AutoWeb, Inc. - Quarter Report: 2007 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended September 30, 2007

or

For the transition period from                      to                     .

Commission file number 0-22239

Autobytel Inc.

(Exact name of registrant as specified in its charter)

(949) 225-4500

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is 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

As of October 31, 2007, there were 43,788,633, shares of the Registrant’s Common Stock outstanding.

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INDEX

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PART I. FINANCIAL INFORMATION

AUTOBYTEL INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

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

(unaudited)

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

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AUTOBYTEL INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

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

(unaudited)

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

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AUTOBYTEL INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(unaudited)

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

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Supplemental disclosure of non-cash activities:

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

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Organization and Operations of Autobytel

Autobytel Inc. (the “Company” or “Autobytel”) is 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. The Company owns and operates automotive Web sites, including MyRide.com^™, 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, consisting of lead management products.

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 $188.5 million as of September 30, 2007. 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

Unaudited Interim Financial Statements

In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements contain all adjustments necessary (which are of a normal recurring nature) to present fairly the financial information contained therein. These statements do not include all disclosures required by accounting principles generally accepted in the United States of America (“GAAP”) for annual periods and should be read in conjunction with the Company’s audited consolidated financial statements and related notes for the year ended December 31, 2006 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 15, 2007. The Company prepared the unaudited interim condensed consolidated financial statements following the requirements of the SEC for interim reporting as contained in the instructions to Form 10-Q in Article 10 of Regulation S-X. As permitted under those rules, certain footnotes or other financial information that are normally required by GAAP can be condensed or omitted. As discussed in more detail in Note 6, Discontinued Operations, and elsewhere in this Quarterly Report on Form 10-Q, the Company sold certain assets and liabilities of its Automotive Information Center (“AIC”) data operations and substantially all of the assets and certain liabilities of its Retention Performance Marketing (“RPM”) business on January 31, 2007 and June 30, 2007, respectively. Accordingly, both the AIC operations and RPM business are presented in the condensed consolidated financial statements as discontinued operations. As discontinued operations, revenues and expenses of the AIC operations and RPM business have been aggregated and stated separately from the respective captions in continuing operations in the Condensed Consolidated Statements of Operations. Expenses include direct costs of the AIC operations and RPM business that the Company believes will be eliminated from future operations as a result of the sale of the AIC operations and RPM business. Assets and liabilities that are included in the sale of the AIC operations have been aggregated and classified as held for sale under current assets and current liabilities, respectively, at December 31, 2006. All other references to operating results reflect the ongoing operations of the Company, excluding the AIC operations and RPM business. The results of operations for the three months and nine months ended September 30, 2007 are not necessarily indicative of the results to be expected for the year ending December 31, 2007 or any other period(s).

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with GAAP 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, valuation of the non-exclusive patent license, accrued liabilities and valuation allowance for deferred tax assets. Actual results could differ from those estimates.

Reclassifications

Certain reclassifications have been made to prior period information to conform to the current period presentations.

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

Revenue Recognition

The Company classifies revenues as lead fees, advertising, CRM services, and other. Revenues from continuing operations by groups of similar services for the three months and nine months ended September 30, 2007 and 2006 were as follows:

The Company recognizes revenues when earned as defined by Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” and Emerging Issues Task Force (“EITF”) Issue No. 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 condensed 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 had deferred revenue in accordance with EITF Issue No. 00-21 under a multiple-element arrangement of $1.1 million at December 31, 2006. There was no revenue recognized under these types of arrangements for the three months ended September 30, 2007. Revenue recognized under these types of arrangements totaled $1.3 million for the nine months ended September 30, 2007 and $0.1 million and $0.9 million for the three months and nine months ended September 30, 2006, respectively.

Risks Due to Concentration of Significant Customers and Export Sales

For the three months and nine months ended September 30, 2007 and 2006, no dealer, major dealer group, manufacturer, international licensee or other customer accounted for more 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 September 30, 2007 and December 31, 2006.

Business Segment

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

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

Recent Accounting Pronouncements

In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48 (As Amended), “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 No. 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 Company adopted the provisions of FIN No. 48 on January 1, 2007.

Upon adoption of FIN No. 48, the Company analyzed its filing positions for all open tax years in all U.S. federal and state jurisdictions where it is required to file. At the adoption date of January 1, 2007, the Company had $0.5 million of unrecognized tax benefits. Of the total unrecognized tax benefits at the adoption date, the entire amount of $0.5 million was recorded as a reduction to deferred tax assets, which caused a corresponding reduction in the Company’s valuation allowance of $0.5 million. To the extent such portion of unrecognized tax benefits is recognized at a time such valuation allowance no longer exists, the recognition would impact the Company’s effective tax rate.

