10-Q 1 a74615e10-q.txt FORM 10-Q QUARTER ENDED JUNE 30, 2001 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to ______________ Commission file number: 000-25577 AUTOWEB.COM, INC. (Exact name of Registrant as specified in its charter) Delaware 77-0412737 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number)

3270 Jay Street Santa Clara, California 95054 (Address of principal executive offices, including zip code) (408) 970-9100 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 month (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] As of July 31, 2001, there were 29,566,117 shares of the Registrant's common stock outstanding. 2 AUTOWEB.COM, INC. INDEX

2 3 PART I: FINANCIAL INFORMATION ITEM 1: CONDENSED FINANCIAL STATEMENTS AUTOWEB.COM, INC. CONDENSED BALANCE SHEETS

The accompanying notes are an integral part of these financial statements. 3 4 AUTOWEB.COM, INC. CONDENSED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these financial statements. 4 5 AUTOWEB.COM, INC. CONDENSED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these financial statements. 5 6 AUTOWEB.COM, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS Note 1--The Company Autoweb.com, Inc. (the "Company") was incorporated in California on October 3, 1995 as Downtown Web, Inc. and reincorporated in Delaware on March 16, 1999. The Company provides a consumer automotive Internet service, whereby its Web site enables consumers to select new or pre-owned vehicles from member dealers, and also offers services that enable consumers to purchase automotive-related products and services such as insurance and financing. The Company also provides, through its division Automotive Information Center ("AIC"), automotive and on-line research tools for automotive manufacturers, major web portals and other industries. The Company markets and sells it's services primarily in North America and operates in one business segment. The Company has sustained net losses and negative cash flows from operations since its inception. The Company's ability to meet its obligations in the ordinary course of business is dependent on its ability to achieve profitable operations and/or raise additional financing through public or private equity financings or other sources of financing to fund operations. However, there is no assurance that the Company will achieve profitable operations or that it will be able to raise adequate financing from other sources. Management believes that its current funds will be sufficient to enable the Company to meet its planned expenditures through at least June 30, 2002. If anticipated operating results are not achieved, management has the intent and it believes that it has the ability to delay or reduce expenditures so as not to require additional financial resources, if such resources were not available on terms acceptable to the Company. Note 2--Summary of Significant Accounting Policies Basis of Preparation The accompanying condensed financial statements as of June 30, 2001, and for the six months ended June 30, 2001 and 2000, are unaudited. These unaudited interim condensed financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company's financial position, results of operations and cash flows as of June 30, 2001 and for the six months ended June 30, 2001 and 2000. These unaudited interim condensed financial statements and notes thereto should be read in conjunction with the Company's financial statements included in the Company's 2000 10-K/A filed with the Securities and Exchange Commission on April 30, 2001. The results for the six months ended June 30, 2001 are not necessarily indicative of the expected results for the year ending December 31, 2001 or any other future period. Concentration of Credit Risk Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents and accounts receivable. Cash and cash equivalents are deposited with six high credit quality financial institutions in the United States. The Company maintains allowances for potential credit losses, and such losses have been within management's expectation. The Company's accounts receivable are derived from revenues earned primarily from customers located in the United States and the Company performs ongoing credit evaluations of its customers' financial condition. Fair Value of Financial Instruments Carrying amounts of certain of the Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and other accrued liabilities, approximate fair value due to their relatively short maturities. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with original maturities or remaining maturities at the time of purchase of ninety days or less to be cash equivalents. Cash equivalents consist primarily of deposits in money market funds. 6 7 Stock-Based Compensation In 1997, the Company adopted the disclosure provisions of Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-based Compensation." The Company has elected to continue accounting for stock-based compensation issued to employees using Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." Under APB No. 25, compensation expense is based on the difference, if any, on the date of the grant between the fair value of the Company's stock and the exercise price. Stock issued to non-employees has been accounted for in accordance with SFAS No. 123 and valued using the Black-Scholes option pricing model. Net Loss Per Share The Company computes net loss per share in accordance with SFAS No. 128, "Earning per Share" and SEC Staff Accounting Bulletin ("SAB") 98. Under the provisions of SFAS No. 128, basic net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing the net loss for the period by the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares, composed of common shares issuable upon the exercise of stock options are included in the diluted net loss per share computation to the extent such shares are dilutive.

Recent Accounting Pronouncements In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interest method. In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is effective for The Company on January 1, 2002. SFAS 142 requires, among other things, the discontinuance of goodwill amortization and includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, and reclassification of certain intangibles out of previously reported goodwill. SFAS 142 also requires The Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently reviewing and assessing the impact of SFAS 141 and 142 on its financial statements. Note 3--Common Stock Unearned Stock-Based Compensation In connection with certain employee stock option grants during the six months ended June 30, 2001 and 2000, the Company recognized unearned compensation and related amortization expense as displayed in the table below. Amortization expense is being recognized over the vesting periods of the related options.

7 8 Note 4--Related Party Transactions At June 30, 2001, the Company had full recourse promissory notes receivable in the amount of approximately $960,000, approximately $922,000 of which is from Dean DeBiase, our Chairman and approximately $38,000 of which is from Samuel Hedgpeth, our former President and Chief Executive Officer. Of this amount, approximately $174,000 is included in "prepaid expenses and other current assets" and approximately $786,000 is included in stockholders' equity as "notes receivable from stockholders." Notes receivable totaling approximately $922,000 are interest free and collateralized by 595,660 shares of common stock and the remaining note receivable for approximately $38,000 bears interest at a rate of 5.59% per annum and is collateralized by 177,012 shares of common stock. On March 22, 2001, the Company entered into a three year non-exclusive agreement with Lycos, Inc., a stockholder of the Company. Under the agreement, the Company receives certain content and customer referrals from a co-branded site, along with certain advertising revenue generated from the co-branded site. For the quarter and six months period ended June 30, 2001, the Company recognized revenues of $454,000 and expenses of $249,000 under this agreement. Note 5--Commitments Through June 30, 2001, the Company had agreements with two global Internet media companies to maintain certain exclusive promotional rights and linkage with the media companies and to receive certain advertising. In addition, the Company shares in certain advertising revenues earned by the media companies. Through June 30, 2001, the Company paid $13.0 million under the terms of these agreements. Cash commitments under these two agreements total $11.4 million and expire in March 2004 and April 2004. The Company expenses all amounts ratably over the term of the agreement. The company also has multi-year agreements with other Internet advertisers and automotive information providers that make available to consumers vehicle research data over the Internet. Such agreements require that the Company pay fees to these companies based on the volume of referrals received by the Company from these services. The company expenses these amounts as the services are provided. Note 6--Subsequent Events Pursuant to the definitive acquisition agreement entered into with Autobytel.com, Inc. on April 11, 2001, Amendment Number 1 to Form S-4 was filed with the Securities Exchange Commission on July 17, 2001. 