Form 10-K for Autobytel, Inc.

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 


 

(Mark One)

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

 

For the fiscal year ended December 31, 2006

 

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

 

For the transition period from              to             

 

Commission File Number 0-22239

 


Autobytel Inc.

(Exact Name of Registrant as Specified in Its Charter)

 


 

Delaware   33-0711569
(State of Incorporation)   (I.R.S. Employer Identification No.)

 

18872 MacArthur Boulevard

Irvine, California 92612-1400

(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code (949) 225-4500

 

Securities registered pursuant to Section 12(b) of the Act:

 

Common Stock, par value $0.001 per share   The NASDAQ Global Market
Title of Class   Name of exchange on which registered

 


 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes ¨    No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes ¨    No x

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ¨    Accelerated filer x    Non-accelerated filer ¨

 

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

 

Based on the closing sale price of $3.53 for our common stock on The NASDAQ Global Market on June 30, 2006, the aggregate market value of outstanding shares of common stock held by non-affiliates was approximately $146.0 million.

 

As of February 28, 2007, 43,041,954 shares of our common stock were outstanding.

 

Documents incorporated by reference. Portions of our Definitive Proxy Statement for the 2007 Annual Meeting, expected to be filed within 120 days of our fiscal year end, are incorporated by reference into Part III of this Annual Report on Form 10-K.

 



Autobytel Inc.

 

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006

 

         

Page

Number


Part I
Item 1   

Business

   1
Item 1A   

Risk Factors

   13
Item 1B   

Unresolved Staff Comments

   29
Item 2   

Properties

   29
Item 3   

Legal Proceedings

   29
Item 4   

Submission of Matters to a Vote of Security Holders

   33
Part II
Item 5   

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   34
Item 6   

Selected Consolidated Financial Data

   35
Item 7   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   36
Item 7A   

Quantitative and Qualitative Disclosures About Market Risk

   53
Item 8   

Financial Statements and Supplementary Data

   53
Item 9   

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

   53
Item 9A   

Controls and Procedures

   53
Item 9B   

Other Information

   55
Part III
Item 10   

Directors, Executive Officers and Corporate Governance

   56
Item 11   

Executive Compensation

   60
Item 12   

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   60
Item 13   

Certain Relationships and Related Transactions, and Director Independence

   63
Item 14   

Principal Accountant Fees and Services

   64
Part IV
Item 15   

Exhibits and Financial Statement Schedules

   66
    

Signatures

   67

 

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PART I

 

Item 1.    Business

 

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

 

Overview

 

We are an automotive media and marketing services company that helps dealers sell cars and services, and manufacturers build brands through efficient marketing and advertising primarily through the Internet. We own and operate automotive Web sites, including Autobytel.com®, Autoweb.com®, Car.comSM, CarSmart.com®, AutoSite.com® and CarTV.com®. We are among the largest automotive shopping content networks and reach millions of Internet visitors as they shop for vehicles and make their vehicle buying decisions. 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.

 

In March 2006, we announced that James E. Riesenbach, former Senior Vice President of AOL’s Search and Directional Media Group, joined us as President and Chief Executive Officer. Shortly after Mr. Riesenbach joined us, we began to implement a series of strategic initiatives, including programs to transition our business toward a more media-centric advertising-driven business model, increasing the focus on providing best-of-class marketing and media services for our dealer and manufacturer customers, and better capturing integration opportunities between our businesses. Toward that end, in 2007, we announced that we expect to launch our next generation consumer Web site, MyRide.comTM, in the first half of the year. We believe MyRide.com will be the first fully-integrated automotive vertical search web experience, and will provide consumers with a single comprehensive gateway to broad and relevant automotive information available on the Internet oriented toward the entire consumer automotive lifecycle—from finding and purchasing a new or used vehicle, enhancing a vehicle with parts and accessories, finding local in-market vehicle services, and accessing extensive multimedia and user-generated automotive content. We also expect MyRide.com to have one of the Internet’s most comprehensive used vehicle products, utilizing search-based technology to incorporate listings of millions of vehicles.

 

We provide tools and programs to automotive dealers and manufacturers to help them generate sales, enhance customer loyalty and reduce customer acquisition costs. We connect automotive marketers with the millions of vehicle shoppers visiting our branded Web sites (Autobytel.com, Autoweb.com, Car.com, CarSmart.com, AutoSite.com and CarTV.com) and third party Web sites (primarily search engines, automotive

 

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information providers and other auto related venues) each month. We provide dynamic marketing and advertising programs that allow manufacturers to interact with Internet vehicle shoppers as they shop for vehicles and make their vehicle buying decisions. Our intent is to garner an increasing share of the approximately $30 billion spent annually by dealers, dealer associations, aftermarket automotive suppliers and manufacturers on marketing and advertising services.

 

Dealers participate in our branded automotive lead generation networks by entering into contracts with us directly or through a major dealer group or an automotive manufacturer or its automotive buying service affiliate. In turn, we direct consumers to dealers in their local area based on the consumers’ vehicle preference. We expect our dealers to promptly provide consumers a haggle-free, competitive offer within 24 hours of being contacted by the customer. We recommend that each dealer have an employee whose principal responsibility is supervising the dealer’s Internet business, similar to the way in which most dealers have a new vehicle sales manager, a used vehicle sales manager and a service and parts department manager who are each responsible for those respective dealership functions. We believe that dealers who immediately respond to consumer inquiries, have readily available inventory and provide up-front competitive pricing benefit the most from our marketing services. We form our dealer relationships after analysis of automotive sales and demographic data in each region. We seek to maintain in our dealer networks the highest quality dealers within defined territories and may terminate dealers that do not comply with the standards we set.

 

Consumers come to our Web sites to research, compare and configure vehicles and to purchase vehicles through one of our network dealers. Once they are ready to buy a vehicle, consumers can submit a purchase request through any of our automotive Web sites and thereby connect to one or more of our participating dealers. Consumers can also shop for used vehicles at our branded Web sites by searching for a used vehicle according to the price, make, model, color, year and location of the vehicle. Consumers can submit credit questionnaires on our Car.com automotive Web site to be connected to a participating dealer or an automotive finance institution. The finance leads provide dealers with another direct channel of consumers, many of whom may not be able to secure loans from conventional lending sources.

 

We are a Delaware corporation. Our principal corporate offices are located in Irvine, California. Our common stock is listed on The NASDAQ Global Market under the symbol ABTL. Our corporate Web site is located at www.autobytel.com. Information on our Web site is not incorporated by reference in this Annual Report. At or through the Investor Relations section of our Web site we make available free of charge our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to these reports as soon as practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. Our Code of Conduct and Ethics for Employees, Officers and Directors is available at the Corporate Governance link of the Investor Relations section of our Web site.

 

Significant Business Developments

 

As described above, shortly after Mr. Riesenbach joined us as President and Chief Executive Officer we began to implement a series of strategic initiatives. As part of these initiatives, we expect to launch the MyRide.com Web site.

 

In 2006, we entered into a settlement agreement with Dealix Corporation relating to a lawsuit we commenced against Dealix for patent infringement. The agreement provides that Dealix will pay us a total of $20.0 million in settlement payments over three years. On March 13, 2007, we received an initial payment of $12.0 million. The agreement also provides for a license from us to Dealix and The Cobalt Group of patents and patent applications and mutual releases of claims. See “Item 3. Legal Proceedings” for more information regarding this matter.

 

In 2006, we began to explore strategic alternatives for our Retention Performance Marketing® (“RPM®”) business and our Automotive Information Center (“AIC”) data business. In February 2007, we announced that we sold the AIC data business to R. L. Polk & Co. We are continuing to explore strategic alternatives for the RPM business.

 

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In 2006, we announced that Michael Schmidt, our Chief Financial Officer, is expected to transition from his position upon the completion of our search for a new chief financial officer. In January 2007, we announced that Monty A. Houdeshell joined us as Executive Vice President, Finance, and will become Executive Vice President and Chief Financial Officer the day after the filing of this Annual Report on Form 10-K.

 

Industry Background

 

Online Commerce Opportunities.    Consumers have rapidly adopted the Internet as part of their car shopping and purchasing process and are expected to continue to do so in the future. According to Jupitermedia Corporation, by 2010, 35% of all new car sales will be Internet generated, up from 25% in 2005. Additionally, according to J.D. Power and Associates, in 2005 90% of new car buyers used a search engine during the car shopping process.

 

The Automotive Vehicle Market.    Automotive dealers operate in local markets and face significant state regulations and increasing business pressures. These fragmented markets are characterized by:

 

   

competitive sales within regional markets,

 

   

increasing advertising and marketing costs that continue to reduce dealer profits, and

 

   

large investments by dealers in inventory, real estate, construction, personnel and other overhead expenses.

 

The ongoing rapid adoption of the Internet by consumers during their vehicle purchasing process has resulted, in part, from the fact that consumers have traditionally entered into the highly negotiated sales process with relatively little information regarding manufacturer’s costs, leasing costs, financing costs, relative specifications and other important information. In addition, the ongoing growth of new vehicle sales generated online is, in part, an outgrowth of the high pressure sales tactics consumers associate with the traditional vehicle buying experience. Buying a vehicle is considered to be one of the most significant purchases a United States consumer makes.

 

The Autobytel Solution

 

We believe that our marketing services improve the vehicle purchasing process for dealers, automotive manufacturers and consumers. The Internet’s wide reach to consumers allows us to leverage our investment in branding and marketing across a very large audience to create qualified purchase requests for vehicles. For these reasons, we believe that the Internet represents the most efficient method of directing purchase requests to dealers. We believe our services enable dealers to reach consumers from an attractive demographic base, reduce marketing costs, increase consumer satisfaction and increase vehicle sales and car sale margins. We offer automotive manufacturers qualified car buyers to target during the consumer’s research and consideration phase. We offer consumers Web sites with quality automotive information, numerous tools to configure and compare this information, and a convenient and efficient car purchasing process.

 

We expect that the benefits for dealers, automotive manufacturers and consumers described below will be enhanced after the launch of MyRide.com.

 

Benefits to Dealers.    We believe we benefit dealers by reducing the dealers’ incremental marketing costs and increasing sales volume. We believe dealers’ personnel productivity could increase as a result of our services because we provide dealers access to potential purchasers who may be ready to buy or lease a vehicle. As a result, reaching these consumers and selling or leasing them vehicles costs the dealer little or no additional overhead expense, other than the fees paid to us and the personnel costs of a dedicated manager. We believe franchised new car retail dealers spend considerably less in marketing costs on each vehicle sold by using our new car marketing services than through traditional forms of marketing. Through our Web Control® product, we

 

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provide dealers with on-site technology to better track sales, inventory, customer solicitations, responses and other communications.

 

We direct consumers to dealers in their local area based on the consumers’ vehicle preference. We believe this provides dealers access to a large number of well informed, ready-to-buy consumers, which allows dealers to compete more effectively.

 

A majority of all dealers that participate in the Autobytel or CarSmart® network were assigned an exclusive geographic territory in such network based upon a specific vehicle make. A territory allocated by us to a dealer is generally larger than a territory assigned to a dealer by a manufacturer. In 2006, we began signing dealers to the Autobytel and CarSmart networks on a non-exclusive territorial basis. Autoweb retail dealers are not assigned exclusive territories to participate in the Autoweb network. Generally, Car.com retail dealers are not assigned exclusive territories to participate in the Car.com network.

 

Benefits to Manufacturers.    Manufacturers can influence car buyers’ decisions by targeting them during their research, consideration and decision process, in particular, by using our dynamic marketing programs. In addition, manufacturers can obtain purchase requests from us.

 

Benefits to Consumers.    Because our Web sites are continually updated and provide a large quantity of quality information, and because consumers have shown a preference for third-party Web sites and a preference for using the Internet during their car shopping experience, we believe our Web sites offer an efficient medium for consumers to learn about and shop for vehicles. Our Web sites provide consumers free of charge, up-to-date specifications and pricing information on vehicles and ready-to-print vehicle information summaries of each new make and model on the market. We also provide informative vehicle video reviews. In addition, our consumers gain easy access to valuable automotive information, such as dealer invoice pricing and tools consisting of a loan calculator to determine monthly payments, and helpful information to make a lease or buy decision. Our database of articles allows consumers to perform online library research by accessing documents, such as consumer and professional reviews. Various automotive information service providers, such as Kelley Blue Book, are also available on our Web sites to assist consumers with specific vehicle and related automotive decisions. Armed with such information, the consumer should be more confident and capable of making an informed and intelligent vehicle buying decision. We believe we offer consumers a significantly different vehicle purchasing experience from that of traditional methods. Consumers using our Web sites are able to shop for a vehicle and make decisions from the convenience of their own home or office. We expect dealers to provide consumers a haggle-free price quote within 24 hours after being contacted by the consumer and a high level of customer service.

 

Strategy

 

We intend to garner an increasing share of the approximately $30 billion spent annually by dealers, dealer associations, aftermarket automotive suppliers and manufacturers on marketing and advertising services. We intend to achieve this objective through the following principal strategies:

 

Develop a Media-Centric Business Model.    We believe that one of the key strengths of the Internet is its efficiency in delivering information to consumers. We further believe that those who can deliver information to consumers in the most effective and organized manner that addresses the consumer automotive lifecycle, which we define as purchase, ownership, enhancement and enthusiasm, will be able to enhance their business. MyRide.com is designed as the next generation automotive consumer experience to meet these objectives and to provide consumers with a fully integrated automotive vertical search experience. MyRide.com will provide a single comprehensive gateway to broad and relevant proprietary, licensed and Internet information related to the automotive lifecycle — from finding and purchasing a new or used vehicle, enhancing a vehicle with parts and accessories, finding local in-market vehicle services, and accessing extensive multimedia and user-generated automotive content. We expect that the MyRide.com product will enable us to attract and serve consumers during

 

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the automotive lifecycle and monetize their behavior by providing dealers, manufacturers and service and parts vendors with unique marketing and advertising opportunities in each part of the automotive lifecycle.

 

Increase the Quality and Quantity of Purchase Requests that Can Be Monetized.    We believe that increasing the quality and quantity of purchase requests that can be monetized is crucial to the long-term growth and success of our business. As part of our strategy to improve the quality of purchase requests, we continue to expand the breadth and depth of information and services available through our Web sites so that well-informed, ready-to-buy consumers can be directed to participating dealers. We are also investing in new initiatives to help drive an increasing number of qualified buyers to dealerships. By augmenting the volume of quality purchase requests, we are attempting to attract additional dealers to our networks, increase services provided to dealers, and solidify our relationships with existing dealers. Our strategy for increasing traffic to our Web sites and the number of purchase requests that can be monetized includes launching MyRide.com and forming and maintaining online sponsorships and alliances with Internet portals and search sites and with Internet automotive information providers.

 

Increase the Number of Profitable Relationships with Retail Dealers Using Our Marketing Services.    Since our inception we have invested heavily to build our dealer networks. We consider our dealer networks to be significant strategic assets where new services and products can be deployed. We believe that strengthening the size and quality of our retail dealer networks is important to the success and growth of our business. Our strategy is to increase the size of our retail dealer networks by attracting new dealers and strengthening relationships with existing dealers by:

 

   

increasing the monetizable volume and quality of purchase requests for new and used vehicles,

 

   

providing new and enhanced marketing, media, and CRM services and support that help dealers more effectively utilize the Internet to sell vehicles and services,

 

   

maintaining our training and support programs to participating dealers, and

 

   

providing dealer management reports to enhance dealership operations.

 

Increase Enterprise Sales to Major Dealer Groups and Automotive Manufacturers.    We believe that strengthening the size and quality of our relationships with major dealer groups and automotive manufacturers is important to the success and growth of our business. Our strategy is to provide major dealer groups, such as AutoNation, and automotive manufacturers, such as General Motors and Ford, with access to a large number of purchase-minded consumers. We have existing relationships with most automotive manufacturers and have an opportunity to expand these relationships into our other marketing services.

 

Strengthen the Advertising Component of our Business Model.    Our advertising sales effort is primarily targeted to vehicle manufacturers and automotive-related mass market consumer vendors. Using the targeted nature of Internet advertising, manufacturers can advertise their brands effectively to specific subsets of our consumers. Vehicle manufacturers can target advertisements to consumers who are researching vehicles, thereby increasing the likelihood of influencing their purchase decisions. We provide dynamic marketing programs that allow manufacturers to interact with Internet car shoppers as they make their car buying decisions. These programs include our CarTVSM ad program that enables manufacturers to present their television commercials to such Internet car shoppers. With the launch of My.Ride.com we expect to offer our advertising customers enhanced marketing and media services, and expect to offer a series of unique advertising opportunities for local dealers and other local automotive-related vendors.

 

Increase CRM Sales to Retail Dealers, Major Dealer Groups and Automotive Manufacturers.    We believe that providing CRM products and tools, such as Web Control, helps support and enhance the quality of our relationships with retail dealers, major dealer groups and automotive manufacturers and may contribute to the success and growth of our overall business. Our strategy is to provide retail dealers, major dealer groups and automotive manufacturers with quality CRM products and tools.

 

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Enter into Acquisitions and Strategic Alliances.    We intend to grow and advance our business and may do so, in part, through acquisitions and strategic alliances. We will continue to review strategic acquisitions and partnership opportunities. We believe that acquisitions and strategic alliances can allow us to increase market share, benefit from advancements in technology and strengthen our business operations by enhancing our offering of products and services. We may acquire businesses that increase our market share in the lead referral and other automotive marketing services businesses. In 2006, we entered into an agreement with AOL that made the Autobytel network the exclusive fulfillment network for the thousands of consumers who visit AOL Autos every month for assistance in obtaining new vehicle price quotes from their local dealers. In addition, to complement our core business and extend our product solutions, we may also acquire businesses primarily focused on automotive related Web sites, content and/or technologies.

 

Capturing Integration Opportunities Within Our Business.    We believe that our business can benefit from capturing integration opportunities. In 2006, we began to integrate the efforts of our sales forces selling purchase requests and the Web Control product. We believe this integration resulted in increased selling efficiencies and sales. We continue to analyze further integration opportunities within our business.

 

Explore Strategic Alternatives for Non-Core Assets.    We intend to focus our efforts to develop our media-centric business. As a result, from time to time we intend to explore strategic alternatives for what we believe are non-core-assets. As part of our continuing focus on our Internet and media-centric strategy, we sold the AIC data business in the beginning of 2007 and are exploring strategic alternatives for our RPM business.

 

Invest in Other Core Product Initiatives Designed to Improve Lead Quality and Dealer Margins.    We believe that expanding our products and services offered to both manufacturers and dealers is critical to establishing ourselves as the premier provider of online automotive marketing services. In 2006, we launched our new Rapid Response program, the first initiative of our “Keep in Touch” (KIT) services designed to make it easier for member dealers to manage and communicate with their online customer leads. The first program of its kind, Rapid Response automatically places phone calls to member dealers, immediately notifying them—generally within seconds—each time a customer requests a price quote from their dealership during normal business hours. This unique service generated significant improvements to customer response rates and sales among dealers who participated in the program’s beta testing. Participating dealers receive an online report that provides detailed reporting on their call activity, including all incoming numbers, which numbers they actually tried to connect with, and call results and duration. In 2007, we plan to launch an Email Manager pilot program, the second phase of KIT. The program is designed to automate long-term dealership follow up for consumer leads generated through our online Web services. When a customer submits an online request to purchase a vehicle at a member dealership, the program allows us to automatically follow up with a series of up to five fully customized, dealership-exclusive branded emails broadcast periodically over a 90-day period. We regularly refine our multi-level program to further qualify consumers we send to the dealers using our services. The Autobytel Quality Verification SystemSM (QVSSM) uses filters and validation processes to identify consumers with strong purchase intent and is designed to improve purchase request quality. 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 also developed a customized program for training dealers. The program teaches dealers to incorporate Internet sales, marketing, management and customer service techniques throughout the dealership. The program is designed to help the overall organization to sell more effectively to automotive consumers.

 

Continue to Build Brand Equity.    In the future we intend to focus the majority of our consumer branding efforts on MyRide.com. While we intend to maintain our network of branded Web sites for the foreseeable future, and users will have access to much of MyRide.com’s functionality on those branded Web sites, our long term goal is to make the MyRide.com property our flagship consumer property. As part of our branding, we plan to reposition the Autobytel.com brand as an industry-focused brand geared towards dealers and manufacturers, and will invest in building more awareness and equity for the brand among those groups. In the future, we intend to market and invest in creating brand equity, awareness and recognition for MyRide.com with consumers

 

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through a variety of media with a focus on Internet-based marketing. In addition, we also plan to advertise through traditional media, such as television, radio and print publications.

 

Provide the Highest Quality Consumer Experience On Our Web Sites.    We believe that consumer satisfaction and loyalty is heavily influenced by the consumer’s experience with our Web sites and with our dealers. In order to enhance our appeal to consumers, we intend to continue developing our Web sites by enhancing vehicle information usability and personalization. We also plan to continue compiling high quality content from third-party sources on our Web sites. We believe that consumer satisfaction with the vehicle purchasing experience is also essential to our success and the differentiation of our services from those of our competitors. We intend to continue to invest in our retail dealer training and support services to provide a consistent, high-quality alternative to the traditional vehicle buying process. We actively monitor participating retail dealers through ongoing consumer surveys and research conducted by our internal dealer support group. Retail dealers that fail to abide by our program guidelines or who generate repeated consumer complaints are reviewed and, if appropriate, terminated. We expect that MyRide.com will enhance the experience of our consumers and differentiate our services from those of our competitors.

 

Enforce and Strengthen our Intellectual Property Rights.    We intend to grow and advance our business, in part, through enforcing and strengthening our intellectual property rights. In 2004 we brought a claim for patent infringement against Dealix Corporation. We have entered into a settlement agreement with Dealix. The agreement provides that Dealix will pay us a total of $20.0 million in settlement payments over three years, $12 million of which has been paid. The agreement also provides for a license from us to Dealix and The Cobalt Group of patents and patent applications and mutual releases of claims. We cannot assure that our patents will be enforceable if subjected to litigation. We regard our trademarks, service marks, brand names and patents as important to our business and intend to protect and enforce our rights with respect to such intellectual property.

 

Programs, Products and Services

 

New Vehicle Purchasing Service.    Our new vehicle purchasing service enables consumers to shop for and select a new vehicle through our Web sites, Autobytel.com, Autoweb.com, Car.com, CarSmart.com, AutoSite.com and CarTV.com, by providing to consumers information about vehicles and the ability to connect with local dealers. In order to assist the consumer in shopping for a new vehicle, we provide a broad range of easy to use research tools, including the ability to research information such as pricing, features, specifications and colors. When consumers indicate they are ready to buy a vehicle, consumers can complete a purchase request online, which specifies the type of vehicle and accessories the consumers desire, along with the consumers’ contact information. We validate the consumer contact information using our proprietary Quality Verification System. We then route such information to one or more local participating dealers, if available, that sell the type of vehicle requested. We promptly return an e-mail message to the consumer with the dealership’s name and phone number and the name of the dedicated manager, if any, at the dealership. We expect retail dealers to contact the consumer within 24 hours of receiving the purchase request with a firm, haggle-free price quote for the requested vehicle. When consumers complete their purchase, they usually take delivery of their vehicle at the dealership showroom. Generally, within 10 days of the submission of a consumer’s purchase request, we contact the consumer again by e-mail to conduct a quality assurance survey that allows us to evaluate the sales process at participating retail dealers and improve the quality of dealer service.

 

Dealers participate in our networks by entering into contracts with us or through major dealer groups or automotive manufacturers or their automotive buying service affiliates with whom we have agreements. Generally, our retail dealer contracts are terminable on 30 days’ notice by either party. The majority of our retail fees consist of monthly subscription and transactional fees paid by dealers in our networks. We reserve the right to adjust our fees to retail dealers upon 30 days notice at any time during the term of the contract. We do not prevent dealers from entering into agreements with our competitors.

 

Used Car Program.    The used car program allows consumers to search for a certified or non-certified used vehicle according to specific search parameters, such as the price, make, model, mileage, year and location of the

 

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vehicle. The used car program locates and displays the description, location and, if available, actual digital photograph of vehicles that satisfy the search parameters. The consumer can then submit a purchase request for a specific vehicle and is contacted by the dealer to conclude the sale. We charge each dealer that participates in the used car program monthly subscription or transactional fees. The used car program provides participating dealers online purchase requests shortly after submission by consumers, as well as the ability to track their inventory on a real-time basis.

