UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

Commission File Number 0-28018

YAHOO! INC.

(Exact name of Registrant as specified in its charter)

701 First Avenue
Sunnyvale, California 94089

(Address of principal executive offices)

Registrant’s telephone number, including area code: (408) 349-3300

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes ý  No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o  No ý

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

YAHOO! INC.

Table of Contents

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PART I—FINANCIAL INFORMATION

Item 1.  Condensed Consolidated Financial Statements (unaudited)

YAHOO! INC.

Condensed Consolidated Statements of Operations

(unaudited, in thousands except per share amounts)

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

2

YAHOO! INC.

Condensed Consolidated Balance Sheets

(unaudited, in thousands, except par values)

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

3

YAHOO! INC.

Condensed Consolidated Statements of Cash Flows

(unaudited, in thousands)

4

YAHOO! INC.

Supplemental schedule:

Acquisition-related activities (in thousands):

See Note 3—“Acquisitions” for additional information.

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

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YAHOO! INC.

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 1—The Company and Summary of Significant Accounting Policies

The Company.  Yahoo! Inc., together with its consolidated subsidiaries (“Yahoo!” or the “Company”) is a leading global Internet brand and one of the most trafficked Internet destinations worldwide.  Yahoo! seeks to provide Internet services that are essential and relevant to users and businesses through the provision of online properties (collectively referred to as the “Yahoo! Network”) to Internet users and a range of tools and marketing solutions for businesses to market to that community of users.

Stock Split.  On April 7, 2004, the Yahoo! Board of Directors approved a two-for-one split of the Company’s shares of common stock effected in the form of a stock dividend.  As a result of the stock split, Yahoo! stockholders received one additional share of Yahoo! common stock for each share of common stock held of record on April 26, 2004.  The additional shares of Yahoo! common stock were distributed on May 11, 2004.  All share and per share amounts in these condensed consolidated financial statements and related notes have been retroactively adjusted to reflect the stock split for all periods presented.

Basis of Presentation.  The condensed consolidated financial statements include the accounts of Yahoo! and its majority-owned subsidiaries.  All significant intercompany accounts and transactions have been eliminated.  Investments in entities in which the Company can exercise significant influence, but are less than majority owned and not otherwise controlled by the Company, are accounted for under the equity method and are included in other assets on the condensed consolidated balance sheets.  The Company has included the results of operations of acquired companies from the closing dates of the acquisitions.

The accompanying unaudited condensed consolidated interim financial statements reflect all adjustments, consisting of only normal recurring items, which in the opinion of management, are necessary for a fair statement of the results of operations for the periods shown.  The results of operations for such periods are not necessarily indicative of the results expected for the full year or for any future period.

The preparation of condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities.  On an on-going basis, the Company evaluates its estimates, including those related to uncollectible receivables, the useful lives of long-lived assets including property and equipment, investment fair values, goodwill and other intangible assets, income taxes and contingencies.  In addition, the Company uses assumptions when employing the Black-Scholes option valuation model to estimate the fair value of stock options granted for pro forma disclosure purposes.  The Company bases its estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, when these carrying values are not readily available from other sources.  Actual results may differ from these estimates.

Certain prior period balances have been reclassified to conform to the current year presentation.  A new subtotal is being presented in the consolidated statement of operations: Income before income taxes, earnings in equity interests, and minority interests.  Earnings in equity interests and minority interests in operations of consolidated subsidiaries are now presented below the provision for income taxes.  In accordance with generally accepted accounting principles, these items have consistently been presented net of income taxes.  In addition, beginning in the fourth quarter of 2004, the Company made reclassifications in the consolidated balance sheets and consolidated cash flow statements related to the classification of auction rate securities.  Certain of these securities were included in the cash and cash equivalents lines in prior periods.  These amounts have been reclassified to short term marketable debt securities.  The reclassification resulted in an increase of $16 million in previously reported net cash used in investing activities and a decrease of $16 million in the previously reported net change in cash and cash equivalents for the nine months ended September 30, 2004.  The increase of $16 million in cash used in investing activities is the result of an increase of $979 million in purchases of marketable debt securities and an increase of $963 million in proceeds from sales and maturities of marketable debt securities.

