Shares of the Internet company, which just settled a proxy battle with activist investor Carl Icahn, rose 2.7% to $21.99 in extended trade following the quarterly report.

“Investors braced for the worst,” said Jeffrey Lindsay, analyst at Sanford Bernstein. “… these results are poor, but relative to what people were expecting, they’re not so bad.”

Chief Financial Officer Blake Jorgensen said Yahoo was not changing its financial view for 2008, even though a difficult economic environment is weighing on online advertising.

“We are pretty pleased (with results), relative to both the distractions and the economy,” he said in an interview.

Yahoo executives made no secret that the quarter included unusual headaches, particularly the back-and-forth with Microsoft. Chief Executive Jerry Yang referred to the battle as “extraordinary,” but said he was committed to staying as CEO. President Sue Decker called the takeover fight a “swirl.”

Despite the distractions of Icahn and Microsoft, Yang said his company intended to keep looking at possible transactions. Since January, Yahoo has faced an unsolicited takeover bid from Microsoft, but talks between the two tech giants have cooled.

“We have looked at just about every alternative you could imagine as far as looking at how do we best position the company to go forward either through transactions and/or financial options,” Yang said on a conference call.

Second-quarter net income fell to $131 million, or 9 cents per diluted share, from $161 million, or 11 cents per share, a year earlier. Wall Street was looking for 10 cents a share, according to Reuters Estimates.

Net revenue excluding payments to affiliated Web sites that carry Yahoo ad services rose 8% to $1.35 billion. Analysts, on average, had expected $1.37 billion.

One negative factor was this year’s unwinding of Yahoo’s highly lucrative joint venture with AT&T to sell broadband Internet access, said Canaccord Adams analyst Colin Gillis.

The deal had added about $40 million in gross profit to the second quarter of 2007, he said, calling it “margin honey” for Yahoo’s bottom line. “It’s regrettable that AT&T revenue loss masks the gains in search and display advertising,” he added.

The headline in the latest issue of Advertising Age warned marketers this week: “Advertisers Ready for Age of Austerity.”

Yahoo said that as advertisers respond to economic woes, a shift is occurring away from brand marketing campaigns on big online portals – banner ads in the simplest sense – to performance-based ads running on sites across the Web.

Executives blamed weak spending on corporate marketing in its online display business by advertisers in consumer packaged goods, autos and parts of the financial services sector, only partly offset by strength in entertainment and technology ads.

Yahoo said it was seeing rapid growth in the newer pay-for-performance side of its display ad business and sees it growing to equal its current brand-marketing business, where it is the leader in a fragmented market. And even on that side of its business, Yahoo said it gained market share amid a slump.

Yahoo forecast revenue of $1.78 billion to $1.98 billion in the third quarter and $7.35 billion to $7.85 billion for 2008.

“It looks like they tightened the range,” Gillis said. “They didn’t make any radical change, but it’s going to be a stretch for them to exceed the numbers.”

The results come a day after Yahoo agreed to appoint Icahn and two of his nominees to its board, eliminating the need for a proxy battle at its August 1 annual meeting, and reducing the chances of immediately revisiting a Microsoft deal.

Analysts said the settlement may buy some time for Yang and his management team to turn around Yahoo, which has struggled for years to keep up with Google Inc. But the reprieve could be limited if investors don’t see a change in fortunes.

Yang said in an interview after the report he was committed to remaining CEO following a tumultuous first year on the job. “If you ask me, I am absolutely committed,” Yang told Reuters.

Yang said he looks forward to Icahn joining him on the board of directors as part of the settlement deal. Icahn had sought to replace the entire Yahoo board and oust Yang.

“Carl is a very smart guy. He is clearly one of the best negotiators out there,” Yang said, adding: “We think it is a good settlement. We avoided a pretty public fight.” (Reuters)