 

Autobytel’s Premium Pre-Owned program offers dealers preferred placement of their vehicle listings and greater advertising opportunities which gives dealers the ability to have more direct impact on consumers. Thumbnail photos of each vehicle listing, with multiple photo view options, are available along with links to the dealership’s Web site and online inventory. AutobytelConnect® is designed to help generate sales for dealers by listing a toll-free number next to each pre-owned vehicle. This allows consumers who prefer to speak with a representative of the dealership to call the representative directly. The “800” number can be routed to any land or mobile line, including a direct connection to the Internet department. All call activity is automatically recorded, enabling dealers to review every call, even if the call is busy, abandoned or after hours.

 

We expect that MyRide.com will have one of the Internet’s most comprehensive used vehicle products, utilizing search-based technology to incorporate listings of millions of vehicles. We believe MyRide.com will feature the Internet’s most advanced used car search tool, enabling MyRide.com shoppers to conduct uniquely precise searches across millions of pre-owned vehicle listings. The program is expected to offer powerful marketing advantages for dealers, including integrated pay-per-call pricing for eligible dealers, dealer specific inventory display, and sophisticated ad display and placement tools.

 

Finance Requests.    In addition to providing new and used car vehicle purchasing services, Car.com enables consumers to submit a credit questionnaire or request for financing. The finance requests are forwarded to the nearest participating dealer that offers financing or, if a dealer is not available, to an automotive finance institution. This program is designed to enable consumers, who may not be able to secure loans through conventional lending sources, to obtain financing and purchase their desired vehicle.

 

Web Control.    Our subsidiary, AVV, Inc. (AVV®) is a leading provider of dealership lead management tools, such as Web Control. Web Control is a customer management tool that enables dealers to manage Internet and walk-in sales activity, maintain customer history and activity, measure and report on marketing effectiveness, as well as establish automated marketing programs and customize sales process and workflow inside the dealership.

 

Automotive Download ServicesSM (ADSSM).    AVV provides dealers with data extraction services through ADS. ADS extracts data, including new and used car inventory and sales, service and finance records, from the dealership management system. Dealers use this service to post their inventory across the Internet, to report on and increase sales effectiveness, and to generate customer loyalty and retention marketing programs.

 

RPM.    The Retention Performance Marketing (RPM) product is designed to deliver a more efficient method for dealers and manufacturers to retain their car buying and service customers. The RPM product integrates advanced customer segmentation with personalized communications across multiple channels, including e-mail, telephone, Web sites and print media. The product filters the data in customer records, verifying contact information from within the dealership management system, then automatically outputs welcome letters or e-mails for new car buying and service customers. Service reminders and campaigns can then be sent out on a regular basis based on each customer’s specific spending, purchase and visitation habits. The product also offers clients a range of reporting and analysis capabilities. Each month, the dealership receives an executive summary that allows the dealership to measure results by showing gross revenue generated per active customer name and response rate. We are exploring strategic alternatives for our RPM business.

 

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Training.    We believe that dealers and their employees require specialized training to learn the skills necessary to serve the Internet user and take full advantage of our proprietary systems. Therefore, we have developed an extensive training program for dealers. We believe this training is critical to enhancing our brands and reputation. We encourage retail dealers to have their representatives trained on our system. Training is conducted at regional training locations and at dealerships’ premises. In training our retail dealers, we de-emphasize traditional vehicle selling techniques and emphasize our approach of immediately responding to consumer inquiries and providing up-front competitive no-haggle pricing. Our customized program for training dealers teaches dealers to incorporate Internet sales, marketing, management and customer service techniques throughout the dealership. The program is designed to help the overall organization to sell more effectively to automotive consumers who have visited the Internet.

 

Advertising Services.    We now have multiple Web site properties on which we offer media products to automotive manufacturers and related businesses. The Web sites attract an audience of car-shopping and car-buying consumers that advertisers can target during the vehicle purchasing decision. A primary way advertisers use our Web sites to reach these consumers is through vehicle content targeting. This allows automotive marketers to reach users while they are researching specific vehicles during the shopping and buying process on our network. Most advertisers use this capability to match their own brand advertising against the same vehicle pages that users are browsing during the research process. This form of placement is also referred to as retention targeting in the online automotive industry. It enables the advertiser to communicate highly relevant messaging to users while they are researching the vehicle of interest to them. If available, some advertisers will seek to buy inventory of other competing automotive brand pages in order to achieve their objectives in capturing new market share. In supporting more brand driven objectives, we sell advertising that consists of fixed ad placement and anchor tenant opportunities. An example is the Featured Model Showcase that runs on our home page and includes an integrated module that showcases a specific vehicle. Unlike typical banner ads, the consumer is linked to a mini-site or showroom or to a specific product page on the advertiser’s site where he or she can receive more specific information on the vehicle from the advertiser. We offer other packages with similar combinations of integrated ad units targeted to key areas of our Web sites, including new, used and certified pre-owned sections. We have a direct marketing platform that helps manufacturers target in-market consumers during the often-extended car shopping process. Designed to keep the brand in consideration, Autobytel Direct allows automotive marketers to deliver specific communications through either email and postal formats to in-market consumers during their purchase cycle. If the advertiser goal is to reach out to new potential customers or retain existing interested consumers, Autobytel Direct provides an effective way to access ready to buy consumers who are still in the decision making process.

 

Service and Maintenance.    We believe our Web sites empower consumers with access to information and research for dealing with common service and maintenance issues.

 

Consumer Products and Other Services.    We offer automotive related products and services, including insurance and finance, that we market to consumers through our Web sites on behalf of participating third-party providers.

 

International.    We do not expect to devote substantial resources to international operations, but may continue to explore additional licensing business as opportunities arise.

 

Seasonality

 

Traditionally, our purchase request volume fluctuates with automotive industry sales volume that has some measure of seasonality. Typically volume is highest in the spring and summer, with lower volume in the fall and winter months.

 

9


Intellectual Property

 

We have registered service marks, including Auto-By-Tel, Autobytel.com, Autoweb, CarSmart and the Autobytel.com logo and have applied for registered service marks for MyRideTM and MyRide.comTM. We have been issued a patent directed toward an innovative method and system for forming and submitting purchase requests over the Internet and other computer networks from consumers to suppliers of goods and services. The method permits suppliers of goods or services to provide enhanced customer service by making the purchasing process convenient for consumers as well as suppliers. The patent is also directed toward the communication system used to bring consumers and suppliers closer together. The patent expires on January 14, 2019. We have also been issued a patent relating to online aftermarket accessory shopping. We cannot assure that the patents will be enforceable if subjected to litigation. We have applied for additional service marks and patents. We regard our trademarks, service marks, brand names and patents as important to our business and intend to protect and enforce our rights with respect to such intellectual property.

 

Competition

 

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. Competition continued to intensify in 2006 as key competitors continued to pursue the best quality consumer leads through strategic relationships, pricing, search marketing programs, and other tactics. Our business is characterized by minimal 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 that 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. Such companies, including vehicle dealers, may already maintain or may introduce Web sites that 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 and Ford Motor Company in its partnership with its dealers through FordDirect.com. The Web Control product competes with products from companies such as Reynolds and Reynolds and The Cobalt Group. Our customer relationship management product, RPM, competes with products from other companies that provide marketing services to automotive manufacturers and dealers, including Reynolds and Reynolds, TVI Inc., Minacs, Online Administrators and Teletech.

 

We believe that the principal competitive factors in the online market are:

 

   

brand recognition,

 

   

dealer return on investment,

 

   

lead quality,

 

   

prices of products and services,

 

   

speed and quality of fulfillment,

 

   

strength of intellectual property,

 

   

field sales and customer support,

 

   

dealer territorial coverage,

 

10


   

relationships with automotive manufacturers,

 

   

variety of integrated products and services,

 

   

ease of use,

 

   

customer satisfaction,

 

   

quality of Web site content,

 

   

quality of service, and

 

   

technical expertise.

 

We cannot assure that we can compete successfully against current or future competitors, many of which have substantially more technical and financial resources as well as existing brand recognition. 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.

 

Operations and Technology

 

We believe that our future success is significantly dependent upon our ability to continue to deliver high-performance, reliable and comprehensive Web sites, enhance consumer/dealer communications, maintain the highest levels of information privacy and ensure transactional security. We currently host all our Web sites at secure data center third-party hosting facilities. The data centers include redundant power infrastructure, redundant network connectivity, fire detection and suppression systems and security systems to prevent unauthorized access. Our network and computer systems are built on industry standard technology. Network security utilizes industry standard products and practices.

 

System enhancements are primarily intended to accommodate increased traffic across our Web sites, improve the speed in which purchase requests are processed and introduce new and enhanced products and services. System enhancements entail the implementation of sophisticated new technology and system processes. We intend to make investments in technology as we believe appropriate.

 

Government Regulation

 

Currently few laws or regulations have been adopted that apply directly to Internet business activities. The adoption of additional local, state or national laws or regulations may decrease the growth of Internet usage or the acceptance of Internet commerce.

 

We believe that our dealer marketing services do not constitute franchising or vehicle brokerage activity in a way that makes franchise, motor vehicle dealer, or vehicle broker licensing laws applicable to us. Through a subsidiary, we are licensed as a motor vehicle dealer and broker. However, if individual state regulatory requirements are deemed applicable to us or change, or additional requirements are imposed on us, we may be required to modify our service programs in that state in a manner that may undermine our program’s attractiveness to consumers or dealers, not offer such service, or terminate our operations in that state, any of which may negatively affect our financial condition and growth. As we introduce new services, we may need to comply with additional licensing regulations and regulatory requirements.

 

Our services may result in changes in the way vehicles are currently sold or may be viewed as threatening by new and used vehicle dealers that do not subscribe to our programs. Such businesses are often represented by influential lobbying organizations, and such organizations or other persons may propose legislation that, if adopted, could impact our evolving marketing and distribution model.

 

To date, we have not expended significant resources on lobbying or related government affairs issues, but may do so in the future.

 

11


Franchise Classification.    If our relationships or written agreements with our dealers were found to be franchises under federal or state franchise laws, we could be subjected to additional regulations, including, but not limited to, licensing and increased reporting and disclosure requirements. Compliance with varied laws, regulations, and enforcement characteristics found in each state may require us to allocate both staff time and monetary resources, each of which may adversely affect our results of operations. As an additional risk, if our dealer relationships or subscription agreements are determined to establish franchises, we may be subject to limitations on our ability to quickly and efficiently effect changes in our dealer relationships in response to changing market trends, which may negatively impact our ability to compete in the marketplace.

 

We believe that neither our relationship with our participating dealers nor our dealer agreements themselves constitute franchises under federal or state franchise laws. This belief has been upheld by a Federal Appeals Court in Michigan that ruled our business relationship and our dealer subscription agreement do not rise to the level of a franchise under Michigan law.

 

Vehicle Brokerage Activities.    We believe that our dealer marketing referral service model does not qualify as an automobile brokerage activity. Accordingly, we believe that state motor vehicles dealer or broker licensing laws generally do not apply to us. In the event such laws are deemed applicable to us, we may be required to cease business in any such state, and pay administrative fees, fines, and penalties for failure to comply with such licensing requirements.

 

In response to concerns about our marketing referral program raised by the Texas Department of Transportation, we modified our program in that state to achieve compliance. These modifications included implementing a pricing model under which all participating dealerships (regardless of brand) in a given zip code in Texas are charged uniform fees and opening our program to all dealerships that wish to apply.

 

In the event any other state’s regulatory requirements impose state specific 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 that may undermine the program’s attractiveness to consumers or dealers. In the alternative, if we determine that the licensing and related requirements are overly burdensome, we may elect to terminate operations in such state. In each case, our business, results of operations and financial condition could be materially and adversely affected.

 

Financing Related Activities.    We provide a connection through our Web sites that allows a consumer to obtain finance information and submit requests for loans to third parties. We receive marketing fees from financial institutions or dealers in connection with this advertising activity. We do not demand nor do we receive any fees from consumers for this service. In the event states require us to be licensed as a financial broker, we intend to obtain such licenses. We may be unable to comply with a state’s regulations affecting our current operations or newly introduced services, or we could be required to incur significant fees and expenses to obtain any required license or be compelled to discontinue such operations in those states.

 

Insurance Related Activities.    We provide links on our Web sites to various third parties so that consumers can receive quotes for insurance coverage and extended warranty coverage from third parties and submit quote applications online through such parties’ Web sites. We receive marketing fees from such participants in connection with this advertising activity. We receive no premiums from consumers nor do we charge consumers fees for our services. All applications are completed on the respective insurance carriers’ or other third parties’ Web sites.

 

We do not believe that our activity requires 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 this uncertainty, we have proactively applied for and currently hold, through a wholly-owned subsidiary, insurance agent licenses or are otherwise authorized to engage in the sale of insurance in certain states.

 

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Employees

 

As of February 28, 2007, we had 364 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.

 

Item 1A.    Risk Factors

 

In addition to the factors discussed in the “Overview” and “Liquidity and Capital Resources” sections of Part II “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Annual Report on Form 10-K, 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 2005 and 2006 and cannot assure that we will be profitable in the future. If we are unable to achieve profitability in the future and we continue to lose money, our operations will not be financially viable.

 

Because of the relatively recent emergence of the Internet-based vehicle information and shopping industry, none of our senior executives have 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 2005 and 2006. We cannot assure that we will be profitable in the future. We had an accumulated deficit of $186.1 million as of December 31, 2006.

 

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:

 

   

generate increased vehicle shopper and buyer traffic to our Web sites,

 

   

successfully introduce new products and services,

 

   

continue to send new and used vehicle purchase requests to dealers that result in sufficient dealer transactions to justify our fees,

 

   

expand the number of dealers in our networks and enhance the quality of dealers,

 

   

sustain and expand our relationships with automotive manufacturers,

 

   

respond to competitive developments,

 

   

maintain a high degree of customer satisfaction,

 

   

provide secure and easy to use Web sites for customers,

 

   

increase visibility of our brand names,

 

   

defend and enforce our intellectual property rights,

 

   

identify and successfully consummate and integrate acquisitions,

 

   

design and implement effective internal control systems,

 

   

continue to attract, retain and motivate qualified personnel, and

 

   

continue to upgrade and enhance our technologies to accommodate expanded service offerings and increased consumer traffic.

 

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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.

 

Our internal controls and procedures need to be improved.

 

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 for external purposes in accordance with generally accepted accounting principles. In making its assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006, management used the criteria described in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 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 a material weakness in our internal control over financial reporting as of December 31, 2006. The material weakness relates to not having a sufficient complement of personnel with the appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles commensurate with our financial reporting which contributed to an individual material weakness in accounting for accrued liabilities and related fixed assets and prepaid expense accounts. Further, the material weakness identified resulted in an adverse opinion by our independent registered public accounting firm on the effectiveness of our internal control over financial reporting as of December 31, 2006.

 

Management determined that we had material weaknesses in our internal control over financial reporting as of December 31, 2005 and 2004. Because of these material weaknesses, management was unable to conclude that we maintained effective internal control over financial reporting as of December 31, 2005 and 2004 based on the criteria in the Internal Control–Integrated Framework. Further, material weaknesses identified resulted in adverse opinions by our registered public accounting firm on the effectiveness of our internal control over financial reporting as of December 31, 2005 and 2004.

 

If we are unable to substantially improve our internal control over financial reporting, our ability to report our financial results on a timely and accurate basis could be adversely affected. If our financial statements are not fairly presented, investors may not have a complete understanding of our operating results and financial condition. If our financial statements are not timely filed with the Securities and Exchange Commission, we could be delisted from The NASDAQ Global Market. If either or both of these events occur, it could have a material adverse affect on our ability to operate our business. Please see Part II “Item 9A. Controls and Procedures” for more information regarding the measures we have commenced to implement, and which we intend to implement during the course of 2007, which are designed to remediate such deficiencies in our internal controls described in our “Management’s Report on Internal Control Over Financial Reporting” set forth on page F-2 of this Annual Report on Form 10-K. The costs of remediating such deficiencies in our internal controls could adversely affect our financial condition and the results of operations. In addition, even after remedial measures discussed in Part II “Item 9A. Controls and Procedures” are fully implemented, our internal controls may not prevent all potential errors 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 derivative and other litigation may be material. We are also subject to the risk of additional litigation in connection with the restatement of our consolidated financial statements and the potential liability from any such litigation could materially and adversely affect our business.

 

We 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.

 

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Certain of our present and former directors and certain former officers 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 principles and SEC 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. Plaintiffs filed and served an Amended Derivative Complaint on July 29, 2005. Defendants filed and served a motion to stay and a demurrer in October 2005. On November 29, 2005, the court granted the motion to stay and set a status conference for March 1, 2006. On February 22, 2006, the parties stipulated to continue the March 1, 2006 status conference, and the court approved the stipulation. The parties negotiated a settlement of the action and submitted it for court approval in November 2006. The court has held a series of status conferences since the settlement was submitted, and a further status conference to discuss the settlement is currently scheduled for April 25, 2007. If the settlement is not finalized for any reason, or the court does not approve the settlement, once the stay is lifted, 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.

 

On October 21, 2005, we received a complaint as well as a demand for arbitration/statement of claim filed by certain former shareholders of Stoneage Corporation (Stoneage). The complaint was filed in the Central District of California and names us as well as certain current and former officers and directors as defendants. The demand for arbitration was filed with the American Arbitration Association and names the same group of defendants. The allegations and claims in both of these matters are virtually identical, and stem from the acquisition of Stoneage by us on April 15, 2004. Both the complaint and demand for arbitration contain causes of action for: breach of the acquisition agreement, breach of the registration rights agreement, violations of California Corporations Code Sections 25401 and 25501, violations of California Corporations Code Sections 25400 and 25500, fraud, negligent misrepresentation, fraudulent concealment, and violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The demand for arbitration also contains a cause of action for violation of Section 17(a) of the Securities Act of 1933. The complaint and demand for arbitration seek unspecified damages and attorneys’ fees and costs, as well as rescission and punitive awards. The defendants have not responded to either the complaint or demand for arbitration. On November 29, 2005, the parties requested that the arbitration be stayed, and on February 8, 2006, the plaintiffs dismissed the complaint without prejudice. Although the parties are engaged in ongoing mediation efforts, the plaintiffs recently requested that the arbitration stay be lifted. If the parties are unable to negotiate a resolution of this matter, we will defend these claims vigorously. We cannot currently predict the outcome of this litigation, which, depending on the outcome, may have a material impact on our results of operations, financial condition or cash flows.

 

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. As of the date hereof, we are not aware of any additional litigation having been commenced against us related to these matters, but we cannot predict whether any such litigation will be commenced or, if it is, the outcome of any such litigation. The initiation of any additional securities litigation, together with the lawsuits described above, may also harm our business and financial condition.

 

Until the existing derivative and other litigation or any additional litigation are 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.

 

15


We are currently involved in ongoing litigation that, until resolved and unless resolved on terms that are favorable to us, could materially and adversely affect our financial condition, results of operations, and cash flow.

 

We are involved in a number of legal proceedings and until all such actions are resolved, we could incur substantial expenses in connection with ongoing litigation, including substantial fees for attorneys and other professional advisors. In addition, unless the actions are resolved on terms that are favorable to us, we could incur substantial expenses in connection with such litigation, which may include costs associated with any negative judgments or awards. We are also obligated to indemnify our current and former officers and directors named as defendants in such actions. These expenses, to the extent not covered by available insurance, could materially and adversely affect our financial condition, results of operations, and cash flows.

 

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 have and expect to continue to replace certain of our executive officers during 2006 and 2007. If we are unable to effectively integrate new executive officers our business, results of operations and financial condition may be materially adversely affected.

 

If a more media-centric advertising-driven business model, including launching the MyRide.com Web site, is not successful, we may not be able to be profitable in the future.

 

In 2006, we began to implement a series of strategic initiatives, including programs to transition our business toward a more media-centric advertising-driven business model. Towards that end, we expect to launch the MyRide.com Web site and other products and services this year. Demand and market acceptance for newly introduced services and products over the Internet are subject to uncertainty and we have no assurance that consumers and other automotive participants will accept and use our new products and services. If consumers and other automotive participants fail to accept and use our new products and services or acceptance is at a lower level than anticipated, our strategy of focusing on a more media-centric advertising-driven business model will not be successful. Accordingly, we cannot assure that we will be profitable in the future.

 

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

 

The majority of our revenues is derived from fees paid by our networks of participating retail and enterprise dealers. A few agreements account for substantially all of our enterprise dealers. 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

 

16


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.com, CarSmart.com 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. 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.

 

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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. Competition continued to intensify in 2006 as key competitors continued to pursue the best quality consumer leads through strategic relationships, pricing, search marketing programs, and other tactics. Our business is characterized by minimal 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. Such companies, including vehicle dealers, 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 and Ford Motor Company in its partnership with its dealers through FordDirect.com. The Web Control product competes with products from companies such as Reynolds and Reynolds and The Cobalt Group. Our customer relationship management product, RPM, competes with products from other companies that provide marketing services to automotive manufacturers and dealers, including Reynolds and Reynolds, TVI Inc., Minacs, Online Administrators and Teletech.

 

We believe that the principal competitive factors in the online market are:

 

   

brand recognition,

 

   

dealer return on investment,

 

   

lead quality,

 

   

prices of products and services,

 

   

speed and quality of fulfillment,

 

   

strength of intellectual property,

 

   

field sales and customer support,

 

   

dealer territorial coverage,

 

   

relationships with automotive manufacturers,

 

   

variety of integrated products and services,

 

   

ease of use,

 

   

customer satisfaction,

 

   

quality of Web site content,

 

   

quality of service, and

 

   

technical expertise.

 

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We cannot assure that we can compete successfully against current or future competitors, many of which have substantially more technical and financial resources as well as existing brand recognition. 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:

 

   

our ability to retain existing dealers, attract new dealers and maintain dealer and customer satisfaction,

 

   

the announcement or introduction of new or enhanced sites such as MyRide.com, services and products by us or our competitors,

 

   

general economic conditions and economic conditions specific to the Internet, online commerce or the automotive industry,

 

   

a decline in the usage levels of online services and consumer acceptance of the Internet and commercial online services for the purchase of consumer products and services such as those offered by us,

 

   

our ability to upgrade and develop our systems and infrastructure and to attract new personnel in a timely and effective manner,

 

   

the level of traffic on our Web sites and other sites that refer traffic to our Web sites,

 

   

technical difficulties, system downtime, Internet brownouts or electricity blackouts,

 

   

the amount and timing of operating costs and capital expenditures relating to expansion of our business, operations and infrastructure,

 

   

costs of ongoing litigation and any adverse judgments resulting from such litigation,

 

   

costs of defending and enforcing our intellectual property rights,

 

   

governmental regulation, and

 

   

unforeseen events affecting the industry.

 

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.

 

Traditionally, our purchase request volume fluctuates with automotive industry sales volume that has some measure of seasonality. Typically volume is highest in the spring and summer, with lower volume in the fall and winter months. 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.

 

Employee pricing and other actions by manufacturers that promote transparent pricing may decrease the perceived value of our services to consumers and dealers. If the number of consumers and dealers who use our services declines, our revenues will decrease.

 

In the summer of 2005, some manufacturers introduced programs allowing all consumers to purchase new vehicles at prices offered to employees. Employee pricing and future actions by manufacturers that promote

 

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transparent pricing may negatively affect the perceived value of our services to consumers and dealers. A decline in the perceived value of our services to consumers and dealers may result in a decline in demand for our services, which could adversely affect our business, financial condition and results of operations.

 

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 customers 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, energy prices and interest rates in regional and local markets). 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, energy prices or a general tightening of lending may affect us more significantly than companies in other industries. In addition, if any of our larger customers were to become insolvent because of economic conditions in the automotive industry, our business, results of operations and financial condition may be materially and adversely affected.

 

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 us or 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 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

 

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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 advertising relationships with 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 MyRide.com, 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 and services, 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.

 

We are a relatively new business in an emerging industry and need to manage the introduction of new products and services 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. Introducing new or enhanced products and services, such as MyRide.com, 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.

 

We must also:

 

   

test, introduce and develop new services and products, including enhancing our Web sites,

 

   

expand the breadth of products and services offered,

 

   

expand our market presence through relationships with third parties, and

 

   

acquire new or complementary businesses, products or technologies.

 

We cannot assure that we can successfully achieve these objectives.

 

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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 generally do not apply to us. 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 for referral of purchase requests. 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 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 certain 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.

 

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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. 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 or business, 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.

 

Acquisitions involve numerous risks. For example:

 

   

It may be difficult to assimilate the operations and personnel of an acquired business into our own business,

 

   

Management information and accounting systems of an acquired business must be integrated into our current systems,

 

   

We may lose dealers participating in both our network as well as that of the acquired business, if any,

 

   

Our management must devote its attention to assimilating the acquired business which diverts attention from other business concerns,

 

   

We may enter markets in which we have limited prior experience, and

 

   

We may lose key employees of an acquired business.