8 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Form 10-Q, including the discussion of our business, should be read in conjunction with the Condensed Financial Statements and Notes, thereto, of Autoweb.com, Inc. The following discussion contains forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual results to differ from anticipated results. In particular, factors that could cause Autoweb not to meet revenue expectations for the any quarter or year-end include, but are not limited to: our ability to attract consumers through existing portal relationships; the combined viability of current and new car buying process on our site; the effect of the restructuring of certain marketing agreements; lower revenue per purchase request associated with certain fixed price agreements with dealers; the inability to adjust the size of dealer network areas for certain fixed price agreements with dealers; and general market trends and conditions in the automotive sales market. Autoweb has also entered into an Acquisition by Merger Agreement with Autobytel.com. Failure to realize anticipated synergies related to the proposed merger, failure of the combined company to retain and hire key employees, difficulties in successfully integrating the parties' businesses and technologies, or failure of the companies to obtain the required stockholder or regulatory approvals or that the merger does not close for any other reason could adversely impact Autoweb. Other risks and uncertainties include the fact that the Company received a Nasdaq Staff Determination letter on March 1, 2001, indicating that the Company has failed to comply with the minimum bid price requirement for continued listing, and is subject to delisting from the Nasdaq National Market; changes in competitive behavior or market forces; uncertainties regarding response from the vehicle manufacturers; changes in the legal or regulatory environment, changes or lack of changes in consumer preferences over time, technological challenges and an inability to forecast future traffic and transactions. Other statements that could cause actual results to differ from those projected in these forward-looking statements include without limitation those discussed below in the "Factors That May Affect Future Results". Readers are urged to carefully review and consider the various disclosures made by us in this report and those detailed from time to time in our reports and filings with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that are likely to affect our business. OVERVIEW Autoweb.com is a leading consumer automotive Internet service. Our Web site centralizes an extensive collection of automotive-related commerce, content and community offerings to assist consumers in researching, evaluating and buying vehicles and automotive-related products and services such as insurance and financing. In addition, we provide automotive content, Web hosting and development services and sales automation services to vehicle manufacturers, dealers and online partners. Through our acquisition of Automotive Information Center ("AIC"), in 1999, we now provide consumers and automotive professionals with Autosite.com, a 20,000-page online vehicle buyer's guide and a rich suite of related services information and original automotive editorial content. We began selling our services to automobile dealers and launched the Autoweb.com Web site for consumer use in October 1995. Currently, our network of member dealers (where each franchise and pre-owned location for a particular vehicle manufacturer is defined as a member dealer) is approximately 4,100. We currently derive approximately 60% of our revenues from fees charged to our member dealers in exchange for qualified purchase inquiries. The revenue related to each fee is recognized in the month the qualified purchase inquiry is provided to the member dealer. We also provide online advertising space on the Autoweb.com site. Revenues from advertising contracts, which typically have terms of less than three months, are recognized as the contracts are fulfilled. In addition, we offer automotive-related services on the Autoweb.com site through agreements with third-party category partners. We derive revenues from third parties for the right to provide its consumer services, such as automobile financing and insurance, on our Web site. Revenues from these agreements are generally recognized ratably over the terms of the agreements. We incurred a net loss of $24.5 million for the six months ended June 30, 2001. Our limited operating history makes it difficult to forecast future operating results. We cannot be certain that net revenues will increase at a rate sufficient to achieve and maintain profitability. Even if we were to achieve profitability in any period, we might fail to sustain or increase that profitability on a quarterly or annual basis. On April 11, 2001, Autoweb entered into a definitive acquisition agreement with Autobytel.com, Inc. The merger is expected to close early in the third calendar quarter of 2001 upon satisfaction of customary and other closing conditions and receipt of governmental and stockholder approvals. Under the terms of the agreement, Autoweb stockholders will receive 0.3553 shares of Autobytel common stock in exchange for each share of Autoweb common stock. Outstanding stock options to purchase shares of Autoweb common stock will be assumed after adjustment at the same exchange ratio. 9 10 Results of Operations The following table sets forth, for the periods presented, certain data derived from our unaudited condensed statements of operations as a percentage of net revenues. The operating results for the six months ended June 30, 2001 are not necessarily indicative of the results that may be expected for any future period.

Net Revenues Net revenues decreased to $9.1 million in the second quarter of 2001, from $15.2 million in the second quarter of 2000, an overall decrease of 40%. Approximately 78% of the decrease in net revenues was due to lower net dealer fees with the remaining decrease primarily attributable to lower business development revenues. Net revenues decreased to $19.2 million for the six months ended June 30, 2001 from $31.0 million for the six months ended June 30, 2000, an overall decrease of 38%. Approximately 88% of the decrease in net revenues was due to lower net dealer fees with the remaining decrease primarily attributable to lower business development fees. The decrease in net dealer fee revenue is primarily the result of decreases in the number of purchase inquiries that we provided to our member dealers, and automotive-related vendors or category partners. Cost of Net Revenues Cost of net revenues increased to $2.0 million in the second quarter of 2001 from $1.5 million in the second quarter of 2000. The increase was due to higher revenue sharing costs partially offset by lower web site operation costs including personnel and site content. Cost of net revenues increased to $3.9 million for the six months ended June 30, 2001 from $3.2 million for the six months ended June 30, 2000. The increase was due to higher revenue sharing costs partially offset by lower web site operation costs including personnel and site content. The increase in revenue sharing costs is the result of the increase in pay-for-performance marketing arrangements. Sales and Marketing Sales and marketing expenses decreased to $6.1 million in the second quarter of 2001 from $13.1 million in the second quarter of 2000. Approximately 47% of the decrease in sales and marketing expense was due to lower online advertising while 32% of the decrease was due to lower offline advertising, with the remaining decrease primarily attributable to lower salary and salary related expenses. Sales and marketing expenses decreased to $14.5 million for the six months ended June 30, 2001 from $27.9 million for the six months ended June 30, 2000. Approximately 50% of the decrease in sales and marketing expense was due to lower offline advertising while 25% of the decrease was due to lower online advertising, with the remaining decrease primarily attributable to lower salary and salary related expenses as well as lower tradeshow costs. 10 11 Sales and Marketing -- Settlement Charge The sales and marketing -- settlement charge for the six months ended June 30, 2001 was $12.6 million. The settlement charge is the result of a payment made to a related party stockholder to terminate and settle all outstanding commitments under an advertising agreement. Product Development Product development expenses decreased to $1.4 million in the second quarter of 2001 from $2.4 million in the second quarter of 2000. The decrease is primarily due to lower salary and salary related costs. Product development expenses decreased to $3.0 million for the six months ended June 30, 2001 from $4.3 million for the six months ended June 30, 2000. The decrease in product development costs is primarily due to lower salary and salary related costs. General and Administrative General and administrative expenses increased to $3.1 million in the second quarter of 2001 from $3.0 million in the first quarter of 2000. For the second quarter, higher bad debt expense and an increase in stock compensation were partially offset by lower salary and salary related costs. General and administrative expenses decreased to $5.4 million for the six months ended June 30, 2001 from $6.2 million for the six months ended June 30, 2000. Approximately 82% of the decrease is due to lower salary and salary related costs. Merger Related Costs Merger related costs in the second quarter of 2001 and six months ended June 30, 2001 were $226,000 and $1.1 million, respectively. The merger related costs represent investment banking, legal fees, and accounting fees for services related to the definitive acquisition agreement entered into with Autobytel. Amortization of Intangible Assets Amortization of intangible assets expense was $1.8 million in the second quarter of 2001 and $1.7 million in the second quarter of 2000. Amortization of intangible assets expense was $3.6 million for the six months ended June 30, 2001 and $3.5 million for the six months ended June 30, 2000. All of the amortization expense was due to the acquisition of certain intangibles. In July 1999, the Company entered into an agreement with SalesEnhancer.com, LLC (SalesEnhancer) to acquire certain technology and other assets and certain liabilities for $3.7 million in cash. In October 1999, the Company entered into an agreement with The Gale Group, Inc., a subsidiary of the Thompson Company, Inc., to acquire certain assets and liabilities of AIC for $19.3 million in cash and common stock. Stock-Based Compensation Stock-based compensation expense decreased to $311,000 in the second quarter of 2001 from $410,000 in the second quarter of 2000. Stock-based compensation expense decreased to $623,000 for the six months ended June 30, 2001 from $829,000 for the six months ended June 30, 2000. The decrease reflects cancellations of previously recorded unearned stock based compensation charges due to employee terminations. Stock based compensation expense has been allocated to the relevant functional expense categories within operating expenses. Interest and Other Income, Net Interest and other income, net, decreased to $63,000 in the second quarter of 2001 from $463,000 in the second quarter of 2000. The decrease is attributable to a lower average cash balance during the quarter. Interest and other income, net, decreased to $388,000 for the six months ended June 30, 2001 from $781,000 for the six months ended June 30, 2000. The decrease is attributable to a lower average cash balance during the period. 11 12 Recent Accounting Pronouncements In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations." SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interest method. In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which is effective for The Company on January 1, 2002. SFAS 142 requires, among other things, the discontinuance of goodwill amortization and includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, and reclassification of certain intangibles out of previously reported goodwill. SFAS 142 also requires The Company to complete a transitional goodwill impairment test six months from the date of adoption. The Company is currently reviewing and assessing the impact of SFAS 141 and 142 on its financial statements. Liquidity and Capital Resources Net cash used in operating activities was $15.8 million in the six months ended June 30, 2001 compared to net cash used in operations of $18.9 million in the six months ended June 30, 2000. Net cash used in operating activities in the six months ended June 30, 2001 was primarily due to the net loss of $24.5 million for the period which includes the settlement charge of $12.6 million, decreases in accounts payable and other accrued expenses of $1.3 million, and increase in the provision for doubtful accounts of $1.1 million, partially offset by decreases in prepaid expenses of $4.5 million, depreciation and amortization expense of $4.6 million and stock based compensation expense of $623,000. Net cash used in operating activities in the six months ended June 30, 2000 of $18.9 million was primarily due to the net loss of $13.2 million, increases in prepaid expenses and other assets of $6.9 million, increases in accounts receivable of $4.2 million, partially offset by depreciation and amortization expense of $4.4 million. Net cash used in investing activities was $211,000 in the first six months of 2001 and was primarily the result of the acquisition of property and equipment. Net cash provided by investing activities was $17.1 million in the first six months of 2000 and was primarily the result of the maturity of short term investments of $20.9 million partially offset the purchase of long-term investments of $2.4 million, and the acquisition of property and equipment of $1.1 million. Net cash provided by financing activities was $126,000 for the first six months of 2001 and was the result of proceeds from borrowing under debt facilities of $499,000 partially offset by principal payments under notes payable and capital lease obligations of $379,000. Net cash provided by financing activities was $30.2 million for the first six months of 2000 and resulted primarily from the issuance of common stock of $30.4 million. At June 30, 2001, the total of our cash and cash equivalents was $11.2 million. We believe that our current cash position together with anticipated future revenues will be sufficient to meet our cash requirements for at least the next 12 months. Depending on our rate of growth and cash requirements, we may require additional equity or debt financing to meet future working capital or capital expenditure needs. There can be no assurance that such additional financing will be available or, if available, that such financing can be obtained on terms satisfactory to us. FACTORS THAT MAY AFFECT FUTURE RESULTS Autoweb will face significant challenges related to its merger with Autobytel. Failure to adequately integrate the two companies or consummate the merger may have a material adverse effect on the company's business. The merger between Autoweb and Autobytel involves the integration of two companies that have previously operated independently. Combining the operations of Autoweb and Autobytel will be a complex process that will require, among other things, integration of various functional areas, such as finance, human resources and sales and marketing groups, and coordination of development efforts. Autoweb cannot be certain that the integration will be completed in a timely manner or that it will achieve the anticipated benefits of the merger. In addition, circumstances may arise that prevent Autoweb from consummating the merger with Autobytel. Failure to adequately manage the integration process and to coordinate the joint efforts of the two companies or failure to close the merger may have a material adverse effect on the business of the company. 12 13 Autoweb will incur significant costs associated with the merger which could negatively affect the company's financial performance. Autoweb expects to incur significant costs and commit significant management time integrating Autoweb's operations, technology, development programs, products, clients and personnel with Autobytel. These costs may be substantial and may include costs for: integration of operations, including combining teams and processes in various functional areas; - fees and expenses of professionals and consultants involved in completing the integration process; - reorganization or closure of facilities; - incurring potential existing liabilities of Autoweb; - employee severance costs; and - integration of technology and products. Other factors to consider if the merger is not consummated. If the merger is not completed for any reason, Autoweb will be subject to a number of material risks, including: the provision in the merger agreement that Autoweb could be required to pay Autobytel a termination fee of up to $1 million and/or that Autoweb could be required to reimburse Autobytel for costs and expenses incurred in connection with the merger; the market price of Autoweb common stock may decline to the extent that the current market price of such shares may reflect a market assumption that the merger will be completed; costs related to the merger, such as legal and accounting fees and a portion of the investment banking fees, must be paid even if the merger is not completed; benefits that Autoweb expects to realize from the merger, such as the potentially enhanced financial and competitive position of the combined companies, would not be realized; the diversion of management attention from day-to-day business, and the potential to disrupt employees and relationships with customers and dealers during the period before consummation of the merger, may affect the financial and market position of Autoweb if the merger does not occur; and if the merger is terminated and the Autoweb board of directors seeks another merger or business combination, Autoweb stockholders cannot be certain that Autoweb will be able to find a partner willing to pay an equivalent or more attractive price than the price to be paid by Autobytel. Additionally, failing to complete the merger could adversely affect Autoweb's continued listing on the Nasdaq National Market. In considering these factors, you should be aware that either Autobytel or Autoweb can terminate the merger for various reasons. We have a limited operating history under our current business model As part of our business strategy, we acquired AIC in 1999. As a result of the acquisition, approximately 40% of our employees are now based outside of our Santa Clara headquarters. If we are unable to effectively manage a large and geographically dispersed group of employees, our business will be adversely affected. In addition, we have a limited operating history and unproven business model as a combined company. A number of risks and challenges accompany our model, including: - the difficulty of continuing to assimilate the operations and personnel of the combined entities; - the impairment or integration of relationships with employees or customers as a result of any integration of the combined companies; - the ability of the combined company to continue to generate revenue streams from fees for consumer inquiries, advertising, automotive content and technology; - the difficulty in maintaining a consumer, dealer, OEM, and affiliate or category partner customer base; and - the ability to continue to develop our technology infrastructure in order to handle greater Internet traffic efficiently. We may not be successful in addressing these risks or any other problems encountered in connection with our current business model. If we are unable to maintain our Nasdaq National Market Listing, the liquidity of our common stock would be seriously limited. On March 1, 2001, the Company received a Nasdaq Staff Determination indicating that the Company has failed to comply with the minimum bid price requirement for continued listing, and is subject to delisting from the Nasdaq National Market. The Company has filed a request for a hearing before the Nasdaq Qualifications Panel ("Panel") to review the staff determination. The hearing was held on April 12, 2001. The Panel ultimately decided to allow Autoweb stock to continue to trade on the Nasdaq National Market on the condition that the merger with Autobytel closes by August 16, 2001, and the shares of Autoweb stock are then voluntarily delisted from the Nasdaq National Market pursuant to the terms of the merger agreement. 13 14 There can be no assurance that the Panel will decide to allow the Company to remain listed in the meantime, or that the Company's actions will prevent the delisting of its common stock in the event that the merger is not completed. . In the event the Company's shares are delisted from the Nasdaq National Market, we will attempt to have our common stock traded on the NASD over-the counter Bulletin Board. If our common stock is delisted, it would seriously limit the liquidity of our common stock and limit our potential to raise future capital through the sale of our common stock, which could have a material adverse effect on our business. Our revenue growth rates, if any, may not be sustainable. Our results of operations have varied widely in the past, and we expect that they will continue to vary significantly from quarter to quarter due to a number of factors described below and elsewhere in this Form 10-Q. Our revenue growth rates, if any, may not be sustainable. Any shortfall in our revenues would immediately increase our operating losses and would adversely affect the market price of our common stock. We continue to be substantially dependent on member dealer fees. Quarterly revenues and operating results for this quarter have been negatively affected by weaker than expected market trends, as well as, a reduced average selling price per customer purchase request, or PR. The reduction in price was driven primarily by higher than expected delivery of PRs under certain fixed price agreements with dealers. Autoweb is working with the affected dealers to adjust territories in an attempt to correct pricing issues. However, there can be no assurances that this effort will result in an incremental increase in revenue. Therefore, our quarterly revenues and operating results are likely to be particularly affected by the level of member dealer fees in each quarter. If revenues from dealer sales continues to fall below our expectations or is not stabilized, we will not be able to reduce our spending rapidly in response to such a shortfall. This will adversely affect our operating results. Autoweb may lose subscribing dealers because of the reconfiguration of the dealer territories. If the volume of purchase requests increases, Autoweb may need to reduce or reconfigure the exclusive territories currently assigned to dealers to serve consumers more effectively. If a dealer is unwilling to accept a reduction or reconfiguration of its territory, it may terminate its relationship with Autoweb. A dealer also could sue Autoweb to prevent such reduction or reconfiguration, or collect damages from Autoweb. Autoweb has experienced one such lawsuit. A material decrease in the number of dealers subscribing to Autoweb's network or litigation with dealers could have a material adverse effect on the companys' business, results of operations and financial condition. It is likely that our results of operations in some future quarter may be below the expectations of public market analysts and investors. In this event, the price of our common stock is likely to decline. We have a history of net losses and expect net losses for the foreseeable future We have incurred net losses in each fiscal year since our inception, including a net loss of $38.4 million in 2000. We had an accumulated deficit of $98.7 million as of June 30, 2001. The size of future net losses will depend, in part, on the rate of growth in our revenues from member dealer fees, category partners fees, advertising sales and other e-commerce activities. It is critical to our success that we continue to expend financial and management resources to develop Autoweb.com brand awareness and loyalty through marketing and promotion, expansion of our member dealer network, development of our online content and expansion of our other services. As a result, a significant portion of our operating expenses for the next several years will continue in sales and marketing. With these expenses, we will need to generate significant additional revenues to achieve profitability. As a result, we may never achieve or sustain profitability, and, if we do achieve profitability in any period, we may not be able to sustain or increase profitability on a quarterly or annual basis. Autoweb's quarterly financial results are subject to significant fluctuations which make it difficult for investors to predict Autoweb's future performance. Each of Autoweb's quarterly operating results have fluctuated in the past, and may fluctuate in the future due to many factors. Autoweb's expense levels are based in part on its expectations of future revenues which may vary significantly. If revenues do not increase faster than expenses, Autoweb's business, results of operations and financial condition will be materially and adversely affected even after giving effect to the merger. Other factors that may adversely affect Autoweb's quarterly operating results include, but are not limited to: Autoweb's ability to consummate the merger with Autobytel, retain existing dealers, attract new dealers and maintain dealer and customer satisfaction; general economic conditions and economic conditions specific to the Internet, online 14 15 commerce or the automobile 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 Autoweb; Autoweb's ability to maintain the proper level of traffic on its Web sites, governmental regulation; and unforeseen events affecting the industry. Seasonality is likely to cause fluctuations in Autoweb's operating results. Investors may not be able to predict Autoweb's annual operating results based on a quarter to quarter comparison. Autoweb's business experiences seasonality. The seasonal patterns of Internet usage and vehicle purchasing do not completely overlap. Historically, Internet usage typically declines during summer and certain holiday periods, while vehicle purchasing in the United States is strongest in the spring and summer months. If seasonality occurs, investors may not be able to predict Autoweb's annual operating results based on a quarter to quarter comparison of Autoweb's operating results. The merger will make comparison to historical results more difficult. Seasonality in the automotive industry, Internet and commercial online service usage and advertising expenditures is likely to cause fluctuations in the combined companies' operating results and could have a material adverse effect on the company's business, operating results and financial condition. Internet commerce is still new and evolving with few profitable business models. Autoweb cannot assure that its business model will profitable. The market for Internet-based purchasing services has only recently begun to develop and is rapidly evolving. While many Internet commerce companies have grown in terms of revenues, few are profitable. Autoweb cannot assure that it will be profitable. As is typical for a new and rapidly evolving industry, demand and market acceptance for recently introduced services and products over the Internet are subject to a high level of uncertainty and there are few proven services and products. Moreover, since the market for such services is still evolving, it is difficult to predict the future growth rate, if any, and size of this market. The extent to which other participants in the automotive industry will accept the role of third-party, all-make, all-model services such as Autobytel and Autoweb is not yet known. Our business is dependent on the economic strength of the automotive industry The economic strength of the automotive industry significantly impacts the revenues we derive from our member dealers, vehicle manufacturers and category partners, advertising revenues and consumer traffic to our Web site. The automotive industry is cyclical, with vehicle sales fluctuating due to changes in national and global economic forces. Vehicle sales in the United States have been declining in the latter part of 2000. We cannot assure you that vehicle sales will increase or stay at their current levels. A further decrease in the current level of vehicle sales could have a material adverse effect on our business, results of operations and financial condition. We currently rely heavily on member dealers We derive the majority of our revenues from member dealer fees (payments from member dealers for each purchase inquiry that we provide to them), and we expect to continue to do so for the foreseeable future. Member dealer fees represented approximately 60%, 66%, and 78% of our net revenues in 2000, 1999, and 1998 respectively. Consequently, our business is highly dependent on consumers' use of Autoweb.com to purchase vehicles so that member dealers will achieve a satisfactory return on their investment in the Autoweb.com program. The success of our business strategy depends on our member dealers' adherence to the Autoweb.com purchase process, including responding to consumer purchase inquiries within 24 hours, providing a competitive, firm quote to consumers during the initial communication, explaining the Autoweb.com purchase process to the consumer and answering any consumer questions. We devote significant efforts and resources to certifying and supporting participating member dealers in these practices that are intended to increase consumer satisfaction. Our inability to certify and support member dealers effectively, or member dealers' failure to adopt such practices, respond rapidly and professionally to vehicle purchase inquiries, or sell vehicles in accordance with our marketing strategies, could result in low consumer satisfaction and materially adversely affect our business, results of operations and financial condition. To maintain and increase our network of member dealers, we must reduce the rate of turnover of our member dealers. Commencing in February 1998, we introduced a new "pay for performance" pricing model and began actively to convert our existing member dealers to this model. Prior to that time, all of our member dealers were on a subscription model under which they paid a fixed amount per month regardless of the number of purchase inquiries that we provided to them. During 1998, we lost approximately 60% of the member dealers that we 15 16 had at the beginning of the year and converted approximately 30% to the new pricing model. During 1998, we lost approximately 22% of the performance-based member dealers that we converted or with which we first entered into a contract in 1998. During 1999, we lost approximately 31% of the performance-based member dealers that we had at the beginning of the year or first entered into a contract during the year. During 2000, we lost approximately 49% of the performance-based member dealers that we had at the beginning of the year. In February 2001, we introduced a flat fee pricing model and began to offer the flat fee option to new and existing dealers. The results of the flat fee program pricing model has been lower than expected quarterly revenues and operating results. The flat fee program had the unexpected result of reducing the average selling price per customer purchase request, or PR. The reduction in price was driven primarily by higher than expected delivery of PRs under certain fixed price agreements with dealers. Autoweb is working with the affected dealers to adjust territories in an attempt to correct pricing issues. However, there can be no assurances that this effort will result in an incremental increase in revenue. Attrition remains high and there is increased competition from the automobile manufacturers and dealers entering this market on their own. We cannot assure you that we will be able to reduce the level of this attrition, and our failure to do so could materially and adversely affect our business, results of operation and financial condition. We must leverage our current technology assets and develop our information services business. Information and technology has a high value to our customers and potential customers that may generate significant additional revenue. In order to capitalize on this revenue stream, we must build on our existing data and technology business and develop our information services. This undertaking must be executed rapidly and is likely to be expensive and complex and require additional technical expertise. Also, as we acquire users who rely upon us for a wide variety of services, it becomes more technologically complex and costly to retrieve, store and integrate data that will enable us to track each user's preferences. Any loss of traffic, increased costs, inefficiencies or failures to adapt our existing and new technologies and the associated adjustment to our business plan would have a material effect on our business. We need to build strong brand loyalty We believe that maintaining and expanding the Autoweb brand is critical to attracting consumers, member dealers, vehicle manufacturers, category partners and advertisers. Furthermore, we believe that the importance of brand loyalty will increase as low barriers to entry encourage the proliferation of Web sites. We have spent considerable monies and resources on the establishment and maintenance of the Autoweb brand and will continue to do so in the form of online advertising campaigns, print media, and other forms of traditional advertising. We may not be able to successfully maintain or enhance consumer awareness of our brand and, even if we are successful in our branding efforts, such efforts may be costly. If we are unable to maintain or enhance customer awareness of the Autoweb brand in a cost-effective manner, our business, operating results and financial condition would be materially and adversely affected. If the merger is completed between Autoweb and Autobytel, the Autoweb brand may be confused with the Autobytel brand and have a negative impact on the perceptions of consumers, business partners, analysts and the media. We depend on third-party relationships We have entered into agreements with various category partners, some of which require us to feature them exclusively in certain sections of our Web site. Existing and future exclusive arrangements may prevent us from entering into other content agreements, advertising or sponsorship arrangements or other commercial relationships. Many companies that we may pursue for a commercial relationship may also offer competing services. As a result, these competitors may be reluctant to enter into commercial relationships with us. Our business could be adversely affected if we do not maintain our existing commercial relationships on terms as favorable as currently in effect, if we do not establish additional commercial relationships on commercially reasonable terms or if our commercial relationships do not result in the expected increased use of our Web site. Additionally, our sale of automotive content, Web hosting and development services and sales automation services to vehicle manufacturers and online partners is dependent upon a few primary relationships, including competitive online automotive car buying services and various vehicle manufacturers. 16 17 We also depend on establishing and maintaining a number of commercial relationships with high-traffic Web sites to increase traffic on Autoweb.com. We currently have agreements with major Internet portals, such as America Online and its related properties and Lycos. There is intense competition for placements on these sites, and in the future we may not be able to enter into distribution relationships on commercially reasonable terms or at all. Even if we enter into distribution relationships with these Web sites, they themselves may not attract significant numbers of consumers. Therefore, our Web site may receive less than the number of additional consumers we expect from these relationships. Moreover, we may have to pay significant fees to establish or renew these relationships. We also depend on establishing and maintaining a number of commercial relationships with other companies. Our current relationships include: - New Car Test Drive and ASE, under which we purchase content for use by our consumers; - America Online's Digital City, iWon.com, AutoNation, CarsDirect, Carprices, Lycos, and Homestore.com, under which we share the revenue generated from automotive and related purchase inquiries submitted by consumers and directed to our Web site through links between our Web site and the other company's Web site; and - members of the Autoweb.com Affiliates Program, each of which receives a commission from us for traffic or vehicle purchase inquiries delivered to us through a link to the affiliate's Web site. We cannot assure you that we will be able to establish new agreements or maintain existing agreements or that the above agreements can be renewed on commercially acceptable terms We also may not be able to maintain relationships with third parties that supply us with software or products that are crucial to our success, and the vendors of these software or products may not be able to sustain any third-party claims or rights against their use. Furthermore, we cannot assure you that the software, services or products of those companies that provide access or links to our services or products will achieve market acceptance or commercial success. In addition, we cannot assure you that our existing relationships will result in sustained business arrangements, successful service or product offerings or the generation of significant revenues for us. Failure of one or more of our relationships to achieve or maintain market acceptance or commercial success or the termination of one or more relationship could have a material adverse effect on our business, results of operations and financial condition. We need to continue to develop Autoweb.com content and service offerings To remain competitive, we must continue to enhance and improve the ease of use, responsiveness, functionality and features of the Autoweb.com site and develop new services in addition to continuing to improve the consumer purchasing experience. These efforts may require the development or licensing of increasingly complex technologies. We may not be successful in developing or introducing new features, functions and services, and these features, functions and services may not achieve market acceptance or enhance our brand loyalty. If we fail to develop and introduce new features, functions or services effectively, it could have a material adverse effect on our business, results of operations and financial condition. We are dependent on certain key personnel Our future success is substantially dependent on our senior management and key technical personnel. If one or more of our key employees decided to leave us, join a competitor or otherwise compete directly or indirectly with us, this could have a material adverse effect on our business, results of operations and financial condition. During the second quarter of 2001, we did not have any senior management changes. However, Autoweb has a history of a high rate of senior management turnover. Any senior management turnover could have a material adverse impact on our business, results of operations and financial condition. In addition, our future success depends on our continuing ability to retain and attract highly qualified technical and managerial personnel. As of June 30, 2001, we had 149 full-time employees. Wages for managerial and technical employees are increasing and are expected to continue to increase in the foreseeable future due to the competitive nature of the current employment market, particularly in Northern California, the location of our headquarters. We may be unable to retain key technical and managerial personnel or to attract and retain additional highly qualified technical and managerial personnel in the future. We have experienced difficulty from time to time attracting the personnel necessary to support the growth of our business, and we may experience similar 17 18 difficulty in the future. Inability to attract and retain the technical and managerial personnel necessary to support the growth of our business could have a material adverse effect upon our business, results of operations and financial condition. We face risks associated with possible regulation under state or federal franchise and brokering laws In May 1998, the Texas Department of Transportation notified us that, in their opinion, our performance-based pricing model is illegal, because it makes us a broker as defined under Texas law. They have taken the position that the fee paid to us by member dealers for each qualified purchase inquiry is equivalent to a broker's fee and that we are arranging for two persons to meet and enter into a transaction that involves the sale of a motor vehicle. In September 1999 the Texas Department of Transportation sent a letter to the same effect to our Texas member dealers, and as a result one of our largest member dealer groups severed its business relationship with us. Shortly after the Department's letter was sent to our Texas member dealers, we modified our pricing model. To date the Department has taken no other action against us or our member dealers based on our pricing model. A proposal to modify the regulations governing how the Texas brokering law is enforced passed in February 2000. We have received written notice from the Texas Department of Transportation that our newly revised pricing model conforms to the new regulations. Other states, substantially all of which have laws that broadly define brokerage activities, could determine that we are acting as a broker. If this occurs, we may be required to comply with burdensome licensing requirements or terminate our operations in those states. In either case, our business, results of operations and financial condition could be materially and adversely affected. We believe that our service does not qualify as a vehicle brokerage activity and therefore that state broker licensing requirements do not apply to us. In addition, government authorities may take the position that motor vehicle dealer franchise laws or related consumer protection or product liability laws apply to aspects of our business, including advertising vehicles on the Internet. We do not believe our present business is subject to these laws, however, we have not sought a legal opinion regarding whether our service complies with the laws and regulations regarding motor vehicle dealer franchises in each state. We generally face risks associated with possible regulation under insurance, financing or other laws State regulatory requirements may also include us within an industry-specific regulatory scheme, such as those for the vehicle insurance or vehicle financing industries. In the event that individual states' regulatory requirements change or additional requirements are imposed on us, we may be required to modify aspects of our business in those states in a manner that might undermine the attractiveness of the Autoweb.com purchase process to consumers, member dealers, vehicle manufacturers, category partners or advertisers or require us to terminate operations in that state, either of which could have a material adverse effect on our business, results of operations and financial condition. Government authorities may take the position that state or federal insurance licensing laws apply to aspects of our business. As we introduce new services and expand our operations to other countries, we will need to comply with additional licensing and regulatory requirements. Autoweb currently provides a link on its Web site so consumers can receive real time quotes for insurance coverage and can submit quote applications online. Autoweb receives fees from its participant in connection with this advertising activity. Autoweb does not believe that the above activity requires Autoweb 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 Autoweb's. We are subject to U.S. government regulation of the Internet, the impact of which is difficult to predict There are currently laws and regulations directly applicable to the Internet. Some of these laws are currently in flux. The applications of existing laws and regulations to Autoweb.com relating to issues such as user privacy, defamation, pricing, taxation, promotions, content regulation, intellectual property ownership and infringement can be unclear. In addition, we expect to be subject to new laws and regulations directly applicable to our activities. Any existing or new legislation applicable to us could expose us to substantial liability, including significant expenses necessary to comply with such laws and regulations. 18 19 Several recently passed federal laws could have an impact on our affiliate and other programs. The Digital Millennium Copyright Act is intended to limit the liability of online services for listing or linking to third-party Web sites that may include materials that infringe the copyrights or other rights of others. We adhere to industry privacy policies and practices concerning the use and disclosure of user data. There are a large number of legislative proposals before the United States Congress and various state legislative bodies regarding privacy issues related to our business. It is not possible to predict whether or when such legislation may be adopted, and whether certain proposals, if adopted, could materially and adversely affect our business. Most recently, Congress passed the GrammLeach Bliloy Act which requires certain companies to send all of its customers an annual privacy policy statement. Autoweb does not believe that the Act applies to its current business, however, if the Act is found to apply to AutoWeb, the annual mailing required under the law will be costly and may have an adverse effect on our business. We depend on increased use of the Internet Our future success and revenue growth depends substantially upon continued growth in the use of the Internet. Consumers and businesses will likely widely accept and adopt the Internet for conducting business and exchanging information only if the Internet provides these consumers and businesses with greater efficiencies and improvements in commerce and communication. In addition, e-commerce generally, and the purchase of automotive and automotive related products and services on the Internet in particular, must become widespread. The Internet may prove not to be a viable commercial marketplace generally, or, in particular, for vehicles and related products and services. If use of the Internet does not continue to increase, our business, results of operations and financial condition would be materially and adversely affected. We depend on continued improvements in our systems and the Internet infrastructure Our ability to retain and attract consumers, member dealers, vehicle manufacturers, category partners and advertisers, and to achieve market acceptance of our services and our brand, depends significantly upon the performance of our systems and network infrastructure. Any system or network failure that causes interruption or slower response time of our services could result in less traffic to our Web site and, if sustained or repeated, could reduce the attractiveness of our services to consumers, member dealers, category partners and advertisers. An increase in the volume of our Web site traffic could strain the capacity of our technical infrastructure, which could lead to slower response times or system failures. This would cause the number of purchase inquiries, advertising impressions, other revenue producing e-commerce offerings and our information and community offerings to decline, any of which could hinder our revenue growth and our brand loyalty. In addition, if traffic increases, we cannot assure you that our technical infrastructure, such as a reliable network backbone with the necessary speed and data capacity and the development of complementary products such as high-speed modems, will be able to increase accordingly, and we face risks related to our ability to scale up to expected consumer levels while maintaining performance. Further, security and authentication concerns regarding the transmission of confidential information over the Internet, such as credit card numbers, may continue. Any failure of our server and networking systems ability to handle current or higher volumes of traffic would have a material adverse effect on our business, results of operations and financial condition. The recent growth in Internet traffic has caused frequent periods of decreased performance, requiring Internet service providers and users of the Internet to upgrade their infrastructures. 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. If outages or delays on the Internet occur frequently, overall Internet usage or usage of our Web site could increase more slowly or decline. Our ability to increase the speed with which we provide services to consumers and to increase the scope of such services is limited by and dependent upon the speed and reliability of the Internet. Consequently, the emergence and growth of the market for our services is dependent on future improvements to the entire Internet. In addition, our operations depend upon our ability to maintain and protect our computer systems, some of which are located at our corporate headquarters in Santa Clara, California. We do have a backup disaster recovery program and fully redundant systems for our service at an off-site location hosted by Exodus Communications, Inc. While this offsite location does provide a significant amount of security and scalability there is no guarantee that the system is not vulnerable to damage from fire, floods, earthquakes, power loss, telecommunications failures and similar events. Although we maintain insurance against fires, floods, earthquakes and general business interruptions, the amount of coverage may not be adequate in any particular case. The occurrence of such an event could have a material adverse effect on our business, results of operations and financial condition. The Internet industry is characterized by rapid technological change Rapid technological developments, evolving industry standards and consumer demands, and frequent new product introductions and enhancements characterize the market for Internet products and services. These market characteristics are exacerbated by the 19 20 emerging nature of the market and the fact that many companies are expected to introduce new Internet products and services in the near future. Our future success will significantly depend on our ability to continually improve the vehicle purchasing experience, the addition of new and useful services and content to our Web site, and the performance, features and reliability of our Web site. In addition, the widespread adoption of developing multimedia-enabling technologies could require fundamental and costly changes in our technology and affect the nature, viability and measurability of Internet- based advertising, which could adversely affect our business, results of operations and financial condition. 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 site, links or car review services. 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 site contains errors, consumers could make claims against us for losses incurred in reliance on such information. We also enter into agreements with other companies under which any revenue that results from the purchase of services through direct links to or from our Web site is shared. Such arrangements may expose us to additional legal risks and uncertainties, including local, state, federal and foreign government regulation and potential liabilities to consumers of these services, even if we do not provide the services ourselves. We cannot assure you 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 for potential liability of 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, member dealers, category partners and others. Our general liability insurance and our communications 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 insurance coverage could have a material adverse effect on our business, results of operations and financial condition. Our intellectual property protection may be inadequate Legal standards relating to the validity, enforceability and scope of protection of certain proprietary rights in Internet-related businesses are uncertain and still evolving, and we can give no assurance regarding the future viability or value of any of our proprietary rights. Despite the precautions we have taken, it may be possible for a third party to copy or otherwise obtain and use our proprietary information without authorization or to develop similar technology independently. We have registered in the United States the "Autoweb" and "Autoweb.com" trademarks associated with the services we provide and have registered the mark "Autoweb" in a foreign jurisdiction. We are aware, however, that another party has registered the "Autoweb" mark internationally. We cannot guarantee, therefore, that we will be able to continue to use the name "Autoweb" or "Autoweb.com" worldwide in the future. If we were required to change our name and adopt a new trademark, we would incur significant expenses related to marketing a replacement trademark, and such a change would likely have a material adverse effect on our business, results of operations and financial condition. We have also registered in the United States "Autokey" trademark associated with a customized search function. We face risks associated with litigation Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or trademarks or to determine the validity and scope of the proprietary rights of others. Such litigation might result in substantial costs and diversion of resources and management attention. Furthermore, our business activities may infringe upon the proprietary rights of others and other parties may assert infringement claims against us, including patent claims or claims that arise from directly or indirectly providing hyperlink text links to Web sites operated by third parties. Moreover, from time to time, we may be subject to claims of alleged infringement by us or our member dealers of the trademarks, service marks, patents and other intellectual property rights of third parties. Such claims and any resultant litigation, should it occur, might subject us to significant liability for damages, might result in 20 21 invalidation of our proprietary rights and, even if not meritorious, could result in substantial costs and diversion of resources and management attention and have a material adverse effect on our business, results of operations and financial condition. Between April and June 2001, eight purported class action lawsuits were filed in the United States District Court, Southern District of New York against certain of Autoweb's current and former directors and officers and underwriters involved in Autoweb's initial public offering. The foregoing actions purport to allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. The enumerated complaints have only recently been filed. Two motions seeking lead counsel status were filed on June 19, 2001. Autoweb anticipates that all actions, except for possibly one separate lawsuit, will ultimately be consolidated into one action and that a consolidated complaint will be filed after appointment of lead plaintiff(s). All of the cases have been assigned to one judge in the Southern District of New York. As of July 13, 2001 Autoweb and the other defendants had not yet answered any of the complaints listed above, and discovery had not yet commenced. Autoweb believes that it has meritorious defenses to the complaints and intends to vigorously defend the actions. In addition, Autoweb believes that its underwriters may have an obligation to indemnify Autoweb against these claims under the terms of the underwriter engagement letter for the initial public offering. We depend on third party technology We currently license from third parties certain technologies and information incorporated into our Web site. As we continue to introduce new services that incorporate new technologies and information, we may be required to license additional technology and information from others. We cannot assure you that these third-party technology and information licenses will continue to be available to us on commercially reasonable terms, if at all. Additionally, we cannot assure you that the third parties from which we currently license our technology and information will be able to defend their proprietary rights successfully against claims of infringement. Any failure to obtain any of these technology and information licenses could result in delays or reductions in the introduction of new features, functions or services. It could also adversely affect the performance of our existing services until equivalent technology or information can be identified, obtained and integrated. We may be affected by general economic conditions Purchases of new 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 by consumers) affecting disposable consumer income (such as employment, wages and salaries, business conditions, interest rates, availability of credit and taxation) for the economy as a whole and in regional and local markets where we operate. In addition, because the purchase of a vehicle is a significant investment and is relatively discretionary, any reduction in disposable income in general may affect us more significantly than companies in other industries. In addition, our business strategy relies on advertising by and agreements with other Internet companies. Any significant deterioration in general economic conditions that adversely affects these companies could also have a material adverse effect on our business, results of operations and financial condition. We have security risks On occasion, some experienced programmers ("hackers") have attempted to penetrate our network security. We expect that these attempts, some of which have succeeded, will continue to occur from time to time. Because a hacker who penetrates our network security could misappropriate proprietary information or cause interruptions in our services, we might be required to expend significant capital and resources to protect against, or to alleviate, problems caused by hackers. Additionally, we may not have a timely remedy against a hacker who is able to penetrate our network security. In addition to purposeful security breaches, the inadvertent transmission of computer viruses could expose us to litigation or to a material risk of loss. Such security breaches and inadvertent transmissions could have a material adverse effect on our business, results of operations and financial condition. In offering certain online payment services, we may increasingly rely on technology licensed from third parties to provide the security and authentication necessary to effect secure transmission of confidential information, such as consumer credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptography, or other events or developments may result in a compromise or breach of the algorithms that we use to protect our consumers' transaction data or our software vendors' products. Any well-publicized compromise of security could deter use of the Internet in general or use of the Internet to conduct transactions that involve transmitting confidential information or downloading sensitive materials. Power shortages in California may adversely affect us We conduct most of our operations in the state of California and rely on a continuous power supply to conduct operations. California's current energy crisis could substantially disrupt our operations and increase our expenses. California has recently implemented, and may in the future continue to implement, rolling blackouts throughout the state. Although state lawmakers are 21 22 working to minimize the impact, if blackouts interrupt our power supply, we may be temporarily unable to continue operations at our facilities. Any such interruption in our ability to continue operations at our facilities could delay the development of our products and disrupt communications with our customers, suppliers or manufacturing operations. Future interruptions could damage our reputation and could result in lost revenue, either of which could substantially harm our business and results of operations. In addition, Autoweb currently hosts its Web sites with a third party service provider. Although this service provider maintains backup generation capabilities, it recently suffered a power disruption that caused its backup system to fail. This recent power disruption did not affect Autoweb's Web site, however, there is no guarantee that future disruptions in power at Autoweb's service provider facility will not affect Autoweb and interrupt the availability of its web site. Interruptions in the accessibility of Autoweb's Web site by consumers and others will have a negative effect on our business and operating results. Furthermore, shortages in wholesale electricity supplies have caused power prices to increase. If wholesale prices continue to increase, our operating expenses will likely increase which will have a negative effect on our operating results. We have risks associated with international operations and expansions A part of our long-term strategy is to establish Autoweb.com and AIC in international markets. However, the Internet, or our commerce, content and community services model, may not become widely accepted in any market. In addition, we expect that the success of any additional foreign operations we initiate will be substantially dependent upon our member dealers, category partners and content services. We may experience difficulty in managing international operations as a result of failure to identify an effective foreign partner, competition, technical problems, local laws and regulations, distance and language and cultural differences. Our international partners may not be able to successfully market and operate our community model in foreign markets. There are also certain risks inherent in doing business internationally, including: - cultural and business practices differences; - fluctuations in currency exchange rates; - political issues; - legal and economic instability; - seasonal reductions in business activity in certain other parts of the world; and - potentially adverse tax consequences. One or more of such factors could have a material adverse effect on our future international operations and, consequently, on our business, results of operations and financial condition. Our Certificate of Incorporation and Bylaws and Delaware law contain provisions that could discourage a takeover. Certain provisions of Delaware law and our Certificate of Incorporation and Bylaws could have the effect of delaying or preventing a change in control. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We considered the provisions of Financial Reporting Release No. 48, "Disclosure of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Financial Instruments, Other Financial Instruments and Derivative Commodity Instruments." We had no holdings of derivative financial or commodity instruments at June 30, 2001. However, we are exposed to financial market risks, including changes in foreign currency exchange rates and interest rates. The majority of our revenue, expenses and capital expenditures are transacted in U.S. dollars. At June 30, 2001, we had no assets classified as short-term investments. The objectives of our investment policy are the safety and preservation of invested funds, and liquidity of investments that is sufficient to meet cash flow requirements. Our policy is to place our cash, cash equivalents, and investments available for sale with high credit quality financial institutions, commercial companies, and government agencies in order to limit the amount of credit exposure. Our investment policy also provides that our investment portfolio 22 23 must not have an average portfolio maturity of beyond one year and that we must maintain liquidity positions. Our investment policy prohibits investments in industries and speculative activities and requires investments be denominated in U.S. dollars. PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Between April and June 2001, eight purported class action lawsuits were filed in the United States District Court, Southern District of New York against certain of Autoweb's current and former directors and officers and underwriters involved in Autoweb's initial public offering. The foregoing actions purport to allege violations of the Securities Act of 1933 and the Securities Exchange Act of 1934. The enumerated complaints have only recently been filed. Two motions seeking lead counsel status were filed on June 19, 2001. Autoweb anticipates that all actions, except for possibly one separate lawsuit, will ultimately be consolidated into one action and that a consolidated complaint will be filed after appointment of lead plaintiff(s). All of the cases have been assigned to one judge in the Southern District of New York. As of July 13, 2001 Autoweb and the other defendants had not yet answered any of the complaints listed above, and discovery had not yet commenced. Autoweb believes that it has meritorious defenses to the complaints and intends to vigorously defend the actions. In addition, Autoweb believes that its underwriters may have an obligation to indemnify Autoweb against these claims under the terms of the underwriter engagement letter for the initial public offering. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Security Holding during the Quarter ending June 30, 2001. However, a proxy was mailed out to the shareholders subsequent to the close of the quarter on July 20, 2001 and a stockholders meeting is set for August 14, 2001, whereby the security holders will be asked to vote to elect two Class II Board members, ratify the selection of PriceWaterhouseCoopers as the company's independent accountants, and consider and vote on the proposed merger of a wholly-owned subsidiary of Autobytel, with and into Autoweb, as contemplated by the Acquisition Agreement between Autobytel, Autobytel Acquisition I Corp. and Autoweb. In the merger, Autobytel will issue 0.3553 shares of its common stock in exchange for each outstanding share of common stock of Autoweb and Autoweb will become a wholly-owned subsidiary of Autobytel. ITEM 5. OTHER INFORMATION As of June 30, 2001, our officers, directors and key employees are as follows:

23 24 (1) Member of the Audit Committee and the Compensation Committee ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K The following reports on Form 8-K were filed during the quarter ended June 30, 2001. On April 11, 2001, the company filed a Form 8-K reporting that Autobytel, Autobytel Acquisition I Corp., a Delaware corporation and wholly-owned subsidiary of Autobytel ("Merger Sub"), and the company entered into an Acquisition Agreement. A copy of the Acquisition Agreement was attached as an exhibit to the report. On April 12, 2001, the company filed a Form 8K/A attaching a copy of the press release announcing the execution of the Acquisition Agreement, as it was inadvertently omitted from the previous filing. The following reports on Form 8-K were filed during the quarter ended June 30, 2001. 24 25 SIGNATURES In accordance with the requirements of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: August 14, 2001 By: /s/ JEFFREY SCHWARTZ ------------------------------------ Jeffrey Schwartz President, Chief Executive Officer Date: August 14, 2001 By: /s/ MICHAEL SCHMIDT ------------------------------------ Michael Schmidt Chief Financial Officer Date: August 14, 2001 By: /s/ SANDRA CRAIG ------------------------------------ Sandra Craig Vice President, Finance 25

AUTOWEB COM INC 10-Q