UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

Commission File Number 000-26659

Homestore, Inc.

(Exact Name of Registrant as Specified in its Charter)

(805) 557-2300

(Registrant’s Telephone Number, including Area Code:)

     Indicate by check mark whether registrant (1) has filed all reports required to be filed 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 þ          No o

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

      At July 29, 2005, the registrant had 147,543,043 shares of its common stock outstanding.

INDEX

      Homestore.com®, REALTOR.com®, HomeBuilder.com^tm, RENTNET.com^tm, Top Producer® and Welcome Wagon® are our trademarks or are exclusively licensed to us. This quarterly report on Form 10-Q contains trademarks of other companies and organizations. REALTOR® is a registered collective membership mark that may be used only by real estate professionals who are members of the National Association of REALTORS® and subscribe to its code of ethics.

PART I.     FINANCIAL INFORMATION

HOMESTORE, INC.

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these unaudited

Condensed Consolidated Financial Statements.

HOMESTORE, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these unaudited

Condensed Consolidated Financial Statements.

HOMESTORE, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these unaudited

Condensed Consolidated Financial Statements.

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

      Homestore, Inc. (“Homestore” or the “Company”) has created an online service that is the leading consumer destination on the Internet for home and real estate-related information based on the number of visitors, time spent on its websites and number of property listings. The Company provides a wide variety of information and tools for consumers, and is a leading supplier of online media and technology solutions for real estate industry professionals, advertisers and providers of home and real estate-related products and services. The Company derives all of its revenue from its North American operations.

      To provide consumers with timely and comprehensive real estate listings, access to real estate professionals and other home and real estate-related information and resources, the Company has established relationships with key industry participants. These participants include real estate market leaders such as the National Association of REALTORS® (“NAR”), the National Association of Home Builders (“NAHB”), hundreds of Multiple Listing Services (“MLSs”), the Manufactured Housing Institute (“MHI”), and leading real estate franchisors, including the six largest franchises, brokers, builders, and apartment owners and managers. Under an agreement with NAR, the Company operates NAR’s official website, REALTOR.com®. Under an agreement with NAHB, the Company operates a new home listing website, HomeBuilder.com^tm, which is endorsed by NAHB. Under agreements with NAR, NAHB, and MHI, the Company receives preferential promotion in their marketing activities.

      We generated positive operating cash flow for the year ended December 31, 2004 and for the quarter and six months ended June 30, 2005 and we have cash and short-term investments of $61.9 million as of June 30, 2005. However, as of June 30, 2005, the Company had an accumulated deficit of $2.0 billion. The Company has no material financial commitments other than those under capital and operating lease agreements and distribution and marketing agreements. However, the Company is now faced with the obligation to advance defense costs to certain of its former officers (described in Note 12) who have recently been criminally indicted and to possibly indemnify these and other former and current officers, directors and employees. The Company is unable to estimate how much it might ultimately cost the Company to meet these obligations. The Company believes that its existing cash and short-term investments, and any cash generated from operations, will be sufficient to fund its working capital requirements, capital expenditures and other obligations through the next 12 months. Long term, the Company may face significant risks associated with the successful execution of its business strategy and may need to raise additional capital in order to fund more rapid expansion, to expand its marketing activities, to develop new, or enhance existing, services or products, to respond to competitive pressures, to acquire complementary services, businesses or technologies and to meet its advancement and possible indemnification obligations to its former and current officers, directors and employees. If the Company is not successful in continuing to generate sufficient cash flow from operations, it may need to raise additional capital through public or private financing, strategic relationships or other arrangements. The Company’s settlement of the Securities Class Action Lawsuit (described in Note 11) reduced its cash balance by $13.0 million, and increased the number of outstanding shares of the Company’s common stock by 20.0 million, which may make it more difficult to raise additional capital. This additional capital, if needed, might not be available on terms acceptable to the Company, or at all. If additional capital were raised through the issuance of equity securities, the percentage of the Company’s stock owned by its then-current stockholders would be further reduced. Furthermore, these equity securities might have rights, preferences or privileges senior to those of the Company’s common and preferred stock. In addition, the Company’s liquidity could be adversely impacted by other litigation (see Note 12).

      The Company’s unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) including those for interim financial information and with the instructions for Form 10-Q and Article 10 of

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

Regulation S-X issued by the Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and note disclosures required by GAAP for complete financial statements. These statements are unaudited and, in the opinion of management, all adjustments (which include only normal recurring adjustments) considered necessary for a fair presentation have been included. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2004 included in the Company’s Form 10-K filed with the SEC on March 11, 2005. The results of operations for these interim periods are not necessarily indicative of the operating results for a full year. As a result of the Company’s sale of its Wyldfyre and Computer for Tracts businesses in 2004, the results of those two businesses have been reclassified as discontinued operations for all periods presented (see Note 5).

      The Company follows the intrinsic value method in accounting for its stock options. Had compensation cost been recognized based on the fair value at the date of grant for options granted during the three and six months ended June 30, 2005 and June 30, 2004, the pro forma amounts of the Company’s net income (loss) per share would have been as follows (in thousands, except per share amounts):

      The fair value for each option granted was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

      In December 2004, the Financial Accounting Standards Board (“FASB”) issued revised Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment.” SFAS No. 123R sets accounting requirements for “share-based” compensation to employees and requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based compensation. SFAS No. 123R is effective for fiscal years beginning after June 15, 2005. The Company will be required to adopt SFAS No. 123R in its first quarter of fiscal 2006. The Company currently discloses the effect on net income (loss) and earnings (loss) per share of the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” however, SFAS 123R provides alternative methods for measuring compensation expense, so the effect on income (loss) disclosed in Note 3 may not be indicative of future compensation expense under SFAS 123R. The Company is currently evaluating the impact of the adoption of SFAS 123R on its financial position and results of operations, including the valuation methods and support for the assumptions that underlie the valuation of the awards.

      On December 21, 2004, the Company entered into an Asset Purchase Agreement with Newstar Systems, Inc. (“Newstar”) pursuant to which the Company agreed to sell its Computer for Tracts (“CFT”) software business, which had been reported as part of the Company’s software segment, for a purchase price of approximately $2.5 million in cash. The transaction closed on December 21, 2004, resulting in a gain on disposition of discontinued operations of approximately $1.6 million.