 

Government regulations may result in increased costs that may reduce our future earnings.

 

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.

 

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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 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 ADS production servers and certain related systems, our production Web sites and certain systems, including Autobytel.com, Autoweb.com, CarSmart.com, AutoSite.com, Car.com, Finance.Car.com, AVV.com, iDriveonline and RPM are currently hosted at secure third-party hosting facilities. We host the ADS production servers at a company owned facility.

 

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 secure facilities 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 $9.0 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-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

 

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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. 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:

 

   

actual or anticipated variations in our quarterly operating results,

 

   

historical and anticipated operating metrics such as the number of participating dealers, the visitors to our Web sites and the frequency with which they transact,

 

   

announcements of new product or service offerings,

 

   

technological innovations,

 

   

competitive developments, including actions by automotive manufacturers,

 

   

changes in financial estimates by securities analysts or our failure to meet such estimates,

 

   

conditions and trends in the Internet, electronic commerce and automotive industries,

 

   

our ability to comply with the conditions to continued listing of our stock on The NASDAQ Global Market,

 

   

adoption of new accounting standards affecting the technology or automotive industry, and

 

   

general market conditions and other factors.

 

Further, the stock markets, and in particular The NASDAQ Global Market, have experienced 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 affected and may adversely affect the market price of our common stock. In addition, general economic, political and market conditions, such as recessions, interest rates, energy prices, 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 marketed and 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.

 

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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.

 

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

 

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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 to protect one of our patents and have since entered into a settlement agreement relating thereto. Future 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 or use of services through direct links to or from our Web sites or on 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 liability insurance may not cover all potential claims to which we are exposed and may not

 

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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 “Item 3. 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 rights holders, except the acquirer, will be entitled to acquire at the then exercise price of a right that number of shares of our 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 right holders, other than the acquirer, 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

 

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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.

 

Item 1B.    Unresolved Staff Comments

 

None.

 

Item 2.    Properties

 

Our headquarters are located in a single office complex in Irvine, California. We lease a total of approximately 63,000 square feet. The lease expires in September 2010. AVV is located in a single office building in Westerville, Ohio and occupies approximately 14,600 square feet. The lease expires in September 2009. Car.com is located in a single suite in an office building in Troy, Michigan and occupies approximately 4,700 square feet. The lease expires in January 2011. CarTV is located in an industrial building in Santa Ana, California and occupies approximately 3,600 square feet. The lease expires in February 2008.

 

We believe that our existing facilities are adequate to meet our needs and that existing needs and future growth can be accommodated by leasing alternative or additional space.

 

Item 3.    Legal Proceedings

 

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 the Company’s current and former directors and officers (the “Autobytel Individual Defendants”) and underwriters involved in the Company’s initial public offering. The complaints against the Company 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 the Company’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 the Company’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 the Company. On October 13, 2004, the Court certified a class in six of the approximately 300 other nearly identical actions (the “focus cases”) and noted that the decision is intended to provide strong guidance to all parties regarding class certification in the remaining cases. The Underwriter defendants appealed the decision and the Second Circuit vacated the district court’s decision granting class certification in those focus cases on December 5, 2006. Plaintiffs have not yet moved to certify a class in our case.

 

The Company 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. It is unclear what impact the Second Circuit’s decision vacating class certification in the focus cases will have on the settlement, which has not yet been finally approved by the Court. On December 14, 2006, Judge Scheindlin held a hearing. Plaintiffs informed the Court that they planned to file a petition for rehearing and

 

29


rehearing en banc. The Court stayed all proceedings, including a decision on final approval of the settlement and any amendments of the complaints, pending the Second Circuit’s decision on plaintiffs’ petition for rehearing. Plaintiffs filed the petition for rehearing and rehearing en banc on January 5, 2007.

 

Among other provisions, if it is finally approved by the Court, the issuers’ settlement provides for a release of the Company and the Autobytel Individual Defendants for the conduct alleged in the action to be wrongful. The Company would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release certain potential claims the Company may have against its underwriters. The settlement agreement also provides a guaranteed recovery of one billion dollars 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 one billion dollars, 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. On April 20, 2006, JPMorgan Chase and the plaintiffs reached a preliminary agreement to settle for $425 million. The JPMorgan Chase preliminary agreement has not yet been approved by the Court. In an amendment to the issuers’ settlement agreement, the issuers’ insurers agreed that the JPMorgan preliminary agreement, if approved, would offset the insurers’ obligation to cover the remainder of plaintiffs’ guaranteed $1 billion recovery by 50% of the value of the JP Morgan settlement, or $212.5 million. Therefore, if the JP Morgan preliminary agreement to settle is finalized, and then preliminarily and finally approved by the Court, then the maximum amount that the issuers’ insurers will be potentially liable for is $787.5 million. It is unclear what impact the Second Circuit’s decision vacating class certification in the focus cases will have on the JP Morgan preliminary agreement.

 

It is anticipated that any potential financial obligation of the Company to plaintiffs pursuant to the terms of the issuers’ settlement agreement and related agreements will be directly covered and paid by its insurance carriers. The Company 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 the Company is not aware of any uncertainties as to the legal sufficiency of an insurance claim with respect to any recovery by plaintiffs. Therefore, the Company does not expect that the settlement will involve any payment by the Company. If material limitations on the expected recovery of any potential financial obligation to the plaintiffs from the Company’s insurance carriers should arise, the Company’s maximum financial obligation to plaintiffs pursuant to the settlement agreement would be less than $3.4 million. However, if the JPMorgan Chase preliminary agreement is finalized, then preliminarily and finally approved by the Court, the Company’s maximum financial obligation would be less than $2.7 million.

 

There is no assurance that the Court will grant final approval to the issuers’ settlement. If the settlement agreement is not approved and the Company is found liable, the Company 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 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.

 

30


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 the focus cases and noted that the decision is intended to provide strong guidance to all parties regarding class certification in the remaining cases. The Underwriter defendants appealed the decision and the Second Circuit vacated the district court’s decision granting class certification in those focus cases on December 5, 2006. 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. It is unclear what impact the Second Circuit’s decision vacating class certification in the focus cases will have on the settlement, which has not yet been finally approved by the Court. On December 14, 2006, Judge Scheindlin held a hearing. Plaintiffs informed the Court that they planned to file a petition for rehearing and rehearing en banc. The Court stayed all proceedings, including a decision on final approval of the settlement and any amendments of the complaints, pending the Second Circuit’s decision on plaintiffs’ petition for rehearing. Plaintiffs filed the petition for rehearing and rehearing en banc on January 5, 2007.

 

Among other provisions, if it is finally approved by the Court, the issuers’ 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 one billion dollars 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 one billion dollars, 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. On April 20, 2006, JPMorgan Chase and the plaintiffs reached a preliminary agreement to settle for $425 million. The JPMorgan Chase preliminary agreement has not yet been approved by the Court. In an amendment to the issuers’ settlement agreement, the issuers’ insurers agreed that the JPMorgan preliminary agreement, if approved, would offset the insurers’ obligation to cover the remainder of plaintiffs’ guaranteed $1 billion recovery by 50% of the value of the JP Morgan settlement, or $212.5 million. Therefore, if the JP Morgan preliminary agreement to settle is finalized, and then preliminarily and finally approved by the Court, then the maximum amount that the issuers’ insurers will be potentially liable for is $787.5 million. It is unclear what impact the Second Circuit’s decision vacating class certification in the focus cases will have on the JP Morgan preliminary agreement.

 

It is anticipated that any potential financial obligation of Autoweb to plaintiffs pursuant to the terms of the issuers’ 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, the Company 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. However, if the JPMorgan Chase preliminary agreement is finalized, then preliminarily and finally approved by the Court, Autoweb’s maximum financial obligation would be less than $2.7 million.

 

There is no assurance that the Court will grant final approval to the issuers’ settlement. If the settlement agreement is not approved and Autoweb is found liable, the Company is 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 the Company’s results of operations, financial condition or cash flows in any future period.

 

31


We reviewed the above class action matters and do not believe that it is probable that a loss contingency has occurred; therefore, we have not recorded a liability against these claims as of December 31, 2006.

 

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 asserted infringement of U.S. Patent No. 6,282,517, entitled “Real Time Communication of Purchase Requests,” against Dealix Corporation. In December 2006, we entered into a settlement agreement with Dealix relating to the lawsuit. The agreement provides that Dealix will pay us a total of $20.0 million in settlement payments, $12.0 million of which was paid to us on March 13, 2007, with the remainder to be paid out in installments of approximately $2.7 million on the next three annual anniversary dates of the initial payment. The remaining payments subsequent to the initial payment are guaranteed by WP Equity Partners, Inc., a Warburg Pincus affiliate. The agreement also provides for a license from us to Dealix and The Cobalt Group of patents and patent applications and mutual releases of claims.

 

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 and former directors 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 were virtually identical, and purported 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 alleged 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 sought 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. On June 30, 2005, the lead plaintiff filed and served a Consolidated Amended Class Action Complaint. The putative class period is July 24, 2003 to October 21, 2004. Defendants filed and served a motion to dismiss the Consolidated Amended Class Action Complaint on August 1, 2005 and filed their reply brief on February 17, 2006. The hearing was set for March 13, 2006, but the parties filed a stipulation to take the hearing off calendar without prejudice to re-noticing the hearing in the future. On July 31, 2006, the parties entered into a Stipulation of Settlement which was subsequently filed with the court for approval. Among the terms of the proposed settlement, we and individual defendants, as well as other released persons, will be released from all claims related to this action, a settlement class consisting of all persons who purchased or otherwise acquired our common stock between July 24, 2003 and October 21, 2004 will be certified, and a settlement fund will be established. The settlement was funded by our insurer. At the final settlement hearing on October 30, 2006, the court approved the settlement.

 

In addition, certain current and former directors and certain former officers of ours 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 principles and SEC 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. Plaintiffs filed and served an Amended Derivative Complaint on July 29, 2005. Defendants filed and served a motion to stay and a demurrer in October 2005. On November 29, 2005, the court granted the motion to stay and set a status conference for March 1, 2006. On February 22, 2006, the parties stipulated to continue the March 1, 2006 status conference, and the court approved the stipulation. The parties negotiated a settlement of the action and submitted it for court approval in November 2006. The court has held a series of status conferences since the settlement was submitted,

 

32


and a further status conference to discuss the settlement is currently scheduled for April 25, 2007. If the settlement is not finalized for any reason, or the court does not approve the settlement, once the stay is lifted, we intend to defend this suit vigorously. However, we cannot currently predict the impact or outcome of such 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, financial condition and cash flows. We have not recorded a liability against this claim as of December 31, 2006.

 

On October 21, 2005, Autobytel received a complaint as well as a demand for arbitration/statement of claim filed by certain former shareholders of Stoneage Corporation (“Stoneage”). The complaint was filed in the Central District of California and names us as well as certain current and former officers and directors as defendants. The demand for arbitration was filed with the American Arbitration Association and names the same group of defendants. The allegations and claims in both of these matters are virtually identical and stem from the acquisition of Stoneage by us on April 15, 2004. Both the complaint and demand for arbitration contain causes of action for: breach of the acquisition agreement, breach of the registration rights agreement, violations of California Corporations Code Sections 25401 and 25501, violations of California Corporations Code Sections 25400 and 25500, fraud, negligent misrepresentation, fraudulent concealment, and violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The demand for arbitration also contains a cause of action for violation of Section 17(a) of the Securities Act of 1933. The complaint and demand for arbitration seek unspecified damages and attorneys’ fees and costs, as well as rescission and punitive awards. The defendants have not responded to either the complaint or demand for arbitration. On November 29, 2005, the parties requested that the arbitration be stayed, and on February 8, 2006, the plaintiffs dismissed the complaint without prejudice. Although the parties are engaged in ongoing mediation efforts, the plaintiffs recently requested that the arbitration stay be lifted. If the parties are unable to negotiate a resolution of this matter, we will defend these claims vigorously. We cannot currently predict the outcome of this litigation, which, depending on the outcome, may have a material impact on our results of operations, financial condition or cash flows. We have not recorded a liability against this claim as of December 31, 2006.

 

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, financial condition and cash flows.

 

Item 4.    Submission of Matters to a Vote of Security Holders

 

No matters were submitted to a vote of security holders during the fourth quarter of 2006.

 

 

33


PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common stock, par value $0.001 per share, has been quoted on The NASDAQ Global Market or its predecessor since March 26, 1999, and currently trades under the symbol “ABTL”. Prior to this time, there was no public market for our common stock. The following table sets forth, for the calendar quarters indicated, the range of high and low sales prices of our common stock as reported on The NASDAQ Global Market.

 

Year


   High

   Low

2005

             

First Quarter

   $ 6.26    $ 4.62

Second Quarter

   $ 5.55    $ 3.57

Third Quarter

   $ 5.99    $ 4.20

Fourth Quarter

   $ 5.55    $ 4.22

2006

             

First Quarter

   $ 5.16    $ 4.01

Second Quarter

   $ 4.83    $ 2.81

Third Quarter

   $ 3.48    $ 2.55

Fourth Quarter

   $ 3.74    $ 2.83

 

As of February 28, 2007, there were 546 holders of record of our common stock. We have never declared or paid any cash dividends on our common stock. We intend to retain all of our future earnings, if any, for use in our business, and therefore we do not expect to pay any cash dividends on our common stock in the foreseeable future.

 

Performance Graph

 

The following graph shows a comparison of cumulative total stockholder returns for our common stock, the NASDAQ Composite, the Russell 2000 Index and the Russell 3000 Index. In 2003, our common stock was included for the first time in the Russell 3000 Index. The graph assumes the investment of $100 on December 31, 2001. The data regarding us assumes an investment at the closing price of $1.72 per share of our common stock on December 31, 2001. The performance shown is not necessarily indicative of future performance.

 

LOGO

 

     Cumulative Total Return

     12/01

   12/02

   12/03

   12/04

   12/05

   12/06

Autobytel

   $ 100.00    $ 162.32    $ 528.12    $ 350.14    $ 286.38    $ 202.90

NASDAQ Composite

     100.00      71.97      107.18      117.07      120.50      137.02

Russell 2000

     100.00      79.52      117.09      138.55      144.86      171.47

Russell 3000

     100.00      78.46      102.83      115.11      122.16      141.35

 

34


 

Item 6.    Selected Consolidated Financial Data

 

The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Annual Report on Form 10-K. Our consolidated financial statements and related notes and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” provide detailed information regarding acquisitions, deconsolidation, impairment, discontinued operation, restructuring and other charges which have impacted our results of operation and financial condition and affect the comparability of the financial data provided below. The Statement of Operations Data for the years ended December 31, 2006, 2005, 2004, 2003 and 2002 and the Balance Sheet Data as of December 31, 2006, 2005, 2004, 2003 and 2002 are derived from our audited consolidated financial statements. In the Statements of Operations Data, the revenues and expenses of our AIC business have been aggregated as discontinued operations and stated separately from the respective captions of continuing operations for all periods presented. Expenses included in discontinued operations represent direct costs of our AIC business that we believe will be eliminated from future operations as a result of the sale of our AIC business. The Balance Sheet Data for 2006 excludes the assets and liabilities of our AIC business which were classified as held for sale at December 31, 2006.

 

     Years Ended December 31,

 
     2006

    2005

    2004

    2003

    2002

 
     (Amounts in thousands, except per share data)  

Statements of Operations Data:

                                        

Revenues

   $ 111,090     $ 122,054     $ 119,089     $ 84,823     $ 75,501  

Costs and expenses:

                                        

Cost of revenues

     55,265       52,189       50,680       36,523       36,647  

Sales and marketing

     26,635       26,872       25,434       19,029       14,300  

Product and technology development

     22,622       20,906       17,608       12,185       16,077  

General and administrative

     39,223       30,004       18,485       9,899       10,260  

Amortization of acquired intangible assets

     1,405       1,540       1,157       62       —    

Autobytel.Europe restructuring, impairment and other international charges

     —         —         —         —         15,015  

Domestic restructuring and other charges, net

     —         —         —         (27 )     (58 )
    


 


 


 


 


Total costs and expenses

     145,150       131,511       113,364       77,671       92,241  
    


 


 


 


 


Operating (loss) income

     (34,060 )     (9,457 )     5,725       7,152       (16,740 )

Loss on recapitalization of Autobytel.Europe

     —         —         —         —         (4,168 )

Other income, net

     1,817       3,131       855       946       206  
    


 


 


 


 


(Loss) income from continuing operations before income taxes and minority interests

     (32,243 )     (6,326 )     6,580       8,098       (20,702 )

Provision for income taxes

     (34 )     (228 )     (430 )     (8 )     (6 )

Minority interest

     (21 )     (249 )     (124 )     —         866  
    


 


 


 


 


(Loss) income from continuing operations

     (32,298 )     (6,803 )     6,026       8,090       (19,842 )

Income (loss) from discontinued operations

     830       545       (189 )     (1,763 )     (1,206 )
    


 


 


 


 


Net (loss) income

   $ (31,468 )   $ (6,258 )   $ 5,837     $ 6,327     $ (21,048 )
    


 


 


 


 


Basic (loss) income per share from continuing operations

   $ (0.76 )   $ (0.16 )   $ 0.15     $ 0.23     $ (0.64 )
    


 


 


 


 


Diluted (loss) income per share from continuing operations

   $ (0.76 )   $ (0.16 )   $ 0.14     $ 0.21     $ (0.64 )
    


 


 


 


 


Basic net (loss) income per share

   $ (0.74 )   $ (0.15 )   $ 0.14     $ 0.18     $ (0.68 )
    


 


 


 


 


Diluted net (loss) income per share

   $ (0.74 )   $ (0.15 )   $ 0.13     $ 0.17     $ (0.68 )
    


 


 


 


 


 

 

35


     December 31,

 
     2006

    2005

    2004

    2003

    2002

 
     (Amounts in thousands)  

Balance Sheet Data:

                                        

Cash and cash equivalents

   $ 22,743     $ 33,353     $ 24,287     $ 45,643     $ 27,543  

Restricted cash

     360       241       9,053       —         28  

Short-term investments

     3,000       12,000       16,500       9,991       —    

Working capital

     25,066       48,426       49,983       53,782       26,093  

Long-term investments

     —         3,000       12,000       6,000       —    

Total assets

     124,694       147,328       160,717       98,509       57,399  

Non-current liabilities

     195       152       8       178       255  

Accumulated deficit

     (186,087 )     (154,619 )     (148,361 )     (154,198 )     (160,525 )

Stockholders’ equity

   $ 103,818     $ 128,347     $ 136,067     $ 84,004     $ 44,156  

 

Item 7.    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 Annual Report on Form 10-K. 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 Part I “Item 1A. Risk Factors” in this Annual Report on Form 10-K.

 

Basis of Presentation

 

We sold certain assets and liabilities of the AIC data business, our price and specification business, on January 31, 2007. Accordingly, our AIC business is presented in the consolidated financial statements as a discontinued operation. As a discontinued operation, revenues and expenses of our AIC business have been aggregated and stated separately from the respective captions in continuing operations in the Consolidated Statements of Operations. Expenses included in discontinued operations are direct costs of our AIC business that we believe will be eliminated from future operations as a result of the sale of our AIC business. Assets and liabilities that are included in the sale of our AIC business have been aggregated and classified as held for sale under current assets and current liabilities, respectively, in our Consolidated Balance Sheet as of December 31, 2006. All other references to operating results reflect our ongoing operations, excluding our AIC business.

 

Overview

 

We are an automotive media and marketing services company that helps dealers sell cars and services, and manufacturers build brands through efficient marketing and advertising, primarily through the Internet. We own and operate automotive Web sites, including Autobytel.com, Autoweb.com, Car.com, CarSmart.com, AutoSite.com and CarTV.com. We are among the largest automotive shopping content networks and reach millions of Internet visitors as they shop for vehicles and make their vehicle buying decisions. 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.

 

In 2006, we began to implement a series of strategic initiatives, including programs to transition our business toward a more media-centric advertising-driven business model, increasing the focus on providing best-of-class marketing and media services for our dealer and manufacturer customers, and better capturing integration opportunities between our businesses. Toward that end, in 2007, we announced that we expect to launch our next generation consumer Web site, MyRide.com, in the first half of the year. We believe MyRide.com will be the first fully-integrated automotive vertical search web experience, and will provide consumers with a single comprehensive gateway to broad and relevant automotive information available on the Internet oriented toward the entire consumer automotive lifecycle—from finding and purchasing a new or used

 

36


vehicle, enhancing a vehicle with parts and accessories, finding local in-market vehicle services, and accessing extensive multimedia and user-generated automotive content. We also expect MyRide.com to have one of the Internet’s most comprehensive used vehicle products, utilizing search-based technology to incorporate listings of millions of vehicles. In 2006, these strategic initiatives resulted in an investment of approximately $1.2 million in operating expenses and approximately $3.0 million in capital expenditures.

 

In November 2006, we began to explore strategic alternatives for our Retention Performance Marketing (RPM) business and our AIC data business. In February 2007, we announced that we sold the AIC data business to R. L. Polk & Co. We are continuing to explore strategic alternatives for the RPM business. We established a retention plan for employees of these businesses. The cost was $0.1 million for the AIC data business and is expected to be approximately $0.4 million for the RPM business which is based on the number of current employees of the RPM business.

 

In 2004, we brought a lawsuit for patent infringement against Dealix Corporation. In December 2006, we entered into a settlement agreement with Dealix. The agreement provides that Dealix will pay us a total of $20.0 million in settlement payments, $12.0 million of which was paid to us on March 13, 2007, with the remainder to be paid out in installments of approximately $2.7 million on the next three annual anniversary dates of the initial payment. The remaining payments subsequent to the initial payment are guaranteed by WP Equity Partners, Inc., a Warburg Pincus affiliate.

 

In December 2005, the owners of Autobytel.Europe agreed to dissolve the company. We completed the dissolution of Autobytel.Europe in February 2007 and received $0.2 million from Autobytel.Europe.

 

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

 

   

general economic and market conditions in the automotive industry;

 

   

the effects of competition (e.g., the availability and pricing of competing services and products and the resulting effects on sales and pricing of our services and products);

 

   

a decline in purchase requests delivered to our retail and enterprise dealers;

 

   

variations in spending by automotive manufacturers on our advertising services;

 

   

costs associated with enforcing our intellectual property rights;

 

   

stock compensation expense as a result of adopting the provisions of Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment,” which is a revision to SFAS No. 123, “Accounting for Stock-Based Compensation”;

 

   

increased spending with third parties who direct search queries to our Web sites;

 

   

the implementation of certain strategic initiatives, including those described above;

 

   

costs associated with the separation of certain employees and the realignment and reduction of our workforce;

 

   

costs associated with relocating certain newly hired employees to our corporate office; and

 

   

costs associated with defending claims and lawsuits filed against us and certain current and former directors and officers relating to the restatements of our consolidated financial statements.

 

On January 1, 2006, we adopted the provisions of SFAS No. 123(R) using the modified prospective application method. Under this transition method, compensation cost of $5.4 million was recognized in 2006, which includes the applicable amounts of: (a) compensation cost of all share-based payments granted prior to, but not yet vested as of December 31, 2005 (based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123 and previously presented in the pro forma footnote disclosures),

 

37


and (b) compensation cost for all share-based payments granted subsequent to December 31, 2005 (based on the grant-date fair value estimated in accordance with the new provisions of SFAS No. 123(R)). See Note 2. of the “Notes to Consolidated Financial Statements” in Part IV “Item 15. Exhibits and Financial Statement Schedules” of this Annual Report on Form 10-K.

 

As of December 31, 2006, we had $25.7 million in domestic cash, cash equivalents, and short-term investments.

 

Net cash used in operating activities was $18.8 million in 2006. In 2007, we may continue to use cash in excess of cash generated from operations.

 

During 2006, we changed how we calculate the number of vehicle lead referral customers. We now calculate a vehicle lead referral customer based on the dealership physical establishment not on the dealer franchise, and we count a customer in a single physical establishment who subscribes to more than one of our new car lead referral programs as one customer. A dealership at a particular physical establishment is considered a single dealership even though it may encompass multiple franchises that use one or more of our new car lead referral programs. Going forward, we will disclose lead referral dealerships for our new car lead referral programs in the aggregate and for our used car lead referral program, and will not count suspended dealers as customers. As an example of how we calculate these customers, a dealer with three different franchises in a single physical establishment that subscribes to the Autoweb.com and Autobytel.com new car lead referral programs for such franchises is counted as one customer. As a further example, a dealership in a single physical establishment that subscribes to the Autobytel.com new car lead referral program and to our used car lead referral program is counted as two customers.

