHMIDT
		Michael F. Schmidt *Chief Financial Officer* (Duly Authorized Officer, Principal Financial Officer, and Principal Accounting Officer)


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

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


		Page
	PART I. FINANCIAL INFORMATION

ITEM 1.	Consolidated Financial Statements (unaudited):

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

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

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

	Notes to Consolidated Financial Statements	10

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

ITEM 4.	Controls and Procedures	58

	PART II. OTHER INFORMATION

ITEM 1.	Legal Proceedings	60

ITEM 6.	Exhibits	62

Signatures		63


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

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

Total assets	$	160,093		$	160,717

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

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

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

Commitments and contingencies (Note 7.)

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

Total stockholders’ equity		133,192			136,067

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


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

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

Total costs and expenses		36,328			24,016

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

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

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

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

Diluted	$	(0.07	)	$	0.02

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

Diluted		41,905,848			42,592,070

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

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


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

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

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

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

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

Net cash provided by financing activities		—			2,419

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

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

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

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


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

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

		15,000		14,935		—		65

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

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

December 31, 2004:

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

		16,500		16,476		—		24

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

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


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

	$	27,000


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


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


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

Total revenue restatement adjustments		(139	)

Total revenue, as restated	$	24,618


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

Total restatement expense adjustments		(1,250	)

Net restatement adjustments		(1,389	)

Restated net income	$	676


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

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

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

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

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

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

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

Diluted	$	0.05		$	—		$	(0.03	)	$	0.02


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

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


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

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


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

	$	4,352		$	4,343


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


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

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


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

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


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


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


31.1		Chief Executive Officer Section 302 Certification of Periodic Report, dated May 31, 2005.

31.2		Chief Financial Officer Section 302 Certification of Periodic Report, dated May 31, 2005.

32.1		Chief Executive Officer and Chief Financial Officer Section 906 Certification of Periodic Report, dated May 31, 2005.