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

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Stock-Based Compensation.  The Company measures compensation expense for its stock-based employee compensation plans using the intrinsic value method.  The Company recorded compensation expense of $6 million and $14 million in the three months ended September 30, 2004 and 2005, respectively.  The Company recorded compensation expense of $26 million and $34 million in the nine months ended September 30, 2004 and 2005 respectively.  If the fair value based method had been applied in measuring stock compensation expense, the pro forma effect on net income and net income per share would have been as follows (in thousands, except per share amounts):

*                                         For the three and nine months ended September 30, 2004, the stock compensation expense amount has been adjusted to reflect lower calculated fair values for employee stock options which resulted in an increase of $7 million ($0.01 per share – basic and diluted) and $17 million ($0.01 per share – basic and diluted), respectively, in pro forma net income.  The adjustment was required as the Company’s estimate of the fair value of employee stock options was incorrectly based on a five-and-one-half year expected life rather than the three-and-one-half year expected life intended by management.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable.  In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility and expected life of the options granted.  Because the Company’s options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in the opinion of management, the existing models do not necessarily provide a reliable single measure of the fair value of its options.

See “Recent Accounting Pronouncements” below regarding the impact of the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment” (“SFAS 123R”).

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS 123R, which requires companies to recognize in the statement of operations all share-based payments to employees, including grants of employee stock options, based on their fair values.  Accounting for share-based compensation transactions using the intrinsic method supplemented by pro forma disclosures will no longer be permissible.  The new statement will be effective for public entities no later than the beginning of the first fiscal year beginning after June 15, 2005.  The Company will adopt the new statement on January 1, 2006.  The Company has not yet completed its analysis of the impact of adopting SFAS 123R and is therefore currently unable to quantify the effect on its financial statements.  However, the adoption of this new statement will have a significant impact on the results of operations and net income per share of the Company as the Company will be required to expense the fair value of all share-based payments.

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In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”, a replacement of Accounting Principles Board Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements” (“SFAS 154”).  SFAS 154 changes the requirements for the accounting for, and reporting of, a change in accounting principle.  Previously, voluntary changes in accounting principles were generally required to be recognized by way of a cumulative effect adjustment within net income during the period of the change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change.  SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, the statement does not change the transition provisions of any existing accounting pronouncements.  The Company does not believe adoption of SFAS 154 will have a material effect on its financial position, cash flows or results of operations.

Note 2—Basic and Diluted Net Income Per Share

Basic net income per share is computed using the weighted average number of common shares outstanding during the period, excluding any unvested restricted stock that is subject to repurchase.  Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period.  Potential common shares consist of unvested restricted stock (using the treasury stock method), the incremental common shares issuable upon the exercise of stock options (using the treasury stock method) and the conversion of the Company’s zero coupon senior convertible notes (using the if-converted method).  For the three months ended September 30, 2004 and 2005, approximately 45 million and 67 million options to purchase common stock, respectively, were excluded from the calculation, as their exercise prices were greater than the average market price of the common stock during the periods.  For the nine months ended September 30, 2004 and 2005, approximately 62 million options to purchase common stock were excluded from the calculations, as their exercise prices were greater than the average market price of the common stock during the periods.  See Note 8—“Long-Term Debt” for additional information related to the Company’s zero coupon senior convertible notes.

The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):

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Note 3—Acquisitions

Acquisitions completed in 2004

3721.  On January 2, 2004, the Company completed the acquisition of all of the outstanding capital shares of 3721 Network Software Company Limited (“3721”), a Hong Kong-based software development company.  The acquisition combined the Company’s global audience and 3721’s keyword search technology to enable the Company to continue improving its global search services.  These factors contributed to a purchase price in excess of the fair value of 3721’s net tangible and intangible assets acquired, and as a result, the Company has recorded goodwill in connection with this transaction.

The total purchase price of approximately $95 million consisted of $92 million in cash consideration, including $41 million related to a contingent earnout, which was finalized and paid in the three months ended June 30, 2005, $2 million related to stock options exchanged, and direct transaction costs of $1 million.  The total cash consideration of approximately $92 million less cash acquired of $7 million resulted in a net cash outlay of $85 million.

The allocation of the purchase price to the assets acquired and liabilities assumed based on the fair values was as follows (in thousands):

The amortizable intangible assets have useful lives not exceeding five years.  No amount has been allocated to in-process research and development, and $81 million has been allocated to goodwill.  Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired, and is not deductible for tax purposes.

Kelkoo.  On April 5, 2004, the Company completed the acquisition of a majority interest in Kelkoo S.A. (“Kelkoo”), a leading European online comparison shopping service.  In July 2004, the Company completed the acquisition of additional interests in Kelkoo, increasing the Company’s total ownership interest in Kelkoo to 100 percent.  The acquisition expanded the Company’s global commerce presence and together with the Company’s current services is expected to increase the Company’s competitive position in Europe.  These factors contributed to a purchase price in excess of the fair value of Kelkoo’s net tangible and intangible assets acquired, and as a result, the Company has recorded goodwill in connection with this transaction.

The total purchase price of approximately $571 million consisted of $562 million in cash consideration, $6 million in incurred liabilities and direct transaction costs of $3 million.  The total cash consideration of approximately $562 million less cash acquired of $39 million resulted in a net cash outlay of $523 million.

The allocation of the purchase price to the assets acquired and liabilities assumed based on the fair values was as follows (in thousands):

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The amortizable intangible assets have useful lives not exceeding five years.  No amount has been allocated to in-process research and development, and $454 million has been allocated to goodwill.  Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired, and is not deductible for tax purposes.

Musicmatch.  On October 18, 2004, the Company completed the acquisition of Musicmatch, Inc. (“Musicmatch”), a leading provider of personalized music software and services.  The acquisition significantly increased the Company’s presence in the digital music business and together with the Company’s current music services,  Yahoo! Music, is expected to provide one of the most comprehensive suites of music services available for users, marketers, artists and record labels.  These factors contributed to a purchase price in excess of the fair value of Musicmatch’s net tangible and intangible assets acquired, and as a result, the Company has recorded goodwill in connection with this transaction.

The total estimated purchase price of approximately $158 million consisted of $156 million in cash consideration, and direct transaction costs of $2 million.  The approximate $156 million of total cash consideration less cash acquired of $3 million resulted in a net cash outlay of $153 million.

The preliminary allocation of the purchase price to the assets acquired and liabilities assumed based on the fair values was as follows (in thousands):

The amortizable intangible assets have useful lives not exceeding 3 years.  Based on a preliminary estimate, no amount has been allocated to in-process research and development, and $171 million has been allocated to goodwill.  Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired, and is not deductible for tax purposes.   The preliminary purchase price allocation for Musicmatch is subject to revision as more detailed analysis is completed and additional information on the fair value of assets and liabilities becomes available.  Any changes in the fair value of the net assets of Musicmatch will change the amount of the purchase price allocable to goodwill.

Other Acquisitions.  During the year ended December 31, 2004 the Company acquired three other companies which were each accounted for as business combinations.  The total purchase price for these three acquisitions was approximately $49 million and consisted of $46 million in cash consideration, $2 million related to stock options exchanged and $1 million of direct transaction costs.  The total cash consideration of $46 million less cash acquired of $2 million resulted in a net cash outlay of $44 million.  Of the purchase price, approximately $41 million was allocated to goodwill, $14 million to amortizable intangible assets and $6 million to net assumed liabilities.  No amounts have been allocated to in-process research and development.  Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired, and is not deductible for tax purposes.

Acquisitions completed in 2005

During the three months ended March 31, 2005 the Company acquired Verdisoft Corporation (“Verdisoft”), a software development company.  The acquisition of Verdisoft enhanced the Company’s platform for delivering content and services to mobile phones and other handheld devices as part of the Company’s strategy to provide users with seamless access to its network. The transaction was treated as an asset acquisition for accounting purposes and therefore no goodwill was recorded.  The estimated purchase price was approximately $58 million and consisted of $54 million in cash consideration, $3 million related to stock options exchanged and $1 million of direct transaction costs.  In connection with the acquisition, the Company also issued approximately 1 million shares of restricted stock valued at $35 million that will be recognized as expense over three years.  For accounting purposes, approximately $93 million was allocated to amortizable intangible assets, with lives not exceeding three years, $37 million to liabilities, primarily deferred income tax liabilities, and $2 million to deferred stock-based compensation.

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During the three months ended June 30, 2005 the Company acquired three companies which were each accounted for as business combinations.  The total estimated purchase price for the three acquisitions was approximately $37 million and consisted of $32 million in cash consideration, $3 million related to stock options exchanged, and $2 million of incurred liabilities and direct transaction costs.  The total cash consideration of approximately $32 million less cash acquired of $1 million resulted in a net cash outlay of $31 million.  Of the total estimated purchase price, approximately $32 million was allocated to goodwill, $6 million to amortizable intangible assets and $1 million to net assumed liabilities.  Less than $1 million has been allocated to in-process research and development and recorded in product development expenses.  Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired, and is not deductible for tax purposes.

The purchase price allocations for these acquisitions are preliminary and subject to revision as more detailed analyses are completed and additional information on the fair value of assets and liabilities becomes available.  Any change in the fair value of the net assets of the acquired companies will change the amount of the purchase price allocable to goodwill.

Pro forma results of operations have not been presented for the acquisitions completed during the nine months ended September 30, 2004 or September 30, 2005 as the results of the acquired companies either individually or in the aggregate were not material to the Company.

Note 4—Goodwill

The changes in the carrying amount of goodwill for the nine months ended September 30, 2005 are as follows (in thousands):

*                                         Other primarily includes certain purchase price adjustments that affect existing goodwill.

Note 5—Intangible Assets, Net

The following table summarizes the Company’s intangible assets, net (in thousands):

*                                         Foreign currency translation adjustments, reflecting movement in the currencies of the underlying entities, totaled approximately $2 million as of September 30, 2005.

The Company recognized amortization expense for intangible assets of approximately $37 million and $41 million for the three months ended September 30, 2004 and 2005, respectively.  The Company recognized amortization expense for intangible assets of approximately $104 million and $123 million for the nine months ended September 30, 2004 and 2005, respectively.  Based on the current amount of intangibles subject to amortization, the estimated amortization expense for each of the succeeding five years is as follows: three months ending December 31, 2005: $41 million; 2006: $171 million; 2007: $126 million; 2008: $76 million, and 2009: $24 million and 2010: $13 million.

Note 6—Other Income, Net

Other income, net is comprised of (in thousands):

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Investment gains (losses), net include realized investment gains, realized investment losses, realized gains on derivatives, and impairment charges related to declines in values of privately held companies judged to be other than temporary.  Investment gains (losses) include gains in the amounts of $105 million in the three and nine months ended September 30, 2004 and $27 million and $987 million in the three and nine months ended September 30, 2005, respectively, related to the sale of non-strategic marketable equity security investments.

Note 7—Comprehensive Income

Comprehensive income, net of taxes, is comprised of (in thousands):

The following table summarizes the components of accumulated other comprehensive income (loss) (in thousands):

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Note 8—Long-Term Debt

In April 2003, the Company issued $750 million of zero coupon senior convertible notes (the “Notes”) due April 2008, which resulted in net proceeds to the Company of approximately $733 million after transaction fees of $17 million, which have been deferred and are included on the condensed consolidated balance sheets in other assets.  As of September 30, 2005, $9 million of the transaction fees remain to be amortized.  The Notes were issued at par and bear no interest.  The Notes are convertible into Yahoo! common stock at a conversion price of $20.50 per share, which would result in the issuance of an aggregate of approximately 37 million shares, subject to adjustment upon the occurrence of specified events.  Each $1,000 principal amount of the Notes will initially be convertible into 48.78 shares of Yahoo! common stock.

The Notes are convertible prior to the final maturity date (1) during any fiscal quarter if the closing sale price of the Company’s common stock for at least 20 trading days in the 30 trading-day period ending on the last trading day of the immediately preceding fiscal quarter exceeded 110 percent of the conversion price on that 30^th trading day, (2) during the period beginning January 1, 2008 through the maturity date, if the closing sale price of the Company’s common stock on the previous trading day was 110 percent or more of the then current conversion price, and (3) upon specified corporate transactions.  Upon conversion, the Company has the right to deliver cash in lieu of common stock.  The Company may be required to repurchase all of the Notes following a fundamental change of the Company, such as a change of control, prior to maturity at face value.  The Company may not redeem the Notes prior to their maturity.

As of September 30, 2005, the market price condition for convertibility of the Notes was satisfied with respect to the fiscal quarter beginning October 1, 2005 and ending on December 31, 2005.  During this period holders of the Notes will be able to convert their Notes into shares of Yahoo! common stock at the rate of 48.78 shares of Yahoo! common stock for each Note.  The Notes will also be convertible into shares of Yahoo! common stock in subsequent fiscal quarters, if any, with respect to which the market price condition for convertibility is met.

As of September 30, 2005, the fair value of the Notes was approximately $1.2 billion based on quoted market prices.  The shares issuable upon conversion of the Notes have been included in the computation of diluted net income per share since the Notes were issued.

Note 9—Stock Repurchase Programs

In March 2001, the Company’s Board of Directors authorized the Company to repurchase up to $500 million of its outstanding shares of common stock from time to time over the next two years, depending on market conditions, share price and other factors. In March 2003, the Company’s Board of Directors authorized a two-year extension of the stock repurchase program until March 2005.  Under this program, from March 2001 through December 31, 2004, the Company repurchased 32.9 million shares of common stock at an average price of $4.86 per share for a total amount of approximately $160 million.  During this period, of the shares repurchased, 32.1 million shares were purchased from SOFTBANK Corp. (“SOFTBANK”) at an average price of $4.84 per share.  During the three months ended March 31, 2005, the Company repurchased an additional 4.9 million shares in the open market, at an average price of $33.60 per share, for total consideration of $165 million.  This stock repurchase program has expired.

In March 2005, the Company’s Board of Directors authorized a new stock repurchase program for the Company to repurchase up to $3 billion of its outstanding shares of common stock from time to time over the next five years, depending on market conditions, share price and other factors.  Under this program in the three months ended September 30, 2005 the Company repurchased 6.3 million shares of common stock at an average price of $32.89 per share, for total consideration of $208 million.  For the nine months ended September 30, 2005 under the expired and current stock repurchase programs, the Company repurchased 11.2 million shares of common stock at an average price of $33.20 per share for a total amount of $373 million.  Treasury stock is accounted for under the cost method.

In August 2004, the Company entered into a $100 million structured stock repurchase transaction which matured in four separate tranches through March 31, 2005.  One of the four $25 million tranches matured and settled in December 2004.  During the six months ended June 30, 2005, each of the three remaining $25 million tranches settled resulting in the Company receiving $82 million in cash.

In February 2005, the Company entered into $150 million in structured stock repurchase transactions which matured in three separate tranches through August 2005.  One of the three $50 million tranches matured and settled in the three months ended June 30, 2005 resulting in the Company receiving $53 million in cash.  Both of the remaining $50 million tranches matured and settled in the three months ended September 30, 2005 resulting in the Company receiving $107 million in cash.

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In April 2005, the Company entered into $500 million in structured stock repurchase transactions which mature in three separate tranches through October 2005.  A $150 million tranche matured and settled in the three months ended June 30, 2005 resulting in the Company receiving $156 million in cash.  The remaining two tranches will mature in October 2005.  On each of the remaining maturity dates, if the market price of Yahoo! common stock is at or above $35.11 for both the $150 million and $200 million tranches, the Company will have its investments returned with a premium.  If the market price is below $35.11, the Company will repurchase up to an aggregate of 11.0 million shares of its common stock.

In July 2005, the Company entered into $500 million in structured stock repurchase transactions which will mature in two separate tranches in January 2006 and April 2006.  On each of the maturity dates, if the market price of Yahoo! common stock is at or above $33.98 for the $250 million tranche maturing in January 2006 and $33.99 for the $250 million tranche maturing in April 2006, the Company will have its investment returned with a premium.  If the market price of the Company’s common stock is below such pre-determined prices, the Company will repurchase up to an aggregate of 16.3 million shares of its common stock.

The outstanding structured stock repurchase transactions as of the balance sheet dates are recorded in stockholders’ equity on the consolidated balance sheets.

Note 10—Commitments and Contingencies

Operating Leases.  The Company has entered into various non-cancelable operating lease agreements for offices and facilities globally, for original lease periods up to 23 years and expiring between 2005 and 2027.

Net lease commitments as of September 30, 2005 can be summarized as follows (in millions):

Affiliate Commitments.  In connection with contracts to provide sponsored search services to affiliates, the Company is obligated to make payments, which represent traffic acquisition costs, to its affiliates.  As of September 30, 2005, the commitments total $293 million of which $64 million will be payable in the remainder of 2005, $214 million will be payable in 2006 and $15 million will be payable in 2007.

Other Commitments.  In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of agreements, services to be provided by the Company, or from intellectual property infringement claims made by third parties.  In addition, the Company has entered into indemnification agreements with its directors and certain of its officers that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers.  The Company has also agreed to indemnify certain former officers, directors and employees of acquired companies in connection with the acquisition of such companies.  The Company maintains director and officer insurance, which may cover certain liabilities arising from its obligation to indemnify its directors and officers, and former directors and officers of acquired companies, in certain circumstances.

It is not possible to determine the maximum potential loss under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement.  Such indemnification agreements may not be subject to maximum loss clauses.  Historically, the Company has not incurred material costs as a result of obligations under these agreements and it has not accrued any liabilities related to such indemnification obligations in its condensed consolidated financial statements.

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On April 21, 2003, Overture Services Inc. (“Overture”) completed its purchase of the Web Search unit of Fast Search and Transfer ASA, a Norway based developer of search and real-time filtering technologies, for $70 million in cash, plus a contingent earn-out payment of up to $30 million over three years based on specified operating criteria.

As of September 30, 2005, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.  As such, the Company is not exposed to any financing, liquidity, market or credit risk that could arise if the Company had engaged in such relationships.

Contingencies.  From time to time, third parties assert patent infringement claims against the Company.  Currently, the Company is engaged in several lawsuits regarding patent issues and has been notified of a number of other potential patent disputes.

In addition, from time to time the Company is subject to other legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights and other intellectual property rights, and a variety of claims, including claims alleging defamation or invasion of privacy, arising in connection with its email, message boards, auction sites, shopping services, and other communications and community features.

In October 2000, 800-JR-Cigar, Inc. filed a complaint in the United States District Court for the District of New Jersey against Overture, a wholly-owned subsidiary of the Company acquired in October 2003.  The plaintiff in this case, and in certain other cases which have been brought against Overture in the past, claims, among other things, that it has trademark rights in certain search terms and that Overture violates these rights by allowing its advertisers to bid on these search terms.  The complaints seek injunctive relief and damages.  The Company and Overture believe that Overture has meritorious defenses to liability and damages and are contesting the lawsuit vigorously.  In August 2003, Accor filed a similar complaint in the Nanterre District Court in France against Overture and Overture S.A.R.L., Overture’s wholly-owned subsidiary in France.  On January 17, 2005, the Nanterre District Court ruled in favor of Accor and found Overture and Overture S.A.R.L. liable for trademark infringement.  Overture S.A.R.L. and Overture have appealed this decision.

On May 24, 2001, Arista Records, Inc., Bad Boy Records, BMG Music d/b/a The RCA Records Label, Capitol Records, Inc., Virgin Records America, Inc., Sony Music Entertainment Inc., UMG Recordings, Inc., Interscope Records, Motown Record Company, L.P., and Zomba Recording Corporation filed a lawsuit alleging copyright infringement against LAUNCH in the United States District Court for the Southern District of New York.  The plaintiffs allege, among other things, that the consumer-influenced portion of LAUNCH’s LAUNCHcast service is “interactive” within the meaning of Section 114 of the Copyright Act and therefore does not qualify for the compulsory license provided for by the Copyright Act.  The Complaint seeks declaratory and injunctive relief and damages for the alleged infringement.  After the lawsuit was commenced, the Company entered into an agreement to acquire LAUNCH.  In June 2001,   LAUNCH settled the LAUNCH litigation as to UMG Recordings, Inc.  The Company’s acquisition of LAUNCH closed in August 2001, and since that time LAUNCH has been a wholly owned subsidiary of the Company.  The Company and LAUNCH do not believe that LAUNCH has infringed any rights of plaintiffs and intend to vigorously contest the lawsuit.  In January 2003, LAUNCH settled the LAUNCH litigation as to Sony Music Entertainment, Inc.  In October 2003, LAUNCH settled the litigation as to Capitol Records, Inc. and Virgin Records America, Inc.  Accordingly, BMG Music d/b/a/ The RCA Records Label is the sole remaining plaintiff in this proceeding.  On March 16, 2004 the plaintiff filed motions for partial summary judgment on the issues of willful infringement and whether the consumer-influenced portion of Launch’s LAUNCHcast service is “interactive” within the meaning of Section 114 of the Copyright Act and therefore does not qualify for the compulsory license provided for by the Copyright Act.  LAUNCH filed its opposition to the motions for partial summary judgment on April 30, 2004, and a hearing on the motions was held on June 18, 2004.  The Court has not yet ruled on the motions for summary judgment.  The Company does not believe it is feasible to predict or determine the outcome or resolution of the remaining LAUNCH litigation at this time.  The range of possible resolutions of such LAUNCH litigation could include judgments against LAUNCH or settlements that could require substantial payments by LAUNCH.

On July 12, 2001, the first of several purported securities class action lawsuits was filed in the United States District Court for the Southern District of New York against certain underwriters involved in Overture’s initial public offering, Overture, and certain of Overture’s current and former officers and directors.  The Court consolidated the cases against Overture.  Plaintiffs allege, among other things, violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 involving undisclosed compensation to the underwriters, and improper practices by the underwriters, and seek unspecified damages.  Similar complaints were filed in the same court against numerous public companies that conducted initial public offerings of their common stock since the mid-1990s.  All of these lawsuits were consolidated for pretrial purposes before Judge Shira Scheindlin.  On April 19, 2002, plaintiffs filed an amended complaint, alleging Rule 10b-5 claims of fraud.  On July 15, 2002, the issuers filed a motion to dismiss for failure to comply with applicable pleading standards.  On October 8, 2002, the Court entered an Order of Dismissal as to all of the individual defendants in the Overture IPO litigation, without prejudice.  On February 19, 2003, the Court denied the motion to dismiss the Rule 10b-5 claims against certain defendants, including Overture.  On August 31 2005, the Court entered an

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order confirming its preliminary approval of a settlement proposal made by plaintiffs, which includes settlement of, and release of claims against, the issuer defendants, including Overture.  A hearing on the fairness of the settlement to the shareholder class is currently set for April 24, 2006.  If the settlement does not occur, and litigation against Overture continues, the Company and Overture believe that Overture has meritorious defenses to liability and damages and will continue to defend the case vigorously.

On or about February 4, 2004, a shareholder derivative action was filed in the Court of Chancery of the State of Delaware in and for New Castle County, against the Company (as nominal defendant) and certain of the Company’s current and former officers and directors (the “Derivative Defendants”).  Two similar shareholder derivative actions were filed in the California Superior Court for the County of San Mateo on February 13, 2004.  The complaints generally alleged breaches of fiduciary duties by the Derivative Defendants related to the alleged purchase of shares in initial public offerings or the alleged acquiescence in such conduct and sought unspecified monetary damages and other relief purportedly on behalf of the Company from the Derivative Defendants.  The action in Delaware was dismissed by the Delaware Court of Chancery, and the dismissal has been affirmed by the Delaware Supreme Court.  The actions in California were dismissed by the California Superior Court on September 13, 2005.

The Company does not believe, based on current knowledge, that any of the foregoing legal proceedings or claims are likely to have a material adverse effect on its financial position, results of operations or cash flows.  However, the Company may incur substantial expenses in defending against third party claims.  In the event of a determination adverse to the Company or its subsidiaries, the Company may incur substantial monetary liability, and be required to change its business practices.  Either of these could have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Note 11—Segments

The Company manages its business geographically.  The primary areas of measurement and decision-making are the United States and International.  Management relies on an internal management reporting process that provides revenue and segment operating income before depreciation and amortization for making financial decisions and allocating resources.  Segment operating income before depreciation and amortization includes income from operations before depreciation, amortization of intangible assets and amortization of stock compensation expense.  Management believes that segment operating income before depreciation and amortization is an appropriate measure of evaluating the operational performance of the Company’s segments.  However, this measure should be considered in addition to, not as a substitute for, or superior to, income from operations or other measures of financial performance prepared in accordance with generally accepted accounting principles.

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The following tables present summarized information by segment (in thousands):

Revenue is attributed to individual countries according to the international online property that generated the revenue.  No single foreign country accounted for more than 10 percent of revenues in the three and nine months ended September 30, 2004 and 2005.

The following table presents revenues for groups of similar services (in thousands):

*                                         In the three and nine months ended September 30, 2004, Fees revenue includes certain revenue previously classified as Marketing services revenues of $6 million and $16 million, respectively.  This reclassification was done to refine the alignment of revenue sources within these classifications of revenue.

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Note 12—Related Party Transactions

The Company and other third parties are limited partners in Softbank Capital Partners LP (“Softbank Capital”), a venture capital fund which is an affiliate of SOFTBANK.  A Managing Partner of Softbank Capital is also a member of the Company’s Board of Directors.  The total investment by the Company in Softbank Capital is approximately $36 million and represents less than a 5% holding in Softbank Capital.  A significant portion of this investment has been impaired by the Company, with the remaining value included on the condensed consolidated balance sheets in other assets.  Pursuant to the Partnership Agreement, the Company invested on the same terms and on the same basis as all other limited partners.

The Company has a joint venture with SOFTBANK in Japan (“Yahoo! Japan”).  The Company has a 34 percent ownership in Yahoo! Japan and accordingly this investment is being accounted for using the equity method.  The Company records its share of the results of Yahoo! Japan one quarter in arrears within earnings in equity interests.  During the three months ended June 30, 2005, the Company received a cash dividend in the amount of $11 million from Yahoo! Japan which was recorded as a reduction in the Company’s investment in Yahoo! Japan.

The Company has commercial arrangements with Yahoo! Japan including algorithmic search services, sponsored search services and the related traffic acquisition costs, and license fees.  The net cost of these arrangements was approximately $22 million and $49 million for the three months ended September 30, 2004 and 2005, respectively.  The net cost of these arrangements was approximately $42 million and $121 million for the nine months ended September 30, 2004 and 2005, respectively.

Note 13—Subsequent Events

Alibaba Investment.  On October 23, 2005, the Company acquired an approximate 46 percent interest in the outstanding common stock of Alibaba.com Corporation, (“Alibaba” ) which represents an approximate 40 percent interest on a fully diluted basis, in exchange for $1 billion in cash, the contribution of the Company’s China based businesses (“Yahoo! China”) and direct transaction costs of $8 million.  Pursuant to the terms of a shareholders agreement, the Company has an approximate 35 percent voting interest in Alibaba, with the remainder of its voting rights subject to a voting agreement with Alibaba management.

The Company will account for this investment using the equity method of accounting and the total investment, including identifiable intangible assets, deferred tax liabilities and goodwill will be classified as a long-term investment on the Company’s consolidated balance sheets.  Following the acquisition date, the Company’s consolidated financial results will include its share of the results of Alibaba, together with amortization expense relating to any acquired intangible assets identified.  The Company will record its share of the results of Alibaba, and any related amortization expense, one quarter in arrears within earnings in equity interests.  Following the acquisition date, Yahoo! China will no longer be consolidated in the Company’s results but included within earnings in equity interests to the extent of the Company’s continued ownership interest in Alibaba.  The revenues and operating income of Yahoo! China were not material to the consolidated results of the Company for the year ended December 31, 2004 and the nine months ended September 30, 2005.  In connection with the transaction, the Company also expects to record a non-cash gain based on the difference between Yahoo! China’s fair value and its carrying value, adjusted for the Company’s continued ownership interest in the newly combined entity.  The Company currently estimates a non-cash pre-tax gain of $300 - $350 million in the fourth quarter of 2005.

Structured Stock Repurchase.  In October and November 2005, the Company received $386 million in cash from the settlement of two structured stock repurchase transactions totaling $350 million that were entered into in April 2005.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward Looking Statements