 

Our lead referral dealerships sell domestic and imported makes of vehicles and light trucks in the United States. As of December 31, 2006 and 2005, our new car lead referral dealerships, excluding lead referral enterprise dealerships attributable to automotive manufacturers or their automotive buying service affiliates, totaled approximately 2,300 and 2,290, respectively. At December 31, 2006 and 2005, our used car lead referral dealerships, excluding lead referral enterprise dealerships attributable to automotive manufacturers or their automotive buying service affiliates, totaled approximately 1,390 and 1,300, respectively. Additionally, through our enterprise sales initiatives, we have 9 direct relationships with automotive manufacturers or their automotive buying service affiliates encompassing 19 brands.

 

A majority of our revenue from lead referral dealerships is derived from retail dealerships and enterprise dealerships with major dealer groups. In addition, as of December 31, 2006, our finance lead referral network included approximately 380 relationships with retail dealerships, finance request intermediaries, and automotive finance companies who participate in our Car.com finance referral network. Participants in the finance referral network receive requests to arrange financing for the purchase of an automobile.

 

As of December 31, 2006, there were approximately 2,610 CRM customer relationships using our Web Control lead management product, and approximately 1,030 CRM customer relationships using our RPM customer loyalty and retention marketing program. Web Control customer relationships are accounted for based on the number of customers using the Web Control product, rather than the number of franchises owned by a given customer. A dealer that subscribes to our Web Control product and RPM program account for two CRM customer relationships. We no longer include iManager® (our legacy lead management tool) product relationships within CRM customer relationships, as we are offering dealers who use iManager the opportunity to migrate to our Web Control product.

 

The number of dealerships and customer relationships as of December 31, 2006 and 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.

 

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

 

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

 

Generally, our dealer contracts are terminable on 30 days’ notice by either party. From time to time, a major dealer group or automotive manufacturer may significantly increase or decrease the number of purchase requests accepted from us.

 

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 3.0 million and 3.5 million purchase requests through our online systems to retail and enterprise dealers in 2006 and 2005, respectively. Of these, approximately 1.9 million and 2.2 million were delivered to retail dealers in 2006 and 2005, respectively, and approximately 1.1 million and 1.3 million were delivered to enterprise dealers in 2006 and 2005, respectively. The number of purchase requests we delivered to our retail and enterprise dealers in 2006 reflects a decline from 2005. In 2006, we took action to increase the quality of purchase requests we deliver to dealers and reduced the number of Internet purchase request providers from which we purchase such requests. We believe this was a contributing factor to the decline in purchase requests we delivered to dealers in 2006 compared to 2005.

 

Additionally, we delivered approximately 0.8 million finance requests in both 2006 and 2005 to retail dealers, finance request intermediaries, and automotive finance companies.

 

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

 

CRM services consist of fees paid by customers who use our customer retention and lead management products. Customer retention and lead management products consist of Web Control, our customer lead management product, RPM, and Automotive Download Services, our data extraction service. Customers using our CRM services pay transaction fees based on the specified service, or ongoing monthly subscription fees based on the level of functionality selected from our suite of lead management products.

 

39


Other revenues include fees from classified listings for used cars, international licensing agreements, internet sales training and other products and services.

 

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:

 

   

termination by the dealer due to issues with purchase request volume, purchase request quality, fee increases or lack of dedicated personnel to manage the program effectively,

 

   

termination by us due to the dealer providing poor customer service to consumers or for nonpayment of fees by the dealer,

 

   

termination by us of dealers that cannot provide us with a reasonable profit,

 

   

elimination of the manufacturer brand, or

 

   

sale or termination of the dealer franchise.

 

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

 

Critical Accounting Policies and Estimates

 

Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America and require us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. We believe the following critical accounting policies, among others, require significant judgment in determining estimates and assumptions used in the preparation of our consolidated financial statements. There can be no assurance that actual results will not differ from our estimates and assumptions. For a detailed discussion of the application of these and other accounting policies, see Note 2. of the “Notes to Consolidated Financial Statements” in Part IV “Item 15. Exhibits and Financial Statement Schedules” of this Annual Report on Form 10-K.

 

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

 

In accounting for multiple-element arrangements, one of the key judgments to be made is the accounting value that is attributable to the different contractual elements. The appropriate allocation of value not only impacts which revenue stream is credited with the revenue, it also impacts the amount and timing of revenue recorded in the consolidated statement of operations during a given period due to the differing methods of recognizing revenue. Revenue is allocated to each element based on the accounting determination of the relative fair value of that element to the aggregate fair value of all elements. The fair values must be reliable, verifiable and objectively determinable. When available, such determination is based principally on the pricing of similar

 

40


cash arrangements with unrelated parties that are not part of a multiple-element arrangement. When sufficient evidence of the fair values of the individual elements does not exist, revenue is not allocated among them until that evidence exists. Instead, the revenue is recognized as earned using revenue recognition principles applicable to the entire arrangement as if it were a single element arrangement.

 

Allowances for Bad Debt and Customer Credits.    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 allowance for bad debts are recorded as an increase in general and administrative expenses and are based on factors such as historical write-off percentages and the current aging of accounts receivables. Reductions in the estimated allowance for bad debts are recorded as a decrease in general and administrative expenses. As specific bad debts are identified, they are written-off against the previously established estimated allowance 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’ requirements. Additions to the estimated allowance for customer credits are recorded as a reduction in revenues and are based on historical experience of: (i) the amount of credits issued; (ii) the length of time after services are rendered that the credits are issued; and (iii) other factors known at the time. Reductions in the estimated allowance 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 allowance for customer credits and have no impact on revenues.

 

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.

 

As of December 31, 2006, our estimated allowances for bad debts and customer credits have decreased to $0.8 million, or 4% of gross accounts receivable from $1.1 million, or 6%, of gross accounts receivable as of December 31, 2005.

 

Capitalized Internal Use Software and Web site Development Costs.    We capitalize costs, including share-based compensation costs, to develop internal use software under the provisions of Statement of Position (“SOP”) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” We capitalize Web site development costs under EITF Issue 00-2, “Accounting for Web Site Development Costs” and SOP 98-1. SOP 98-1 and EITF Issue 00-2 require the capitalization of external and internal computer software costs and Web site development costs, respectively, incurred during the application development stage. The application development stage is characterized by software design and configuration activities, coding, testing and installation. Training and maintenance costs are expensed as incurred while upgrades and enhancements are capitalized if it is probable that such expenditures will result in additional functionality. Capitalized internal use software development costs are amortized using the straight-line method over an estimated useful life of three years. Capitalized Web site development costs, once placed in service, will be amortized using the straight-line method over the estimated useful life. These costs are subject to periodic reviews and evaluations for indications that the software may no longer be expected to provide any service potential or placed in service for its intended use.

 

Changes in strategy and/or market conditions could significantly impact the estimated value of our capitalized software and Web site development costs. We use estimates and make assumptions to determine the related estimated useful lives and the fair value of capitalized software and Web site development costs. In future

 

41


periods, if the carrying value of capitalized software or Web site development costs is determined to be in excess of the estimated fair value, we will recognize a non-cash charge for the impairment of capitalized software or Web site development costs. As of December 31, 2006, we had capitalized software and Web site development costs, net of amortization, of $2.9 million.

 

Goodwill.    The determination as to whether events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable involves our judgment. In addition, should we conclude that recoverability of goodwill is in question, the market approach is used to determine whether goodwill is recoverable and, if not, the final determination of the fair value of the asset is also based on our judgment. These judgments can be impacted by a variety of underlying assumptions, such as the general business climate, effectiveness of competition and supply and cost of resources. Accordingly, actual results can differ significantly from the assumptions made by us in making our estimates. Future changes in our estimates could result in indicators of impairment and actual impairment charges where none exist as of the date of this Annual Report on Form 10-K. In future periods, if goodwill is determined to be impaired we will recognize a non-cash charge equal to the excess of the carrying value over the determined fair value. Absent any interim evidence of impairments, we perform our annual impairment test of goodwill on June 30 of each year. No impairment charge of goodwill was recognized in 2006, 2005 and 2004. As of December 31, 2006, the balance of goodwill was $70.7 million.

 

Loss Contingencies.    We are subject to proceedings, lawsuits and other claims. We are required to assess the likelihood of any adverse judgments or outcomes of these matters as well as potential ranges of probable losses. We are required to record a loss contingency when an unfavorable outcome is probable and the amount of the loss can be reasonably estimated. The amount of allowances required, if any, for these contingencies is determined after analysis of each individual case. The amount of allowances may change in the future if there are new material developments in each matter. Any legal fees expected to be incurred in connection with a contingency are expensed as incurred.

 

Income Taxes.    We account for income taxes under the liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We record a valuation allowance, if necessary, to reduce deferred tax assets to an amount we believe is more likely than not to be realized.

 

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 expense and assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. 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 planning 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. At December 31, 2006 and 2005, we were unable to assert that more likely than not our deferred tax assets will be realized. However, our assessment may change in future periods if we generate positive operating results. A change in our assessment and the corresponding reduction of valuation allowance would generally impact our provision for income taxes in the period of such change.

 

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

 

42


Opinion No. 25 and, accordingly, generally recognized no compensation expense related to share-based awards as awards were generally granted at fair value at the date of grant and accounted for forfeitures as they occurred.

 

Calculating share-based compensation expense requires the input of highly subjective assumptions, including the expected term of the share-based awards, expected stock price volatility, and expected pre-vesting option forfeitures. We estimate the expected life of options granted based on historical exercise patterns, which we believe are representative of future behavior, using a lattice expected term model. We estimate the volatility of the price of our common stock at the date of grant based on historical volatility of the price of our common stock for a period equal to the expected term of the awards. We have used historical volatility because we have a limited number of options traded on our common stock to support the use of an implied volatility or a combination of both historical and implied volatility. The assumptions used in calculating the fair value of share-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our share-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those options expected to vest. We estimate the forfeiture rate based on historical experience of our share-based awards that are granted, exercised and cancelled. If our actual forfeiture rate is materially different from our estimate, the share-based compensation expense could be significantly different from what we have recorded in the current period. See Note 2. of the “Notes to Consolidated Financial Statements” in Part IV “Item 15. Exhibits and Financial Statement Schedules” of this Annual Report on Form 10-K.

 

Results of Operations

 

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

 

     Years Ended December 31,

 
     2006

    2005

    2004

 

Revenues

   100 %   100 %   100 %
    

 

 

Costs and expenses:

                  

Cost of revenues

   50     43     43  

Sales and marketing

   24     22     21  

Product and technology development

   20     17     15  

General and administrative

   35     25     15  

Amortization of acquired intangible assets

   1     1     1  
    

 

 

Total costs and expenses

   130     108     95  
    

 

 

Operating (loss) income

   (30 )   (8 )   5  

Other income

   1     3     —    
    

 

 

(Loss) income from continuing operations before income taxes and minority interest

   (29 )   (5 )   5  

Provision for income taxes

   —       —       —    

Minority interest

   —       —       —    
    

 

 

(Loss) income from continuing operations

   (29 )   (5 )   5  

Income (loss) from discontinued operations

   1     —       —    
    

 

 

Net (loss) income

   (28 )%   (5 )%   5 %
    

 

 

 

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

 

     Years Ended December 31,

     2006

   2005

   2004

Revenues:

                    

Lead fees

   $ 67,496    $ 77,513    $ 84,822

Advertising

     17,505      19,207      13,695

CRM services

     25,283      24,121      18,959

Other

     806      1,213      1,613
    

  

  

Total revenues

   $ 111,090    $ 122,054    $ 119,089
    

  

  

 

2006 Compared to 2005

 

Revenues.    Our revenues decreased by $11.0 million, or 9%, to $111.1 million in 2006 compared to $122.1 million in 2005.

 

Lead Fees.    Lead fees decreased by $10.0 million, or 13%, to $67.5 million in 2006 compared to $77.5 million in 2005. The decrease was primarily due to a decline in the purchase requests delivered to our retail and enterprise dealers coupled with a lower average selling price per retail purchase request. This decline was partially offset by an increase in the average sales price per finance request delivered. The decline in retail purchase requests was primarily due to a lower average monthly delivery of purchase requests per dealer.

 

Advertising.    Advertising revenue decreased by $1.7 million, or 9%, to $17.5 million in 2006 compared to $19.2 million in 2005. The decrease was primarily due to lower spending by automotive manufacturers with our Web properties.

 

CRM Services.    CRM services increased by $1.2 million, or 5%, to $25.3 million in 2006 compared to $24.1 million in 2005. The increase was due to a $1.0 million increase in fees primarily from Web Control products and a $0.2 million increase in RPM revenue. The increase in Web Control products was primarily due to an increase in the average fee per customer, offset by a decline in the number of customers using Web Control. The increase in RPM revenue was primarily due to an increase in the number of customer relationships, offset by a decline in the average fee per customer.

 

Other.    Other revenues decreased by $0.4 million, or 34%, to $0.8 million in 2006 compared to $1.2 million in 2005. The decrease was primarily due to a $0.1 million decrease in fees from classified advertising that was discontinued in the second quarter of 2005, a $0.1 million decrease in international licensing fees as a result of the substantially complete liquidation of Autobytel.Europe in the fourth quarter of 2005, a $0.1 million decline in fees from training and a $0.1 million decrease in other revenue.

 

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

 

Cost of revenues increased by $3.1 million or 6% to $55.3 million in 2006 compared to $52.2 million in 2005. This represents 50% and 43% of total revenues for 2006 and 2005, respectively. The increase was primarily due to a $3.0 million increase in TAC, a $0.9 million increase in printing, production and postage costs and a $0.1 million increase in other costs. These increases were partially offset by a $0.5 million decrease in amortization of capitalized internal use software and acquired intangible assets and a $0.4 million decrease in

 

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personnel and related costs. The increase in TAC was primarily due to our increased spending with third parties who direct search queries to our Web sites and an increase in the costs of finance requests acquired from third parties, partially offset by a decrease in the number of purchase requests acquired directly from third parties. The increase in printing, production and postage costs was primarily due to the increase in customer loyalty and retention program volume in our RPM business. The decrease in amortization of capitalized internal use software and acquired intangible assets was due to certain costs that were fully amortized in 2005. The decrease in personnel and related costs was primarily due to a decline in headcount.

 

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 decreased by $0.2 million, or 1%, to $26.6 million in 2006 compared to $26.9 million in 2005. This represents 24% and 22% of total revenues for 2006 and 2005, respectively. The decrease was primarily due to a $1.3 million decline in advertising spending and a $0.2 million decrease in other costs, offset by a $1.3 million increase in stock compensation expense as a result of adopting the provisions of SFAS No. 123(R) on January 1, 2006.

 

Product and Technology Development.    Product and technology development expense includes personnel costs related to developing new products, enhancing the features, content and functionality of our Web sites and our Internet-based 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 8%, to $22.6 million in 2006 compared to $20.9 million in 2005. This represents 20% and 17% of total revenues for 2006 and 2005, respectively. The increase was primarily due to:

 

   

increased stock compensation expense of $1.1 million as a result of adopting the provisions of SFAS No. 123(R) on January 1, 2006,

 

   

increased professional fees of $0.6 million, which was primarily due to spending with third parties to assist us with the implementation of certain strategic initiatives,

 

   

an increase in depreciation expense of $0.6 million, which was primarily due to an increase in purchases of equipment,

 

   

a $0.3 million charge associated with the write-off of a capitalized internal use software no longer being developed or expected to be placed in service for its intended use, and

 

   

an increase in relocation costs of $0.4 million associated with the relocation of certain newly hired employees to our corporate office.

 

These increases were offset by lower personnel and related costs of $1.0 million, a $0.2 million decrease in telephone costs and a $0.1 million decrease in other costs. The decrease in personnel and related costs was due to an increase in personnel costs relating to software development that were capitalized under SOP 98-1 and reduced headcount.

 

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 $9.2 million, or 31%, to $39.2 million in 2006 compared to $30.0 million in 2005. This represents 35% and 25% of total revenues for 2006 and 2005, respectively. The increase was primarily due to an:

 

   

increase in legal fees of $8.6 million associated with enforcing our intellectual property rights,

 

   

increase in stock compensation expense of $2.8 million as a result of adopting the provisions of SFAS No. 123(R) on January 1, 2006,

 

   

increase in compensation costs of $1.3 million, which includes $0.6 million associated with the separation of certain employees and $0.1 million associated with the realignment and reduction of our workforce,

 

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increased professional fees of $0.6 million primarily due to spending with third parties to assist us with the implementation of certain strategic initiatives,

 

   

increase in temporary personnel costs of $0.3 million,

 

   

increase in relocation costs of $0.5 million associated with the relocation of certain newly hired employees to our corporate office, and

 

   

increase of $0.1 million in other costs.

 

These increases were offset by a:

 

   

decrease in costs associated with the preparation and audits of our consolidated financial statements of $3.4 million, which were primarily due to professional fees incurred during the first six months of 2005 associated with the internal review and restatements of our consolidated financial statements,

 

   

decrease in bad debt expense of $0.5 million,

 

   

decrease in other legal fees of $0.7 million associated with defending purported class action and derivative lawsuits filed against us and other legal matters, and

 

   

reimbursement of $0.4 million by our insurance carrier for specific legal costs incurred associated with defending purported class and derivative action lawsuits and other claims.

 

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 decreased by $0.1 million to $1.4 million in 2006 compared to $1.5 million in 2005.

 

Interest Income.    In 2006, interest income increased by $0.2 million, to $1.8 million compared to $1.6 million in 2005. The increase in interest income was due to the investment of our cash in accounts yielding higher interest rates.

 

Minority Interest.    Minority interest represents the portion of Autobytel.Europe’s net income allocable to Autobytel.Europe’s other shareholder. In February 2007, Autobytel.Europe was dissolved.

 

Income Taxes.    In 2006, a minimal provision for state income taxes has been recorded compared to $0.2 million in 2005. No provision for federal income taxes has been recorded as we generated taxable losses through December 31, 2006.

 

Income (loss) from discontinued operations.    Income (loss) from discontinued operations represents the operations of our AIC business which was sold in January 2007. We will not have any significant continuing involvement in the operations of the AIC business.

 

2005 Compared to 2004

 

Revenues.    Our revenues increased by $3.0 million, or 2%, to $122.1 million in 2005 compared to $119.1 million in 2004. The revenue increase was due to growth in advertising and CRM services. Advertising and CRM services growth benefited by us having owned the operation of Car.com and iDriveonline, respectively, for a full year.

 

Lead Fees.    Lead fees decreased by $7.3 million, or 9%, to $77.5 million in 2005 compared to $84.8 million in 2004. The decrease was due to a decline in purchase requests delivered to our retail and enterprise dealers of 0.5 million and 0.2 million, respectively, offset by an increase of 0.3 million finance requests delivered to dealers, finance request intermediaries and automotive finance companies. The decrease in purchase request delivered to retail dealers was primarily due to a lower average monthly delivery of purchase requests per dealer coupled with a decline in our retail dealer relationships. The decrease in purchase requests delivered to our

 

46


enterprise dealers was primarily due to a lower average monthly delivery of purchase requests to our enterprise dealers. The increase in finance requests was primarily due to an increase of approximately 80 retail dealers, finance request intermediaries, and automotive finance companies who participate in the Car.com finance referral network and the benefit of us having owned the operation of Car.com for a full year in 2005 compared to approximately nine months in 2004.

 

Advertising.    Advertising revenue increased by $5.5 million, or 40%, to $19.2 million in 2005 compared to $13.7 million in 2004. The increase was primarily due to higher spending by automotive manufacturers, the additional Web site advertising sales to Car.com customers and the addition of new products, such as rich media and direct marketing offerings.

 

CRM Services.    CRM services increased by $5.1 million, or 27%, to $24.1 million in 2005 compared to $19.0 million in 2004. The increase was due to a $3.3 million increase in RPM revenues and a $1.8 million increase in fees from Web Control products and ADS services. The increase in RPM revenue was due to an increase in the number of customers from approximately 760 at December 31, 2004 to approximately 820 at December 31, 2005 and the benefit of us having owned the operation of iDriveonline for a full year. The increase in Web Control products and ADS services was due to an increase in the number of customers from approximately 2,790 at December 31, 2004 to approximately 2,980 at December 31, 2005.

 

Other.    Other revenues decreased by $0.4 million or 25%, to $1.2 million in 2005 compared to $1.6 million in 2004. The decrease was primarily due to a $0.3 million decrease in fees from classified advertising that was discontinued in the second quarter of 2005 and a $0.1 million decrease in fees from a program offered to credit unions that was discontinued in the fourth quarter of 2004.

 

Cost of Revenues.    Cost of revenues increased by $1.5 million or 3% to $52.2 million in 2005 compared to $50.7 million in 2004. This represents 43% of total revenues in both 2005 and 2004. The increase was due to a $2.0 million increase in printing, production, and postage costs, a $0.2 million increase in TAC and a $0.2 million increase in amortization of acquired technology. The increase was offset by a $0.7 million decrease in amortization of capitalized internal use software and a $0.2 million decrease in depreciation expense. The increase in printing, production and postage costs was primarily due to the increase in customer loyalty and retention program volume in our RPM business. The increase in amortization of acquired technology was a result of the acquisitions of Stoneage and iDriveonline. The decrease in amortization of capitalized internal use software and depreciation was due to certain costs that were fully amortized and depreciated in 2004.

 

Sales and Marketing.    Sales and marketing expense increased by $1.4 million, or 6%, to $26.9 million in 2005 compared to $25.4 million in 2004. This represents 22% and 21% of total revenues for 2005 and 2004, respectively. The increase was due to a $2.1 million increase in costs associated with sales and customer support, a $0.1 million increase in marketing personnel and related costs and a $0.1 million increase in other costs, offset by a $0.9 million decrease in advertising expenses. The increase in sales and customer support and marketing personnel and related costs was due to higher personnel costs related to increased headcount and severance costs associated with the separation of two employees from us.

 

Product and Technology Development.    Product and technology development expense increased by $3.3 million, or 19%, to $20.9 million in 2005 compared to $17.6 million in 2004. This represents 17% and 15% of total revenues for 2005 and 2004, respectively. The increase was due to higher personnel and related costs of $2.4 million, a $0.1 million in severance costs associated with the separation of three employees from us, a $0.3 million in retention and severance costs associated with the relocation of the Houston office, a $0.3 million increase in telephone costs related to our voice communications and a $0.2 million increase in other costs. The higher personnel and related costs are associated with the increase in headcount, largely from the acquisitions of iDriveonline and Stoneage.

 

47


General and Administrative.    General and administrative expense increased by $11.5 million, or 62%, to $30.0 million in 2005 compared to $18.5 million in 2004. This represents 25% and 15% of total revenues for 2005 and 2004, respectively. The increase was primarily due to:

 

   

costs associated with the internal review, restatements and audits of our consolidated financial statements of $5.9 million,

 

   

increase in legal fees of $3.6 million, of which $1.8 million was associated with enforcing our intellectual property rights, $0.7 million was associated with defending purported class action and derivative lawsuits filed against us and $1.1 million was related to other legal matters,

 

   

increase in temporary personnel costs of $1.5 million,

 

   

increase in compensation costs of $1.2 million,

 

   

increase in the estimated provision for bad debt of $0.6 million, and

 

   

increase in insurance costs of $0.4 million.

 

These increases were offset by a $0.3 million decrease in other costs, a $0.3 million charge related to an abandoned acquisition in 2004 and a $1.1 million charge associated with a contract dispute recorded in 2004.

 

Amortization of Acquired Intangible Assets.    Amortization of acquired intangible assets increased by $0.3 million to $1.5 million in 2005 compared to $1.2 million in 2004. The increase was primarily due to a full year of amortization of acquired intangible assets associated with the iDriveonline and Stoneage acquisitions which took place in 2004.

 

Interest Income.    In 2005, interest income increased by $0.7 million, to $1.6 million compared to $0.9 million in 2004. The increase in interest income was due to the investment of our cash in accounts yielding higher interest rates.

 

Foreign Currency Exchange Gain.    In 2005, foreign currency exchange gain was $1.6 million compared to a nominal amount in 2004. The increase was primarily due to the substantially complete liquidation of Autobytel.Europe.

 

Loss in Equity Investees.    Loss in equity investee in 2004 represents our share of loss in Autobytel.Europe prior to April 1, 2004.

 

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

 

Income Taxes.    In 2005, a $0.2 million provision for state income taxes has been recorded compared to $0.4 million in 2004. No provision for federal income taxes has been recorded as we generated taxable losses through December 31, 2005.