      On October 6, 2004, the Company entered into an Asset Purchase Agreement with Wyld Acquisition Corp. (“Wyld”), a wholly owned subsidiary of Seigel Enterprises, Inc., pursuant to which the Company agreed to sell its Wyldfyre software business, which had been reported as part of the Company’s software segment, for a purchase price of $8.5 million in cash. The transaction closed on October 6, 2004, resulting in a gain on disposition of discontinued operations. The sale generated net proceeds of approximately $7.0 million after transaction fees and monies placed in escrow pursuant to the Asset Purchase Agreement. To date, approximately $5.7 million has been recorded as “Gain on disposition of discontinued operations.”

      On March 19, 2002, the Company entered into an agreement to sell its ConsumerInfo division, a former subsidiary of iPlace, to Experian Holdings, Inc. (“Experian”), for $130.0 million in cash. The transaction closed on April 2, 2002. The sale generated net proceeds of approximately $117.1 million after transaction fees, settlement of litigation, and monies placed in escrow.

      As part of the sale to Experian, $10.0 million of the purchase price was put in escrow to secure our indemnification obligations (the “Indemnity Escrow”). In the second quarter of 2003, $2.3 million was released to us from the Indemnity Escrow and recognized as “Gain on disposition of discontinued operations.” As of June 30, 2005, cash in the Indemnity Escrow was $7.4 million. To the extent the Indemnity Escrow is released to us, we will recognize additional gain on disposition of discontinued operations.

      The Indemnity Escrow was scheduled to terminate in the third quarter of 2003, but prior to the scheduled termination, Experian demanded indemnification from us for claims made against Experian or its subsidiaries by several parties (see Note 12).

      Pursuant to SFAS No. 144, the consolidated financial statements of the Company for all periods presented reflect the disposition of its Wyldfyre, CFT, and ConsumerInfo divisions as discontinued operations. Accordingly, the revenue, costs and expenses, and cash flows of these divisions have been excluded from the respective captions in the Consolidated Statements of Operations and Consolidated Statements of Cash Flows and have been reported as “Loss from discontinued operations,” net of applicable income taxes of zero; and as “Net cash used in discontinued operations.” Total revenue and loss from discontinued operations was

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

$2.5 million and $302,000, respectively, for the three months ended June 30, 2004 and $5.1 million and $608,000, respectively, for the six months ended June 30, 2004. There were no revenues or operating expenses associated with discontinued operations for the three or six months ended June 30, 2005.

      The Company has taken four restructuring charges: in the fourth quarter of 2001, the first quarter of 2002, the third quarter of 2002 and the fourth quarter of 2003. All of these charges were a part of plans approved by the Company’s Board of Directors, with the objective of eliminating duplicate resources and redundancies. A summary of each is outlined below. The Company has also revised previous estimates from time to time.

      In the fourth quarter of 2001, the Company recorded a charge of $35.8 million, which was included in restructuring charges in the Consolidated Statement of Operations. As part of this restructuring and integration plan, the Company undertook a review of its existing locations and elected to close a number of satellite offices and identified and notified approximately 700 employees whose positions with the Company were eliminated. The work force reductions affected approximately 150 members of management, 100 in research and development, 200 in sales and marketing and 250 in administrative functions. This charge consisted of the following: (i) employee termination benefits of $6.4 million; (ii) facility closure charges of $20.8 million, comprised of $12.8 million in future lease obligations, exit costs and cancellation penalties, net of estimated sublease income of $11.9 million, and $8.0 million of non-cash fixed asset disposals related to vacating duplicate facilities and decreased equipment requirements due to lower headcount; (iii) non-cash write-offs of $2.9 million in other assets related to exited activities; and (iv) accrued future payments of $5.7 million for existing contractual obligations with no future benefits to the Company.

      In the first quarter of 2004, the Company increased its estimate for lease obligations and related charges for its San Francisco property by $139,000. In the fourth quarter of 2004, the Company took an additional charge of $877,000 because the Company was uncertain it would be able to sublease the remaining one-third of the San Francisco property and to increase its liability for certain contractual obligations that are subject to exchange rate fluctuations. In the second quarter of 2005, the Company was able to negotiate more favorable terms for the remaining term of the lease of its San Francisco property and surrendered a portion of the property to the landlord. As a result, the Company reduced its estimate for lease obligations and related charges by $1.3 million. The Company also revised its estimates of the contractual liabilities in connection with its former operations in Europe reducing these obligations by $51,000 and its estimate for employee termination benefits, reducing them by approximately $6,000. As of June 30, 2005, all of the planned 700 employees have been terminated and paid severance.

      In the first quarter of 2002, the Company recorded a charge of $2.3 million, which was included in restructuring charges in the Consolidated Statement of Operations. As part of this restructuring and integration plan, the Company undertook a review of its existing locations and elected to close offices and identified and notified approximately 270 employees whose positions with the Company were eliminated. The work force reductions affected approximately 30 members of management, 40 in research and development, 140 in sales and marketing and 60 in administrative functions. This charge consisted of employee termination benefits of $1.7 million and facility closure charges of approximately $600,000. In the first quarter of 2004, the Company increased its charge for lease obligations by $277,000 as a result of changes in exchange rates which increased its Canadian lease obligations. In the fourth quarter of 2004, the Company increased its charge for lease obligations by $94,000 for the same reason. In the second quarter of 2005, the Company decreased its charge for lease obligations by $27,000 for the same reason. As of June 30, 2005, all of the planned 270 employees have been terminated and paid severance.

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

      In the third quarter of 2002, the Company recorded a charge of $3.6 million, which was included in restructuring charges in the Consolidated Statement of Operations. As part of this restructuring and integration plan, the Company undertook a review of its existing locations and elected to close an office and identified and notified approximately 190 employees whose positions with the Company were eliminated. The work force reductions affected approximately 30 in research and development, 10 in production, 140 in sales and marketing and 10 in administrative functions. This charge consisted of employee termination benefits of $1.6 million and facility closure charges of approximately $2.0 million. In the fourth quarter of 2003, the Company decreased its estimates regarding employee termination benefits by $133,000 and its lease obligations and related charges by $417,000. As of June 30, 2005, all of the planned 190 employees have been terminated and paid severance.

      In the fourth quarter of 2003, the Company recorded a charge of $3.5 million, which was included in restructuring charges in the Consolidated Statement of Operations. As part of this restructuring and integration plan, the Company undertook a review of its existing operations and elected to change its management structure and identified and notified approximately 95 employees whose positions with the Company were eliminated. The work force reductions affected approximately seven in research and development, 17 in production, 37 in sales and marketing and 34 in administrative functions. This charge consists of employee termination benefits of approximately $1.4 million and stock-based charges related to the acceleration of vesting of certain options for terminated management personnel of $2.1 million. In the first quarter of 2004, the Company reduced its estimate for employee termination benefits by $71,000. In the second quarter of 2005, the Company reduced its estimate for employee termination benefits by an additional $15,000. As of June 30, 2005, all of the planned 95 employees have been terminated and paid severance.

      A summary of activity in 2004 and 2005 related to the four restructuring charges and the changes in the Company’s estimates is as follows (in thousands):

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

      Substantially all of the remaining restructuring liabilities at June 30, 2005 will be paid over the next six quarters. Any further changes to the accruals based upon current estimates will be reflected through the restructuring charges line in the Consolidated Statement of Operations.

      Goodwill, net, by segment, as of June 30, 2005 and December 31, 2004 is as follows (in thousands):

      Definite-lived intangible assets consist of purchased content, portal relationships, purchased technology, and other miscellaneous agreements entered into in connection with business combinations and are amortized over expected periods of benefits. There are no indefinite lived intangibles and no expected residual values related to these intangible assets (in thousands):

      Amortization expense for intangible assets was $1.0 million and $2.2 million, respectively, for the three and six months ended June 30, 2005, and $2.1 million and $4.4 million, respectively, for the three and six months ended June 30, 2004. Amortization expense for the next five years is estimated to be as follows (in thousands):

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

      The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”(“APB No. 25”), and complies with the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”(“SFAS No. 123”). Under APB No. 25, compensation expense is recognized over the vesting period based on the difference, if any, on the date of grant between the deemed fair value for accounting purposes of the Company’s stock and the exercise price on the date of grant. The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force (“EITF”) No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services.”

      The following chart summarizes the stock-based charges that have been included in the following captions for each of the periods presented (in thousands):

      Stock-based charges included in sales and marketing represent costs related to vendor agreements and charges included in general and administrative represent amortization of restricted stock.

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

      The following table sets forth the computation of basic and diluted net income (loss) per share applicable to common stockholders for the periods indicated (in thousands, except per share amounts):

      The per share computations exclude preferred stock, options and warrants which are anti-dilutive. The number of shares excluded from the basic and diluted net income (loss) per share computations were 16,877,796 and 12,318,125 for the three and six months ended June 30, 2005, respectively, and 24,692,898 for the three and six months ended June 30, 2004.

      Segment information is presented in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” This standard is based on a management approach, which requires segmentation based upon the Company’s internal organization and disclosure of revenue and operating expenses based upon internal accounting methods. The Company’s management evaluates performance and allocates resources based on three segments consisting of Media Services, Software and Print. This is consistent with the data that is made available to our management to assess performance and make decisions.

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

      The expenses presented below for each of the business segments include an allocation of certain corporate expenses that are identifiable and benefit those segments and are allocated for internal management reporting purposes. The unallocated expenses are those corporate overhead expenses that are not directly attributable to a segment and include: corporate expenses, such as finance, legal, internal business systems, and human resources; amortization of intangible assets; litigation settlement charges; stock-based charges; and restructuring charges. There is no inter-segment revenue. Assets and liabilities are not fully allocated to segments for internal reporting purposes.

      Summarized information, by segment, as excerpted from internal management reports is as follows (excluding discontinued operations (see Note 5)) (in thousands):

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

      Beginning in December 2001, numerous separate complaints purporting to be class actions were filed in various jurisdictions alleging that the Company and certain of its current and former officers and directors violated certain provisions of the Securities Exchange Act of 1934. The complaints contain varying allegations, including that the Company made materially false and misleading statements with respect to the Company’s 2000 and 2001 financial results included in the Company’s filings with the SEC, analysts reports, press releases and media reports. The complaints sought an unspecified amount of damages. In March 2002, the California State Teachers’ Retirement System was named lead plaintiff (the “Plaintiff”), and the complaints were consolidated in the United States District Court, Central District of California. In November 2002, the Plaintiff filed a first amended consolidated class action complaint (“Securities Class Action Lawsuit”) naming the Company, certain of its current officers, directors and employees, certain of the Company’s former officers, directors and employees, and various other parties, including, among others, PricewaterhouseCoopers LLP as defendants. The amended complaint made various allegations, including that the Company violated federal securities laws, and sought an unspecified amount of damages.

      On August 12, 2003, the Company entered into a settlement agreement with the Plaintiff to resolve all outstanding claims against the Company in the Securities Class Action Lawsuit. On May 14, 2004, the District Court entered final judgment and an order of dismissal with prejudice of the Securities Class Action Lawsuit as to the Company. The final judgment includes a bar order providing for the maximum protection to which the Company is entitled under the law with respect to all future claims, whether under federal, state or common law. On June 10, 2004, an objector to the settlement filed a notice of appeal. The Company and Plaintiff reached a settlement with the objector and the objector filed a dismissal of the appeal on March 4, 2005.

      As a result of the settlement, the Company recorded a litigation settlement charge of $63.6 million in its operating results in the year ended December 31, 2003. In addition, the Company has adopted certain corporate governance principles, including requirements for independent directors and special committees, the agreement to appoint a new shareholder-nominated director, prohibition on the future use of stock options for director compensation, minimum stock retention by officers after exercise of future stock option grants, and elimination of the classification of the Board of Directors such that beginning with the 2008 annual stockholders meeting, all directors will be elected at each annual meeting for a term of one year. The Company will also divide equally with the class any future net proceeds from insurance with respect to the litigation after provision for legal expenses incurred against the Company. Any members of the class who participate in the settlement will release and discharge all claims against the Company. The Company is aware that several persons, who purportedly acquired the Company’s shares during the class period during January 1, 2000 through December 21, 2002, representing approximately 1% of our outstanding shares, have elected to be excluded from the settlement, and some of those have filed litigation against the Company. Moreover, the Company could be subject to claims that may not have been discharged or barred by the settlement, including potential claims by Cendant described below.

      On March 7, 2003, the court in the Securities Class Action Lawsuit dismissed with prejudice Cendant as a defendant. However, that dismissal has been appealed to the United States Court of Appeals for the Ninth Circuit. In October 2004, the Securities and Exchange Commission filed an amicus brief in support of the appeal. If Cendant’s dismissal as a defendant in the Securities Class Action Lawsuit is reversed on appeal and Cendant is subsequently found liable or settles the claims against it in the Securities Class Action Lawsuit, Cendant will likely seek indemnification, contribution or similar relief from the Company up to the amount for which it is held liable or for which it settles. However, on March 16, 2004, as part of the Company’s settlement of the Securities Class Action Lawsuit, the United States District Court issued an order approving the

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

settlement and barring claims by third parties against the Company for indemnification, contribution and similar relief with respect to liability such third parties may have in the Securities Class Action Lawsuit.

      The March 16, 2004 order may preclude Cendant from seeking indemnification, contribution or similar relief from the Company in the event Cendant is found liable or settles claims against it in the Securities Class Action Lawsuit. However, the Company has been advised by counsel that the law is unclear on whether Cendant would be so precluded. Therefore, the Company would likely incur significant expenses in defending such an action by Cendant and could ultimately be found liable to Cendant or settle with Cendant, notwithstanding the bar order. Such expenses, liability or settlement could have a material adverse effect on the Company’s results of operations and financial position.

      In addition, if Cendant is not permitted to share in the settlement of the Securities Class Action Lawsuit (which would be the case if its dismissal as a defendant is reversed on appeal), the Company has agreed to pay or otherwise provide to Cendant the amount of money and/or other consideration that Cendant would have been otherwise entitled to receive from that portion of the class action settlement fund provided by the Company had Cendant been a class member and Cendant’s proof of claim in respect of its shares had been accepted in full. At this time, Cendant is still a member of the class and has not been excluded. Pending distribution to the class of the cash and shares, the Company is unable to estimate the amount of cash and number of shares that Cendant could be entitled to receive from the Company should Cendant be prevented from participating in the settlement.

      In April 2004, the U.S. Department of Labor Wage and Hour Division (the “DOL”), commenced a preliminary investigation into the Company’s compliance with the Fair Labor Standards Act with regard to job classifications. The DOL and the Company entered into a settlement on September 30, 2004 in connection with the DOL’s investigation pursuant to which the Company, without admitting liability, agreed to (1) convert its account executives to “non-exempt” classifications effective October 11, 2004; and (2) make payments of approximately $1.4 million to 434 current and former account executives for past overtime compensation under Federal law. These payments were made in October 2004 and have been reflected as sales and marketing expenses in the quarter ended September 30, 2004.

      In September 2004, Elizabeth Hathaway filed a class action lawsuit in Los Angeles Superior Court on behalf of herself and all current and former account executives employed by Homestore, alleging that the Company misclassified account executives as exempt from overtime wage requirements in violation of California law. Hathaway sought back wages, interest and attorneys’ fees. On March 11, 2005, Hathaway and Homestore reached a settlement for an additional $1.4 million. This has been reflected as sales and marketing expenses in the six months ended June 30, 2005. The court preliminarily approved the settlement on June 23, 2005. The settlement is subject to final court approval and certain conditions, such as a cap on the number of class members who may elect to opt out.

      On June 7, 2004, the Company entered into an agreement providing for the settlement of three lawsuits brought against it by certain former shareholders of Top Producer® in connection with the acquisition of Top Producer® in May 2000. Pursuant to this settlement, on July 6, 2004, the Company (i) issued 2,097,984 shares of common stock in satisfaction of the remaining installments of the Company’s purchase price of Top Producer® that were due in 2003, 2004 and 2005, (ii) issued 151,064 shares of common stock and paid $104,000 in cash in satisfaction of non-competition payments due to the former president of Top Producer®, and (iii) issued an additional 75,988 shares of common stock in settlement of the various claims. Issuance of the shares was exempt from registration under Section 3(a)(10) of the Securities Act of 1933. As a result of the acceleration of the remaining installments of the purchase price and the issuance of

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

additional stock to settle this dispute, the Company recorded a litigation settlement charge of $793,000 in the year ended December 31, 2004.

      On July 6, 2004, the Company settled a lawsuit brought against it by certain former owners and directors of iPlace. Pursuant to this settlement, on July 9, 2004, the Company issued to the plaintiffs 177,631 shares of the Company’s common stock and paid $700,000 in cash. The issuance of the shares in the settlement was exempt from registration under Section 3(a)(10) of the Securities Act of 1933. As a result of the settlement, the Company recorded a litigation settlement charge of approximately $1.4 million in the year ended December 31, 2004.

      See Note 11, “Settlements of Disputes and Litigation — Settlement of Securities Class Action Lawsuit,” for contingencies related to the settlement of the Class Action Lawsuit.

      In December 2001, Pentawave Inc. and its principal stockholder, Bruce Culver, filed a suit for fraud, securities fraud, rescission, breach of contract and defamation in Ventura County Superior Court seeking approximately $5.0 million in compensatory damages, plus punitive damages. The Company filed for summary judgment and in February 2005, the court granted the motion in part, dismissing the defamation and securities fraud claims, and denied it as to plaintiffs’ breach of contract, common law fraud and rescission claims. Although the Company intends to defend this claim vigorously, the Company is unable to express an opinion as to the outcome of the litigation. No trial date is currently scheduled.

      In June 2002, Tren Technologies Holdings LLC., (“Tren”) served a complaint on Homestore, NAR and NAHB in the United States District Court, Eastern District of Pennsylvania. The complaint alleged a claim for patent infringement based on activities related to the websites REALTOR.com® and HomeBuilder.com^tm. Specifically, Tren alleged that it owns a patent (U.S. Patent No. 5,584,025) on an application, method and system for tracking demographic customer information, including tracking information related to real estate and real estate demographics information, and that the Company has developed an infringing technology for the NAR’s REALTOR.com® and the NAHB’s HomeBuilder.com^tm websites. The complaint sought unspecified damages and a permanent injunction against the Company using the technology. On May 22, 2004, the Company filed with the United States Patent and Trademark Office (“USPTO”) a Request for Reexamination of the patent at issue in the action. On May 25, 2004, the Court issued an order dismissing the action without prejudice and stating that the matter is to remain status quo and that the statute of limitations is tolled, and further stating that the matter remains active and any discovery and settlement discussions will continue. On September 8, 2004, a status conference was held in which the Court informed the parties to contact it after there has been further progress in the Reexamination hearing. On January 25, 2005, the USPTO issued an office action rejecting the specific patent claims at issue stating that they were not unique or proprietary and could not be patented. Tren filed a response to this office action arguing that the rejection of those specific claims was not proper, but the USPTO has not yet ruled on the matter. The USPTO’s ultimate decision in the reexamination proceeding is likely to have an impact on the outcome of the action. The action remains stayed at this time. The Company believes Tren’s claims are without merit and intends to vigorously defend the case.

      On October 1, 2003, Plaintiff Kevin Keithley (“Keithley”) filed a complaint against the Company, NAR and NAHB in the United States District Court for the Northern District of California alleging infringement of

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

U.S. Patent No. 5,584,025. The complaint sought unspecified damages and a permanent injunction against the Company using the technology. In the complaint, Keithley asserts exclusive license of the patent. After Keithley filed and served the complaint, defendants, including the Company, on May 24, 2004 filed an answer and counterclaims seeking declarations of non-infringement and invalidity of the patent at issue in the action. Keithley has answered the counterclaims. On May 22, 2004, the Company filed with the USPTO a Request for Reexamination of the patent at issue in the action. The Court has stayed this action pending the Reexamination proceeding. On January 25, 2005, the USPTO issued an office action rejecting the specific patent claims at issue stating that they were not unique or proprietary and could not be patented. Keithley filed a response to this office action arguing that the rejection of those specific claims was not proper, but the USPTO has not yet ruled on the matter. The USPTO’s ultimate decision in the reexamination proceeding is likely to have an impact on the outcome of the action. The Court stayed the action pending reexamination, and has since lifted the stay to allow the Company to move for transfer of the case to Pennsylvania. A motion to transfer or dismiss is pending. The Company believes Keithley’s claims are without merit and intends to vigorously defend the case.

      On October 29, 2003, Peter Tafeen (“Tafeen”), a former officer of Homestore, filed suit in the Delaware Chancery Court in New Castle County. The complaint asserted a claim for advancement of fees and expenses already incurred and for future expenses to be incurred in connection with the SEC and DOJ investigations and the civil actions filed against Tafeen for his purported role in a scheme to inflate the Company’s revenues. On October 27, 2004, the Court ruled that the Company is obligated to advance to Tafeen all reasonable attorney’s fees and costs associated with the various legal proceedings in which Tafeen is involved by reason of his service as an officer of the Company, as well as Tafeen’s fees in prosecuting the action before the Court. On April 27, 2005, the Court entered final judgment requiring the Company to advance fees to Tafeen in the amount of $4.2 million which were paid on June 14, 2005. Under the Court’s final judgment, the Company is also required to advance future costs incurred for his defense, pending the outcome of the criminal and civil actions. Mr. Tafeen has submitted requests for payment of approximately $700,000 in additional costs. The Company is unable to estimate the amount of costs it may ultimately have to advance Mr. Tafeen. The Company is in the process of appealing the Court’s decision.

      On June 14, 2005, Homestore received a demand from Stuart Wolff (“Wolff”), Homestore’s former Chairman and Chief Executive Officer, for advancement of legal fees and expenses purportedly incurred and to be incurred by Wolff in connection with the SEC and DOJ investigations and certain civil actions filed against Wolff for his purported role in a scheme to inflate the Company’s revenues. On July 1, 2005, Wolff filed a suit in the Delaware Chancery Court in New Castle County. The complaint seeks advancement for legal fees and expenses purportedly incurred by Wolff in the amount of approximately $6.3 million. The complaint also seeks an award of expenses and fees incurred in connection with prosecuting Wolff’s claim for advancement. The Company is currently reviewing the issues raised by the complaint. It is likely that the Company will be required to advance a substantial portion of the $6.3 million and any future costs for his defense, pending the outcome of the criminal and civil actions. The Company is unable to estimate the amount of costs it may ultimately have to advance Mr. Wolff.

      On July 8, 2005, the Company received a demand from David Rosenblatt, (“Rosenblatt”), the Company’s former General Counsel, seeking indemnification totaling approximately $690,000 for fees and expenses purportedly incurred by Rosenblatt in connection with the SEC and DOJ investigations and certain civil actions filed against Rosenblatt including indemnification of a settlement payment of $195,000 made by Rosenblatt in connection with his settlement of the claims brought against him in the securities class action. The Company is currently reviewing the demand from Rosenblatt. The Company has not determined what portion, if any, of Mr. Rosenblatt’s fees and expenses it will have to pay and whether there will be significant future costs it will have to pay, however, it is likely the Company will be required to pay a substantial portion of his demand.

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

      Notwithstanding the possibility of the Company prevailing on its appeal in the Tafeen case, as a result of the Court’s ruling, the Company recorded an accrual of $7.2 million for its estimate of the potential advancement of legal costs of former officers, including Tafeen, in the quarter ended September 30, 2004 bringing the total accrual balance to $8.0 million as of September 30, 2004. Additionally, based on new information received from the various parties, the Company recorded an additional accrual of $4.2 million during the quarter ended June 30, 2005. As of June 30, 2005, the balance of the accrual for legal costs of former officers is $7.9 million and represents those costs represented to us as incurred through June 30, 2005. The Company anticipates additional charges in the future, but is unable to estimate the amount of future costs it may ultimately incur in these matters. In the event the Company ultimately prevails on its appeal of the decision in the Tafeen case, or if it is ultimately determined that any officer to whom the Company advanced funds is not entitled to indemnification under Delaware law, the officer would be obligated to repay all costs advanced. In either of these situations, there is no assurance the officer would have the ability to repay amounts previously advanced to him.

      On March 30, 2004, three shareholders of WyldFyre Technologies, Inc. (“WyldFyre”), two of whom had previously opted out of the settlement of the Securities Class Action Lawsuit, filed a complaint in the Superior Court of California, County of Los Angeles against the Company, two of its former officers and Merrill Lynch & Co., Inc. The complaint alleges fraud, negligent misrepresentation, vicarious liability, unfair business practices, unjust enrichment and breach of contract arising out of the Company’s acquisition of WyldFyre in March 2000. The complaint seeks restitution, rescissionary or compensatory damages in an unspecified amount, disgorgement of benefits, punitive damages and costs of litigation. The Company intends to vigorously defend this action. At this time, however, the Company is unable to express an opinion on the outcome of this case.

      On July 29, 2004, the Company was served with an amended complaint in Stichting Pensioenfonds ABP v. AOL Time Warner. et.al in which the Company was named as a defendant. The case was originally filed in July 2003 in the U.S. District Court for the Southern District of New York against Time Warner (formerly, AOL Time Warner), current and former officers and directors of Time Warner and America Online, Inc. (“AOL”), and Time Warner’s outside auditor alleging that Time Warner and AOL made material misrepresentations and/or omissions of material fact in connection with the business of AOL both before and after the merger of AOL and Time Warner in violation of federal securities laws and constituting common law fraud and negligent misrepresentation. In adding the Company as a defendant, the plaintiff, a Dutch pension fund, alleges that the Company and four other third parties with whom AOL did business and who are also named as defendants, aided and abetted the alleged common law fraud and themselves engaged in common law fraud as part of a civil conspiracy. The allegations against the Company, which are based on the factual allegations in the first amended consolidated class action complaint and other filings in the Company’s Securities Class Action Lawsuit, are that certain former officers of the Company knew of the alleged fraud at AOL and knowingly participated in and substantially assisted that alleged fraud by negotiating, structuring and participating in numerous “triangular” round trip transactions with AOL and others. The plaintiff seeks an unspecified amount of compensatory and punitive damages. The Company intends to defend vigorously against this suit. The Company has moved to dismiss the claims against it in the amended complaint. Discovery has not commenced as of the filing of this Form 10-Q. The Company is unable to predict the outcome of this case or reasonably estimate a range of possible loss.

      As part of the sale in 2002 of the ConsumerInfo division, the former subsidiary of iPlace, to Experian Holdings, Inc. (“Experian”), $10.0 million of the purchase price was put in escrow to secure the Company’s indemnification obligations (the “Indemnity Escrow”). The Indemnity Escrow was scheduled to terminate in the third quarter of 2003, but prior to the scheduled termination, Experian demanded indemnification from the Company for claims made against Experian or its subsidiaries by several parties, including allegations of unfair and deceptive advertising in connection with ConsumerInfo’s furnishing of credit reports and providing

HOMESTORE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

“Advice for Improving Credit” that appeared on its website both before, during, and after the Company’s ownership of ConsumerInfo. Under the stock purchase agreement, pursuant to which the Company sold ConsumerInfo to Experian, the Company could have elected to defend against the claims, but because the alleged conduct occurred both before and after the Company’s sale to Experian, the Company elected to rely on Experian to defend it. Accordingly, the Company has not made a complete evaluation of the underlying claims, but rather receives periodic updates from Experian and its counsel concerning its defense of the claims.

      In June of 2005, Experian informed the Company that they entered into a preliminary settlement in connection with certain of the unfair and deceptive advertising allegations. The preliminary settlement covers a multi-year period, during a portion of which the Company owned ConsumerInfo. If the preliminary settlement becomes final and Experian resolves the other claims, there can be no assurance that Experian will not seek to recover from the Company an amount in excess of the Indemnity Escrow.

      Under the terms of the stock purchase agreement, the Company’s maximum potential liability for the claims made by Experian is capped at $29.3 million less the balance in the Indemnity Escrow, which was $7.4 million at June 30, 2005.

      From time to time, the Company is party to various other litigation and administrative proceedings relating to claims arising from its operations in the ordinary course of business. As of the date of this Form 10-Q, and except as set forth herein, the Company is not a party to any other litigation or administrative proceedings that management believes will have a material adverse effect on the Company’s business, results of operations, financial condition or cash flows.

      This Form 10-Q and the following “Management’s Discussion and Analysis of Financial Condition and Results of Operations” include “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact that we make in this Form 10-Q are forward-looking. In particular, the statements herein regarding industry prospects and our future consolidated results of operations or financial position are forward-looking statements. Forward-looking statements reflect our current expectations and are inherently uncertain. Our actual results may differ significantly from our expectations. Factors that could cause or contribute to such differences include those discussed below and elsewhere in this Form 10-Q, as well as those discussed in our Annual Report on Form 10-K for the year ended December 31, 2004, and in other documents we file with the Securities and Exchange Commission, or SEC. This Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2004.

Recent History

      In recent years, our company has faced a number of difficult challenges. After discovering accounting irregularities in late 2001, we restated our financial statements for 2000 and the first three quarters of 2001. In the wake of these accounting irregularities and subsequent restatements, we have faced:

      We believe that we have addressed each of these challenges, while recognizing that many risks persist. See Item 1, “Business — Risk Factors,” contained in Part I to our Annual Report on Form 10-K for the year ended December 31, 2004 and “Risk Factors” below for more information.

      During this time of uncertainty, many of our customers and potential customers expressed concerns about our ability to provide value-added products and services. At the same time, we modified our product and service offerings and introduced new pricing structures that we believe better reflect the value of our products and services. We believe that the changes in our products and service offerings have been accepted by our customers, despite initial resistance by some.

      We have implemented four restructurings during the last four years. These restructurings were designed to focus our business and to eliminate redundancies in our organization. We believe these restructurings were necessary to address both our product and service offerings and our cost structure.

Our Business

      We have created an online service that is the leading consumer destination on the Internet for home and real estate-related information based on the number of visitors, time spent on our websites and number of property listings. We provide a wide variety of information and tools for consumers and are a leading supplier

of online media and technology solutions for real estate industry professionals, advertisers and providers of home and real estate-related products and services.

      To provide consumers with timely and comprehensive real estate listings, access to real estate professionals and other home and real estate-related information and resources, we have established relationships with key industry participants. These participants include real estate market leaders such as the National Association of REALTORS®, or NAR, the National Association of Home Builders, or NAHB, hundreds of Multiple Listing Services, or MLSs, the Manufactured Housing Institute, or MHI, and leading real estate franchisors, including the six largest franchises, brokers, builders and apartment owners and managers. Under our agreement with NAR, we operate NAR’s official website, REALTOR.com®. Under our agreement with NAHB, we operate its new home listing website, HomeBuilder.com^tm. Under our agreements with NAR, NAHB, and MHI, we receive preferential promotion in their marketing activities.

Basis of Presentation

      Our unaudited Condensed Consolidated Financial Statements reflect the historical results of Homestore, Inc. and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Business Trends and Conditions

      In recent years, our business has been, and we expect will continue to be, influenced by a number of macroeconomic, industry-wide and product-specific trends and conditions:

      Media Services segment: Our Media Services segment evolved as a business providing Internet applications to real estate professionals. In recent years, it became apparent that our customers valued the media exposure that the Internet offered them, but not the actual “technology” that we were offering. Many of our customers objected to our proposition that they purchase our templated website in order to gain access to our networks. In addition, we were charging a fixed price to all customers regardless of the market they operated in or the size of their business.

      In 2003, we responded to our customers’ needs and revamped our service offerings. We began to price our services based on the size of the market and the number of properties the customer displayed. For many of our customers this change led to substantial price increases over our former technology pricing. This change has been reasonably well-accepted by our customers, however, it has caused us to lose some customers. While we do not expect this trend to continue, it could materially and adversely impact our Media Services segment revenue.

      Software segment: In our Software segment, Top Producer® introduced a monthly subscription model of an online application in late 2002. This had a negative impact on our revenues over the first eighteen months of this offering as we attempted to build the subscriber base. While our desktop product is still attractive to some real estate professionals, our customer base continues to shift to the online application and we believe it will completely replace our desktop product by the end of 2005. We recently sold our Wyldfyre and Computer for Tracts businesses that had been a part of this segment and have reclassified the results of these businesses as discontinued operations for all periods presented.

      Print segment: The uncertain economic conditions since 2001 had an adverse effect on our Welcome Wagon® business. Our primary customers are small local merchants trying to reach new movers and economic conditions have negatively impacted the small business more than other businesses. These economic conditions caused a significant decline in our revenue in this segment over the past three years. Although we are starting to see some improvement in market conditions in some geographic areas, it could take considerable time before this segment yields meaningful growth, if at all. In addition, we have not invested in this business in the last three years and our product offering has become outdated. We have announced plans to invest in this business in 2005, but we do not expect any significant improvement until 2006.

      Because of the limited resources we have available, we have instituted a staged investment strategy. Starting in mid-2002, we began conceiving and executing the repositioning of REALTOR.com®, Top Producer® and our retail advertising activities. Our improved performance is entirely related to the improvement in those three businesses, which, in turn, gives us increasing confidence in the longer term results that we should be able to generate from our current and planned investments in other areas of our business. We are now focusing on investing in and improving our RENTNET.com^tm, HomeBuilder.com^tm and Welcome Wagon® businesses and expect to continue to do so through much of 2005 and into 2006.

Critical Accounting Policies

      Our discussion and analysis of our financial condition and results of operations is based upon our unaudited Condensed Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these unaudited Condensed Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, uncollectible receivables, intangible and other long-lived assets and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. This Form 10-Q should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2004.

Legal Contingencies

      We are currently involved in certain legal proceedings, as discussed in Note 11, “Settlements of Disputes and Litigation,” and Note 12, “Commitments and Contingencies”, to our unaudited Condensed Consolidated Financial Statements contained in Item 1 of this Form 10-Q. For those matters where we have reached agreed-upon settlements, we have estimated the amount of those settlements and accrued the amount of the settlement in our financial statements. Because of the uncertainties related to both the amount and range of loss on the remaining pending litigation, we are unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of the potential liability could materially impact our results of operations and financial position.

Results of Operations

      Revenue increased approximately $9.0 million, or 16%, to $63.3 million for the three months ended June 30, 2005 from $54.3 million for the three months ended June 30, 2004. The increase in revenue was due to increases of $6.8 million in the Media Services segment, $2.1 million in the Software segment, and $0.1 million in the Print segment. These increases by segment are explained in the segment information below.

      Cost of revenue increased approximately $1.0 million, or 8%, to $13.5 million for the three months ended June 30, 2005 from $12.5 million for the three months ended June 30, 2004. The increase was primarily due to increases in personnel related costs of $0.6 million and increases in hosting and imaging costs of $0.4 million.

      Gross margin percentage increased to 79% for the three months ended June 30, 2005 compared to 77% for the three months ended June 30, 2004. This improvement in gross margin percentage was primarily due to the increased revenues and the operating efficiencies derived from them.

      Sales and marketing. Sales and marketing expenses, including non-cash stock-based charges, remained constant, at $22.7 million for the three months ended June 30, 2005 and June 30, 2004.

      Product and website development. Product and website development expenses increased approximately $1.3 million, or 34%, to $5.1 million for the three months ended June 30, 2005 from $3.8 million for the three months ended June 30, 2004 primarily due to an increase in consulting and personnel related costs to improve our product offerings in our HomeBuilder.com^tm, RENTNET.com^tm, and Welcome Wagon® businesses.

      General and administrative. General and administrative expenses, including non-cash stock-based charges, increased approximately $4.6 million, or 30%, to $19.7 million for the three months ended June 30, 2005 from $15.1 million for the three months ended June 30, 2004. As a result of our obligation to advance defense costs to, and in certain cases indemnify, our former officers as discussed in Note 12, “Commitments and Contingencies”, to our unaudited Condensed Consolidated Financial Statements contained in Item 1 of this Form 10-Q, we recorded a $4.2 million accrual during the three months ended June 30, 2005. The remaining increase of $0.4 million was primarily due to increased personnel related costs of $1.5 million partially offset by decreases in other outside legal costs of $0.9 million.

      Amortization of intangible assets. Amortization of intangible assets decreased approximately $1.1 million to $1.0 million for the three months ended June 30, 2005 from $2.1 million for the three months ended June 30, 2004. The decrease in amortization was primarily due to certain intangible assets becoming fully amortized during 2004.

      Litigation settlement. As a result of our settlement of the Top Producer and Siegel litigation, as discussed in Note 11, “Settlements of Disputes and Litigation”, we recorded a litigation settlement charge of $2.2 million for the three months ended June 30, 2004. There were no litigation settlement charges for the three months ended June 30, 2005.

      Restructuring charges. During the three months ended June 30, 2005, there was a $1.4 million reduction in restructuring charges as a result of changes in estimates for previous restructuring plans. These changes resulted primarily from a decrease in the estimate for charges related to our San Francisco property and a change in the exchange rates decreasing our Canadian lease obligation as well as other revisions of estimated contractual liabilities. There were no changes to estimates or new restructuring plans approved during the three months ended June 30, 2004.

      We have taken four restructuring charges: in the fourth quarter of 2001, the first quarter of 2002, the third quarter of 2002, and the fourth quarter of 2003. All of these charges were a part of plans approved by our Board of Directors, with the objective of eliminating duplicate resources and redundancies. A summary of each is outlined below. We have also revised previous estimates from time to time.

      In the fourth quarter of 2001, we recorded a charge of $35.8 million, which was included in restructuring charges in the Consolidated Statement of Operations. As part of this restructuring and integration plan, we undertook a review of our existing locations and elected to close a number of satellite offices and identified and notified approximately 700 employees whose positions with us were eliminated. The work force reductions affected approximately 150 members of management, 100 in research and development, 200 in sales and marketing and 250 in administrative functions. This charge consisted of the following: (i) employee termination benefits of $6.4 million; (ii) facility closure charges of $20.8 million, comprised of $12.8 million in

future lease obligations, exit costs and cancellation penalties, net of estimated sublease income of $11.9 million, and $8.0 million of non-cash fixed asset disposals related to vacating duplicate facilities and decreased equipment requirements due to lower headcount; (iii) non-cash write-offs of $2.9 million in other assets related to exited activities; and (iv) accrued future payments of $5.7 million for existing contractual obligations with no future benefits to us.

      In the first quarter of 2004, we increased our estimate for lease obligations and related charges for our San Francisco property by $139,000. In the fourth quarter of 2004, we took an additional charge of $877,000 because we were uncertain we would be able to sublease the remaining one-third of the San Francisco property and to increase our liability for certain contractual obligations that are subject to exchange rate fluctuations. In the second quarter of 2005, we were able to negotiate more favorable terms for the remaining term of the lease of our San Francisco property and surrender a portion of the property to the landlord. As a result, we reduced our estimate for lease obligations and related charges by $1.3 million. We also revised our estimates of the contractual liabilities in connection with our former operations in Europe, reducing these obligations by $51,000. We also revised our estimate for employee termination benefits, reducing them by approximately $6,000. As of June 30, 2005, all of the planned 700 employees have been terminated and paid severance.

      In the first quarter of 2002, we recorded a charge of $2.3 million, which was included in restructuring charges in the Consolidated Statement of Operations. As part of this restructuring and integration plan, we undertook a review of our existing locations and elected to close offices and identified and notified approximately 270 employees whose positions with us were eliminated. The work force reductions affected approximately 30 members of management, 40 in research and development, 140 in sales and marketing and 60 in administrative functions. This charge consisted of employee termination benefits of $1.7 million and facility closure charges of approximately $600,000. In the first quarter of 2004, we increased our charge for lease obligations by $277,000 as a result of changes in exchange rates which increased our Canadian lease obligations. In the fourth quarter of 2004, we increased our charge for lease obligations by $94,000 for the same reason. In the second quarter of 2005, we decreased our charge for lease obligations by $27,000 for the same reason. As of June 30, 2005, all of the planned 270 employees have been terminated and paid severance.

      In the third quarter of 2002, we recorded a charge of $3.6 million, which was included in restructuring charges in the Consolidated Statement of Operations. As part of this restructuring and integration plan, we undertook a review of our existing locations and elected to close an office and identified and notified approximately 190 employees whose positions with us were eliminated. The work force reductions affected approximately 30 in research and development, 10 in production, 140 in sales and marketing and 10 in administrative functions. This charge consisted of employee termination benefits of $1.6 million and facility closure charges of approximately $2.0 million. In the fourth quarter of 2003, we decreased our estimates regarding employee termination benefits by $133,000 and our lease obligations and related charges by $417,000. As of June 30, 2005, all of the planned 190 employees have been terminated and paid severance.

      In the fourth quarter of 2003, we recorded a charge of $3.5 million, which was included in restructuring charges in the Consolidated Statement of Operations. As part of this restructuring and integration plan, we undertook a review of our existing operations and elected to change our management structure and identified and notified approximately 95 employees whose positions with us were eliminated. The work force reductions affected approximately seven in research and development, 17 in production, 37 in sales and marketing and 34 in administrative functions. This charge consists of employee termination benefits of approximately $1.4 million and stock-based charges related to the acceleration of vesting of certain options for terminated management personnel of approximately $2.1 million. In the first quarter of 2004, we reduced our estimate for employee termination benefits by $71,000. In the second quarter of 2005, we reduced our estimate for employee termination benefits by an additional $15,000. As of June 30, 2005, all of the planned 95 employees have been terminated and paid severance.

      A summary of activity in 2004 and 2005 related to the four restructuring charges and the changes in our estimates is as follows (in thousands):

      Substantially all of the remaining restructuring liabilities at June 30, 2005 will be paid over the next six quarters. Any further changes to the accruals based upon current estimates will be reflected through the restructuring charges line in the Consolidated Statement of Operations.

      Stock-based charges. The following chart summarizes the stock-based charges that have been included in the following captions for each of the periods presented (in thousands):

      Stock-based charges remained constant for the three months ended June 30, 2005 compared to the three months ended June 30, 2004.

      Interest income (expense), net, increased $471,000 to a net interest income of $496,000 for the three months ended June 30, 2005 compared to $25,000 for the three months ended June 30, 2004, primarily due to increases in short-term investment balances and higher interest yields on those balances and the expiration of the AOL distribution obligation and corresponding reduction in imputed interest.

      Other income (expense), net, was $69,000 for the three months ended June 30, 2005, compared to other income, net, of $16,000 for the three months ended June 30, 2004 primarily due to gains realized on the sale of assets.

      On October 6, 2004, we sold our Wyldfyre business and on December 21, 2004, we sold our Computer for Tracts business. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” the Condensed Consolidated Financial Statements reflect these businesses as discontinued operations for all periods presented.

      Even though we have achieved net income in the quarter ended June 30, 2005, we have not recorded a tax provision on that income because of recurring operating losses and our inability to recognize any past benefit from our deferred tax assets. Because of our investment program and to meet our advancement and possible indemnification obligations to former and current officers, directors and employees, it is possible we will not have net income for the full year of 2005. If we do, we will not have any material tax liability because of our previously unrecognized deferred tax assets. As of December 31, 2004, we had $975.9 million of net operating loss carryforwards for federal income tax purposes, which expire beginning in 2008. We have provided a full valuation allowance on our deferred tax assets, consisting primarily of net operating loss carryforwards, due to the likelihood that we may not generate sufficient taxable income during the carryforward period to utilize the net operating loss carryforwards.

      Segment information is presented in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” This standard is based on a management approach, which requires segmentation based upon our internal organization and disclosure of revenue and operating expenses based upon internal accounting methods. We evaluate performance and allocate resources based on three segments, consisting of Media Services, Software, and Print. This is consistent with the data that is made available to our management to assess performance and make decisions.

      The expenses presented below for each of the business segments include an allocation of certain corporate expenses that are identifiable and benefit those segments and are allocated for internal management reporting purposes. The unallocated expenses are those corporate overhead expenses that are not directly attributable to a segment and include: corporate expenses, such as finance, legal, internal business systems, and human resources; amortization of intangible assets; litigation settlement charges; stock-based charges; and restructuring charges. There is no inter-segment revenue. Assets and liabilities are not fully allocated to segments for internal reporting purposes.

      Summarized information by segment, as excerpted from internal management reports, is as follows (excluding discontinued operations (See Note 5, “Discontinued Operations”, to our unaudited Condensed Consolidated Financial Statements contained in Item 1 of this Form 10-Q)) (in thousands):