As used in this Report, references to "we," "our," "the Company" or "Internet Brands" refer to Internet Brands, Inc. and its consolidated subsidiaries unless otherwise indicated. This discussion includes forward-looking statements which are subject to certain risks and uncertainties as discussed in the preceding Item 1A, Risk Factors, of this Report.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes to those statements as included elsewhere in this Report. In addition to the historical financial information, the following discussion and analysis contain forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under "Risk Factors" and elsewhere in this Report. See "Cautionary Note Regarding Forward-Looking Statements."

Overview

We are an Internet media company that owns, operates and grows branded websites in categories marked by high consumer involvement, strong advertising spending, and significant fragmentation in offline sources of consumer information. We operate a rapidly growing network of websites, currently grouped into five vertical categories: automotive, careers, home, shopping and travel and leisure. We operated more than 80 principal websites as of December 31, 2008. We also license our content and Internet technology products and services to major companies and individual website owners around the world.

We operate our business in two segments: Consumer Internet and Licensing. During the year ended December 31, 2008, we completed 29 website-related acquisitions in our Consumer Internet segment for an aggregate purchase price of $62.6 million. We expect to continue to grow our business by acquiring additional websites and improving our existing websites through the application of our operating platform.

• Online Traffic. A principal element of our strategy in expanding our Consumer Internet business is expanding the size of the audiences visiting our websites. Thus, we use measures of online traffic to our portfolio of websites, such as page views and monthly unique visitors, as key performance indicators.
• Consumer Internet Revenue Per View. Increasing monetization of traffic to our websites is a key component of our growth strategy. We use Revenue Per View, or RPV, as one measure to evaluate our operational success. RPV is a measure of the average amount of advertising revenue generated per each page viewed by visitors to our websites.
• Sales of Additional Licenses. For our licensing business, we view the sale of additional licenses and related products, such as website content and user tools, to existing and new customers as a key driver of associated revenue.
• Acquisitions. We believe that acquisitions will continue to be an important component of our ability to expand our Consumer Internet and licensing businesses. We therefore monitor our acquisitions activity, and our ability to integrate such acquisitions, to assess the success of our growth strategy.
• Adjusted EBITDA. As discussed in "Selected Consolidated Financial Data, (Item 6)" we employ Adjusted EBITDA for several purposes, including as a measure of our operating performance. We use Adjusted EBITDA because it removes the impact of items not directly resulting from our core operations, thus allowing us to better assess whether the elements of our growth strategy-increasing audience sizes, increasing monetization of such audiences, selling additional licenses and related products, and adding and developing new websites-are yielding positive results.

We depend on our five vertical consumer website categories for a significant portion of our revenues. We have continued to diversify the Company's revenue streams as evidenced by adding two verticals in 2008 - shopping and careers
- which continue to mitigate the risk of downward cycles in any one consumer category.

Our Revenues

We derive our revenues from two segments: Consumer Internet and Licensing. In our Consumer Internet segment, our revenues are primarily derived from advertisers. In our Licensing segment, our revenues are derived from the licensing of data and technology tools and services to automotive manufacturers and proprietary software for website communities.
Our revenues grew 15.7% from $89.9 million in 2007 to $104.0 million in 2008. The key factors influencing our growth were:

• the addition of websites that we owned, operated and grew, which offered new advertising opportunities to our existing advertisers and facilitated new advertising relationships;
• increased advertising sales on our websites as our Consumer Internet audiences grew;
• increased licensing revenues from our automotive licensing customer base; and
• increased licensing revenues from Jelsoft's vBulletin software.

Our revenues in the Consumer Internet segment increased $7.8 million, or a 12.3% increase, during the year ended December 31, 2008 compared to the prior year. This increase was primarily a result of a $14.4 million increase in advertising revenues from our existing and acquired automotive enthusiast, careers, home-related, shopping and travel and leisure websites. Partially offsetting this growth and primarily reflecting the continuing weakness in the automotive industry, our CPA and CPL revenues from automotive dealers declined $6.6 million during fiscal 2008 compared to the same period in the prior year. Such reduced advertising spending is consistent with the industry-wide downturn in the automotive sector. This industry has generally been in a downward cycle that began in the second half of 2006 and significantly deepened in the second half of 2008. We cannot predict how long this negative trend will continue, or when it will end or reverse; our prospects in this area are therefore unpredictable.

During the year ended December 31, 2008 our licensing revenues increased $6.3 million, or a 24.2% increase, as a result of the development of new client accounts and the sale of additional services to existing Autodata client accounts, and by organic growth from Jelsoft's vBulletin software, which was acquired in June 2007.

Historically, our revenues have come from clients located in the United States. Sales denominated in non-U.S. currencies accounted for 12.4% of our revenues in the year ended December 31, 2007, and 17.9% of our revenues during the year ended December 31, 2008. The sales revenues we currently receive in non-U.S. currencies are generally denominated in Canadian dollars and British pound sterling. We receive a small portion of our revenues, which we believe to be an immaterial amount compared to our total revenues, from additional sources outside the United States through credit card and merchant account transactions through the Internet. In these transactions, non-U.S. currencies paid are automatically converted to U.S. dollars by credit card companies and other payment intermediaries.

Our Consumer Internet segment generates revenues through sales of online advertising in various monetization formats such as cost per lead (CPL), cost per thousand impressions (CPM), cost per click (CPC), cost per action (CPA) and flat fees. Under the CPL model, our advertiser customers pay for leads generated through our websites and accepted by the customer. Under the CPM format, advertisers pay a fee for displays of their graphical advertisements, typically at an incremental rate per thousand displays or "impressions." Under the CPC model, we earn revenues based on "click-throughs" on text-based links displayed on our websites, which occur when a user clicks on an advertiser's listing. We derive revenues on a CPC model through direct sales to advertisers, as well as through various third-party advertising networks, such as Google, Yahoo! and Tribal Fusion, for which we receive a negotiated percentage of their advertising revenues. Under the CPA format, we earn revenues for consumer transactions undertaken through our websites.

We vary our advertising formats based on consumer and advertiser preferences in a particular category and our ability to optimize revenue yields. For example, we sell display advertising directly to automotive manufacturers and home improvement advertisers on a CPC or CPM basis, and consumer auto and auto finance leads to auto dealers on a CPL basis. We typically invoice our advertisers for display ads and CPL products on a monthly basis after we have run the ads or delivered the leads. Our contracts with these advertisers are typically on a multiple-month basis and are cancelable on 60 days or less notice. Revenue from our shopping sites is typically generated on a CPA basis where we earn commissions as website users buy products online. We also sell classified listings for annual flat fees to hundreds of vacation rental property owners and managers and bed and breakfast owners. Advertisers typically pay flat fees by credit card, PayPal or similar online payment service, utilizing online "self serve" tools provided on the website. Some of these flat fees are automatically renewed utilizing payment information on file with us. Our policy is not to offer refunds for mid-term cancellation of advertisements sold on a flat-fee basis. As consumer and advertiser preferences continue to evolve, we expect that we will adjust our revenue sources and mix on our websites to address those changing needs and optimize our revenue yields.

Our advertiser base is highly diversified across our consumer categories. As of December 31, 2008, we had nearly 40,000 advertising customers in our Consumer Internet segment. We also utilize a variety of advertising networks and affiliate relationships to monetize our websites. As our website audiences continue to grow and diversify among our consumer categories, we expect that our sources of advertising revenues also will continue to grow and diversify.

Our Consumer Internet segment revenues represented approximately 71% and 69% of our total revenues in 2007 and 2008, respectively.

Licensing Revenues

We license customized products and services and automotive vehicle and marketing data to most major U.S., Japanese and European automotive manufacturers and other online automotive service providers. Customers typically enter into multi-year licensing and technology development agreements for these products and services, which include market analytics, product planning, vehicle configuration, management and order placement, in-dealership retail systems and consumer-facing websites.

With the 2007 acquisition of Jelsoft, we also sell and license vBulletin Internet software to U.S. and international website owners. vBulletin revenues are primarily derived from software license purchases and leasing for a flat fee, as well as annual maintenance fees for customer support and software updates. Jelsoft received payments from more than 40,000 user community websites in 2008.

Our licensing segment revenues represented approximately 29% and 31% of our total revenues in 2007 and 2008, respectively.

Expenses

The largest component of our expenses is personnel. Personnel costs include salaries and benefits for our employees, commissions for our sales staff and stock-based compensation, which are categorized in our statements of operations based on each employee's principal function (i.e. Sales and Marketing, Technology or General and Administrative). Cost of revenues primarily consists of development costs, including personnel cost, related to the licensing business, marketing costs directly related to the fulfillment of specific customer advertising orders and costs of hosting our websites. Sales and marketing expenses include both personnel and online marketing costs. General and administrative expenses include personnel, audit, tax and legal fees, insurance and facilities costs.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S., or GAAP. The preparation of these financial statements requires us to make estimates, assumptions and judgments that affect the amounts reported in our financial statements and the accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. We believe the following accounting policies to be the most critical to the judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

We recognize revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition." Revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed and collectibility of the resulting receivable is reasonably assured. Our revenues are derived from our Consumer Internet and Licensing segments.

Consumer Internet

· Consumer Internet segment revenue is earned from online advertising sales on a cost per impression (CPM), cost per click (CPC), cost per lead (CPL), cost per action (CPA) or flat-fee basis.

· We recognize revenue from the display of graphical advertisements delivered on a CPM basis as impressions are delivered. An impression is delivered when an advertisement appears in pages viewed by users. Advertisements are billed on a flat-rate basis and revenue is recognized ratably over the contracted time period, which generally varies from one to twelve months. A reserve is calculated to accrue for the under-delivery of guaranteed minimum impressions and credits.

· Revenue from the display of text-based links to the websites of our advertisers is recognized on a CPC basis, and search advertising is recognized as "click-throughs" occur. A "click-through" occurs when a user clicks on an advertiser's link.

· Revenue from advertisers on a CPL basis is recognized in the period the leads are accepted by the dealer or mortgage lender, following the execution of a service agreement and commencement of the services. Service agreements generally have a term of twelve months or less.

· New car brokerage revenue and the related auto-financing brokerage revenue and after-market sales revenue are recognized on a CPA basis. Similar to a sales commission, this brokerage revenue is recognized on a net basis in accordance with Emerging Issue Task Force (EITF) Issue No. 99-19, "Reporting Revenue Gross as a Principal Versus Net as an Agent." As contrasted to the gross revenue a car dealership would typically report, we report brokerage revenue on a net basis as we do not bear inventory or credit risk, are not involved in the specification of the product and do not change the product or perform part of the services.

· Revenue from flat-fee, listings-based services are based on a customer's subscription to the service for up to twelve months and are recognized on a straight-line basis over the term of the subscription.

Licensing

We enter into contractual arrangements with customers to develop customized software and content products; revenue is earned from software licenses, content syndication, maintenance fees and consulting services. Agreements with these customers are typically for multi-year periods. For each arrangement, revenue is recognized when both parties have signed an agreement, the fees to be paid by the customer are fixed or determinable, collection of the fees is probable, delivery of the product has occurred, and no other significant obligations on our part remain. We do not offer a right of return on these products.

Software-related revenue is accounted for in accordance with the American Institute of Certified Public Accountants' (AICPA) Statement of Position (SOP) No. 97-2, "Software Revenue Recognition," and interpretations thereof. Post-implementation development and enhancement services are not sold separately; the revenue and all related cost of these arrangements are deferred until the commencement of the applicable license period. Revenue is recognized ratably over the term of the license; deferred costs are amortized over the same period as the revenue is recognized.

Fees for stand-alone projects are fixed-bid and determined based on estimated effort and client billing rates since we can reasonably estimate the required effort to complete each project or each milestone within the project. There are no non-software deliverables and the functionality delivered is specific to a customer's previously licensed application.

Business Combinations

We use the purchase method of accounting for business combinations and the results of the acquired businesses are included in the income statement from the date of acquisition. The purchase price includes the direct costs of the acquisition. However, beginning in fiscal 2009, acquisition-related costs will be expensed as incurred, in accordance with Financial Accounting Standards Board
(FASB) issued revision to Statement of Financial Accounting Standards (SFAS)
No. 141, "Business Combinations"(SFAS 141(R)). Amounts allocated to intangible assets are amortized over their estimated useful lives; no amounts are allocated to in-progress research and development. Goodwill represents the excess of consideration paid over the net identifiable business assets acquired.

We have entered into earnout agreements which are contingent on the acquired business achieving agreed upon performance milestones. Earnout payments are not based on the seller's on-going service to the Company; when the seller does provide services following the acquisitions, the cost of the seller's services is recorded as compensation expense in the period the services were performed. We account for earnout consideration as an addition to goodwill in the period earned. Beginning with fiscal 2009 acquisitions, in accordance with SFAS 141 (R), we will estimate the net present value of expected earnout payments and record such amount as an addition to goodwill and liability or equity, at the time of closing. Subsequent changes of earnout projections are recorded on the statement of operations as other income or expense in the period of remeasurement. If earnout projections are recorded as equity, then no subsequent remeasurement is required.

Goodwill, Intangible Assets and the Impairment of Long-Lived Assets

We assess the recoverability of the carrying value of long-lived assets. If circumstances suggest that long-lived assets may be impaired, and a review indicates that the carrying value will not be recoverable, as determined based on the projected undiscounted future cash flows, the carrying value is reduced to its estimated fair value. The determination of cash flows is based upon assumptions and forecasts that may not occur. In addition, we assess goodwill and indefinite-lived intangible assets for impairment annually, or more frequently if circumstances indicate impairment may have occurred. The December 31, 2008 consolidated balance sheet includes $203.8 million of goodwill, $24.6 million of intangible assets, net, and $11.5 million of fixed assets, net. Management updated its analysis of goodwill, intangible assets and long-lived assets as of December 31, 2008, and we determined that no impairment had occurred.

We have acquired many companies in each of the last few years and our current business strategy includes continuing to make additional acquisitions in the future. These acquisitions will continue to give rise to goodwill and other intangible assets which will need to be assessed for impairment from time to time.

Provision for Income Taxes and Deferred Income Tax Assets

Deferred income tax assets and liabilities are periodically computed for temporary differences between the financial statement and income tax bases of assets and liabilities. Such deferred income tax asset and liability computations are based on enacted tax laws and rates applicable to years in which the differences are expected to reverse. A valuation allowance is established, when necessary, to reduce deferred income tax assets to the amount expected to be realized. Significant judgment is necessary in determining valuation allowances necessary for our deferred tax assets. Accounting standards require us to establish a valuation allowance for that portion of our deferred tax assets for which it is more likely than not that we will not receive a future benefit. In making this judgment, all available evidence is considered, some of which, particularly estimates of future profitability and income tax rates, are subjective in nature. Estimates of deferred income taxes are based on management's assessment of actual future taxes to be paid on items reflected in the consolidated financial statements, giving consideration to both timing and the probability of realization. Actual income taxes could vary from these estimates due to future changes in income tax law, state income tax apportionment or the outcome of any review of our tax returns by the Internal Revenue Service, as well as actual operating results that vary significantly from anticipated results. Our effective income tax (benefit) rates for the years ended December 31, 2008, 2007 and 2006 were 41.4%, 97.1% and (304.9)%, respectively.

The automotive industry in which we provide consumer Internet products and services has historically experienced seasonality with relatively stronger sales in the second and third quarters and weaker sales in the fourth quarter. In 2008, we entered the online shopping category which has historically experienced relatively stronger sales in the fourth quarter.

Results of Operations

The following table sets forth our consolidated statements of operation data as a percentage of total revenues for each of the periods indicated:

                                                    Year Ended December 31,
                                             2006           2007           2008

       Revenues
       ……………………………………………………………………………           100.0 %        100.0 %        100.0 %
       Costs and operating expenses:
       Cost of revenues
       ……………………………………………………………                  23.9           27.4           23.0
       Sales and marketing
       …………………………………………………………                   22.4           23.4           20.6
       Technology and product
       development …………………………………….               7.7            8.5            8.4
       General and administrative
       ………………………………………………..                     21.6           26.4           16.5
       Depreciation and amortization of
       intangibles……………………………..                  4.7            8.9           13.0
       Total operating expenses
       …………………………………………………..                    80.3           94.6           81.5
       Operating income
       ………………………………………………………………                 19.7            5.4           18.5
       Investment and other income
       ……………………………………………….                       7.4            6.7            0.5
       Income from operations before
       income taxes ……………………………….               27.1           12.1           19.0
       Provision (benefit) for income
       taxes ………………………………………….                 (82.6 )         11.8            7.8
       Net income
       ……………………………………………………………………..            109.7            0.3           11.1

Years Ended December 31, 2006, 2007 and 2008

Total Revenues

                                                            Increase (decrease)           Increase (decrease)
                        Year Ended December 31,                2006 vs. 2007                 2007 vs. 2008
                    2006         2007         2008             $              %               $             %
Revenues:
Consumer
Internet
……….....          $ 67,752     $ 63,738     $  71,564     $     (4,014 )      (5.9 )%   $      7,826        12.3 %
Licensing
…………………….           17,052       26,151        32,472            9,099        53.4 %           6,321        24.2 %
Total revenues
………………            $ 84,804     $ 89,889     $ 104,036     $      5,085         6.0 %    $     14,147        15.7 %

Total revenues increased $14.1 million, or 15.7%, for the year ended December 31, 2008 compared to the year ended December 31, 2007. The key factors influencing our growth were:

• the addition of websites that we owned, operated and grew, which offered new advertising opportunities to our existing advertisers and facilitated new advertising relationships;
• increased advertising sales on our websites as our Consumer Internet audiences grew;
• increased licensing revenues from our automotive licensing customer base; and
• increased licensing revenues from Jelsoft's vBulletin software.

Our revenues in the Consumer Internet segment increased $7.8 million, or a 12.3% increase, during the year ended December 31, 2008 compared to the prior year. This increase was primarily a result of a $14.4 million increase in advertising revenues from our existing and acquired automotive enthusiast, careers, home-related, shopping and travel and leisure websites. Partially offsetting this growth and primarily reflecting the continuing weakness in the automotive industry, our CPA and CPL revenues from automotive dealers declined $6.6 million during fiscal 2008 compared to the same period in the prior year. Such reduced advertising spending is consistent with the industry-wide downturn in the automotive sector.

During the year ended December 31, 2008 our licensing revenues increased $6.3 million, or a 24.2% increase, a result of the development of new client accounts and the sale of additional services to existing Autodata client accounts, and organic growth from Jelsoft's vBulletin software, which was acquired in June 2007.

2007 vs. 2006

Our revenues in the Consumer Internet segment decreased $4.0 million, or a 5.9% decrease, during the year ended December 31, 2007 compared to the prior year. This decrease was primarily a result of a $13.0 million decrease in automotive CPM, CPA and CPL revenues. Partially offsetting this decline was a $9.0 million increase in advertising revenues from our existing and acquired automotive enthusiast, travel and home-related websites.

During the year ended December 31, 2007 our licensing revenues increased $9.1 million, or a 53.4% increase, reflecting primarily the successful development of new client accounts and the sale of additional services to existing clients at Autodata, and the inclusion of $2.2 million in revenue from our vBulletin licensing business which we acquired in June 2007.

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