 

Income (loss) from discontinued operations.    Income (loss) from discontinued operations represents the operations of our AIC business which was sold in January 2007. We will not have any significant continuing involvement in the operations of the AIC business.

 

Stock Options Granted in 2006

 

In 2006, we granted (i) stock options to purchase 3,017,500 shares of common stock under our 1996 Stock Incentive Plan, 1998 Stock Option Plan, 1999 Stock Option Plan, 1999 Employee and Acquisition Related Stock Option Plan, 2000 Stock Option Plan, Amended and Restated 2001 Restricted Stock and Option Plan, 2004

 

48


Restricted Stock and Option Plan, and 2006 Inducement Stock Option Plan and 173,714 shares of common stock under our 1996 Employee Stock Purchase Plan and (ii) an inducement stock option to purchase 1,000,000 shares of common stock to Mr. Riesenbach. The stock options were granted at our common stock closing price on the date of grant. Of the inducement stock options to purchase 1,000,000 shares of common stock granted to Mr. Riesenbach, performance-based options to purchase 400,000 shares of common stock were granted with the performance criteria to be defined at a later date. These performance-based options to purchase 400,000 shares of common stock are not reflected in outstanding stock options at December 31, 2006. As of December 31, 2006, we had outstanding stock options to purchase 10,661,551 shares of common stock and potential employee stock purchase plan awards to purchase 83,827 shares of common stock.

 

Liquidity and Capital Resources

 

Our working capital, including assets and liabilities held for sale, decreased by $23.8 million, to $24.7 million at December 31, 2006 compared to $48.4 million at December 31, 2005. The decrease was primarily related to cash used by operations and purchases of property and equipment, offset in part by cash proceeds received from issuances of common stock in connection with the exercise of employee stock options and pursuant to our employee stock purchase plan and the maturity of long-term investments.

 

Our domestic cash, cash equivalents and short-term investments totaled $25.7 million as of December 31, 2006 compared to domestic cash, cash equivalents, short-term and long-term investments of $48.4 million as of December 31, 2005. As of December 31, 2006, we had $22.7 million in domestic cash and cash equivalents, and $3.0 million in short-term investments.

 

In December 2006, we entered into a settlement agreement with Dealix relating to a patent infringement lawsuit. The agreement provides that Dealix will pay us a total of $20.0 million in settlement payments, $12.0 million of which was paid to us on March 13, 2007, with the remainder to be paid out in installments of approximately $2.7 million on the next three annual anniversary dates of the initial payment. The remaining payments subsequent to the initial payment are guaranteed by WP Equity Partners, Inc., a Warburg Pincus affiliate.

 

Net Cash (Used in) Provided by Operating Activities

 

Net cash used in operating activities was $18.8 million in 2006 compared to net cash used in operating activities of $6.1 million in 2005 and net cash provided by operating activities of $7.6 million in 2004. Net cash used in operating activities in 2006 resulted primarily from a net loss of $31.5 million and a $1.4 million decrease in deferred revenues, which were partially offset by a $2.8 million increase in accounts payable as well as non-cash charges. The decrease in deferred revenue was primarily due to the change in billing monthly subscription fees for customers participating in our car buying referral networks from advance to arrears, offset by the deferral of revenue related to a multiple-element arrangement (see Note 2. of the “Notes to Consolidated Financial Statements” in Part IV “Item 15. Exhibits and Financial Statement Schedules” of this Annual Report on Form 10-K). The increase in accounts payable was primarily due to the timing of when payments are made and an increase in professional fees incurred associated with the enforcement of our intellectual property rights and implementation of certain strategic initiatives.

 

Net cash used in operating activities was $6.1 million in 2005, and resulted from a net loss of $6.3 million for the period, a $4.8 million increase in accounts receivable, a $0.9 million decrease in accounts payable and accrued expenses, a $0.4 million decrease in other current liabilities and a $0.1 million increase in prepaid expenses and other current assets, which were partially offset by non-cash charges. The increase in accounts receivable was primarily due to the increase in days sales outstanding from 57 days during the year ended December 31, 2004 to 59 days for the year ended December 31, 2005. The decrease in accounts payable and accrued expenses was primarily due to estimated income tax payments in 2005. The decrease in other current liabilities was due to refund payments made to retail dealers. The increase in prepaid expenses and other current assets was primarily due to the payment of higher insurance premiums.

 

49


Net cash provided by operating activities was $7.6 million in 2004, and resulted from net income for the period before non-cash charges, partially offset by an increase in accounts receivable and a decrease in deferred revenues and accrued international licensee liabilities. A $3.7 million increase in accounts receivable was due to higher billing as a result of increased revenues. A $0.6 million decrease in deferred revenue is primarily due to revenue recognized for our services provided to iDriveonline dealers that were billed prior to the acquisition of iDriveonline and a decline in deferred revenue related to Web site advertising, automotive data and technology license fees and dealers paying ongoing fixed monthly subscription fees for the year ended December 31, 2004 that were billed in 2003. A $1.5 million decrease in accrued international licensee liabilities was due to payments made in April 2004 by Autobytel.Europe to Autobytel.Europe licensees for amounts due under agreements entered into in March 2002.

 

Net Cash Provided by (Used in) Investing Activities

 

Net cash provided by investing activities was $6.6 million and $18.6 million in 2006 and 2005, respectively. Net cash used in investing activities was $33.2 million in 2004. Net cash provided by investing activities in 2006 was related to the maturity of investments in government sponsored agency bonds, offset by purchases of short-term investment in commercial paper and purchases of property and equipment.

 

Net cash provided by investing activities in 2005 was related to the sale and maturities of short-term investment in government sponsored agency bonds and auction rate securities and a cash distribution from Autobytel.Europe, offset by purchases of short-term and long-term investments in government sponsored agency bonds and auction rate securities, purchases of property and equipment and expenditures for capitalized software.

 

Net cash used in investing activities in 2004 was related to the acquisitions of Stoneage and iDriveonline, net purchases of investments in government sponsored agency bonds and auction rate securities, and purchases of property and equipment, offset by the change in restricted cash.

 

Net Cash Provided by (Used in) Financing Activities

 

Net cash provided by financing activities was $1.5 million in 2006. Net cash used in financing activities was $3.4 million in 2005 and net cash provided by financing activities was $4.3 million in 2004. Net cash provided by financing activities in 2006 was due to proceeds received from the issuances of common stock in connection with the exercise of employee stock options and pursuant to our employee stock purchase plan.

 

Net cash used in financing activities in 2005 was due to cash distribution to the minority interest shareholder offset by proceeds received from the sale of common stock through our employee stock purchase plan and the exercise of stock options.

 

Net cash provided by financing activities in 2004 was due to $4.5 million in proceeds received from the sale of common stock through our employee stock purchase plan and the exercise of stock options, offset by $0.2 million in payments of capital lease obligations assumed in the Stoneage acquisition.

 

50


Our contractual commitments primarily consist of operating leases related to our facilities in Irvine, California, Santa Ana, California, Westerville, Ohio, and Troy, Michigan and our technology and communications infrastructure. The following are our contractual commitments associated with our lease obligations and vendor obligations as of December 31, 2006 (in thousands):

 

     Years Ending December 31,

     2007

   2008

   2009

   2010

   2011 and
thereafter


   Total

Operating leases

   $ 1,753    $ 1,708    $ 1,632    $ 1,130    $ 9    $ 6,232

Hosting and communication

     534      —        —        —        —        534

Other

     58      —        —        —        —        58
    

  

  

  

  

  

Total

   $ 2,345    $ 1,708    $ 1,632    $ 1,130    $ 9    $ 6,824
    

  

  

  

  

  

 

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

 

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

 

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

 

   

the level of expenditures required to implement certain strategic initiatives;

 

   

planned future growth, hiring, infrastructure and facility needs;

 

   

changes in our compensation policies;

 

   

the level of exercises of stock options and stock purchases under our employee stock purchase plan;

 

   

our competitors’ responses to our products and services;

 

   

our relationships with suppliers and customers;

 

   

the level of expenditures on marketing and advertising, including the cost of contractual arrangements with Internet portals, online information providers and other referral sources;

 

   

the level of expenditures on product and technology development;

 

   

the level of expenditures for general and administrative matters, including compliance with the Sarbanes-Oxley Act of 2002;

 

   

costs of enforcing our intellectual property rights;

 

   

any license fees obtained for our intellectual property, including in connection with enforcing our intellectual property rights;

 

   

the ability to increase the volume of purchase requests and finance requests and transactions related to our Web sites;

 

   

the amount and timing of cash collection and disbursements;

 

   

the cash portion of acquisition transactions and joint ventures; and

 

51


   

costs of ongoing litigation and any adverse judgments resulting from such litigation.

 

Off-Balance Sheet Arrangements

 

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

 

Recent Accounting Pronouncements

 

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

 

In June 2006, FASB’s Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 06-1, “Accounting for Consideration Given by a Service Provider to Manufacturers or Resellers of Equipment Necessary for an End-Customer to Receive Service from the Service Provider”. EITF Issue 06-1 provides guidance on the accounting for consideration given to third party manufacturers or resellers of equipment which is required by the end-customer in order to utilize the service from the service provider. EITF Issue 06-1 is effective for fiscal years beginning after June 15, 2007 and its adoption is not expected to have a material effect on our consolidated financial position or results of operations.

 

In June 2006, FASB’s EITF reached a consensus on Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement”. EITF Issue 06-3 provides accounting guidance regarding the presentation of taxes assessed by a governmental authority on a revenue producing transaction between a seller and a customer such as sales and use taxes. EITF Issue 06-3 is effective for fiscal years beginning after December 15, 2006 and its adoption is not expected to have a material effect on our consolidated financial position or results of operations.

 

In July 2006, FASB issued FASB Interpretation (“FIN”) 48, “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109,” which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. FIN 48 requires that a company recognize the financial statement effects of a tax position when there is a likelihood of more than 50 percent, based on the technical merits, that the position will be sustained upon examination. FIN 48 also provides guidance on the derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition requirements for uncertain tax positions. The accounting provisions of FIN 48 will be effective for us beginning January 1, 2007. We are currently evaluating the impact of adopting FIN 48 on our consolidated financial statements.

 

In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a frame work for measuring fair value and expands disclosure about fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of adopting SFAS No. 157 on our consolidated financial statements.

 

In September 2006, the SEC issued SAB No. 108, “Financial Statements—Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements”. SAB No. 108 expresses the SEC Staff’s views regarding the process of quantifying the effect of financial statement misstatements by providing interpretive guidance on how the effects of the carryover or reversal of prior year

 

52


misstatements should be considered in quantifying a current year misstatement. SAB No. 108 requires companies to quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB No.108 is effective for fiscal years ending after November 15, 2006. We did not record a cumulative effect adjustment as a result of adopting SAB No. 108.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted provided the entity also elects to apply the provisions of SFAS No. 157. We are currently evaluating the impact of adopting SFAS No. 159 on our consolidated financial statements

 

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

 

We are exposed to the impact of changes in the market values of our investments.

 

Investment Risk

 

The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and short-term and long-term investments in a variety of securities, including both government and corporate obligations and money market funds. In 2006 and 2005 net unrealized losses on these investments were not material.

 

Investments in both fixed-rate and floating-rate interest-earning instruments carry varying degrees of interest rate risk. The fair market value of our fixed-rate securities may be adversely impacted due to a rise in interest rates. In general, securities with longer maturities are subject to greater interest-rate risk than those with shorter maturities. While floating rate securities generally are subject to less interest-rate risk than fixed-rate securities, floating-rate securities may produce less income than expected if interest rates decrease. Due in part to these factors, our investment income may fall short of expectations. If interest rates were to increase (decrease) by 100 basis points, the fair market value of our total investment portfolio could decrease (increase) on an annual basis by approximately $0.3 million.

 

Item 8.    Financial Statements and Supplementary Data

 

Our Consolidated Balance Sheets as of December 31, 2006 and 2005 and our Consolidated Statements of Operations and Comprehensive Income (Loss), Stockholders’ Equity and Cash Flows for each of the years in the three-year period ended December 31, 2006, together with the reports of our independent registered public accounting firms, begin on page F-1 of this Annual Report on Form 10-K and are incorporated herein by reference.

 

Item 9.    Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

Item 9A.    Controls and Procedures

 

Our Management Report on Internal Control Over Financial Reporting is set forth on page F-2 of this Annual Report on Form 10-K.

 

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Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of December 31, 2006. Because of the material weakness discussed in Management’s Report On Internal Control Over Financial Reporting, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of the period covered by this Annual Report on Form 10-K, our disclosure controls and procedures were not effective at ensuring that the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms or (ii) accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required financial disclosure. Notwithstanding the material weakness, our management concluded that the financial statements included in this Annual Report on Form 10-K fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles (“GAAP”).

 

Plan for Remediation of Material Weakness

 

Management has identified internal control deficiencies and reviewed these internal control deficiencies with the Audit Committee of the Board of Directors and has advised the Audit Committee that certain of the deficiencies aggregated to a material weakness in our internal control over financial reporting.

 

Management and the Audit Committee of the Board of Directors have adopted certain remedial measures that are designed to address the material weakness described beginning on page F-2 (the “Remedial Measures”). The Remedial Measures include, but are not limited to, the following:

 

   

Perform an assessment of the accounts payable function to determine the appropriate staffing and supervisory levels and necessary experience requirements that are needed to ensure that transactions being recorded as accounts payable and accrued liabilities are timely, complete and accurate. Based on the assessment, we will recruit individuals with the requisite knowledge and experience as deemed necessary.

 

   

Additional training for our finance staff and accounting personnel involved with accounts payable and accrued liabilities to familiarize them with our accounting policies and U.S. GAAP concerning the proper capitalization of assets and the related accounts payable or accrued liability obligation.

 

   

Enhance our accrued liabilities process to include review of recorded accruals against the open purchase order log, as well as include a business owner review of the fixed asset clearing account to ensure that fixed assets that are received are properly accrued for in the correct period.

 

   

Enhance our prepaid expense process to include identifying the date as to when the prepayments were made within the prepaid expense reconciliations to ensure we are not incorrectly accruing for prepaid expense items.

 

At the direction of, and in consultation with, the Audit Committee of the Board of Directors, management currently is implementing certain of the Remedial Measures and intends to implement the remaining Remedial Measures during the course of 2007. While this implementation is underway, we are relying on additional manual procedures and the utilization of outside accounting professionals to assist us with meeting the objectives otherwise fulfilled by an effective control environment. While we are implementing changes to our control 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 above. Please see Part I “Item 1A. Risk Factors—Our internal controls and procedures need to be improved.”

 

54


Remediation of Prior Year Material Weaknesses

 

As previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005, our management concluded that our internal control over financial reporting was not effective as of December 31, 2005. Management identified the material weakness related to the lack of sufficient complement of personnel with an appropriate level of accounting and financial reporting experience commensurate with our financial reporting requirements that contributed to the following individual material weaknesses: (i) we did not maintain effective controls over revenue and deferred revenue accounts—specifically, our controls were not adequate to ensure the completeness and accuracy of revenues recorded under multiple element arrangements; and (ii) we did not maintain effective controls over accrued liabilities and the related expense accounts— specifically, our controls over the completeness, valuation, and existence of the determination of accruals as part of the close process were not effective.

 

To address and remediate the prior year material weaknesses in our internal control over financial reporting at December 31, 2005, we implemented the following measures during 2006 to change or enhance the design and operating effectiveness of our internal control over financial reporting:

 

   

We hired additional accounting management and staff trained in financial reporting under GAAP, with some having the designation of Certified Public Accountant, to enhance supervision and review with regard to, among other things, (i) revenue recognition and deferred revenue, (ii) accrued liabilities and related expenses and (iii) account reconciliations and documentation supporting our quarterly and annual financial statements.

 

   

We implemented training for executive and senior management on basic revenue recognition rules and their applicability.

 

   

We implemented enhanced training for our accounting and finance personnel to familiarize them with current GAAP updates, SEC financial reporting updates, and revenue recognition.

 

   

We enhanced our procedures related to reconciliation and review of accrued liabilities to help ensure that our accrued liabilities are complete and properly stated.

 

We have concluded that the above measures have effectively remediated certain of the material weaknesses that were identified as of December 31, 2005. Therefore, all prior year material weaknesses have been remediated except for those related to not having a sufficient complement of personnel with an appropriate level of accounting knowledge, experience, and training in the application of GAAP commensurate with our financial reporting requirements which contributed to a material weakness in accrued liabilities and the related expense/asset accounts.

 

Changes in Internal Control Over Financial Reporting

 

Except for the changes related to remediation of the prior year material weaknesses described above, there have been no changes in our internal controls over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 of the Securities Exchange Act of 1934 that have occurred during the fourth quarter of fiscal year 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B.    Other Information

 

None.

 

 

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PART III

 

Item 10.    Directors, Executive Officers and Corporate Governance

 

Our current directors and executive officers are as follows:

 

Name


   Age

  

Position


Michael J. Fuchs

   61    Chairman of the Board and Director

James E. Riesenbach

   50    Chief Executive Officer, President and Director

Mark R. Ross

   61    Vice Chairman and Director

Ariel Amir

   47    Executive Vice President, Chief Legal and Administrative Officer and Secretary

Russell L. Bartlett

   37    Senior Vice President, CRM and Data Services

Mark A. Garms

   42    Senior Vice President, Dealer Operations and Strategy

Monty A. Houdeshell

   58    Executive Vice President, Finance

Michael F. Schmidt

   44    Executive Vice President and Chief Financial Officer

Jeffrey H. Coats

   49    Director

Robert S. Grimes

   63    Director

Mark N. Kaplan

   77    Director

Jeffrey M. Stibel

   33    Director

 

Jeffrey H. Coats was elected a director of Autobytel in August 1996. Mr. Coats has been Chief Executive Officer, President and director of Mikronite Technologies Group Inc., an industrial technology company, since February 2002. Since August 2001, Mr. Coats has also been Managing Director of Maverick Associates LLC, a financial consulting and investment company. From July 1999 to July 2001, Mr. Coats was a Founder and Managing Director of TH Lee Global Internet Managers, L.P., a fund focused on making equity investments in eCommerce and Internet-related companies globally. Mr. Coats remains a limited partner of the fund. Mr. Coats served as Managing Director of GE Equity, Inc., a wholly-owned subsidiary of General Electric Capital Corporation, from April 1996 to July 1999. Mr. Coats holds a B.B.A. in Finance from the University of Georgia and an M.B.A. in International Management from the American Graduate School of International Management. Mr. Coats serves on the board of directors of Congoleum Corporation, Inc. (resilient sheet and tile flooring).

 

Michael J. Fuchs was elected as a director of Autobytel in September 1996 and became Chairman in June 1998. From November 2000 to May 2001, Mr. Fuchs was Chief Executive Officer of MyTurn.com, Inc. and was Interim Chief Executive Officer from April 2000 to October 2000. Mr. Fuchs was a consultant from November 1995 to April 2000. Mr. Fuchs was Chairman and Chief Executive Officer of Home Box Office, a Division of TimeWarner Entertainment Company, L.P., a leading pay-television company, from October 1984 until November 1995, and Chairman and Chief Executive Officer of Warner Music Group, a Division of Time Warner Inc., from May 1995 to November 1995. Mr. Fuchs holds a B.A. from Union College and a J.D. from the New York University School of Law. Mr. Fuchs is a member of the board of directors of Imax Corporation (entertainment).

 

Robert S. Grimes has been a director of Autobytel since inception and from April 2000 to December 2005 was a consultant to Autobytel. From July 1996 through March 2000, Mr. Grimes served as Executive Vice President of Autobytel. Since September 1987, Mr. Grimes has been President of R.S. Grimes & Co., Inc., a private investment company. Mr. Grimes holds a B.S. from the Wharton School of Commerce and Finance at the University of Pennsylvania and an L.L.B. from the University of Pennsylvania Law School. Mr. Grimes has served on the board of directors of Philips International Realty Corp., a New York Stock Exchange listed company, since April 1998.

 

Mark N. Kaplan was elected as a director of Autobytel in June 1998. Mr. Kaplan was a member of the law firm of Skadden, Arps, Slate, Meagher & Flom LLP from 1979 through 1998 and currently is of counsel to such firm. Mr. Kaplan serves on the board of directors of the following companies whose shares are publicly traded:

 

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American Biltrite Inc. (adhesive-coated, pressure-sensitive papers and films; tile flooring), Congoleum Corporation, Inc. (resilient sheet and tile flooring), DRS Technologies, Inc. (defense electronic products and systems) and Volt Information Sciences, Inc. (staffing services and telecommunications and information solutions). Mr. Kaplan holds an A.B. from Columbia College and a J.D. from Columbia Law School.

 

James E. Riesenbach joined Autobytel as President, Chief Executive Officer and a director on March 20, 2006. Mr. Riesenbach was Senior Vice President of America Online’s Search & Directional Media Group from August 2001 to March 2006. Mr. Riesenbach was a founder and Vice President of AOL’s Local Group (then known as Digital City) from April, 1996 through August 2001. From March 1990 through April 1996, Mr. Riesenbach led consumer marketing and programming for Comcast Corporation in its largest region. Mr. Riesenbach holds a Bachelors of Science in Management from Rutgers University.

 

Mark R. Ross has been a director of Autobytel since August 2001 and Vice Chairman since April 2005. Mr. Ross was a founding investor and director of Autoweb.com, Inc. from 1996 until its merger with Autobytel in August 2001. Since November 2006, Mr. Ross has been a Managing Director of Mosaic Capital LLC (investment banking). From 1999 until March 2004, Mr. Ross was a Managing Director of Chatsworth Securities, L.L.C., an investment firm. Since May 1996, Mr. Ross has been Managing Director of Cogito Capital Partners, L.L.C., a merchant bank focusing on advising, investing in and raising funds for technology companies. Mr. Ross has served on the board of advisors of numerous Internet companies, including iCastle.com and MediaPlex, Inc. Since May 1984, Mr. Ross has served as President, Chief Executive Officer and a director of On Word Information, Inc. He received a Bachelor of Science degree in finance from Lehigh University and studied at the graduate level in education at the University of Massachusetts.

 

Jeffrey M. Stibel has been a director of Autobytel since December 2006. Mr. Stibel was appointed President and Chief Executive Officer of Web.com, Inc. and a member of its Board of Directors in August 2005. From August 2000 to August 2005, Mr. Stibel held executive positions, including General Manager and Senior Vice President at United Online, Inc., a technology company that owns and operates branded ISPs and Web services. Mr. Stibel serves on the Board of Brown University’s Entrepreneurship Program and Tufts University’s Gordon Center for Leadership, along with a number of private companies. Mr. Stibel received a Bachelors degree from Tufts University, a Masters degree from Brown University and studied business and brain science at MIT’s Sloan School of Management and at Brown University, where he was a Brain and Behavior Fellow.

 

Ariel Amir joined Autobytel as Vice President and General Counsel in March 1999, was elected Secretary in April 1999 and was promoted to Senior Vice President in April 2000, Executive Vice President in September 2000 and Chief Legal and Administrative Officer in July 2005. Mr. Amir was Vice President of Security Capital U.S. Realty from February 1998 until March 1999, where he was responsible for mergers and acquisitions and relations with strategic investees. Mr. Amir was Vice President of Security Capital Group Incorporated, where he provided securities offering and corporate acquisitions services from June 1994 until January 1998. Prior to joining Security Capital Group, Mr. Amir was an attorney with the law firm of Weil, Gotshal & Manges in New York where he practiced securities and corporate law from September 1985 until April 1994. Mr. Amir received his law degree from Georgetown University Law Center, an M.S. in industrial administration from Carnegie-Mellon University Graduate School of Industrial Administration and an A.B. in Economics from Washington University in St. Louis.

 

Russell L. Bartlett joined Autobytel as Regional Internet Director in June 2000, and was promoted to Director of Product Development in 2002, Vice President, Product Marketing in September 2004, Vice President, Business Development and Project Management in July 2005 and Senior Vice President, CRM and Data Services in May 2006. Prior to joining Autobytel, Mr. Bartlett held field management positions in both the Sales and Service Divisions at American Honda from July 1996 to June 2000. Prior thereto, Mr. Bartlett held several corporate and regional management positions at Nissan Motor Corporation from June 1992 to July 1996. Mr. Bartlett received a B.A. in marketing from California State University at Fullerton.