The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. In general, the Company is no longer subject to U.S. federal and state tax examinations for years prior to 2003. The Company does not believe there will be any material changes in its unrecognized tax positions over the next 12 months. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to FIN No. 48. In addition, the Company did not record a cumulative effect adjustment related to the adoption of FIN No. 48 and the adoption of FIN No. 48 did not have a material effect on the Company’s consolidated financial position or results of operations.

The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption and September 30, 2007, the Company did not have any accrued interest or penalties associated with any unrecognized tax benefits, nor was any interest expense recognized in the three months and nine months ended September 30, 2007.

In September 2006, the Financial Accounting Standards Board’s (“FASB”) Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 06-1, “Accounting for Consideration Given by a Service Provider to a Manufacturer or Reseller of Equipment Necessary for an End-Customer to Receive Service from the Service Provider”. EITF Issue No. 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 No. 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 September 2006, the FASB issued Statement of Financial Accounting Standards (“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.

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.

In May 2007, the FASB issued FASB Staff Position (“FSP”) FIN 48-1, “Definition of Settlement in FASB Interpretation No. 48”. FSP FIN 48-1 provides guidance on how to determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. FSP FIN 48-1 is effective retroactively to January 1, 2007. The implementation of FSP FIN 48-1 did not have an impact on the Company’s consolidated financial position or results of operations.

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

3. Computation of Basic and Diluted Net Income (Loss) Per Share

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

For the three months and nine months ended September 30, 2007, 7,770,298 and 8,045,931, respectively, antidilutive potential shares of common stock, consisting of employee and director stock options and employee stock purchase plan awards, have been excluded from the calculation of diluted (loss) income per share, as they represent stock options and awards for which the total employee proceeds per share exceed the average market price of a share of common stock for the period. In addition, for the three months and nine months ended September 30, 2007, 493,656 and 694,955, respectively, antidilutive potential shares of common stock, consisting of employee and director stock options and employee stock purchase plan awards, have been excluded from the calculation of diluted (loss) income per share, as the Company incurred a loss from continuing operations for both periods.

For the three months and nine months ended September 30, 2006, 7,515,742 and 6,419,291 respectively, anti-dilutive potential shares of common stock, consisting of employee and director stock options and employee stock purchase plan awards, have been excluded from the calculation of diluted loss per share, as they represent stock options and awards for which the total employee proceeds per share exceed the average market price of a share of common stock for the period. In addition, for the three months and nine months ended September 30, 2006, 764,572 and 1,178,261, respectively, antidilutive potential shares of common stock, consisting of employee and director stock options, have been excluded from the calculation of diluted loss per share, as the Company incurred a loss from continuing operations for both periods.

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

4. Share-Based Compensation

For the three months ended September 30, 2007 and 2006, the Company recorded $1.2 million and $1.4 million, respectively, of share-based compensation expense, or $0.03 earnings per share for each period. For the nine months ended September 30, 2007 and 2006, the Company recorded $3.8 million and $3.9 million of share-based compensation expense, respectively, or $0.09 earnings per share for each period. Share-based compensation expense is included in costs and expenses in the accompanying condensed consolidated statement of operations as follows:

The Company issued 205,799 and 102,250 shares of common stock upon exercise of stock options for the three months ended September 30, 2007 and 2006, respectively. The Company issued 964,412 and 269,341 shares of common stock upon exercise of stock options for the nine months ended September 30, 2007 and 2006, respectively. The Company granted 453,667 and 2,141,500, stock options for the three months ended September 30, 2007 and 2006, respectively, with a weighted-average fair market value per option granted of $2.24 and $2.01, respectively. The Company granted 949,167 and 3,332,000 stock options for the nine months ended September 30, 2007 and 2006, respectively, with a weighted-average fair market value per option granted of $2.15 and $2.28, respectively. The fair market value of the stock options at the date of grant was estimated using the Black-Scholes option-pricing model on the date of grant and the following assumptions:

The Company issued 43,267 and 65,560 shares of common stock under the employee stock purchase plan for the three months ended September 30, 2007 and 2006, respectively. The Company issued 108,381 and 119,264 shares of common stock under the employee stock purchase plan for the nine months ended September 30, 2007 and 2006, respectively. The Company granted 66,741 and 83,827 awards under the employee stock purchase plan for the three months ended September 30, 2007 and 2006, respectively. The awards granted were estimated to have a weighted-average fair value per share awarded of $0. 72 and $0.75 for the three months ended September 30, 2007 and 2006, respectively. The Company granted 126,480 and 149,812 awards for the nine months ended September 30, 2007 and 2006, respectively, under the employee stock purchase plan. The awards granted were estimated to have a weighted-average fair value per share awarded of $0.79 and $0.93 for the nine months ended September 30, 2007 and 2006, respectively. The fair value of the awards is based on the Black-Scholes option-pricing model and the following assumptions:

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

To induce James E. Riesenbach to join the Company as Chief Executive Officer and President, on March 20, 2006, the Company entered into an agreement with Mr. Riesenbach whereby the Company granted 1,000,000 options to him at an exercise price of $4.68 per share. Of the 1,000,000 options granted, 600,000 were service-based awards and met the criteria for granted options in accordance with SFAS No. 123(R), “Share-Based Payment”, as of March 20, 2006. The remaining 400,000 options are performance-based awards where the future performance criteria were to be defined at a future date. As such, in accordance with SFAS No. 123(R), the awards were not considered granted until such time that the performance criteria have been defined and were not included in outstanding options in prior periods.

To induce Monty A. Houdeshell to join the Company as Chief Financial Officer, on January 30, 2007, the Company entered into an agreement with Mr. Houdeshell whereby the Company granted 300,000 options to him at an exercise price of $3.74 per share. Of the 300,000 options granted, 250,000 were service-based awards and met the criteria for granted options in accordance with SFAS No. 123(R) as of January 30, 2007. The remaining 50,000 options are performance-based awards where the future performance criteria were to 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 and were not included in outstanding options in prior periods.

On July 17, 2007, the Compensation Committee of the Board of Directors established performance criteria for the vesting of 200,000 performance-based options held by Mr. Riesenbach and 16,667 performance-based options held by Mr. Houdeshell. The performance criteria are based upon the attainment by the Company of certain revenue, earnings before income taxes, depreciation and amortization (EBITDA) and strategic goals. Therefore, under SFAS 123(R), the total performance-based awards of 216,667 were deemed granted as of July 17, 2007 and are included in the outstanding options for the three and nine months ended September 30, 2007. The Company also began recognizing compensation expense for these awards on that date.

5. Selected Balance Sheet Accounts

Property and Equipment

Property and equipment consisted of the following at:

At September 30, 2007 and December 31, 2006, capitalized internal use software, net of amortization, and development in process were $6.5 million and $2.9 million, respectively. Total depreciation and amortization expense related to property and equipment was $1.3 million and $2.4 million for the three months and nine months ended September 30, 2007, respectively. Total depreciation and amortization expense related to property and equipment was $0.6 million and $1.6 million for the three months and nine months ended September 30, 2006, respectively.

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

Goodwill

In June 2007, the Company performed an annual impairment test of enterprise goodwill and concluded that enterprise goodwill was not impaired. The decrease in the carrying amount of goodwill of $3.0 million represents the allocation of goodwill associated with the sale of the Company’s RPM business (see Note 6).

Intangible Assets

Intangible assets at September 30, 2007 and December 31, 2006 are amortized over their estimated useful lives (weighted-average life is approximately 3 years) and consisted of the following:

The decreases in the gross carrying amount of developed technology and customer relationships were primarily associated with the sale of the Company’s RPM business. Amortization expense for the three months ended September 30, 2007 was immaterial. Amortization expense for the nine months ended September 30, 2007 was $0.5 million. Amortization expense for the three months and nine months ended September 30, 2006 was $0.4 million and $1.3 million, respectively. Amortization expense related to developed technology is classified as cost of revenues. Amortization expense for the remaining lives of the intangible assets is estimated to be as follows:

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

6. Discontinued Operations

On January 31, 2007, the Company completed the sale of certain assets and liabilities of the AIC operations to R.L. Polk (“Polk”) for $3.0 million. The Company received cash of $2.1 million, net of $0.4 million associated with AIC’s deferred revenues and prepaid expenses at January 31, 2007. The balance of $0.5 million was deposited by Polk in an escrow account and was distributed to the Company in the second quarter of 2007. As part of the transaction, the Company received a license to use data supplied by Polk at no cost for a period of three years and the Company licensed to Polk certain data at no cost for a period of three years and certain software at no cost in perpetuity. The Company recognized a gain on the sale of the AIC operations of $2.8 million during the nine months ended September 30, 2007.

On June 30, 2007, the Company sold its RPM business to Call Command, Inc. (“Call Command”) pursuant to a Stock Purchase Agreement (the “RPM Agreement”) for an aggregate purchase price of $7.6 million, subject to a working capital adjustment. Substantially all the assets and certain liabilities of the RPM business were included in the sale and consisted primarily of accounts receivable, prepaid expenses, certain property and equipment, intangible assets, accounts payable and accrued expenses. The Company received cash of $7.1 million and the balance of $0.5 million was deposited by Call Command in an escrow account to be distributed to the Company upon determination of the working capital adjustment and any indemnification claims made against the Company in accordance with the terms of the RPM Agreement. The $0.5 million deposited in escrow is a contingent gain as defined by SFAS No. 5, “Accounting for Contingencies”, and will be recognized as a gain on the sale if, and when, the Company receives these funds. The Company received $0.25 million of the amount deposited in escrow in October 2007.

In conjunction with the sale of the Company’s RPM business, the Company entered into a Transition Services and Arrangements Agreement (“TSAA”) whereby the Company agreed to provide certain transition services to RPM for a period not to exceed six months. The expected cash flows under the TSAA do not represent a significant continuation of the direct cash flows of the disposed RPM business. The Company also agreed to indemnify Call Command for pre-closing tax obligations and other unknown pre-closing obligations. The term of the indemnification for the pre-closing tax obligations is based on the statute of limitation as set forth by the taxing authority. The term of the indemnification for other obligations ranges from 1 year to 2 years. The maximum obligation is the purchase price of the transaction. Since it is not possible to determine whether there will be any obligations in the future or the amounts thereof, the Company cannot estimate the potential amount of future payments, if any, under these indemnification obligations. Therefore, no liability has been recorded.

The assets and liabilities that were included in the sale of the AIC operations met the criteria defined in SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” as of December 31, 2006 and were classified as held for sale at December 31, 2006. Pursuant to SFAS No. 144 and EITF Issue No. 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations,” Assets and liabilities that are included in the sale of the AIC operations have been aggregated and classified as held for sale under current assets and current liabilities, respectively, at December 31, 2006. Current assets are comprised of prepaid expenses and current liabilities are comprised of deferred revenues. The results of operations presented in the Condensed Consolidated Financial Statements reflect the AIC operations and RPM business as discontinued operations for all periods presented. As discontinued operations, revenues and expenses of the AIC operations and RPM business have been aggregated and stated separately from the respective captions of continuing operations in the Condensed Consolidated Statements of Operations. Expenses include direct costs of the operations that the Company believes will be eliminated from future operations as a result of the sale of the AIC operations and RPM business. All other references to operating results reflect the ongoing operations of the Company, excluding the AIC operations and RPM business. The results of operations of the AIC operations and RPM business reported as discontinued operations are summarized as follows:

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

AIC STATEMENTS OF OPERATIONS

(In thousands)

The results of operations of the AIC operations for the nine months ended September 30, 2007 reflect results through January 31, 2007, the date of sale.

RPM STATEMENTS OF OPERATIONS

(In thousands)

The results of operations of the RPM business for the nine months ended September 30, 2007 reflect results through June 30, 2007, the date of sale.

7. Patent Litigation Settlement

In 2004, the Company filed a lawsuit in the United States District Court for the Eastern District of Texas against Dealix Corporation, a wholly-owned subsidiary of The Cobalt Group. In that lawsuit, the Company asserted infringement of U.S. Patent No. 6,282,517, entitled “Real Time Communication of Purchase Requests,” against Dealix Corporation. In December 2006, the Company entered into a settlement agreement (the “Settlement Agreement”) with Dealix relating to the lawsuit. The Settlement Agreement provides that Dealix will pay the Company a total of $20.0 million in settlement payments for a mutual release of claims and a non-exclusive license from the Company to Dealix and the Cobalt Group of certain of the Company’s patent and patent applications. On March 13, 2007, the Company received the initial $12.0 million settlement payment with the remainder to be paid out in installments of $2.7 million on the next three annual anniversary dates of the initial payment. These remaining payments are guaranteed by WP Equity Partners, Inc., a Warburg Pincus affiliate. With court approval on March 25, 2007, the lawsuit against Dealix was dismissed.

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

In accounting for the Settlement Agreement, the mutual release of claims was estimated as $9.9 million by deducting the fair value of the non-exclusive license from the total settlement amount, net of the interest discount associated with the receivable, and recorded in patent litigation settlement in the Condensed Consolidated Statement of Operations for the nine months ended September 30, 2007.

To estimate the fair value of the non-exclusive license, an income approach was used, which included estimates of projected licensee revenue and related expenses, discounted utilizing a rate of 17%. The fair value of the non-exclusive license was estimated at $9.2 million and reported in other liabilities, which is being recognized to other income on a straight-line basis through January 2019, the patent’s remaining life. The Company recognized $0.2 million and $0.4 million in interest and other income in the Condensed Consolidated Statement of Operations for the three months and nine months ended September 30, 2007, respectively. As of September 30, 2007, the remaining balance in current and non-current other liabilities was $0.8 million and $8.0 million, respectively.

The remaining payments of $8.0 million were discounted to their net present value using a discount rate of 6.38%. As of September 30, 2007, $2.6 million and $4.7 million was included in prepaid expenses and other current assets, and other assets, respectively, in the Condensed Consolidated Balance Sheet. The discount of $0.9 million is being amortized to interest and other income over a three-year period using the effective interest method.

On April 27, 2007, the Company received a comment letter from the staff of the Division of Corporation Finance of the SEC (the “Staff”). Additional questions were received in comment letters dated June 4, 2007, June 22, 2007, July 25, 2007 and September 19, 2007. The Staff’s letters included comments relating to the accounting treatment of the patent litigation settlement with Dealix, specifically, the classification of amounts to be recorded, the timing of recognition and the allocation of the proceeds between the mutual release of claims and the non-exclusive patent license. Should the Staff disagree with the Company’s accounting for this legal settlement, it will not affect the amounts referenced above that have been received or are to be received by the Company under the settlement but might result in a change in the accounting treatment of the settlement, specifically, acceleration of all or a portion of deferred gain associated with the settlement or further deferral of all or a portion of amounts already recorded. This may have a material impact on the Company’s consolidated financial statements as of March 31, 2007, June 30, 2007 and September 30, 2007 and for the three months ended March 31, 2007, June 30, 2007 and September 30, 2007, the six months ended June 30, 2007 and the nine months ended September 30, 2007.

8. Commitments and Contingencies

Litigation

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. 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. On October 9, 2002, the District Court dismissed the Autobytel Individual Defendants from the case without prejudice. On February 19, 2003, the District Court denied the Company’s motion to dismiss the complaint. On December 5, 2006, the Second Circuit vacated a decision by the District Court granting class certification in six of the coordinated cases, which are intended to serve as test, or “focus” cases. The plaintiffs selected these six cases, which do not include the Company. On April 6, 2007, the Second Circuit denied a petition for rehearing filed by the plaintiffs, but noted that the plaintiffs could ask the District Court to certify more narrow classes than those that were rejected.

Prior to the Second Circuit’s December 5, 2006 ruling, the majority of issuers, including the Company, and their insurers had submitted a settlement agreement to the District Court for approval. In light of the Second Circuit opinion, the parties agreed that the settlement could not be approved. On September 25, 2007, the District Court approved a stipulation filed by the plaintiffs and the issuers terminating the proposed settlement. On August 14, 2007, the plaintiffs filed amended complaints in the six focus cases. The amended complaints include a number of changes, such as changes to the definition of the purported class of investors, and the elimination of the individual defendants as defendants. On September 27, 2007, the plaintiffs filed a motion for class certification in the six focus cases. If the plaintiffs are successful in obtaining class certification, they are expected to amend the complaint against the Company and the other non-focus case issuers in the same

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

manner that they amended the complaints against the focus case issuers and to seek certification of a class in the Company’s case. Due to the inherent uncertainties of litigation, the Company cannot accurately predict the ultimate outcome of the matter. The Company cannot predict whether it will be able to renegotiate a settlement that complies with the Second Circuit’s mandate. The plaintiffs now plan to replead their complaints and move for class certification again. If 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 September 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. A Consolidated Amended Complaint, which is now the operative complaint, was filed on April 19, 2002. It 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. On October 9, 2002, the District Court dismissed the Autoweb Individual Defendants from the case without prejudice. On February 19, 2003, the District Court denied Autoweb’s motion to dismiss the complaint. On December 5, 2006, the Second Circuit vacated a decision by the District Court granting class certification in six of the coordinated cases, which are intended to serve as test, or “focus” cases. The plaintiffs selected these six cases, which do not include Autoweb. On April 6, 2007, the Second Circuit denied a petition for rehearing filed by the plaintiffs, but noted that the plaintiffs could ask the District Court to certify more narrow classes than those that were rejected.

Prior to the Second Circuit’s December 5, 2006 ruling, the majority of issuers, including Autoweb, and their insurers had submitted a settlement agreement to the District Court for approval. In light of the Second Circuit opinion, the parties agreed that the settlement could not be approved. On September 25, 2007, the District Court approved a stipulation filed by the plaintiffs and the issuers terminating the proposed settlement. On August 14, 2007, the plaintiffs filed amended complaints in the six focus cases. The amended complaints include a number of changes, such as changes to the definition of the purported class of investors, and the elimination of the individual defendants as defendants. On September 27, 2007, the plaintiffs filed a motion for class certification in the six focus cases. If the plaintiffs are successful in obtaining class certification, they are expected to amend the complaint against Autoweb and the other non-focus case issuers in the same manner that they amended the complaints against the focus case issuers and to seek certification of a class in Autoweb’s case. Due to the inherent uncertainties of litigation, the Company cannot accurately predict the ultimate outcome of the matter. The Company cannot predict whether Autoweb will be able to renegotiate a settlement that complies with the Second Circuit’s mandate. The plaintiffs now plan to replead their complaints and move for class certification again. If 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.

The Company has reviewed the above class action matters and does not believe that it is probable that a loss contingency has occurred; therefore, the Company has not recorded a liability against these claims as of September 30, 2007.

Certain current and former directors and certain former officers of the Company are defendants in a derivative suit pending in the Superior Court of Orange County, California, and Autobytel is named as a nominal defendant in this suit. This suit purports to allege that the defendants breached numerous duties to the Company, 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 the Company, including damages to its reputation and goodwill. Plaintiffs’ claims are based on allegations that the defendants disseminated false and misleading statements concerning the Company’s results of operations and that these results were inflated at all relevant times due to violations of generally accepted accounting principles and Securities and Exchange Commission rules. The 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 was held on April 25, 2007. At that status conference, the court preliminarily approved the settlement, and requested that an order be prepared and submitted for such preliminary approval. A final settlement hearing was held on September 26, 2007, and the court approved the settlement and signed the Final Order and Judgment Approving Settlement. The Company has not recorded a liability against this claim as of September 30, 2007 because the settlement was covered by insurance.

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

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 Autobytel 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 Autobytel 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. On May 2, 2007, the parties tentatively agreed to a settlement in principle, and a settlement agreement was negotiated and fully executed in September 2007. The Company recorded a liability of $1.0 million against this claim as of March 31, 2007. Payments in accordance with the settlement agreement were made by the Company and its insurer in October 2007.

In August 2007, AVV, Inc. received a letter from a customer claiming indemnification regarding an action brought against such customer for alleged patent infringement. The customer later made a similar claim against the Company. The Company and AVV are in discussions with such customer regarding such claim. The Company cannot currently predict the outcome of this matter, which, depending on the outcome, may have a material impact on its results of operations, financial condition or cash flows.

From time to time, the Company is involved in other litigation matters arising from the normal course of its business activities. The actions filed against the Company 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 the Company’s business, results of operations, financial condition and cash flows.

Contractual Obligations

In 2007, the Company entered into a web search agreement with a vendor that guaranteed monthly minimum payments over a two-year period from June 15, 2007. The table below summarizes this obligation as of September 30, 2007 (in thousands):

From time to time, the Company enters into agreements in the ordinary course of business pursuant to which the Company agrees to indemnify, hold harmless and reimburse the indemnified party for losses suffered or incurred by it, which may include losses relating to intellectual property infringement claims. The term of these indemnifications may vary depending on the agreement. Other than the claim against AVV and the Company discussed above, the Company currently has no knowledge of any other intellectual property infringement claim that would be subject to indemnification by it, nor can the Company estimate the maximum potential amount of future payments under any such indemnification. Therefore, no liability has been recorded.

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AUTOBYTEL INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(continued)

(unaudited)

9. Subsequent events

In November, 2007, the Company sold all its ownership interest in its Japanese licensee for approximately $4.0 million. The carrying amount of the investment in the Japanese licensee was zero as of September 30, 2007. In connection with the sale, the Company amended the license agreement for certain intellectual property with such licensee effective April 1, 2008 to a perpetual royalty free license agreement.

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

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

Basis of Presentation

We sold certain assets and liabilities of our Automotive Information Center (“AIC”) data operations, our new vehicle price and specification business, on January 31, 2007. We also sold our wholly-owned subsidiary, Retention Performance Marketing, Inc., our business of providing customer loyalty and retention marketing programs (“RPM”), on June 30, 2007. Accordingly, our AIC operations and RPM business are presented in the consolidated financial statements as discontinued operations. As discontinued operations, revenues and expenses of our AIC operations and RPM business have been aggregated and stated separately from the respective captions in continuing operations in the Condensed Consolidated Statements of Operations. Expenses included in discontinued operations are direct costs of our AIC operations and RPM business that we believe will be eliminated from future operations as a result of the sale of our AIC operations and RPM business. Assets and liabilities that are included in the sale of our AIC operations have been aggregated and classified as held for sale under current assets and current liabilities, respectively, in our Condensed Consolidated Balance Sheet as of December 31, 2006. All other references to operating results reflect our ongoing operations, excluding our AIC operations and RPM 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 MyRide.com^™, 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.

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. In October 2007, we officially launched MyRide.com^™, the first fully-integrated automotive vertical search web experience, which is designed to 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 vehicle services, and accessing extensive multimedia and user-generated automotive content. We believe MyRide.com^™ is one of the Internet’s most comprehensive used vehicle Web sites, utilizing search-based technology to incorporate listings of millions of vehicles.

Our results of operations have been affected in the first nine months of 2007 by various factors, including, but not limited to, the following:

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In the future, our results of operations may continue to be affected by various factors, including, but not limited to, some of those mentioned above.

As part of our cost reduction efforts, in the fourth quarter of 2007, we initiated a workforce reduction of approximately 14% of our workforce. The affected employees were mostly in the areas of accounting and finance, information technology, and other general and administrative related areas. The reduction was effected in order to reduce our overall cost structure and generate operational efficiencies across our product lines. We expect the reduction in workforce to occur over the fourth quarter of 2007 and the first quarter of 2008. We expect that the charges associated with the reduction in workforce will range between $0.8 million and $1.0 million, which are expected to be incurred in the fourth quarter of 2007 and the first quarter of 2008. The charges consist mainly of severance costs and other benefits.

In 2004, we filed a lawsuit in the United States District Court for the Eastern District of Texas against Dealix Corporation, a wholly-owned subsidiary of The Cobalt Group. 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 (the “Settlement Agreement”) with Dealix relating to the lawsuit. The Settlement Agreement provides that Dealix will pay us a total of $20.0 million in settlement payments for a mutual release of claims and a non-exclusive license from us to Dealix and the Cobalt Group of certain of our patent and patent applications. On March 13, 2007, we received the initial $12.0 million settlement payment with the remainder to be paid out in installments of $2.7 million on the next three annual anniversary dates of the initial payment. These remaining payments are guaranteed by WP Equity Partners, Inc., a Warburg Pincus affiliate. With court approval on March 25, 2007, the lawsuit against Dealix was dismissed.

On April 27, 2007, we received a comment letter from the staff of the Division of Corporation Finance of the SEC (the “Staff”). Additional questions were received in comment letters dated June 4, 2007, June 22, 2007, July 25, 2007 and September 19, 2007. The Staff’s letters included comments relating to the accounting treatment of the patent litigation settlement with Dealix, specifically, the classification of amounts to be recorded, the timing of recognition and the allocation of the proceeds between the mutual release of claims and the non-exclusive patent license. We are responding to the Staff’s comments. Should the Staff disagree with our accounting for this legal settlement, it will not affect the amounts referenced above that have been received or are to be received by us under the settlement but might result in a change in the accounting treatment of the settlement, specifically, acceleration of all or a portion of deferred gain associated with the settlement or further deferral of all or a portion of amounts already recorded. This may have a material impact on our consolidated financial statements as of March 31, 2007, June 30, 2007 and September 30, 2007 and for the three months ended March 31, 2007, June 30, 2007 and September 30, 2007, the six months ended June 30, 2007 and the nine months ended September 30, 2007.

As of September 30, 2007, we had $28.3 million in domestic cash and cash equivalents. For the remainder of 2007, we expect to continue to use cash in excess of cash generated from operations.

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

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

Fees for 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

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(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 the 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^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.

During the third quarter of 2007, we broadly applied our new proprietary technology that allows multiple lead placements to leverage our dealer base.

We delivered approximately 825,000 and 712,000 purchase requests through our online systems to retail and enterprise dealers in the third quarters of 2007 and 2006, respectively. Of these, approximately 479,000 and 486,000 were delivered to retail dealers in the third quarters of 2007 and 2006, respectively, and approximately 346,000 and 226,000 were delivered to enterprise dealers in the third quarters of 2007 and 2006, respectively.

Additionally, we delivered approximately 180,000 and 212,000 finance requests in the third quarters of 2007 and 2006, respectively, to retail dealers, finance request intermediaries, and automotive finance companies.

Advertising revenues represent fees from automotive manufacturers and other advertisers who target car shoppers 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. We recently initiated a program to eliminate lower quality traffic sources to improve the performance of our advertising business. This may reduce total advertising page views in the short-term.

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

Other revenues include fees from intellectual property 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:

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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

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

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

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.

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. Gain contingencies are not recorded until all elements necessary to realize the gain are present. Any legal fees incurred in connection with a contingency are expensed as incurred.

Fair Value of Financial Instruments. The estimated fair values of our financial instruments, such as 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. The fair value of the non-exclusive license under the patent litigation settlement was estimated using an income approach, which included an estimate of projected licensee revenue and related expenses, discounted utilizing a rate of 17%.

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Share-Based Compensation Expense. We account for our share-based compensation using the fair value method as required by Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment.” 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. 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.

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.

Results of Operations

Three Months Ended September 30, 2007 Compared to the Three Months Ended September 30, 2006

Revenues by groups of similar services were as follows:

Lead Fees. Our lead fees are influenced by numerous factors, including but not limited to, purchase request volume, mix between purchase requests delivered to retail dealers and enterprise dealers, pricing and general market conditions. The increase in lead fees was primarily due to an increase of approximately 54% in the number of purchase requests delivered to our enterprise dealers and an increase of approximately 14% in the average sales price per finance request delivered. The increase in purchase requests delivered to enterprise dealers is primarily the result of increased demand during the third quarter of 2007, which we met through our newly launched multiple lead distribution technology. The increase in lead fees was partially offset by a change in the mix of purchase requests delivered, with an increase of approximately 10% in the proportion of purchase requests delivered to enterprise dealers that generally have a lower average sales price per purchase request.

Advertising. Advertising revenue in the third quarter of 2007 remained flat compared to the third quarter of 2006.

CRM Services. The decrease was primarily due to a $0.1 million decline in fees from data extraction service through ADS. The decrease in fees from ADS was primarily due to a decline in the number of customers using ADS.

Other. Other revenue in the third quarter of 2007 remained flat when compared to the third quarter of 2006.

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Cost and expenses were as follows:

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 fees paid to third parties for data and content included on our Web site properties, connectivity costs, technology license fees, server equipment depreciation and technology amortization and compensation related expense.

The increase in cost of revenues in the third quarter of 2007 compared to the third quarter of 2006 was due to a $1.7 million increase in TAC, a $1.0 million increase in maintenance, depreciation and amortization of computer equipment and software, a $0.4 million increase in data and content and hosting services fees and a $0.1 million increase in personnel cost. The increase in TAC was primarily due to an increase in the number of purchase requests acquired from our internet consumer request providers, partially offset by a slight decrease in the average price per purchase requests acquired and a decline in spending with third parties who direct search queries to our Web sites. The increase in maintenance, depreciation and amortization of computer equipment and software was primarily related to the equipment and software associated with the full launch of MyRide.com^™. The increase in data and content and hosting services fees is related to fees paid to third parties primarily in connection with MyRide.com^™. The increase in personnel cost is primarily due to increase in head count.

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. The increase in sales and marketing expense in the third quarter of 2007 compared to the third quarter of 2006 was primarily due to a $0.4 million increase in personnel and related costs and a $0.3 million in advertising costs. The increase in personnel and related costs was primarily due to an increase in headcount and completion of relocation of certain employees to our corporate headquarters. The increase in advertising was associated with the full launch of MyRide.com^™.

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. The decrease in product and technology development expense in the third quarter of 2007 compared to the third quarter of 2006 was primarily due to a $0.3 million decrease in consulting fees.

General and Administrative. General and administrative expense consists of executive, financial and legal expenses and costs related to being a public company. The decrease was primarily due to:

Amortization of Intangibles. The decrease in amortization of intangibles of $0.3 million in the third quarter of 2007 compared to the third quarter of 2006 was associated with certain intangible assets being fully amortized.

Interest and Other Income. The increase in interest and other income of $0.2 million in the third quarter of 2007, compared to the third quarter of 2006 was primarily due to the recognition of amortization of the deferred gain on the Dealix settlement. (See “Overview” for further details).

Income Taxes. We recorded an immaterial amount as provision for state income taxes in the third quarter of 2007 compared to a provision for state income taxes of $0.1 million in the third quarter of 2006.

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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.

Nine Months Ended September 30, 2007 Compared to Nine Months Ended September 30, 2006

Revenues by groups of similar services were as follows: