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.
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.
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 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.
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.
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
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.
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.
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
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
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.
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.
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.
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
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.
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
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
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
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.
Item 1B. Unresolved Staff Comments
None.
Item 2.
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.
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
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.
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.
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,
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.
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.
PART II
Item 5.
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.
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.
Item 6.
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.
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
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),
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.
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.
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
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
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
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:
Revenues by groups of similar services are as follows (in thousands):
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
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,
•
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
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.
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
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.
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.
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):
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
•
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
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.
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.
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 of this Annual Report on Form 10-K and are incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Our Management Report on Internal Control Over Financial Reporting is set forth on page of this Annual Report on Form 10-K.
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 (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.”
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.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Our current directors and executive officers are as follows:
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:
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
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
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.
Item 11.
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.
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.
(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.
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.
*
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.
(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.
Item 13.
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
(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.
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:
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
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.
PART IV
Item 15.
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
Management’s Report on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations and Comprehensive Income (Loss)
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules:
Schedule II-Valuation and Qualifying Accounts
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.
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.
AUTOBYTEL INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Management’s Report On Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations and Comprehensive Income (Loss)
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
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.
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
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
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
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
AUTOBYTEL INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
AUTOBYTEL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Amounts in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
AUTOBYTEL INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Amounts in thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
AUTOBYTEL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
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.
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
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.
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
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,
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:
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.
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.
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
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.
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:
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
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:
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:
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):
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:
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
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.
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:
The maturities of investments as of December 31, 2006 are due within one year.
Accounts Receivable, Net of Allowances for Bad Debts and Customer Credits
As of December 31, 2006 and 2005, accounts receivable and allowances for bad debts and customer credits were as follows:
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Property and Equipment
Property and equipment consists of the following:
During 2006, the Company recorded a charge of $264,000 associated with the write-off of a capitalized internal use software project no longer being developed or expected to be placed in service for its intended use. This charge was included in products and technology development expenses. As of December 31, 2006 and 2005, capitalized internal use software, net of amortization, and development in process were $2,903,000 and $183,000, respectively.
Depreciation and amortization expense related to property and equipment was $2,171,000, $1,999,000 and $2,447,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
Acquired Intangible Assets
Intangible assets recorded as a part of acquisitions are amortized over their estimated useful lives (weighted-average life is approximately 3 years) and consist of the following:
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Amortization expense for the years ended December 31, 2006, 2005 and 2004 was $1,515,000 $1,998,000 and $1,603,000, respectively. Amortization expense related to acquired technology is classified as cost of revenues. Amortization expense for the remaining lives of the intangible assets is estimated to be as follows:
Accounts Payable
Accounts payable consists of the following:
Accrued Expenses
The Company accrues expenses that are incurred and reasonably estimable based on the facts and circumstances available. As of December 31, 2006 and 2005, accrued expenses consisted of the following:
Other Current Liabilities
As of December 31, 2006 and 2005, other current liabilities consisted of the following:
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
4. Discontinued Operations
In November 2006, the Company announced it was exploring strategic alternatives for its Automotive Information Center (AIC) data business, the price and specification business of the Company. At December 31, 2006, the Company was in negotiations to sell the AIC business to R.L. Polk. On January 31, 2007, the Company completed the sale of certain assets and liabilities of the AIC business to R.L. Polk for $3,000,000. The Company received $2,073,000, net of $427,000 associated with AIC’s deferred revenues and prepaid expenses at January 31, 2007. The balance of $500,000 was deposited by R.L. Polk in an escrow account to be distributed to the Company upon completion of certain milestones as defined in the purchase agreement. As part of the transaction, the Company received a license to use data supplied by R.L. Polk at no cost for a period of three years.
The assets and liabilities that are included in the sale of the AIC business meet the criteria defined in SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” as of December 31, 2006 and are classified as held for sale at December 31, 2006. Pursuant to FAS 144 and EITF Issue 03-13, “Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations,” the results of operations presented in the Consolidated Financial Statements reflect the AIC business as a discontinued operation for all periods presented. As a discontinued operation, revenues and expenses of the AIC business have been aggregated and stated separately from the respective captions of continuing operations in the Consolidated Statements of Operations. Expenses include direct costs of the 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. Current assets are comprised of prepaid expenses and current liabilities are comprised of deferred revenues. All other references to operating results reflect the ongoing operations of the Company, excluding the AIC business. The results of operations of the AIC business reported as discontinued operations are summarized as follows:
AIC STATEMENTS OF OPERATIONS
(Amounts in thousands)
5. Acquisitions
Acquisition of Stoneage Corporation
On April 15, 2004, the Company acquired all of the outstanding common stock of Stoneage Corporation (“Stoneage”), now Car.com, Inc., a provider of Internet automotive buying services and owner of the Car.com
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Web site. Stoneage was acquired to expand the Company’s market share of new car buyers, increase the number of purchase requests processed through the Company, and add retail and enterprise dealer relationships to the Company. The acquisition also added the Car.com finance request business to the Company. The Company believes that the combined assets will further position it as a leader in the internet automotive business services sector. These factors contributed to a purchase price in excess of the fair value of the net tangible and intangible assets acquired from Stoneage Corporation, and as a result, the Company has recorded goodwill in connection with this transaction.
Under the terms of the agreement, former Stoneage shareholders received 2,257,733 shares of the Company’s common stock and $15,251,000 in cash, subject to a post closing purchase price adjustment. In June 2004, the final purchase price adjustment was determined and resulted in the Company’s obligation to issue 47,511 additional shares of common stock, which were issued in July 2004. The acquisition has been accounted for using the purchase method of accounting.
The aggregate purchase price was $50,767,000 and consisted of $15,251,000 in cash and 2,305,244 shares of common stock valued at $34,480,000 and transaction costs of $1,036,000. The value of the stock issued was determined based on the average market price of the Company’s common stock for the two days before and the date of the announcement/consummation of the acquisition. The final purchase price was allocated to the net tangible and intangible assets based on their respective estimated fair values on the acquisition date as follows (in thousands, except share and per share data):
The excess of the purchase price over the estimated fair value of the net tangible and intangible assets acquired was recorded as goodwill in the amount of $42,845,000. Goodwill is not amortized, rather it is evaluated on at least an annual basis for impairment. Goodwill is not deductible for income tax purposes. Intangible assets acquired consist of acquired technology at $200,000 which is amortized over an estimated useful life of 30 months, customer relationships at $3,575,000 which are amortized over an estimated useful life of three years and the Car.com domain name at $700,000 which is amortized over an estimated useful life of five years. To estimate the fair value of the customer relationships, an income approach was used with a discount rate of 27% which included an analysis of future cash flows and risks associated with achieving such cash flows. To
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
estimate the fair value of the Car.com domain name, a market approach was used utilizing historical costs to acquire in 2002 and an adjustment factor of 70%. To estimate the fair value of acquired technology, a cost approach was used which involves estimating the programming hours required to construct a software application with equivalent functionality multiplied by the cost per hour for engineers and programmers.
Stoneage’s financial position and results of operations from the date of acquisition on April 15, 2004 have been included in the accompanying consolidated financial statements (see discussion under Litigation in Note 7.)
Acquisition of iDriveonline, Inc.
On April 9, 2004, the Company acquired all of the outstanding common stock of iDriveonline, Inc. (iDriveonline), now Retention Performance Marketing, Inc., a provider of customer loyalty and retention marketing programs for the automotive industry, in exchange for cash and common stock. The acquisition combines iDriveonline’s leading applications, including an online prospecting and retention tool, enhanced data and segmentation tools, and improved dealer reporting capabilities with the Company’s existing customer retention program. Through this acquisition, the Company gained a meaningful presence in the automotive CRM marketplace. These factors contributed to a purchase price in excess of fair market value of iDriveonline’s net tangible and intangible assets acquired, and as a result, the Company has recorded goodwill in connection with the transaction. The acquisition has been accounted for using the purchase method of accounting.
The aggregate purchase price was $12,168,000 and consisted of $5,021,000 in cash, 474,501 shares of common stock valued at $6,775,000 and transaction costs of $372,000. The value of the stock issued was determined based on the average market price of the Company’s common stock for the two days before through the day after the date of the announcement of the acquisition. The final purchase price was allocated to the underlying net tangible and intangible assets based on their respective estimated fair values on the acquisition date as follows (in thousands, except share and per share data):
The excess of the purchase price over the estimated fair value of the net tangible and intangible assets acquired was recorded as goodwill in the amount of $11,022,000. Goodwill is not amortized, rather it is evaluated on at least an annual basis for impairment. Goodwill is not deductible for income tax purposes.
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Intangible assets acquired consist of acquired technology at $400,000 which is amortized over an estimated useful life of 18 months and customer relationships at $600,000 which are amortized over an estimated useful life of three years. To estimate the fair value of the customer relationships, an income approach was used with a discount rate of 28% which included an analysis of future cash flows and risks associated with achieving such cash flows. To estimate the fair value of acquired technology, a cost approach was used which involves estimating the programming hours required to construct a software application with equivalent functionality multiplied by the cost per hour for engineers and programmers.
iDriveonline’s financial position and results of operations from the date of acquisition on April 9, 2004 have been included in the accompanying consolidated financial statements.
Pro forma Consolidated Results of Operations
The following summarized unaudited pro forma consolidated results of operations are presented as if the acquisitions of iDriveonline and Stoneage had occurred on January 1, 2004. The unaudited pro forma results are not necessarily indicative of future earnings or earnings that would have been reported had the acquisitions been completed as presented.
6. Autobytel.Europe LLC
Autobytel.Europe was organized and formed in 1997 to expand the Company’s business model and operations throughout Europe.
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
On March 31, 2004, the Company adopted the provisions of FIN 46(R) and determined it was the primary beneficiary of Autobytel.Europe. As a result of adopting FIN 46(R), Autobytel consolidated Autobytel.Europe in its consolidated financial statements. As of December 31, 2006 and 2005, the assets and liabilities of Autobytel.Europe were as follows:
In December 2005, the Company received $3,889,000 from Autobytel.Europe as part of an agreement to dissolve Autobytel.Europe and recognized a foreign currency exchange gain of $1,533,000.
Autobytel.Europe’s revenue and expenses are included in the Company’s consolidated results of operations beginning April 1, 2004. Total revenue for the year ended December 31, 2005 and nine months ended December 31, 2004 was $272,000 and $133,000, respectively. Autobytel.Europe did not generate any revenue for the year ended December 31, 2006 as a result of the substantial liquidation. The dissolution of Autobytel.Europe was completed in February 2007.
7. Commitments and Contingencies
Operating Leases
The Company leases its facilities, certain office equipment and a domain name under operating leases which expire on various dates through 2011. As of December 31, 2006, future minimum lease payments on leases with non-cancelable terms in excess of one year were as follows (in thousands):
Rent expense included in costs and expenses from continuing operations was $1,801,000, $1,727,000 and $1,530,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
Guarantees
The Company guarantees operating lease commitments related to facilities in Westerville, Ohio and Troy, Michigan for some of its wholly-owned subsidiaries. The maximum guarantee amount is approximately $874,000 which represents the remaining commitment, through January 2011, on such operating lease arrangements as of December 31, 2006.
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Employment Agreements
As of December 31, 2006, Autobytel had agreements with James E. Riesenbach, Chief Executive Officer and President, Michael Schmidt, Executive Vice President and Chief Financial Officer, Ariel Amir, Executive Vice President and Chief Legal and Administrative Officer, Russell Bartlett, Senior Vice President, CRM and Data Services, and Mark Garms, Senior Vice President, Dealer Operations and Strategy. In the event of termination, non-renewal or change of control, Mr. Riesenbach is entitled to payments of two times the sum of his annual base salary and a bonus of 100% of base salary and benefits for twenty four months. In the event of termination or non-renewal, Mr. Amir is entitled to payments of one year base salary plus bonus of 50% of base salary and benefits for twelve months. In the case of termination by Mr. Schmidt or the Company, Mr. Schmidt is entitled to a lump sum payment equal to his annual base salary plus bonus, as well as benefits for one year following such termination. Messrs. Schmidt and Amir are also entitled to additional severance payments in the event of a change of control. The agreements for Messrs. Riesenbach, Amir and Schmidt also provide that if compensation in the event of a change of control is deemed to be parachute payments under the Internal Revenue Code, then the Company will make additional payments to compensate for their additional tax obligations. The agreement for Mr. Riesenbach expires on March 20, 2009 and provides for a one year extension. If the agreement with Mr. Riesenbach expires by its terms upon the expiration of the additional one year period, Mr. Riesenbach is entitled to receive a severance payment equal to two times his highest annual base salary as well as benefits for twelve months following such expiration. The agreements of Messrs. Schmidt and Amir expire on May 30, 2007 and July 19, 2007, respectively. In addition, the agreements provide for vesting of options upon a change of control. In addition, certain other officers, including Messrs. Bartlett and Garms, are entitled to six months’ base salary in the event of a termination without cause or for good reason. Such officers hold certain options that vest upon a change of control. The agreements with such officers are ‘at will’.
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. 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 the Company case.
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
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 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 JP Morgan preliminary agreement, if approved, would only 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 is 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
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. Plaintiffs allege that the underwriter defendants agreed to allocate stock in Autoweb’s initial public offering to certain investors in exchange for excessive and undisclosed commissions and agreements by those investors to make additional purchases of stock in the aftermarket at pre-determined prices. Plaintiffs allege that the prospectus for Autoweb’s initial public offering was false and misleading in violation of the securities laws because it did not disclose these arrangements. The action seeks damages in an unspecified amount. The action is being coordinated with approximately 300 other nearly identical actions filed against other companies. A motion to dismiss addressing issues common to the companies and individuals who have been sued in these actions was filed on July 15, 2002. On October 9, 2002, the Court dismissed the Autoweb Individual Defendants from the case without prejudice based upon Stipulations of Dismissal filed by the plaintiffs and the Autoweb Individual Defendants. On February 19, 2003, the Court dismissed the Section 10(b) claim without prejudice and with leave to replead but denied the motion to dismiss the claim under Section 11 of the Securities Act of 1933 against Autoweb. On October 13, 2004, the Court certified a class in 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 six 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, 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
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
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.
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 December 31, 2006.
On September 24, 2004, the Company filed a lawsuit in the United States District Court for the Eastern District of Texas against Dealix Corporation. 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 with Dealix relating to the lawsuit. The agreement provides that Dealix will pay the Company a total of $20,000,000 in settlement payments, $12,000,000 of which was paid to the Company on March 13, 2007, with the remainder to be paid out in installments of $2,666,666 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 the Company 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 Autobytel and certain of its 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 the Company misrepresented and omitted material facts with respect to its financial results and operations during the time period between July 24, 2003 and October 20, 2004. The complaint 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, the Company 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 the common stock of Autobytel between July 24, 2003 and October 21, 2004 will be certified, and a settlement fund will be established. The settlement was funded by the Company’s insurer. At the final settlement hearing on October 30, 2006, the court approved the settlement. In
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
addition, 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 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, the Company intends to defend this suit vigorously. However, the Company 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 the Company’s results of operations, financial condition and cash flows. The Company has 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 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. 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, the Company will defend these claims vigorously. The Company cannot currently predict the outcome of this litigation, which, depending on the outcome, may have a material impact on its results of operations, financial condition or cash flows. The Company has not recorded a liability against this claim as of December 31, 2006.
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
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
litigation could materially adversely affect the Company’s business, results of operations, financial condition and cash flows.
8. Retirement Savings Plan
The Company has a retirement savings plan which qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code (IRC or Code) (the 401(k) Plan.) The 401(k) Plan covers all employees of the Company who are over 21 years of age and is effective on the first day of the month following date of hire. Under the 401(k) Plan, participating employees are allowed to defer up to 50% of their pretax salaries not to exceed the maximum IRC deferral amount. The Company contributions to the 401(k) Plan are discretionary. During 2006, 2005 and 2004, the Company contributed $724,000, $720,000 and $595,000, respectively, related to continuing operations and $44,000, $48,000 and $53,000, respectively, related to discontinued operations.
9. Stockholders’ Equity
Preferred Stock
As of December 31, 2006, 11,445,187 shares of preferred stock with a $0.001 par value were authorized and undesignated. There were no shares of preferred stock issued or outstanding as of December 31, 2006.
1996 Stock Incentive Plan
The Company’s 1996 Stock Incentive Plan (the Incentive Plan) was approved by the Board of Directors in October 1996. The Incentive Plan provides for the granting to employees of incentive stock options within the meaning of Section 422 of the Code, and for the granting to employees, directors and consultants of nonstatutory stock options and stock purchase rights. The Company has reserved a total of 833,333 shares of common stock for issuance under the Incentive Plan. The exercise price of stock options granted under the Incentive Plan cannot be lower than the fair market value of the common stock, as determined by the Board of Directors, on the date of grant. With respect to any participants who, at the time of grant, own stock possessing more than 10% of the voting power of all classes of stock of the Company, the exercise price of stock options granted to such person must be at least 110% of the fair market value on the grant date, and the maximum term of such options is five years. The term of all other options granted under the Incentive Plan may be up to 10 years. Stock options granted under the Incentive Plan vest according to vesting schedules determined by the Board of Directors.
1998 Stock Option Plan
The Company’s 1998 Stock Option Plan (the 1998 Option Plan) was adopted in December 1998. The Company has reserved 1,500,000 shares under the 1998 Option Plan. The 1998 Option Plan provides for the granting to employees of incentive stock options within the meaning of the Code and nonstatutory stock options.
The exercise price of non-statutory options granted under the 1998 Option Plan cannot be lower than 85% of the fair market value of the common stock on the date of grant. The exercise price of all incentive stock options granted cannot be lower than the fair market value on the grant date. With respect to any participants who beneficially own more than 10% of the voting power of all classes of stock of the Company, the exercise price of any stock option granted to such person must be at least 110% of the fair market value on the grant date, and the maximum term of such option is five years. The term of all other options granted under the 1998 Option Plan may be up to 10 years. Under the 1998 Option Plan, certain stock options (Performance Options) vest over a time period determined by the Board of Directors, however, the vesting could be accelerated based on the
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
performance of the Company’s common stock. At December 31, 2006, there were no non-vested performance options outstanding under the 1998 Option Plan.
In December 2001, the Board of Directors granted Performance Options to purchase 200,000 shares of common stock to Jeffrey Schwartz at an exercise price of $1.60 per share, which represented the fair market value on the date of grant. These options vest over a five-year period, but the vesting could be accelerated based on the performance of the Company’s common stock. The accelerated vesting schedule provides that the grants will vest if the average trading price of the common stock for any 60 consecutive trading days is equal to or exceeds $5.00. As of December 31, 2004, all of these Performance Options were vested. All other stock options granted under the 1998 Option Plan vest according to vesting schedules determined by the Board of Directors.
The 1998 Option Plan provides that, unless otherwise provided in the stock option agreement, in the event of any merger, consolidation, or sale or transfer of all or any part of the Company’s business or assets, all rights of the optionee with respect to the unexercised portion of any option will become immediately vested and may be exercised immediately, except to the extent that any agreement or undertaking of any party to any such merger, consolidation, or sale or transfer of assets makes specific provisions for the assumption of the obligations of the Company with respect to the 1998 Option Plan.
1999 Stock Option Plan
The Company’s 1999 Stock Option Plan (the 1999 Option Plan) was adopted in January 1999. The Company has reserved 1,800,000 shares under the 1999 Option Plan. The 1999 Option Plan provides for the granting of stock options to employees of the Company. Under the 1999 Option Plan, not more than 1,000,000 shares may be issued pursuant to options granted after March 31, 1999.
The 1999 Option Plan provides for an automatic grant of an option to purchase 20,000 shares of common stock to each non-employee director on the date on which the person first becomes a non-employee director. In each successive year the non-employee director will automatically be granted an option to purchase 5,000 shares on November 1 of each subsequent year provided the non-employee director has served on the Board for at least six months. Each option will have a term of 10 years and will be granted at the fair market value of the Company’s common stock on the date of grant. The options vest in their entirety and become exercisable on the first anniversary of the grant date, provided that the optionee continues to serve as a director on such date.
The 1999 Option Plan is similar in all other material respects to the 1998 Option Plan.
1999 Employee and Acquisition Related Stock Option Plan
The Company’s 1999 Employee and Acquisition Related Stock Option Plan (the Employee and Acquisition Option Plan) was approved by the Board of Directors in September 1999. The Company has reserved a total of 1,500,000 shares of common stock for issuance under the Employee and Acquisition Option Plan. The Employee and Acquisition Option Plan provides for the granting to employees and acquired employees of stock options, and for the granting to employees, acquired employees and service providers of nonstatutory stock options. The exercise price of incentive stock options granted can not be lower than the fair market value on the date of grant and the exercise price of nonstatutory stock options can not be less than 85% of the fair market value of the common stock on the date of grant. The exercise price of stock options granted to individuals beneficially owning more than 10% of the voting power of all classes of the Company stock must be at least 110% of the fair market value on the grant date and have a maximum term of five years. The term of all other options granted under the Employee and Acquisition Option Plan may be up to 10 years. Stock options granted under the Employee and Acquisition Option Plan vest according to vesting schedules determined by the Board of Directors.
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
2000 Stock Option Plan
The Company’s 2000 Stock Option Plan (the 2000 Option Plan) was approved by the Board of Directors in April 2000. The 2000 Option Plan provides for the granting of both incentive stock options and nonqualified stock options to eligible employees, consultants and outside directors of the Company. The Company has reserved 3,000,000 shares under the 2000 Option Plan. Stock options granted under the 2000 Option Plan vest according to vesting schedules determined by the Board of Directors.
The 2000 Option Plan is similar in all other material respects to the 1999 Option Plan.
Amended and Restated 2001 Restricted Stock and Option Plan
On February 25, 2003, the Board of Directors approved the Amended and Restated 2001 Restricted Stock and Option Plan, which was approved by stockholders on June 25, 2003 (the Restricted Plan). The Restricted Plan allows for the granting of restricted stock, deferred share awards, stock options and stock appreciation rights to selected directors, officers, employees, consultants or other service providers of the Company. The Company has reserved 1,500,000 shares under the Restricted Plan. The Restricted Plan prohibits anyone from receiving awards for more than 400,000 shares per year. The Board may grant awards that vest immediately or based on future conditions. The Board has the discretionary authority to impose, in agreements, such restrictions on shares of common stock issued pursuant to restricted stock awards under the Restricted Plan as it may deem appropriate or desirable, including but not limited to the authority to impose a right of first refusal or to establish repurchase rights or both of these restrictions. Any repurchase right of the Company lapses on consummation of a change of control. Options may be either incentive stock options or nonqualified stock options. The per share exercise price of an incentive stock option shall not be less than 100% of the fair market value of a share on the date the option is granted (110% in the case of a grant to a ten-percent stockholder). The per share exercise price of a nonqualified stock option shall not be less than 85% of the fair market value of a share on the date the option is granted. No option shall be exercisable after the expiration of ten years from its grant date (five years in the case of an incentive stock option granted to a ten-percent stockholder). Options granted to optionees who are not directors, officers, or consultants must become exercisable at a rate no longer than 20% per year for five years from the grant date. Except as described below and as provided in the Restricted Plan, participants will not have any rights in the event that the Company is sold, merged, or otherwise reorganized. Unless the award agreement provides differently or unless any party to the merger, consolidation, or sale or transfer of the Company assets assumes the Company’s obligations with respect to awards under the Restricted Plan, the unvested portion of awards will become immediately vested upon any merger (other than a merger in which the Company is the surviving entity and the terms and number of outstanding shares remain unchanged as compared to the terms and number of outstanding shares prior to the merger), consolidation, or sale or transfer of the Company assets.
2004 Restricted Stock and Option Plan
The Company’s 2004 Restricted Stock and Option Plan (the 2004 Plan) was adopted by the board of directors on March 2, 2004, and approved by the stockholders on June 24, 2004. The 2004 Plan provides that an aggregate of 2,700,000 shares of the Company’s common stock are available to be awarded to the Company’s directors, officers, employees, consultants, or other service providers in the form of restricted shares, restricted units, deferred shares, options, SARs, and performance units; provided, that the maximum number of shares that can be awarded in the form of restricted shares, restricted units, deferred shares, or performance awards cannot exceed 200,000 shares. The 2004 Plan prohibits anyone from receiving an award of more than 500,000 shares of the Company’s common stock during any one calendar year, or 1,000,000 shares of the Company’s common stock during the term of the 2004 Plan. In addition, the 2004 Plan prohibits anyone from receiving performance units in any performance period (which shall not be less than one fiscal year) in excess of $2,500 in cash. The
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Board may grant awards that vest immediately or based on future conditions. The Board has the discretionary authority to impose certain restrictions on awards, including repurchase rights in favor of the Company. The per share exercise price of both incentive and nonstatutory stock options shall not be less than 100% of the fair market value of a share on the date the option is granted (110% in the case of a grant to a ten-percent stockholder). No option shall be exercisable after the expiration of ten years from its grant date (five years in the case of an incentive stock option granted to a ten-percent stockholder). Options granted to optionees who are not directors, officers, or consultants must become exercisable at a rate no longer than 20% per year for five years from the grant date. Unless the award agreement provides differently or unless any party to the merger, consolidation, or sale or transfer of the Company assets assumes the Company’s obligations with respect to awards under the 2004 Plan, the unvested portion of awards will become immediately vested upon any merger (other than a merger in which the Company is the surviving entity and the terms and number of outstanding shares remain unchanged as compared to the terms and number of outstanding shares prior to the merger), consolidation, or sale or transfer of the Company assets. Unless the award agreement provides differently, upon any liquidation or dissolution of the Company as provided in the 2004 Plan, all of the rights to any portion of unvested awards will end, and the awards will be canceled at the time of the liquidation or dissolution unless the relevant dissolution or liquidation plan provides otherwise.
2006 Inducement Stock Option Plan
In June 2006, the 2006 Inducement Stock Option Plan (the 2006 Plan) was approved by the Board of Directors. The 2006 Plan provides that an aggregate of 2,000,000 shares of the Company’s common stock are available to be awarded to the Company’s newly hired employees or appointed directors, solely in connection with the hiring of the employee or appointing of the director, in the form of nonqualified stock options. The per share exercise price of the stock options shall not be less than 100% of the fair market value of a share on the date of grant. No option shall be exercisable after the expiration of ten years from its grant date. An optionee who is not an officer or a director must have the right to exercise at least 20% of the options granted per year over five years from the date of grant. Unless the award agreement provides differently, the unvested portion of the awards will immediately become vested upon any merger (other than a merger in which the Company is the surviving entity and the terms remain unchanged as compared to the terms prior to the merger), consolidation, or sale or transfer of the Company’s assets, except if the options are assumed by the acquiring party. Unless the award agreement provides differently, upon any liquidation or dissolution of the Company, all the rights to any portion of unvested awards will end, and the awards will be canceled at the time of the liquidation or dissolution unless the relevant dissolution or liquidation plan provides otherwise.
2006 Riesenbach Options
In connection with hiring Mr. Riesenbach as President and Chief Executive Officer on March 20, 2006, Mr. Riesenbach was granted stock options to purchase 1,000,000 shares of our common stock, which vest, as to 333,333 of the options, on March 20, 2007, and thereafter (i) 11,111 of the options vest on each monthly anniversary of the grant date over the period beginning on the 13th monthly anniversary and ending on the 35th monthly anniversary of the grant date, (ii) 11,114 of the options vest on the day immediately preceding the 36th monthly anniversary of the grant date, provided that the vesting of such options will accelerate upon a change of control, or termination due to death or disability, by us without cause or by Mr. Riesenbach for good reason, and (iii) 200,000 of the options will vest upon each filing by us of our Annual Report on Form 10-K for each of the fiscal years ending on December 31, 2007 and December 31, 2008 provided Mr. Riesenbach is actively employed by us on the respective vesting dates and Mr. Riesenbach and we have satisfied reasonable performance criteria established by the Board of Directors or a committee thereof in its sole discretion after consulting with Mr. Riesenbach, provided that the vesting of such options will accelerate upon a change of control. Most vested options held by Mr. Riesenbach may be exercised for two years after termination other than in the event of termination for cause.
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Outstanding Stock Options and Stock Option Activity
The Company grants incentive and non-qualified stock options at an exercise price equal to the market closing price at the date of grant and that vest according to vesting schedules determined by the Board of Directors or a committee thereof. Shares of common stock issued upon exercise of stock options or awards under the employee stock purchase plan are from previously unissued shares.
A summary of the Company’s outstanding stock options as of December 31, 2006, and changes during the year then ended is presented below:
To induce Mr. 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. 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) as of March 20, 2006. The remaining 400,000 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 and were not included in outstanding options at December 31, 2006. The Company will begin recognizing share-based compensation expense based on the fair value of the performance-based options on the date the performance criteria have been defined.
The total intrinsic value of options exercised during 2006, 2005 and 2004, was $402,000, $424,000 and $10,005,000, respectively.
As of December 31, 2006, 1,620,680 stock options were available for grant under the Company’s stock option plans.
1996 Employee Stock Purchase Plan
The Company’s 1996 Employee Stock Purchase Plan was adopted by the Board of Directors in November 1996. On February 25, 2003, the Board of Directors approved an amendment providing for an additional 300,000 shares of common stock issuable over a ten-year period ending on February 24, 2013. The amendment was approved by stockholders on June 25, 2003. The Purchase Plan, which is intended to qualify under Section 423 of the Code, permits eligible employees of the Company to purchase shares of common stock through payroll deductions of up to ten percent of their compensation, up to a certain maximum amount for all purchase periods ending within any calendar year. The Company has reserved a total of 744,444 shares of common stock for
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
issuance under the Purchase Plan. The price of common stock purchased under the Purchase Plan will be 85% of the lower of the fair market value of the common stock on the first or last day of each six month purchase period. Employees may end their participation in the Purchase Plan at any time during an offering period, and they will be paid their payroll deductions to date. Participation ends automatically upon termination of employment with the Company.
A summary of the Company’s outstanding awards under the employee stock purchase plan as of December 31, 2006, and changes during the period then ended is presented below:
Preferred Shares Purchase Rights Plan
In July 2004, the Company’s Board of Directors approved the adoption of a stockholder rights plan under which all stockholders of record as of August 10, 2004 received rights to purchase shares of Series A Junior Participating Preferred Stock. The rights were distributed as a non-taxable dividend and will expire July 30, 2014.
The rights will be exercisable only if a person or group acquires 15% or more of the common stock of the Company or announces a tender offer for 15% or more of the common stock. If a person or group acquires 15% or more of the common stock, all rightholders, except the acquirer, will be entitled to acquire at the then exercise price of a right that number of shares of the Company’s common stock which at the time will have a market value of two times the exercise price of the right. Under certain circumstances, all rightholders, other than the 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 will have a market value of two times the exercise price of the right. The initial exercise price of a right is sixty five dollars.
The Board of Directors may terminate the rights plan at any time or redeem the rights prior to the time a person or group acquires more than 15% of the Company’s common stock.
10. Accrued Liability for Restructuring
In 2002, the Company recorded a charge of $769,000 related to the restructuring of the Company’s operations to reduce costs and enhance efficiencies. The charges included severance costs and a lease obligation. Payments related to the restructuring charge liabilities were made at various times between 2002 and 2005, with payment in full in 2005. There are no further liabilities or obligations related to this restructuring charge.
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
11. Income Taxes
The provision for income taxes consists of the following for the years ended December 31:
The reconciliation of the U.S. federal statutory rate to the effective income tax rate for the years ended December 31, 2006, 2005 and 2004, is as follows:
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred taxes as of December 31, 2006 and 2005 are as follows:
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
At December 31, 2006, the Company had recorded a valuation allowance of $39,180,000 on its net deferred tax assets. Based on the weight of available evidence, the Company believes that it is more likely than not that these deferred tax assets will not be realized.
At December 31, 2006, the Company had federal and state net operating loss carryforwards of approximately $83,859,000 and $47,209,000, respectively. A portion of these net operating losses is subject to an annual limitation of approximately $495,000 per year. The federal and state net operating losses begin to expire in 2021 and 2012, respectively. Approximately $10,800,000 and $5,000,000, respectively, of the federal and state net operating loss carryforwards were incurred by subsidiaries prior to the date of the Company’s acquisition of such subsidiaries. The Company established a valuation allowance of $4,065,000 at the date of acquisitions related to these subsidiaries. Accordingly, the tax benefits associated with the realization of such net operating losses will be credited to goodwill if realized. In addition, the federal and state net operating losses of approximately $13,484,000 and $8,476,000, respectively, relate to stock option deductions. Therefore, to the extent that the valuation allowance is reduced in the future and such options are realized in accordance with SFAS No. 123(R), approximately $4,719,000 and $509,000, respectively, will be credited to stockholder’s equity rather than to income tax benefit.
At December 31, 2006, deferred tax assets exclude approximately $140,000 and $18,000 of tax-effected federal and state net operating losses pertaining to tax deductions from stock-based compensation. Upon future realization of these benefits, the Company expects to increase additional paid-in capital and reduce income taxes payable. For purposes of SFAS No. 123(R), the benefit of excess stock option deductions is not recorded until such time that the deductions reduce income taxes payable. For purposes of determining when the stock options reduce income taxes payable, the Company has adopted the “with and without” approach under SFAS No. 123(R) whereby the Company considers net operating losses arising from continuing operations prior to net operating losses attributable to excess stock option deductions.
At December 31, 2006 the Company had federal and state tax credit carryforwards of $275,000 and $189,000, respectively, which begin to expire in 2021.
12. Related Party Transactions
Consulting Agreement
On January 5, 2006, the Company 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 the Company. 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. These costs were incurred in 2005 and, 2004 and are included in product and technology development expenses in the consolidated statements of operations. Also under the consulting agreement, Mr. Grimes made himself available to the executive officers of the Company for up to 16 hours a month for consultation and other activities related to formulating and implementing business strategies and relationships.
The wife of Mark Garms, Senior Vice President, Dealer Operations and Strategy, joined the Company 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.
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
13. Subsequent Events
Employment Agreement
In January 2007, the Company entered into an employment agreement with Monty A. Houdeshell in connection with his appointment as Executive Vice President, Finance, and his becoming Executive Vice President and Chief Financial Officer the day after the filing of this Annual Report on Form 10-K.
The Employment Agreement is for a three year term that ends on January 30, 2010 and automatically renews for additional one year periods unless either party notifies the other of its intent not to renew no later than one hundred twenty days prior to the expiration of the then current term. Mr. Houdeshell is entitled to an annual base salary of $300,000 during the term, and is eligible for a bonus of at least 60% of his annual base salary. In addition, Mr. Houdeshell may participate in any benefit plans generally afforded to executive officers. If Mr. Houdeshell’s employment is terminated without “cause,” if Mr. Houdeshell terminates his employment with “good reason” or if the Company delivers to Mr. Houdeshell a non-renewal notice, Mr. Houdeshell is entitled to a payment equal to the sum of his then annual base salary and a bonus of 60% of his annual base salary, as well as benefits for twelve months following such termination.
In the event of a change of control during the term of his employment or at any time during the six month period following such term, Mr. Houdeshell is entitled to a lump sum payment equal to two times the sum of his then annual base salary and a bonus of 60% of his annual base salary, so long as Mr. Houdeshell agrees, if requested, to continue with the Company or any successor for ninety days after the change of control. If Mr. Houdeshell’s compensation is deemed to be parachute payments under the Code, then the Company has agreed to make additional payments to him to compensate for his additional tax obligations.
Mr. Houdeshell was granted options to purchase 300,000 shares of common stock. Assuming Mr. Houdeshell remains actively employed by the Company through each stated anniversary date then Mr. Houdeshell’s options vest, as to 100,000 of the shares, on January 30, 2008, and thereafter, (i) options to purchase 6,250 of the shares will vest on each monthly anniversary thereafter ending on January 30, 2010, and (ii) upon filing by the Company of its Annual Report on Form 10-K for the fiscal years ending on December 31, 2007, December 31, 2008 and December 31, 2009, options to purchase 16,667, 16,667 and 16,666 shares, respectively, will vest, provided in respect of this clause (ii) Mr. Houdeshell and the Company have satisfied reasonable performance criteria established by the Board of Directors or a committee thereof in its sole discretion. The vesting of the options will accelerate upon a change of control. The options may be exercised once they vest.
Litigation Settlement
As discussed in Note 7, the Company received $12,000,000 on March 13, 2007 from Dealix.
AUTOBYTEL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
14. Quarterly Financial Data (Unaudited)
Quarterly financial data for the Company is summarized in the table below. The Quarterly Financial Data of all prior periods presented reflect the revenues and expenses of the AIC business as a discontinued operation. As a discontinued operation, revenues and expenses of AIC have been aggregated and stated separately from the respective captions of continuing operations. Expenses included in discontinued operations are direct costs of the AIC business that the Company believes will be eliminated from future operations as a result of the sale of the AIC business.
AUTOBYTEL INC.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
(Dollar amounts in thousands)
EXHIBIT INDEX
*
Filed herewith.

Confidential treatment has been requested with regard to certain portions of this document. Such portions were filed separately with the Securities and Exchange Commission.