 

Mark A. Garms joined Autobytel as Director of Consumer Experience in February 2002, and was promoted to Vice President, Dealer Operations and Strategy in June 2004, Senior Vice President, Dealer Operations in

 

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September 2004 and Senior Vice President, Dealer Operations and Strategy in July 2005. Prior to joining Autobytel, Mr. Garms was Vice President of Client Services for SourceTrack (software), where he was responsible for client implementation and servicing from 2000 to 2001. Mr. Garms was with T. Rowe Price Services, the Baltimore based mutual fund company from October 1988 through December 1999, most recently as a Vice President and Department Manager, assisting in the start up of Customer Operations Centers in Tampa and Colorado Springs. Mr. Garms received a B.A. from Ambassador College.

 

Monty A. Houdeshell joined Autobytel as Executive Vice President, Finance in January 2007. Prior thereto, Mr. Houdeshell served as Senior Vice President, Chief Administrative Officer of RemedyTemp, Inc. (staffing) from December 2004 to June 2006. From January 2003 to June 2006, he also served as Senior Vice President, Chief Financial Officer of RemedyTemp. From 1988 until November 1999 he was Vice President, Chief Financial Officer of Furon Company (polymer products). Prior to 1988, he was Vice President, Chief Financial Officer of Oak Industries, Inc. (electronic components and communications and cable equipment). Mr. Houdeshell holds a Masters in Business Administration from the University of Southern California and a Bachelor of Science from Ohio State University.

 

Michael F. Schmidt joined Autobytel as Senior Vice President, Finance in April 2004, and was appointed Executive Vice President and Chief Financial Officer in May 2005. From April 2002 to April 2004, Mr. Schmidt was Chief Financial Officer at Telephia Inc., a leading provider of performance information for the mobile telecommunications industry. From December 2000 to August 2001, Mr. Schmidt was Chief Financial Officer of Autoweb.com, Inc., an automotive marketing services company. From May 2000 to October 2000, Mr. Schmidt was Chief Operating Officer and Chief Financial Officer at MizBiz, an internet startup. From September 1999 to May 2000, Mr. Schmidt was Director of Finance at Pacificare Health Systems, a health care company. From 1988 to March 1999, Mr. Schmidt held various senior level finance and operational positions at IMS Health, a worldwide provider of information services. Mr. Schmidt began his career as a certified public accountant with Ernst & Whinney. Mr. Schmidt received a Bachelors of Business Administration and Accounting from Cleveland State University.

 

Board of Directors and Committee Meetings

 

The board of directors is divided into three classes, with each class holding office for staggered three-year terms. The term of Class I Directors Jeffrey H. Coats, Jeffrey M. Stibel and Mark R. Ross expires in 2008, the terms of Class II Directors Mark N. Kaplan and James E. Riesenbach expire in 2009 and the terms of Class III Directors Michael J. Fuchs and Robert S. Grimes expire in 2007. There are no family relationships among our officers and directors.

 

During the fiscal year ended December 31, 2006, the board of directors held a total of 26 meetings. Each member of the board of directors attended more than 75% of the meetings of the board and of the committees of which he was a member.

 

The board of directors has constituted a Corporate Governance and Nominations Committee, a Compensation Committee and an Audit Committee.

 

The Corporate Governance and Nominations Committee, which was established in March 2004, met on 4 occasions in 2006 and operates under a charter approved by the board of directors, is responsible for (i) identifying individuals qualified to become directors and selecting director nominees or recommending nominees to the board of directors for nomination; (ii) recommending nominees for appointment to committees of the board of directors; (iii) developing and recommending charters of committees of the board of directors; and (iv) overseeing the corporate governance of Autobytel and, as deemed necessary or desirable from time to time, developing and recommending corporate governance policies to the board of directors. The Corporate Governance and Nominations Committee currently consists of Michael J. Fuchs (Chairman), Mark N. Kaplan and Mark R. Ross. A copy of the charter of the Corporate Governance and Nominations Committee is posted and

 

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available on the Corporate Governance link of the Investor Relations section of our Web site, www.autobytel.com. Information on our Web site is not incorporated by reference in this Annual Report on Form 10-K.

 

The Compensation Committee, which met on 27 occasions in 2006 and operates under a charter approved by the board of directors, is responsible for (i) determining or recommending to the board of directors the compensation of the Chief Executive Officer and each other executive officer or any other officer who reports directly to the Chief Executive Officer based on the performance of each officer, (ii) making recommendations to the board of directors regarding stock option and purchase plans and other equity compensation arrangements, (iii) granting equity awards and approving any delegation of such authority under certain circumstances and (iv) preparing reports regarding executive compensation for disclosure in Autobytel’s proxy statements or as otherwise required by applicable laws. The Compensation Committee currently consists of Jeffrey H. Coats (Chairman), Michael J. Fuchs and Mark N. Kaplan. A copy of the Compensation Committee charter is posted and available on the Corporate Governance link of the Investor Relations section of our Web site, www.autobytel.com. Information on our Web site is not incorporated by reference in this Annual Report on Form 10-K.

 

The Audit Committee operates under a charter approved by the board of directors. The Audit Committee’s primary responsibilities are to (i) oversee Autobytel’s accounting and financial reporting policies, processes, practices and internal controls, (ii) appoint, compensate and oversee the independent registered public accounting firm, (iii) review the quality and objectivity of Autobytel’s independent audit and financial statements and (iv) act as liaison between the board of directors and the independent registered public accounting firm. The Audit Committee currently consists of Jeffrey H. Coats, Mark N. Kaplan (Chairman) and Mark R. Ross and met on 22 occasions in 2006. The board of directors has determined that Mr. Kaplan is an “independent director” within the meaning of the listing standards of The NASDAQ Global Market applicable to us (Marketplace Rules 4200(a)(15) and 4350(d)) and audit committee financial expert within the meaning of federal securities laws. A copy of the Audit Committee charter is posted and available on the Corporate Governance link of the Investor Relations section of our Web site, www.autobytel.com. Information on our Web site is not incorporated by reference in this Annual Report on Form 10-K.

 

All directors attended the 2006 annual meeting of stockholders, other than Richard A. Post whose term expired on the date of such annual meeting.

 

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Based upon our review of forms filed by directors, officers and certain beneficial owners of our common stock (the “Section 16 Reporting Persons”) pursuant to Section 16 of the Securities Exchange Act of 1934, we are not aware of any failures by the Section 16 Reporting Persons to file the forms required to be filed by them pursuant to Section 16 of the Securities Exchange Act of 1934, other than one Form 4 filing by Jill Richling, our Vice President and Controller, regarding options granted on August 14, 2006 that was filed on September 15, 2006.

 

Code of Conduct and Ethics

 

The board of directors adopted a Code of Conduct and Ethics for Employees, Officers and Directors (the “Code of Ethics”). The Code of Ethics is applicable to our employees, officers and directors, including the principal executive officer, the principal financial officer and the principal accounting officer. The Code of Ethics is posted and available on the Corporate Governance link of the Investor Relations section of our Web site, www.autobytel.com. We intend to post amendments to or waivers from the Code of Ethics (to the extent applicable to our chief executive officer, principal financial officer or principal accounting officer or directors) at this location on our Web site. Information on our Web site is not incorporated by reference in this Annual Report on Form 10-K.

 

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Item 11.    Executive Compensation

 

We will file the information called for in this item not later than 120 days after our fiscal year end (December 31, 2006) in our definitive Proxy Statement in connection with our 2007 Annual Meeting of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or in an amendment to this Annual Report on Form 10-K.

 

Item 12.    Security Ownership of Certain Beneficial Owners And Management and Related Stockholder Matters

 

Equity Compensation Plans

 

The following table summarizes information, as of December 31, 2006, relating to our equity compensation plans pursuant to which grants of options, restricted stock or other rights to acquire shares may be granted from time to time.

 

     Number of securities
to be issued upon
exercise of outstanding
options and rights


   Weighted-average
exercise price of
outstanding options
and rights


   Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))


     (a)    (b)    (c)

Plan category

                

Equity compensation plans approved by stock holders(1)

   7,983,279    $ 5.06    731,671

Equity compensation plans not approved by stock holders(2)(3)

   2,740,672    $ 4.98    966,545
    
         

Total(3)(4)

   10,723,951    $ 5.04    1,698,216

(1)   These plans are our 1996 Stock Incentive Plan, 1996 Employee Stock Purchase Plan, 1998 Stock Option Plan, 1999 Stock Option Plan, 2000 Stock Option Plan, Amended and Restated 2001 Restricted Stock and Option Plan and 2004 Restricted Stock and Option Plan.

 

(2)   These plans are our 1999 Employee and Acquisition Related Stock Option Plan (the “1999 EA Plan”), 2006 Inducement Stock Option Plan (the “2006 Plan”) and Inducement Stock Option Agreement, dated March 20, 2006, between us and Mr. Riesenbach (the “Riesenbach Plan”). For a description of the key provisions of the 1999 EA Plan, the 2006 Plan and the Riesenbach Plan, see Note 9 of the “Notes to Consolidated Financial Statements” in Part IV “Item 15. Exhibits and Financial Statement Schedules” of this Annual Report on Form 10-K.

 

(3)   Does not include options to purchase 400,000 shares of common stock, at an exercise price of $4.68 per share, granted to Mr. Riesenbach under the Riesenbach Plan. These options are performance-based awards where the future performance criteria will be defined at a future date. As such, in accordance with SFAS No. 123(R), the awards are not considered granted until such time that the performance criteria have been defined.

 

(4)   Does not include options to purchase an aggregate of 21,427 shares, at a weighted average exercise price of $15.24, granted under plans assumed in connection with acquisition transactions. No additional options may be granted under these assumed plans.

 

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Security Ownership of Certain Beneficial Owners and Management

 

The following table sets forth certain information regarding the beneficial ownership of the common stock as of February 28, 2007, by each director, each executive officer who was an executive officer at any time during 2006 (“Autobytel Executive Officers”), all directors and executive officers as a group, including Monty Houdeshell, and all beneficial owners of more than five percent (5%) of the common stock of Autobytel. The “Number of Shares Beneficially Owned” is based on 43,041,954 outstanding shares of common stock as of February 28, 2007. Shares of common stock are deemed to be outstanding and to be beneficially owned by the person listed below for the purpose of computing the percentage ownership of the person, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person, if such person has the right to acquire beneficial ownership of such shares within 60 days of February 28, 2007, through the exercise of any option, warrant or other right or the conversion of any security, or pursuant to the power to revoke, or the automatic termination of, a trust, discretionary account, or similar arrangement. Except as otherwise noted, the persons or entities in this table have sole voting and investing power with respect to all the shares of Autobytel common stock beneficially owned by them subject to community property laws, where applicable. The information with respect to each person specified is as supplied or confirmed by such person, based upon statements filed with the U.S. Securities and Exchange Commission, or based upon the actual knowledge of Autobytel.

 

     Shares Beneficially
Owned


 

Name of Beneficial Owner:


   Number

   Percent

 

Coghill Capital Management, L.L.C.

One North Wacker Drive, Suite 4350, Chicago, IL 60606(1)

   4,241,250    9.9 %

Morgan Stanley

1585 Broadway, New York, NY 10036(2)

   3,569,646    8.3 %

Dimensional Fund Advisors LP

1299 Ocean Avenue, Santa Monica, CA 90401(3)

   3,367,232    7.8 %

BC Advisors, LLC

300 Crescent Court, Suite 1111, Dallas, Texas 75201(4)

   2,426,900    5.6 %

Penninsula Capital Management, LP

235 Pine Street, Suite 1818, San Francisco, CA 94104(5)

   2,155,000    5.0 %

Robert S. Grimes(6)

   915,367    2.1 %

Ariel Amir(7)

   739,493    1.7 %

Richard Walker(8)

   525,000    1.2 %

Mark R. Ross(9)

   516,790    1.2 %

Michael J. Fuchs(10)

   360,952    *  

James E. Riesenbach(11)

   357,444    *  

Michael F. Schmidt(12)

   293,189    *  

Richard A. Post(13)

   251,882    *  

Mark Garms(14)

   204,541    *  

Mark N. Kaplan(15)

   150,031    *  

Jeffrey H. Coats(16)

   134,746    *  

Russell Bartlett(17)

   113,632    *  

Jeffrey M. Stibel

   0    *  

All executive officers, including Autobytel Executive Officers, and directors as a group (14 persons)(18)

   4,663,067    10.1 %

 *   Less than 1%.

 

(1)   Represents 4,241,250 shares held in the account of CCM Master Qualified Fund, Ltd. managed by Coghill Capital Management, L.L.C. Clint D. Coghill may be deemed to be the beneficial owner of such shares by virtue of his role as managing member of Coghill Capital Management, L.L.C. All the information presented in this Item with respect to this beneficial owner was extracted solely from the Amendment No. 2 to Schedule 13G filed with the SEC on February 14, 2007.

 

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(2)   Sole voting power and sole dispositive power with respect to all of such 3,569,646 shares. All the information presented in this Item with respect to this beneficial owner was extracted solely from the Amendment No. 1 to Schedule 13G filed with the SEC on February 15, 2007.

 

(3)   Represents 3,367,232 shares acquired by Dimensional Fund Advisors LP (formerly, Dimensional Fund Advisors Inc.) (“Dimensional”), an investment advisor that furnishes investment advice to four investment companies registered under the Investment Company Act of 1940, and serves as investment manager to certain other commingled group trusts and separate accounts. These investment companies, trusts and accounts are the “Funds.” In its role as investment advisor or manager, Dimensional possesses investment and/or voting power over the shares that are owned by the Funds, and may be deemed to be the beneficial owner of the shares held by the Funds. However, all shares are owned by the Funds. Dimensional disclaims beneficial ownership of such securities. All the information presented in this Item with respect to such beneficial owners was extracted solely from the Amendment to Schedule 13G filed with the SEC on March 1, 2007.

 

(4)   Represents 2,426,900 shares acquired by BC Advisors, LLC, a Texas limited liability company (“BCA”), for the account of (1) SRB Greenway Capital, L.P., a Texas limited partnership (“SRBGC”), (2) SRB Greenway Capital (Q.P.), L.P., a Texas limited partnership (“SRBQP”) and (3) SRB Greenway Offshore Operating Fund, L.P., a Cayman Islands limited partnership (“SRB Offshore”). BCA is the general partner of SRB Management, L.P., a Texas limited partnership (“SRB Management”),which is the general partner of SRBGC, SRBQP and SRB Offshore. Steven R. Becker is the sole principal of BCA. All the information presented in this Item with respect to such beneficial owners was extracted solely from the Amendment No. 1 to Schedule 13G filed with the SEC on February 9, 2007.

 

(5)   Represents 2,155,000 shares held in the account of Peninsula Capital Management, L.P. managed by Peninsula Capital Management, Inc. (“PCMI”), the general partner of Peninsula Capital Management, L.P. Scott Bedford may be deemed to be the beneficial owner of such shares by virtue of his role as President of PCMI. All the information presented in this Item with respect to such beneficial owners was extracted solely from Schedule 13G filed with the SEC on February 12, 2007.

 

(6)   Includes an aggregate of 72,386 shares held by Mr. Grimes’ wife, 138,909 shares held in the Grimes Family Charitable Remainder Unitrust, Stefan F. Tucker, Trustee (the “Trust”), and 358,386 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007. Mr. Grimes and his wife are lifetime beneficiaries of the Trust. Mr. Grimes disclaims beneficial ownership of the shares held by the Trust to the extent he does not have a pecuniary interest therein.

 

(7)   Includes 690,552 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007.

 

(8)   Represents 525,000 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007.

 

(9)   Includes an aggregate of 405,382 shares held by On Word Information, Inc., of which Mr. Ross is a director and 97,000 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007.

 

(10)   Includes 120,898 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007.

 

(11)   Includes 344,444 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007.

 

(12)   Includes 288,189 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007.

 

(13)   Includes 240,000 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007.

 

(14)   Includes 196,915 shares issuable upon exercise of options held by Mr. Garms and exercisable within 60 days of February 28, 2007. Also includes 4,583 shares issuable upon exercise of options held by Mr. Garms’ spouse and exercisable within 60 days of February 28, 2007, of which he disclaims beneficial ownership, except to the extent of his pecuniary interest therein.

 

(15)   Includes 136,531 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007.

 

(16)   Includes 125,476 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007.

 

(17)   Includes 112,289 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007.

 

(18)   Includes 3,240,263 shares issuable upon exercise of options exercisable within 60 days of February 28, 2007.

 

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Item 13.    Certain Relationships and Related Transactions, and Director Independence

 

On January 5, 2006, we and Robert S. Grimes, a current director and former Executive Vice President, agreed to terminate a consulting agreement pursuant to which Mr. Grimes provided consulting services to us. The termination was effective as of December 31, 2005. Under the consulting agreement, Mr. Grimes received $50,000 per year payable on a monthly basis and a $2,500 monthly office expense allowance. Also under the consulting agreement, Mr. Grimes made himself available to our executive officers for up to 16 hours a month for consultation and other activities related to formulating and implementing business strategies and relationships.

 

Mark Garms’ wife joined us in February 2005 as Director, Project Management and was promoted to Senior Director, Project Management in June 2006. Her base salary is $145,000 and she is eligible for a bonus of up to 20% of her base salary. Her base salary and bonus payments for 2006 were $136,000 and $26,100, respectively. Ms. Garms was granted 15,000 options on August 14, 2006 at $2.99 per share. The options vest as to 33 1/3% on the first anniversary of the grant date and as to  1/36th at the end of each successive monthly anniversary thereafter for the following 24 months. In January 2007, the Audit Committee approved and ratified the current compensation arrangements with Ms. Garms and approved future ordinary course changes in base salary, bonus amounts and option grants for Ms. Garms that are consistent with those of similarly situated employees.

 

Review, Approval or Ratification of Transactions with Related Persons

 

Under its charter, the Audit Committee, in its discretion, must approve all related party transactions prior to us entering into any such transactions. The Audit Committee is also responsible for taking reasonable steps to provide that we conduct an appropriate review of all related party transactions for potential conflict of interest situations on an ongoing basis. Our Code of Conduct provides specific guidelines regarding conflict of interest situations as well as a process for reporting and approving related party transactions. Our Code of Conduct provides that any director, officer or other employee who may be involved in a related party transaction must immediately report such transaction to the Chairman of the Audit Committee or to the general counsel or such individual’s supervisor, who must report such transaction to the Chairman of the Audit Committee upon becoming advised of such transaction. We also review such transactions for potential conflict of interest situations.

 

Our Code of Conduct defines a related party transaction as follows:

 

  (i)   any transaction (or series of transactions) in excess of $60,000 involving any director, officer or other employee of ours since the beginning of our last fiscal year or currently proposed, in which there is a direct or indirect material interest by a director, director nominee, executive officer, stockholder owning more than 5% of our voting stock, or immediate family member or live-in partner of any of the foregoing persons;

 

  (ii)   any relationship where a director or director nominee is/was since the beginning of our last fiscal year an executive officer or greater than 10% equity owner of any business or entity (A) that has made to us or received from us during our last fiscal year, or proposes to make or receive during our current fiscal year, payments for property or services in excess of 5% of our or the other entity’s consolidated gross revenues for its last full fiscal year, or (B) to which any director, officer or other employee of ours was indebted at the end of our last full fiscal year in excess of 5% of our consolidated assets at the end of such fiscal year;

 

  (iii)   any relationship where a director or director nominee is/was since the beginning of our last fiscal year (A) a member of, or of counsel to, a law firm retained by us during our last fiscal year or proposed to be retained during our current fiscal year, or (B) a partner or executive officer of any investment banking firm that performed services for us during our last fiscal year or proposes to perform services during our current fiscal year;

 

  (iv)   any other similar relationship; and

 

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  (v)   indebtedness to us in excess of $60,000 since the beginning of our last fiscal year by a corporation or organization of which a director, director nominee or executive officer of ours is an executive officer, partner or greater than 10% equity owner, or a trust of which a director, director nominee or executive officer of ours is a substantial beneficiary or a trustee.

 

Although our Code of Conduct provides guidelines regarding conflict of interest situations, it cannot and does not set forth every possible conflict of interest scenario. Therefore, the Code of Conduct indicates that there is no substitute for sound judgment by directors, officers or other employees in each case based upon the particular facts involved.

 

The Code of Conduct provides that any director, officer or other employee who may be involved in a situation or activity that might be a conflict of interest or give the appearance of a conflict of interest must immediately report such situation or activity to the Chairman of the Audit Committee or to the general counsel or such person’s supervisor, who must report such situation or activity to the Chairman of the Audit Committee upon becoming advised of such situation or activity. The Code of Conduct further provides that the Chairman of the Audit Committee then confer with the other members of the Audit Committee and, if appropriate under the circumstances, request that the general counsel issue a written advisory to such person as to whether or not the reported situation or activity is in fact a conflict of interest. If the general counsel would not be the appropriate party to issue such written advisory, outside counsel may be retained to issue such written advisory unless the Audit Committee determines that such written advisory can be issued by the Chairman of the Audit Committee without outside counsel input. The Audit Committee, however, is not responsible for monitoring or enforcing our conflict of interest policy, but rather each director, officer or other employee is responsible for self-compliance with our conflict of interest policy.

 

Independence

 

All directors, other than existing directors James E. Riesenbach and Robert S. Grimes, and former director Richard A. Post, and all committee members satisfy the definition of independent director under applicable federal securities laws and rules of The NASDAQ Global Market. All members of the Audit Committee satisfy the definition for audit committee independence under federal securities laws and The NASDAQ Global Market. Richard A. Post, whose term as director ended on June 22, 2006, was not an independent director during his service as a director in 2006.

 

Item 14.    Principal Accountant Fees and Services

 

Principal Accountant Fees and Services

 

Aggregate fees for professional services rendered by McGladrey & Pullen LLP for the year ended December 31, 2006 and PricewaterhouseCoopers LLP for the years ended December 31, 2006 and 2005 were as follows:

 

     2006

   2005

Audit fees

   $ 2,122,800    $ 1,918,100

Audit related fees

     —        —  

Tax fees

     19,800      45,400

All other fees

     —        —  
    

  

Total

   $ 2,142,600    $ 1,963,500
    

  

 

Audit Fees

 

The audit fees billed by McGladrey & Pullen LLP in the amount of $1,528,500 for the year ended December 31, 2006 were for professional services rendered for the audit of our annual financial statements and

 

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the review of the interim financial statements included in our Quarterly Report on Form 10-Q for the period ended September 30, 2006. The audit fees billed by PricewaterhouseCoopers LLP for the year ended December 31, 2006 totaled $594,300 for the reviews of the interim financial statements included in our Quarterly Reports on Form 10-Q for the first two quarters of 2006. The audit fees billed by PricewaterhouseCoopers LLP for the year ended December 31, 2005 were for professional services rendered for the audits of our restated financial statements filed on May 31, 2005 and our financial statements for the year ended December 31, 2005, as well as the reviews of the interim financial statements included in our Quarterly Reports on Form 10-Q for 2005.

 

Audit Related Fees

 

There were no audit related fees billed by McGladrey & Pullen LLP or PricewaterhouseCoopers LLP for the years ended December 31, 2006 and 2005 other than for services described above.

 

Tax Fees

 

Tax fees billed by PricewaterhouseCoopers LLP for the years ended December 31, 2006 and 2005 were for professional services rendered for tax compliance and tax advice, including tax advice and tax due diligence relating to acquisitions.

 

All Other Fees

 

There were no other fees billed by McGladrey & Pullen LLP or PricewaterhouseCoopers LLP for the years ended December 31, 2006 and 2005 other than for services described above.

 

The Audit Committee has determined that the provision of services rendered above is compatible with maintaining McGladrey & Pullen LLP’s and PricewaterhouseCoopers LLP’s independence.

 

Pre-Approval Policy

 

Under its charter, the Audit Committee is required to pre-approve all audit (including the annual audit engagement letter with the independent registered public accounting firm) and permitted non-audit services (including the fees and terms thereof) provided to us by the independent registered public accounting firm, subject to the de minimus exception for non-audit services as described in the Securities Exchange Act of 1934, as amended. The Audit Committee consults with management with respect to pre-approval, including whether the provision of permitted non-audit services is compatible with maintaining the registered public accounting firm’s independence, and may not delegate these responsibilities to management. The Audit Committee may delegate to any member or members of the Audit Committee the power to grant any pre-approval, provided that such pre-approval is reported to the Audit Committee at the next scheduled Audit Committee meeting.

 

Each member of the Audit Committee has the authority to approve fees for services by McGladrey & Pullen LLP and PricewaterhouseCoopers LLP of up to $50,000. Any approved fees may be exceeded by no more than 20% without seeking further approval even if the total amount of such fees, including the excess, exceeds $50,000. Such authority is delegated first to Mark N. Kaplan and then to Mark R. Ross and Jeffrey H. Coats in such order. Any approval by a member of the Audit Committee is required to be reported to the Audit Committee at the next regularly scheduled meeting. All fees for services by McGladrey & Pullen LLP and PricewaterhouseCoopers LLP during 2006 were approved by the Audit Committee.

 

From time to time, the Audit Committee pre-approves fees and services up to a maximum amount for future services relating to recurring tax matters and securities filings.

 

65


PART IV

 

Item 15.    Exhibits and Financial Statement Schedules

 

(a)  The following documents are filed as a part of this Annual Report on Form 10-K:

 

(1)  Financial Statements:

 

     Page

Index

   F-1

Management’s Report on Internal Control Over Financial Reporting

   F-2

Report of Independent Registered Public Accounting Firm

   F-3

Consolidated Balance Sheets

   F-7

Consolidated Statements of Operations and Comprehensive Income (Loss)

   F-8

Consolidated Statements of Stockholders’ Equity

   F-9

Consolidated Statements of Cash Flows

   F-10

Notes to Consolidated Financial Statements

   F-12

 

(2)  Financial Statement Schedules:

 

Schedule II—Valuation and Qualifying Accounts

   F-48

 

All other schedules have been omitted since the required information is presented in the financial statements and the related notes or is not applicable.

 

(3)  Exhibits:

 

The exhibits filed or furnished as part of this Annual Report on Form 10-K are listed in the Index to Exhibits immediately preceding such exhibits, which Index to Exhibits is incorporated herein by reference.

 

66


SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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, on the 15th day of March, 2007.

 

AUTOBYTEL INC.
By:   /s/    JAMES E. RIESENBACH        
   

James E. Riesenbach

Chief Executive Officer, President and Director

 

POWER OF ATTORNEY

 

KNOW ALL PERSONS BY THESE PRESENTS, that each of Autobytel Inc., a Delaware corporation, and the undersigned Directors and Officers of Autobytel Inc. hereby constitute and appoint James E. Riesenbach or Ariel Amir as its, his or her true and lawful attorneys-in-fact and agents, for it, him or her and in its, his or her name, place and stead, in any and all capacities, with full power to act alone, to sign any and all amendments to this report, and to file each such amendment to this report, with all exhibits thereto, and any and all documents in connection therewith, with the Securities and Exchange Commission, hereby granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform any and all acts and things requisite and necessary to be done in connection therewith, as fully to all intents and purposes as it, he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them may lawfully do or cause to be done by virtue hereof.

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature


  

Title


   Date

/s/    MICHAEL FUCHS        


Michael Fuchs

  

Chairman of the Board and Director

   March 15, 2007

/s/    JAMES E. RIESENBACH        


James E. Riesenbach

  

Chief Executive Officer, President and Director (Principal Executive Officer)

   March 15, 2007

/s/    MICHAEL SCHMIDT        


Michael Schmidt

  

Executive Vice President and Chief Financial Officer (Principal Financial Officer)

   March 15, 2007

/s/    JILL RICHLING        


Jill Richling

  

Vice President and Controller (Principal Accounting Officer)

   March 15, 2007

/s/    MARK R. ROSS        


Mark R. Ross

  

Vice Chairman and Director

   March 15, 2007

/s/    JEFFREY H. COATS        


Jeffrey H. Coats

  

Director

   March 15, 2007

/s/    ROBERT S. GRIMES        


Robert S. Grimes

  

Director

   March 15, 2007

/s/    MARK N. KAPLAN        


Mark N. Kaplan

  

Director

   March 15, 2007

/s/    JEFFREY M. STIBEL        


Jeffrey M. Stibel

  

Director

   March 15, 2007

 

 

67


AUTOBYTEL INC.

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page

Management’s Report On Internal Control Over Financial Reporting

   F-2

Report of Independent Registered Public Accounting Firm

   F-3

Consolidated Balance Sheets

   F-7

Consolidated Statements of Operations and Comprehensive Income (Loss)

   F-8

Consolidated Statements of Stockholders’ Equity

   F-9

Consolidated Statements of Cash Flows

   F-10

Notes to Consolidated Financial Statements

   F-12

 

F-1


Management’s Report On Internal Control Over Financial Reporting

 

The management of Autobytel Inc. is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended. A company’s 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 for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth in the framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) entitled Internal Control—Integrated Framework.

 

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Management has identified the following material weakness:

 

         As of December 31, 2006, the Company did not maintain a sufficient complement of personnel with an appropriate level of accounting knowledge, experience, and training in the application of generally accepted accounting principles commensurate with the Company’s corporate accounting function. Specifically, the Company lacked an adequate number of accounting staff possessing appropriate knowledge, experience and training in the application of U.S. generally accepted accounting principles to support its Accounts Payable and General Accounting departments within the corporate accounting function. This material weakness resulted in the following as of December 31, 2006:

 

         The Company did not maintain effective controls over its accrued liabilities account. Specifically, the Company’s controls were not adequate to ensure completeness of accrued liabilities relating to fixed assets that were received at the end of December 2006, as well as the accuracy of accrued liabilities related to the recording of prepaid expense transactions at the end of December 2006. This control deficiency resulted in audit adjustments to accrued liabilities, prepaid expenses and the fixed asset accounts within the Company’s 2006 consolidated financial statements.

 

Additionally, the aggregation of these control deficiencies could result in a misstatement of the aforementioned account balances or disclosures that would result in a material misstatement to the annual or interim financial statements that would not be prevented or detected. Accordingly, management has determined that the control deficiencies discussed above aggregate to a material weakness.

 

Because of this material weakness, management has concluded that the Company did not maintain effective internal control over financial reporting as of December 31, 2006, based on the criteria in Internal Control-Integrated Framework issued by COSO.

 

Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006 has been audited by McGladrey & Pullen LLP, an independent registered public accounting firm, as stated in their report which appears herein.

 

F-2


Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of

Autobytel Inc.

Irvine, California

 

We have audited the consolidated balance sheet of Autobytel Inc. and subsidiaries (the Company) as of December 31, 2006, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity and cash flows for the year then ended. Our audit also included the financial statement schedule listed in item 15(a). These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2006, and the results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for stock-based compensation in 2006.

 

We have also audited the reclassifications to the 2005 and 2004 statements of operations and comprehensive loss to retrospectively apply the accounting for discontinued operations with no effect on the net income or stockholder’ equity, as discussed in Note 4 to the consolidated financial statements. In our opinion, such reclassifications are appropriate and have been properly applied. We were not engaged to audit, review or apply any procedures to the 2005 or 2004 consolidated financial statements of the Company other than with respect to the reclassifications and, accordingly, we do not express an opinion or any other form of assurance on the 2005 and 2004 consolidated financial statements taken as a whole.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Our report dated March 15, 2007 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an opinion that the Company had not maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

/s/    McGladrey & Pullen, LLP

 

Irvine, California

March 15, 2007

 

F-3


To the Board of Directors and Shareholders of

Autobytel Inc.

Irvine, California

 

We have audited management’s assessment, included in the accompanying Management Report on Internal Control over Financial Reporting, that Autobytel Inc. and subsidiaries (the Company) did not maintain effective internal control over financial reporting as of December 31, 2006, because of the effect of a material weakness related to the Company not maintaining control over the recognition of accrued liabilities related to property and equipment and prepaid expenses based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s 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 for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management’s assessment. As of December 31, 2006, the Company did not maintain control over the recognition of accrued liabilities related to property and equipment and prepaid expenses. This material weakness was considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2006 consolidated financial statements, and this report does not affect our report dated March 15, 2007 on those consolidated financial statements

 

In our opinion, management’s assessment that Autobytel Inc. and subsidiaries did not maintain effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, because of the effect of the material

 

F-4


weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

 

/s/    McGladrey & Pullen, LLP

 

Irvine, California

March 15, 2007

 

F-5


Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of Autobytel Inc.:

 

In our opinion, the consolidated balance sheet as of December 31, 2005 and the related consolidated statements of operations and comprehensive income (loss), statements of stockholders’ equity and statements of cash flows for each of two years in the period ended December 31, 2005, before the effects of the adjustments to retrospectively reflect the discontinued operations described in Note 4, present fairly, in all material respects, the financial position of Autobytel Inc. and its subsidiaries at December 31, 2005, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America (the 2005 financial statements before the effects of the adjustments discussed in Note 4 are not presented herein). In addition, in our opinion, the financial statement schedule, for each of the two years in the period ended December 31, 2005 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements before the effects of the adjustments described above. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits, before the effects of the adjustments described above, of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

We were not engaged to audit, review, or apply any procedures to the adjustments to retrospectively reflect the discontinued operations described in Note 4 and accordingly, we do not express an opinion or any other form of assurance about whether such adjustments are appropriate and have been properly applied. Those adjustments were audited by other auditors.

 

/s/    PricewaterhouseCoopers LLP

 

Irvine, California

March 16, 2006

 

F-6


AUTOBYTEL INC.

 

CONSOLIDATED BALANCE SHEETS

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

 

    

December 31,

2006


   

December 31,

2005


 
ASSETS                 

Current assets:

                

Domestic cash and cash equivalents

   $ 22,743     $ 33,353  

Restricted international cash and cash equivalents

     360       241  

Short-term investments

     3,000       12,000  

Accounts receivable, net of allowances for bad debts and customer credits of $798 and $1,124, respectively

     17,250       19,042  

Prepaid expenses and other current assets

     1,819       2,456  

Current assets held for sale

     2       —    
    


 


Total current assets

     45,174       67,092  

Long-term investments

     —         3,000  

Property and equipment, net

     7,954       4,226  

Goodwill

     70,697       70,697  

Acquired intangible assets, net

     674       2,189  

Other assets

     197       124  
    


 


Total assets

   $ 124,696     $ 147,328  
    


 


LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’ EQUITY                 

Current liabilities:

                

Accounts payable

   $ 9,271     $ 5,709  

Accrued expenses

     7,607       7,417  

Deferred revenues

     2,138       3,874  

Current liabilities held for sale

     393       —    

Other current liabilities

     1,090       1,666  
    


 


Total current liabilities

     20,499       18,666  

Deferred rent—non-current

     195       131  

Deferred revenues—non-current

     —         21  
    


 


Total liabilities

     20,694       18,818  

Minority interest

     184       163  

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; 42,665,840 and 42,133,410 shares issued and outstanding, respectively

     43       42  

Additional paid-in capital

     289,862       282,924  

Accumulated deficit

     (186,087 )     (154,619 )
    


 


Total stockholders’ equity

     103,818       128,347  
    


 


Total liabilities, minority interest and stockholders’ equity

   $ 124,696     $ 147,328  
    


 


 

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

 

F-7


AUTOBYTEL INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

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

 

     Years Ended December 31,

 
     2006

    2005

    2004

 

Revenues

   $ 111,090     $ 122,054     $ 119,089  

Costs and expenses:

                        

Cost of revenues

     55,265       52,189       50,680  

Sales and marketing

     26,635       26,872       25,434  

Product and technology development

     22,622       20,906       17,608  

General and administrative

     39,223       30,004       18,485  

Amortization of acquired intangible assets

     1,405       1,540       1,157  
    


 


 


Total costs and expenses

     145,150       131,511       113,364  
    


 


 


Operating (loss) income

     (34,060 )     (9,457 )     5,725  

Interest income

     1,795       1,562       946  

Foreign currency exchange gain

     22       1,569       2  

Loss in equity investees

     —         —         (84 )

Other expense

     —         —         (9 )
    


 


 


(Loss) income from continuing operations before income taxes and minority interest

     (32,243 )     (6,326 )     6,580  

Provision for income taxes

     (34 )     (228 )     (430 )

Minority interest

     (21 )     (249 )     (124 )
    


 


 


(Loss) income from continuing operations

     (32,298 )     (6,803 )     6,026  

Income (loss) from discontinued operations

     830       545       (189 )
    


 


 


Net (loss) income

   $ (31,468 )   $ (6,258 )   $ 5,837  
    


 


 


(Loss) income per share from continuing operations:

                        

Basic

   $ (0.76 )   $ (0.16 )   $ 0.15  
    


 


 


Diluted

   $ (0.76 )   $ (0.16 )   $ 0.14  
    


 


 


Net (loss) income per share:

                        

Basic

   $ (0.74 )   $ (0.15 )   $ 0.14  
    


 


 


Diluted

   $ (0.74 )   $ (0.15 )   $ 0.13  
    


 


 


Comprehensive (loss) income:

                        

Net (loss) income

   $ (31,468 )   $ (6,258 )   $ 5,837  

Foreign currency translation adjustment

     —         (566 )     479  

Reclassification of foreign cumulative translation adjustment for liquidation of Autobytel.Europe recognized in net (loss) income

     —         (1,533 )     —    
    


 


 


Comprehensive (loss) income

   $ (31,468 )   $ (8,357 )   $ 6,316  
    


 


 


 

 

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

 

F-8


AUTOBYTEL INC.

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

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

 

     Common Stock

   Additional
Paid-In
Capital


   Accumulated
Other
Comprehensive
Income (Loss)


    Accumulated
Deficit


    Total

 
     Number of
Shares


    Amount

         

Balance, December 31, 2003

   37,786,767     $ 38    $ 236,544    $ 1,620     $ (154,198 )   $ 84,004  

Issuance of common stock upon acquisition of iDriveonline, Inc.

   474,501       1      6,774      —         —         6,775  

Issuance of common stock upon acquisition of Stoneage Corporation

   2,305,244       2      34,478      —         —         34,480  

Issuance of common stock upon exercise of stock options

   1,269,698       1      4,093      —         —         4,094  

Issuance of common stock under employee stock purchase plan

   69,640       —        398      —         —         398  

Adjustment for fractional shares on exchange of Autoweb shares for Autobytel shares

   (2 )     —        —        —         —         —    

Foreign currency translation adjustment

   —         —        —        479       —         479  

Net income

   —         —        —        —         5,837       5,837  
    

 

  

  


 


 


Balance, December 31, 2004

   41,905,848       42      282,287      2,099       (148,361 )     136,067  

Issuance of common stock upon exercise of stock options

   193,304       —        499      —         —         499  

Issuance of common stock under employee stock purchase plan

   34,297       —        138      —         —         138  

Adjustment for fractional shares on exchange of Autoweb shares for Autobytel shares

   (39 )     —        —        —         —         —    

Foreign currency translation adjustment

   —         —        —        (566 )     —         (566 )

Realization of foreign cumulative translation adjustment for liquidation of Autobytel.Europe

   —         —        —        (1,533 )     —         (1,533 )

Net loss

   —         —        —        —         (6,258 )     (6,258 )
    

 

  

  


 


 


Balance, December 31, 2005

   42,133,410       42      282,924      —         (154,619 )     128,347  

Issuance of common stock upon exercise of stock options

   413,167       1      1,132      —         —         1,133  

Issuance of common stock under employee stock purchase plan

   119,264       —        404      —         —         404  

Share-based compensation

   —         —        5,402      —         —         5,402  

Adjustment for fractional shares on exchange of Autoweb shares for Autobytel shares

   (1 )     —        —        —         —         —    

Net loss

   —         —        —        —         (31,468 )     (31,468 )
    

 

  

  


 


 


Balance, December 31, 2006

   42,665,840     $ 43    $ 289,862    $ —       $ (186,087 )   $ 103,818  
    

 

  

  


 


 


 

 

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

 

F-9


AUTOBYTEL INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands, except share data)

 

     Years Ended December 31,

 
     2006

    2005

    2004

 

Cash flows from operating activities:

                        

Net (loss) income

   $ (31,468 )   $ (6,258 )   $ 5,837  

Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:

                        

Non-cash charges:

                        

Depreciation and amortization

     2,171       1,999       2,447  

Amortization of acquired intangible assets

     1,515       1,998       1,603  

Provision for bad debt

     391       906       303  

Provision for customer credits

     1,645       2,816       1,969  

Write-off of capitalized internal use software

     264       —         —    

Loss on disposal of property and equipment

     111       103       23  

Share-based compensation

     5,397       —         —    

Loss in equity investees

     —         —         84  

Minority interest

     21       249       124  

Foreign currency exchange gain

     (22 )     (1,533 )     —    

Changes in assets and liabilities, excluding the effect of acquisitions and consolidation of Autobytel.Europe:

                        

Accounts receivable

     (244 )     (4,790 )     (3,728 )

Prepaid expenses and other current assets

     635       (92 )     (204 )

Other assets

     (73 )     (9 )     19  

Accounts payable

     2,754       (175 )     310  

Accrued expenses

     (4 )     (713 )     558  

Deferred revenues

     (1,364 )     (142 )     (638 )

Accrued domestic restructuring

     —         (74 )     (184 )

Accrued international licensee liabilities

     —         —         (1,541 )

Other current liabilities

     (512 )     (410 )     613  
    


 


 


Net cash (used in) provided by operating activities

     (18,783 )     (6,125 )     7,595  
    


 


 


Cash flows from investing activities:

                        

Acquisitions of businesses, net of cash acquired

     —         —         (20,631 )

Maturities of short-term investments

     14,998       21,600       20,991  

Purchases of short-term and long-term investments

     (2,998 )     (8,100 )     (45,500 )

Redemption of long-term investments

     —         —         12,000  

Distribution of foreign investment

     —         7,941       —    

Change in restricted cash and cash equivalents

     (97 )     (121 )     1,943  

Purchases of property and equipment

     (5,282 )     (2,809 )     (2,021 )

Proceeds from sale of property and equipment

     15       95       —    
    


 


 


Net cash provided by (used in) investing activities

     6,636       18,606       (33,218 )
    


 


 


Cash flows from financing activities:

                        

Distribution to minority interest shareholder

     —         (4,052 )     —    

Capital lease payments

     —         —         (225 )

Net proceeds from exercise of stock options and awards issued under the employee stock purchase plan

     1,537       637       4,492  
    


 


 


Net cash provided by (used in) financing activities

     1,537       (3,415 )     4,267  
    


 


 


Net (decrease) increase in cash and cash equivalents

     (10,610 )     9,066       (21,356 )

Cash and cash equivalents, beginning of period

     33,353       24,287       45,643  
    


 


 


Cash and cash equivalents, end of period

   $ 22,743     $ 33,353     $ 24,287  
    


 


 


Supplemental disclosure of cash flow information:

                        

Cash paid during the period for income taxes

   $ 465     $ 588     $ 87  
    


 


 


Cash paid during the period for interest

   $ —       $ —       $ 9  
    


 


 


 

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

 

F-10


Supplemental disclosure of non-cash investing and financing activities:

 

   

In March 2004, the Company consolidated Autobytel.Europe due to the adoption of FIN 46(R). As a result of this adoption, the Company recorded $10,459 in assets (including $10,425 of restricted international cash and cash equivalents), $2,300 in liabilities and $4,161 in minority interest. (See Note 6.)

 

   

In April 2004, in conjunction with the acquisition of iDriveonline, Inc., tangible and intangible assets of $12,672 were acquired, liabilities of $770 were assumed and 474,501 shares of common stock valued at $6,775 were issued. (See Note 5.)

 

   

In April 2004, in conjunction with the acquisition of Stoneage Corporation, tangible and intangible assets of $53,715 were acquired (including $149 of property and equipment acquired under capital leases), liabilities of $3,547 were assumed and 2,257,733 shares of common stock valued at $33,770 were issued. Additionally, based on the determination of the Stoneage Corporation final purchase price allocation, 47,511 additional shares of common stock valued at $710 were issued in July 2004. (See Note 5.)

 

   

The aggregate purchase price of certain property and equipment purchases totaling $1,002 was not paid as of December 31, 2006.

 

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

 

F-11


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.    Organization and Operations of Autobytel

 

Autobytel Inc. (the “Company” or “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. The Company owns and operates automotive Web sites Autobytel.com, Autoweb.com, Car.com, CarSmart.com, AutoSite.com, and CarTV.com. The Company is among the largest automotive shopping content networks and reaches millions of Internet visitors as they shop for vehicles and make their vehicle buying decisions. The Company is also a leading provider of customer relationship management (“CRM”) products and programs, consisting of lead management products, customer loyalty and retention marketing programs.

 

The Company is a Delaware corporation incorporated on May 17, 1996. Its principal corporate offices are located in Irvine, California. The Company’s common stock is listed on The NASDAQ Global Market under the symbol ABTL.

 

From its inception in January 1995 through December 31, 2002 and for the years ended December 31, 2005 and 2006, the Company has experienced annual operating losses and has an accumulated deficit of $186,087,000 as of December 31, 2006. The Company believes current cash and cash equivalents are sufficient to meet anticipated cash needs for working capital and capital expenditures for at least the next 12 months. The Company’s results of operations and financial condition may be affected by its dependence on, and the general economic conditions of, the automotive industry.

 

2.    Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying consolidated financial statements include the accounts of the Company and its wholly and majority owned subsidiaries.

 

Investments in entities in which the Company has the ability to exercise significant influence, but not control, are accounted for using the equity method. The Company accounts for its investment in Autobytel Japan under the equity method. Since 1999, the application of the equity method with respect to the Company’s investments in Autobytel Japan has been suspended, as the Company’s share of investee losses has reduced its investments to zero and no additional funding is required or expected. The Company will resume application of the equity method when its share of net income equals its share of net losses unrecognized during the suspension period.

 

Prior to March 31, 2004, the Company accounted for its investment in Autobytel.Europe under the equity method. On March 31, 2004, the Company adopted FASB Interpretation (“FIN”) 46(R), “Consolidation of Variable Interest Entities,” and determined it was the primary beneficiary of Autobytel.Europe. As a result of this adoption, the Company consolidated Autobytel.Europe’s balance sheet and its results of operations starting on April 1, 2004. The Company owns 49% of Autobytel.Europe. In December 2005, the owners of Autobytel.Europe agreed to dissolve the company, which was completed in February 2007 (see Note 6).

 

All intercompany transactions and balances have been eliminated in consolidation.

 

The Company sold certain assets and liabilities of Automotive Information Center (“AIC”) data business, its price and specification business, on January 31, 2007 (see Note 4). Accordingly, the AIC business is presented in the consolidated financial statements as a discontinued operation. As a discontinued operation, revenues and expenses of the AIC business have been aggregated and stated separately from the respective captions in continuing operations in the Consolidated Statements of Operations. Expenses include direct costs of the AIC

 

F-12


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

business that the Company believes will be eliminated from future operations as a result of the sale of the AIC business. Assets and liabilities that are included in the sale of the AIC business have been aggregated and classified as held for sale under current assets and current liabilities, respectively. All other references to operating results reflect the ongoing operations of the Company, excluding the AIC business.

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company 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. Significant estimates include, but are not limited to, allowances for bad debts and customer credits, useful lives of depreciable assets, accrued liabilities and valuation allowance for deferred tax assets. Actual results could differ from those estimates.

 

Cash and Cash Equivalents

 

For purposes of the consolidated balance sheets and the consolidated statements of cash flows, the Company 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 the Company for use by the Company.

 

Restricted International Cash and Cash Equivalents

 

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

 

Short-Term and Long-Term Investments

 

The Company categorized its debt securities as held-to-maturity investments in accordance with Statement of Financial Accounting Standards (“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.

 

The longer the term of the securities, the more susceptible they are to changes in market rates of interest and yields on bonds. The Company reviews its investments in debt securities for potential impairment on a regular basis. As part of the evaluation process, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and the Company’s intent and ability to hold the investment for a period of time which may be sufficient for anticipated recovery in market value. The Company has the intent and ability to hold these securities for a reasonable period of time sufficient for a forecasted recovery of fair value up to the initial cost of the investment. The Company expects to realize the full value of all of these investments upon maturity. The Company 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 years ended December 31, 2006, 2005 and 2004, the Company did not record any impairment losses that were related to other-than-temporary decline in fair value of its debt securities.

 

F-13


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Accounts Receivable

 

Credit is extended to customers based on an evaluation of the customer’s financial condition, and when credit is extended, collateral is generally not required. Interest is not normally charged on receivables.

 

Allowances for Bad Debts and Customer Credits

 

The allowance for bad debts is an estimate of bad debt expense that could result from the inability or refusal of customers to pay for services. Additions to the estimated allowance for bad debts are recorded to general and administrative expenses and are based on factors such as historical write-off percentages and the current aging of accounts receivable. Reductions in the estimated allowance for bad debts are recorded as a decrease in general and administrative expenses. As specific bad debts are identified, they are written-off against the previously established estimated allowance for bad debts and have no impact on operating expenses.

 

The allowance for customer credits is an estimate of adjustments for services that do not meet our customers’ requirements. Additions to the estimated allowance for customer credits are recorded as a reduction in revenue and are based on the Company’s historical experience of: (i) the amount of credits issued; (ii) the length of time after services are rendered that the credits are issued; and (iii) other factors known at the time. Reductions in the estimated allowance 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 allowance for customer credits and have no impact on revenues.

 

Fair Value of Financial Instruments

 

The Company’s financial instruments, including cash, cash equivalents, accounts receivable and accounts payable are carried at cost, which approximates their fair value because of the short-term maturity of these instruments.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and accounts receivable. Cash, cash equivalents and short-term investments are primarily maintained with two financial institutions in the United States. Deposits held by banks may exceed the amount of insurance provided for such deposits. Generally these deposits may be redeemed upon demand. Accounts receivable are primarily derived from fees billed to automotive dealers and automotive manufacturers. The Company generally requires no collateral to support customer receivables and maintains an allowance for bad debts for potential credit losses.

 

Property and Equipment

 

Property and equipment are stated at cost less accumulated depreciation. Depreciation is provided using the straight-line method over the estimated useful lives of the respective assets, generally three years. Amortization of leasehold improvements is provided using the straight-line method over the shorter of the remaining lease term or the estimated useful lives of the improvements. Repair and maintenance costs are charged to operating expenses as incurred. Gains or losses resulting from the retirement or sale of property and equipment are recorded as operating income or expenses, respectively.

 

The Company evaluates the carrying value of property and equipment for impairment in accordance with SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.” The Company records

 

F-14


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

impairment losses on long-lived assets used in operations when events and circumstances indicate that long-lived assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. The impairment recognized is the difference between the fair value of the asset and its carrying amount. The Company did not record any impairment losses on its property and equipment in 2006, 2005 and 2004.

 

Operating Leases

 

The Company leases office space, certain office equipment and domain name under operating lease agreements which expire on various dates through 2011, with options to renew on expiration of the original lease terms. Certain of the lease agreements contain rent holiday provisions. Rent holidays are considered in determining straight-line rent expense from the date the Company takes possession of the property to the end of the initial lease term, with differences between rent expense and rent paid recorded as deferred rent liabilities on the Consolidated Balance Sheets. The lease term begins on the date of initial possession of the leased property for purposes of recognizing rent expense on a straight-line basis over the term of the lease. Lease renewal periods are considered on a lease-by-lease basis and are generally not included in the initial lease term.

 

Capitalized Internal Use Software and Web site Development Costs

 

The Company capitalizes costs, including share-based compensation costs, to develop internal use software under the provisions of Statement of Position (“SOP”) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” The Company capitalizes Web site Development Costs under EITF Issue No. 00-2, “Accounting for Web Site Development Costs” and SOP 98-1. SOP 98-1 and EITF Issue 00-2 require the capitalization of external and internal computer software costs and Web site development costs, respectively, incurred during the application development stage. The application development stage is characterized by software design and configuration activities, coding, testing and installation. Training and maintenance costs are expensed as incurred while upgrades and enhancements are capitalized if it is probable that such expenditures will result in additional functionality. Capitalized internal use software development costs are amortized using the straight-line method over an estimated useful life of three years. Capitalized Web site development costs, once placed in service, will be amortized using the straight-line method over the estimated useful life. These costs are subject to periodic reviews and evaluations for indications that the software may no longer be expected to provide any service potential or placed in service for its intended use.

 

Goodwill and Intangible Assets

 

Goodwill represents the excess of the purchase price for business acquisitions over the fair value of identifiable assets and liabilities acquired. The Company uses estimates and makes assumptions to determine the fair value of acquired assets and liabilities.

 

The Company evaluates the carrying value of enterprise goodwill for impairment in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Under SFAS No. 142, goodwill is tested for impairment by comparing its fair value to its carrying value. Testing for impairment of goodwill is a two-step process. The first step requires the Company to compare the enterprise’s carrying value to its fair value. If the fair value is less than the carrying value, enterprise goodwill is potentially impaired and the Company then completes the second step to measure the impairment loss, if any. The second step requires the calculation of the implied fair value of enterprise goodwill by deducting the fair value of all tangible and intangible net assets from the fair value of the reporting unit. If the implied fair value of enterprise goodwill is less than the carrying amount of enterprise goodwill, an impairment loss is recognized equal to the difference. The Company evaluates enterprise goodwill,

 

F-15


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

at a minimum, on an annual basis and whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. In June 2006, Autobytel performed an annual impairment test of enterprise goodwill and concluded that enterprise goodwill was not impaired.

 

Intangible assets with identifiable lives are amortized on a straight-line basis over their estimated useful life. Amortization is charged to operating expenses. The Company evaluates the carrying value of these intangible assets for impairment in accordance with SFAS No. 144.

 

Loss Contingencies

 

In conformity with accounting principles generally accepted in the United States of America, the Company establishes an accrual for an estimated loss contingency when it is both probable that an asset has been impaired or that a liability has been incurred and the amount of the loss can be reasonably estimated. Any legal fees expected to be incurred in connection with a contingency are expensed as incurred.

 

Revenue Recognition

 

The Company classifies revenues as lead fees, advertising, customer relationship management (“CRM”) services, and other.

 

Revenues by groups of similar services are as follows:

 

     Years Ended December 31,

     2006

   2005

   2004

     (in thousands)

Revenues:

                    

Lead fees

   $ 67,496    $ 77,513    $ 84,822

Advertising

     17,505      19,207      13,695

CRM services

     25,283      24,121      18,959

Other

     806      1,213      1,613
    

  

  

Total revenues

   $ 111,090    $ 122,054    $ 119,089
    

  

  

 

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

 

Lead fees consist of car buying purchase request fees for new and used cars, and finance request fees. Fees for car buying purchase requests are paid by retail dealers, enterprise dealers and automotive manufacturers or their automotive buying service affiliates who participate in our online car buying referral networks. Enterprise dealers consist of (i) dealers that are part of major dealer groups with more than 25 dealerships with whom we have a single agreement and (ii) dealers that are eligible to receive purchase requests from the Company as part of a single agreement with an automotive manufacturer or its automotive buying service affiliate. Fees paid by customers participating in our car buying referral networks are comprised of monthly subscription and/or transaction fees for consumer leads, or purchase requests, which are directed to participating dealers. These monthly subscription and transaction fees are recognized in the period service is provided.

 

F-16


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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.

 

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. Advertising revenues are recognized in the period the advertisements are displayed on the Web sites.

 

CRM services consist of fees paid by customers who use the Company’s customer retention and lead management products. Customer retention and lead management products consist of the Web Control system (“Web Control”), the Company’s customer lead management product, Retention Performance Marketing (“RPM”), the Company’s customer loyalty and retention marketing program, and Automotive Download Services (“ADS”), the Company’s data extraction service. CRM services include fees from dealers using iDriveonline beginning April 9, 2004, the acquisition date of iDriveonline. Customers using Autobytel’s CRM services pay transaction fees based on the specified service, or ongoing monthly subscription fees based on the level of functionality selected from its suite of lead management products. Fees from CRM services are recognized as services are provided.

 

Other revenues include fees from classified listings for used cars, internet sales training and other products and services. Fees from other products and services are recognized as products are delivered or services are provided. Other revenues also include fees from international licensing agreements. These agreements grant licensees the right to use the Company’s brand in exchange for certain fees, which are recognized on a straight-line basis over the period the fees are earned.

 

Fees billed prior to providing services are deferred, as they do not satisfy all of the revenue recognition criteria in SAB No. 104. Deferred revenues are recognized as revenue over the periods services are provided or purchase requests are delivered.

 

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

 

The Company deferred revenue of $1,056,000 and $300,000 at December 31, 2006 and 2005, respectively, in accordance with EITF Issue 00-21 under a multiple-element arrangement. Revenue recognized under these arrangements totaled $909,000 for the year ended December 31, 2006. No revenue was recognized under these arrangements for the year ended December 31, 2005.

 

F-17


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Risks Due to Concentration of Significant Customers and Export Sales

 

In 2006, 2005 and 2004, no dealer, major dealer group, manufacturer, international licensee or other customer accounted for greater than 10% of total revenues. The Company had no balances owed from any single automotive manufacturer that accounted for more than 10% of total accounts receivable as of December 31, 2006. The Company had balances owed from two automotive manufacturers that accounted for more than 10% of total accounts receivable as of December 31, 2005.

 

Revenues from customers outside of the United States were less than 1% of total revenues for the years ended December 31, 2006, 2005 and 2004.

 

Cost of Revenues

 

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

 

Sales and Marketing

 

Sales and marketing expense primarily consists of personnel and other costs associated with sales, marketing, training and support of the Company’s dealer networks as well as advertising expenses to develop brand equity and encourage potential customers to visit the Company’s Web sites. Sales and marketing costs are recorded as expenses are incurred. Advertising expenses were $1,246,000, $2,352,000 and $3,167,000 in 2006, 2005 and 2004, respectively.

 

Product and Technology Development

 

Product and technology development expense primarily consists of personnel costs related to developing new dealer and manufacturer programs and products, and enhancing the features, content and functionality of the Company’s Web sites and its Internet-based dealer communications platform. It also includes expenses associated with the customization of the Company’s software for international licensees and telecommunications and computer infrastructure. Product and technology development expenditures are expensed as incurred or capitalized in accordance with SOP 98-1.

 

General and Administrative

 

General and administrative expense primarily consists of executive, financial, human resources and legal personnel expenses, and costs related to being a public company. General and administrative expenditures are expensed as incurred. Certain expenses such as rent, certain employee benefits, facility maintenance, and insurance are allocated from general and administrative expenses to other cost categories based on employee count.

 

Foreign Currency Translation

 

The assets and liabilities of the Company’s foreign subsidiaries, whose functional currencies are the local currencies, are translated into United States dollars at the current exchange rate as of the applicable balance sheet

 

F-18


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

date. Revenues and expenses are translated at the average exchange rate prevailing during the period. Gains and losses resulting from the translation of the financial statements are reported as a separate component of stockholders’ equity.

 

Transaction gains and losses arising from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in foreign currency exchange gain (loss) in the consolidated statement of operations.

 

Prior to December 15, 2005, Autobytel.Europe operated in a functional currency other than the U.S. Dollar. At December 15, 2005, the owners of Autobytel.Europe agreed to dissolve the company. As a part of the liquidation, the assets and liabilities were translated at the current exchange rate at December 15, 2005, while the revenue and expenses were translated at the average exchange rate prevailing for the period between January 1, 2005 and December 15, 2005. Subsequent to December 15, 2005, Autobytel.Europe accounted for any remaining assets, liabilities, revenue and expenses using the U.S. Dollar. In February 2007, Autobytel.Europe was dissolved.

 

Income Taxes

 

The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” Under SFAS No. 109, deferred income tax assets and liabilities are determined based on the differences between the book and tax basis of assets and liabilities and are measured using the currently enacted tax rates and laws. A valuation allowance is recorded against deferred tax assets when it is more likely than not that such deferred tax assets will not be realized.

 

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

 

Net (loss) income per share has been calculated under SFAS No. 128, “Earnings per Share.” SFAS No. 128 requires companies to compute earnings per share under two different methods, basic and diluted. Basic net (loss) income per share is calculated by dividing the net (loss) income by the weighted average shares of common stock outstanding during the period. Diluted net (loss) income per share is calculated by dividing the net (loss) 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 the company from the exercise proceeds.

 

F-19


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

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

 

     Years Ended December 31,

 
     2006

    2005

    2004

 
     (in thousands, except share and per share data)  

Continuing operations:

                        

Numerator:

                        

Net (loss) income from continuing operations

   $ (32,298 )   $ (6,803 )   $ 6,026  

Denominator:

                        

Weighted average common shares and denominator for basic calculation

     42,389,050       41,956,799       40,785,743  

Weighted average effect of dilutive securities:

                        

Employee stock options

     —         —         3,262,841  
    


 


 


Denominator for diluted calculation

     42,389,050       41,956,799       44,048,584  

Net (loss) income per share from continuing operations—basic

   $ (0.76 )   $ (0.16 )   $ 0.15  

Net (loss) income per share from continuing operations—diluted

   $ (0.76 )   $ (0.16 )   $ 0.14  

Discontinued operations:

                        

Numerator:

                        

Net income (loss) from discontinued operations

   $ 830     $ 545     $ (189 )

Denominator:

                        

Weighted average common shares and denominator for basic calculation

     42,389,050       41,956,799       40,785,743  

Weighted average effect of dilutive securities:

                        

Employee stock options

     —         —         3,262,841  
    


 


 


Denominator for diluted calculation

     42,389,050       41,956,799       44,048,584  

Net (loss) income per share from discontinued operations—basic

   $ 0.02     $ 0.01     $ 0.00  

Net (loss) income per share from discontinued operations—diluted

   $ 0.02     $ 0.01     $ 0.00  

Net (loss) income:

                        

Numerator:

                        

Net (loss) income

   $ (31,468 )   $ (6,258 )   $ 5,837  

Denominator:

                        

Weighted average common shares and denominator for basic calculation

     42,389,050       41,956,799       40,785,743  

Weighted average effect of dilutive securities:

                        

Employee stock options

     —         —         3,262,841  
    


 


 


Denominator for diluted calculation

     42,389,050       41,956,799       44,048,584  

Net (loss) income per share—basic

   $ (0.74 )   $ (0.15 )   $ 0.14  

Net (loss) income per share—diluted

   $ (0.74 )   $ (0.15 )   $ 0.13  

 

For the years ended December 31, 2006 and 2005, 6,892,552 and 4,305,210, respectively, antidilutive potential shares of common stock, consisting of shares issuable under employee and director stock options and employee stock purchase plan awards, have been excluded from the calculation of diluted net loss per share, as they represent stock options with an exercise price greater than the average market price for the period.

In addition, for the years ended December 31, 2006 and 2005, 1,080,048 and 1,739,470, respectively, antidilutive

potential shares of common stock have been excluded from the calculation of diluted net loss per share, as the

 

F-20


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Company incurred a net loss for the period. For the year ended December 31, 2004, 1,450,190 antidilutive potential shares of common stock have been excluded from the calculation of diluted net income per share as they represent stock options with an exercise price greater than the average market price for the period.

 

Share-Based Compensation

 

Effective January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment,” which is a revision to SFAS No. 123, “Accounting for Stock-Based Compensation” issued in 1995, using the modified prospective method and therefore has not restated prior periods’ results. Under the fair value recognition provisions of SFAS No. 123(R), the Company recognizes share-based compensation net of an estimated forfeiture rate and therefore only recognizes compensation cost for those shares expected to vest over the service period of the award. The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model based on the underlying common stock closing price as of the date of grant, the expected term, expected stock price volatility, and expected risk-free interest rates. Prior to SFAS No. 123(R) adoption, the Company accounted for share-based payments under APB Opinion No. 25 “Accounting for Stock Issued to Employees,” and, accordingly, generally recognized no compensation expense related to share-based awards as awards were generally granted at fair value at the date of grant and accounted for forfeitures as they occurred.

 

Calculating share-based compensation expense requires the input of highly subjective assumptions, including the expected term of the share-based awards, expected stock price volatility, and expected pre-vesting option forfeitures. The assumptions used in calculating the fair value of share-based awards represent the Company’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and the Company uses different assumptions, share-based compensation expense could be materially different in the future. In addition, the Company is required to estimate the expected forfeiture rate and only recognize expense for those options expected to vest. The Company estimates the forfeiture rate based on historical experience of its share-based awards that are granted, exercised and cancelled. If its actual forfeiture rate is materially different from its estimate, the share-based compensation expense could be significantly different from what it has recorded in the current period.

 

The Company utilizes the straight-line attribution method for recognizing share-based compensation expense under SFAS No. 123(R). For the year ended December 31, 2006, the Company recorded share-based compensation expense of $5,397,000 or $0.13 earnings per share. Share-based compensation expense is included in costs and expenses in the Consolidated Statement of Operations as follows:

 

     Year Ended
December 31,
2006


     (in thousands)

Share-based compensation expense:

      

Cost of revenues

   $ 215

Sales and marketing

     1,276

Product and technology development

     1,075

General and administrative

     2,797
    

Share-based compensation expense included in continuing operations

     5,363

Share-based compensation expense included in discontinued operations

     34
    

Total share-based compensation expense

     5,397

Amount capitalized to internal use software

     5
    

Total share-based compensation costs

   $ 5,402
    

 

F-21


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Prior to adopting SFAS No. 123(R) on January 1, 2006, the Company accounted for share-based compensation plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. No compensation cost was reflected in the net (loss) income for 2005 and for 2004 related to stock options as all options granted under share-based compensation plans had an exercise price equal to the market closing price of the underlying common stock on the date of grant.

 

The following table illustrates the pro forma effect on net (loss) income and net (loss) income per share as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation for 2005 and 2004:

 

     Years Ended
December 31,


 
     2005

    2004

 
     (in thousands,
except share and
per share data)
 

Net (loss) income:

                

As reported

   $ (6,258 )   $ 5,837  

Add: Employee stock-based compensation included in reported net (loss) income

     —         —    

Less: Employee stock-based compensation determined under the fair value based method

     (6,703 )     (6,068 )
    


 


Pro forma

   $ (12,961 )   $ (231 )
    


 


Net (loss) income per share—basic:

                

As reported

   $ (0.15 )   $ 0.14  

Pro forma

   $ (0.31 )   $ (0.01 )

Net (loss) income per share—diluted:

                

As reported

   $ (0.15 )   $ 0.13  

Pro forma

   $ (0.31 )   $ (0.01 )

 

Prior to the adoption of SFAS No. 123(R), the Company did not record any tax benefits resulting from the exercise of options due to uncertainty surrounding the timing of realizing the benefits of its deferred tax assets in future periods. SFAS No. 123(R) requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than an operating cash flow as required under APB No. 25. Had the Company recognized an excess tax benefit from deductions resulting from the exercise of stock options, it would have classified the benefit as a financing cash inflow in the consolidated statement of cash flows.

 

Awards granted under the Company’s stock option plans were estimated to have a weighted average fair value per share of $2.26, $2.52, and $5.38 for the years ended December 31, 2006, 2005 and 2004, respectively, based on the Black-Scholes option-pricing model on the date of grant and the following assumptions (the weighted average fair value per share of $2.26 includes the inducement options granted to James E. Riesenbach, Chief Executive Officer and President):

 

     Years Ended December 31,

 
     2006

    2005

    2004

 

Expected dividend yield

   0 %   0 %   0 %

Weighted-average expected volatility

   78.70 %   71.19 %   68.56 %

Weighted-average expected risk-free interest rate

   4.827 %   3.859 %   2.592 %

Weighted-average expected life

   4.99 years     3.6 years     3.5 years  

 

F-22


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The expected risk-free interest rate is based on United States treasury yield for a term consistent with the expected life of the stock option in effect at the time of grant. Expected volatility is based on the Company’s historical experience for a period equal to the expected life. The Company has used historical volatility because it has a limited number of options traded on its common stock to support the use of an implied volatility or a combination of both historical and implied volatility. Expected life is calculated using a lattice expected term model for 2006, which utilizes historical data to calculate future behavior. Expected life for 2005 and 2004 is based on historical exercise patterns. A dividend yield was not considered in the option-pricing formula since the Company has not paid dividends in the past and has no current plans to do so in the future. The estimated forfeiture rate used was based on historical experience. As required by SFAS No. 123(R), the Company adjusts the estimated forfeiture rate based on actual experience.

 

As of December 31, 2006, there was $4,805,000 of total unrecognized compensation cost, net of estimated forfeitures, related to nonvested share-based compensation arrangements granted under share-based compensation plans. The cost is expected to be recognized over a weighted-average period of 1.10 years using the straight-line attribution method.

 

Awards issued under the employee stock purchase plan were estimated to have a weighted average fair value per award of $0.93, $1.09, and $2.33 for the years ended December 31, 2006, 2005, and 2004, respectively, based on the Black-Scholes option-pricing model and the following assumptions:

 

     Years Ended December 31,

 
     2006

    2005

    2004

 

Expected dividend yield

   0 %   0 %   0 %

Expected volatility

   53.42% - 53.51 %   44.95% - 77.97 %   66.06% - 73.86 %

Expected risk-free interest rate

   4.60% - 5.18 %   2.99% - 3.69 %   1.03% -1.05 %

Expected life

   6 months     1.4 - 6 months     6 months  

 

The expected risk-free interest rate is based on United States treasury yield for a term consistent with the expected life of the award in effect at the time of grant. Expected volatility is based on the Company’s historical experience for a period equal to the expected life. Expected life is based on the term of the offering period. A dividend yield was not considered in the option-pricing formula since the Company has not paid dividends in the past and has no current plans to do so in the future. The estimated forfeiture rate used was based on historical experience. As required by SFAS No. 123(R), the Company adjusts the estimated forfeiture rate based on actual experience.

 

As of December 31, 2006, there was $10,000 of total unrecognized compensation cost related to options granted under the employee stock purchase plan. The cost is expected to be recognized over 1 month using the straight-line attribution method.

 

Business Segment

 

The Company conducts its business within one business segment which is defined as providing automotive marketing services.

 

Recently Adopted Accounting Pronouncements

 

In May 2005, FASB issued SFAS No. 154, “Accounting Changes and Error Corrections—A Replacement of APB Opinion No. 20 and FASB Statement No. 3”. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle. It also requires that the new accounting principle be applied to the balances of assets and liabilities as of the beginning of the earliest period for which

 

F-23


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

retrospective application is practicable and that a corresponding adjustment be made to the opening balance of retained earnings for that period rather than being reported in an income statement. The statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company adopted SFAS No. 154 on January 1, 2006, and its adoption did not have a material effect on the Company’s consolidated financial position or results of operations.

 

In September 2006, the SEC issued SAB No. 108, “Financial Statements—Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements”. SAB No. 108 expresses the SEC Staff’s views regarding the process of quantifying the effect of financial statement misstatements by providing interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB No. 108 requires companies to quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The Company did not record a cumulative effect adjustment as a result of adopting SAB No. 108.

 

Accounting Pronouncements Not Yet Adopted

 

In June 2006, FASB’s EITF reached a consensus on Issue No. 06-1, “Accounting for Consideration Given by a Service Provider to Manufacturers or Resellers of Equipment Necessary for an End-Customer to Receive Service from the Service Provider”. EITF 06-1 provides guidance on the accounting for consideration given to third party manufacturers or resellers of equipment which is required by the end-customer in order to utilize the service from the service provider. EITF 06-1 is effective for fiscal years beginning after June 15, 2007 and its adoption is not expected to have a material effect on the Company’s consolidated financial position or results of operations.

 

In June 2006, FASB’s EITF reached a consensus on Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should be Presented in the Income Statement”. EITF 06-3 provides accounting guidance regarding the presentation of taxes assessed by a governmental authority on a revenue producing transaction between a seller and a customer such as sales and use taxes. EITF 06-3 is effective for fiscal years beginning after December 15, 2006 and its adoption is not expected to have a material effect on the Company’s consolidated financial position or results of operations.

 

In July 2006, FASB issued FIN 48 “Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109” which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. FIN 48 requires that a company recognize the financial statement effects of a tax position when there is a likelihood of more than 50 percent, based on the technical merits, that the position will be sustained upon examination. It also provides guidance on the derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition requirements for uncertain tax positions. The accounting provisions of FIN 48 will be effective for the Company beginning January 1, 2007. The Company is currently evaluating the impact of adopting FIN 48 on its consolidated financial statements.

 

In September 2006, FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a frame work for measuring fair value and expands disclosure about fair value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of adopting SFAS No. 157 on its consolidated financial statements.

 

F-24


AUTOBYTEL INC.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007, with early adoption permitted provided the entity also elects to apply the provisions of SFAS No. 157. The Company is currently evaluating the impact of adopting SFAS No. 159 on its consolidated financial statements.

 

3.    Selected Balance Sheet Accounts

 

Short-Term and Long-Term Investments

 

As of December 31, 2006 and 2005, the amortized cost basis, aggregate fair value, unrealized gains and losses by security type were as follows:

 

     Amortized
Cost Basis


   Aggregate
Fair
Value


   Unrealized
Gains


   Unrealized
Losses


     (in thousands)

December 31, 2006:

                           

Short-term investments, held-to-maturity:

                           

Government sponsored agency bonds

   $ 3,000    $ 2,993    $ —      $ 7
    

  

  

  

Total as of December 31, 2006

   $ 3,000    $ 2,993    $ —      $ 7
    

  

  

  

December 31, 2005:

                           

Short-term investments, held-to-maturity:

                           

Government sponsored agency bonds

   $ 12,000    $ 11,901    $ —      $ 99

Long-term investments, held-to-maturity: