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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   Form 10-K   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended August 31, 2004 Commission File Number: 0-17932 Interland, Inc. ( Exact name of registrant as specified in its charter )
 Minnesota
(State or other jurisdiction
of incorporation or organization)
    
    41-1404301
(I.R.S. Employer
Identification No.)
 303 Peachtree Center Avenue, Suite 500, Atlanta, GA 30303(Address, including Zip Code, of principal executive offices) (404) 720-8301(Registrants telephone number, including area code) Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share
Registered on The Nasdaq National Market Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes þ No o Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes þ No o The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 29, 2004 was approximately $84 million. The number of outstanding shares of the registrants Common Stock on September
30, 2004 was 16,091,602. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the registrants 2004 Annual Meeting of
Shareholders are incorporated by reference into Part III of this Annual Report
on Form 10-K.




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TABLE OF CONTENTS PART IItem 1.
    
    BusinessItem 2.
    
    PropertiesItem 3.
    
    Legal ProceedingsItem 4.
    
    Submission Of Matters To A Vote Of Security HoldersItem 4A.
    
    Executive Officers and Directors of the RegistrantPART IIItem 5.
    
    Market For Registrant's Common Equity And Related Shareholder MattersItem 6.
    
    Selected Financial Data (In thousands)Item 7.
    
    Management's
Discussion And Analysis Of Financial Condition and Results Of
OperationsItem 8.
    
    Financial Statements
And supplementary DataItem 9.
    
    Changes In And
Disagreements With Accountants On Accounting And Financial
DisclosureItem 9A.
    
    Controls And
ProceduresItem 9B.
    
    Other InformationPART IIIItem 10.
    
    Directors And
Executive Officers Of The RegistrantItem 11.
    
    Executive
CompensationItem 12.
    
    Security Ownership
Of Certain Beneficial Owners And ManagementItem 13.
    
    Certain
Relationships And Related TransactionsItem 14.
    
    Principal Accounting Fees And
ServicesPART IVITEM 15.
    
    Exhibits and
Financial Statement SchedulesSignaturesEX-10.36(B)1995 EMPLOYEE STOCK PURCHASE PLANEX-10.122 FORM OF STOCK OPTION AGREEMENTEX-21.01 SUBSIDIARIES OF THE REGISTRANTEX-23.01 CONSENT OF INDEPENDENT REGISTEREDEX-24.01 POWER OF ATTORNEYEX-31.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICE PURSUANT TO SECTION 302EX-31.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302EX-32.1 CERTIFICATION OF CHIEF EXECUTIVE OFFICER UNDER SECTION 906EX-32.2 CERTIFICATION OF CHIEF FINANCIAL OFFICER UNDER SECTION 906




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PART I 
 Item 1. Business Statements contained in this Form 10-K that are not purely historical are
forward-looking statements and are being provided in reliance upon the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995.
Words such as anticipates, expects, intends, plans, believes,
seeks, estimates, and similar expressions identify forward looking
statements. These forward-looking statements include but are not limited to
statements regarding Interlands expectations of the Companys future liquidity
needs, its expectations regarding its future operating results including its
planned increase in its revenue levels and the actions the Company expects to
take in order to maintain its existing customers and expand its operations and
customer base. All forward-looking statements are made as of the date hereof
and are based on current management expectations and information available to
the Company as of such date. The Company assumes no obligation to update any
forward-looking statement. It is important to note that actual results could
differ materially from historical results or those contemplated in the
forward-looking statements. Forward-looking statements involve a number of
risks and uncertainties, and include risks associated with our target markets
and risks pertaining to competition, other trend information and the Companys
ability to successfully enhance its operations. Factors that could cause
actual results to differ materially include, but are not limited to, those
identified in Item 7. Managements Discussion and Analysis of Financial
Condition and Results of OperationsRisk Factors and in other Company filings
with the Securities and Exchange Commission. All references to Interland or
the Company in this Annual Report on Form 10-K mean Interland, Inc., a
Minnesota corporation, and all entities owned or controlled by Interland, Inc.,
except where it is made clear that the term only means the parent company. All
annual references are on a fiscal August 31st year-end basis, unless otherwise
indicated. All tabular amounts are stated in thousands. General Interland, Inc. (Company), is a leading provider of online solutions for
small- and medium-sized enterprises (SMEs) which enable them to design,
sustain, and modify a website to facilitate the acquisition, maintenance and
servicing of their customers. These products and services include: online
marketing services, electronic commerce services, website creation and
management, shared and dedicated hosting services, and application hosting
management. Interland acquires customers directlyprimarily through
advertising in print and electronic mediaand through distribution partners. The current Web hosting business was formed through the merger of the Companys
HostPro division and Interland, Inc., a Georgia Corporation
(Interland-Georgia), followed by eight company or account acquisitions from
October 2001 through June 2003. On August 6, 2001, the Company acquired Interland-Georgia, an Atlanta,
Georgia-based provider of a broad range of Web hosting, applications hosting
and other related Web-based business solutions specifically designed to meet
the needs of small-and-medium-sized businesses. In connection with the
acquisition of Interland-Georgia, Micron Electronics, Inc., (MEI), changed
its name to Interland, Inc. and its trading symbol to INLD. In October 2001, January 2002, and May 2002 the Company acquired the small
business-focused shared and dedicated Web hosting customer accounts of
Interliant, Inc., (Interliant), AT&T Corp., (AT&T), and Burlee Networks
LLC, (Burlee), respectively. On February 8, 2002, the Company acquired CommuniTech.Net, Inc.,
(CommuniTech.Net) a Kansas City, Missouri based Web hosting company. On May 3, 2002, the Company acquired Dialtone, Inc., (Dialtone), a Fort
Lauderdale, Florida based leading dedicated Web hosting company. On August 1, 2002, the Company acquired iNNERHOST, Inc., (iNNERHOST), a
Miami, Florida based Web hosting company serving small- and-medium-sized
businesses. On January 3, 2003, the Company acquired Trellix Corporation (Trellix), a
privately held developer of software-based website solutions. Founded in 1995,
Trellix is a provider of private-label website publishing solutions, integrated
business services, and low-cost hosting technology. Trellix offers a suite of
site building tools and services that enable Interland and its users to create
professional websites highly efficiently. On June 13, 2003, the Company acquired Hostcentric, Inc., (Hostcentric) a
privately held provider of a broad range of Web hosting services to small
business and enterprise customers.




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The Company has no current plans to make additional acquisitions for the
purposes of adding customers. The Companys revenue is primarily derived from recurring monthly charges to
its customers supplemented by, among other things, setup fees, domain name
acquisition and renewal fees, excess data communications charges, and
consulting services. The Company plans to grow by offering combined website
design, website hosting, and servicing and marketing-related products and
consultation to small-and-medium-sized business owners. The targeted market is
sometimes referred to as the mass market or mainstream market strategy to
distinguish it from the market for traditional technical hosting. The
Companys strategy is based on the assumption that its targeted market is in
greater need of expertise and value-added solutions and is therefore more
likely to pay for higher margin services and less likely to switch providers. The Companys operations are reported on a fiscal basis with its fiscal year
ending on August 31. All references contained herein including annual and
quarterly periods are on a fiscal basis. The Companys common stock is listed
on the Nasdaq National Market under the trading symbol INLD. The Companys
principal executive offices are located at 303 Peachtree Center Avenue, Suite
500, Atlanta, Georgia 30303. The Companys telephone number is (404) 720-8301
and its website is located at www.interland.com. Information contained in the
Companys website is not part of this annual report. The company makes available free of charge on its website its annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all
amendments to those reports as soon as reasonably practicable after filing with
the SEC. Corporate Strategy Interland is a leader in making the power of the Internet available to SMEs.
In addition to providing traditional web-hosting and electronic commerce
services to those who desire mere presence on the World Wide Web, Interland
offers products and services designed to permit an SME to utilize a website as
an alternative communication channel with its clients and potential clients.
The Companys offerings make it possible and efficient for SMEs to find leads,
make sales, and to service their clients online. Interland offers to provide website marketing, design and management, as well
as management of hosted application services through both its shared and
dedicated lines of business. (The shared line of business provides services to
customers whose needs are compatible with being hosted on a server that hosts
hundreds of other similar customers; the dedicated line of business serves
customers who require a server or servers exclusively devoted to their needs.)
Interland periodically assesses the value of both existing and contemplated
service offerings to customers through extensive marketing research directed to
its existing customers, with special focus on customers who appear to be
successful in using online resources. Interlands products are sold directly and through distribution partners, for
both shared and dedicated hosting business lines. Interland assembles, bundles
and tailors its products to meet the requirements of the distribution partners
targeted markets, taking into account the respective mechanisms of distribution
and branding. Interland provides applications on Linux and Microsoft Windows
platforms, which may be used while the customer is an Interland hosting
customer. Among these services are website marketing services, website creation
and management services, electronic commerce services, email services, and
hosting services. In the dedicated line of business Interland provides
applications on dedicated servers, as well as network and hardware reliability
and security products, marketing services, and bundles supporting outsourcing
of specific web-based applications. The lack of technical sophistication of
many SMEs, coupled with the relatively high cost of maintaining dedicated
servers in-house makes Interlands dedicated offerings attractive to this
market. Larger enterprises use Interlands dedicated services to develop and
host specific activities, often those that are specialized or developmental in
nature. A smaller portion of Interlands dedicated business serves larger
enterprises that require managed services provided through multiple servers. Interland has acquired and developed proprietary software for the efficient
integration, packaging and support of new technologies and services into its
basic hosting products. The software or technology may be developed by the
Company, acquired, or licensed from third parties. The Companys web design
products are largely derived from, or influenced by software and related
technology obtained through the acquisition of Trellix Corporation in early
2003. These tools can be configured to enable only modestly-trained SME
business personnel to design a website with great functionality in a fraction
of the time and at a fraction of the cost charged by website development firms.
The tools can also be configured to provide additional functionality designed
to be used by professional web designers who can thereby gain high
productivity, enabling the Company to provide professional-quality websites at
modest cost. The Companys growing experience in designing websites for a
large number of types of businesses further contributes to efficiency. Using
the website development tools as a base, the Company is continuing to develop a
broad range of products and services, collectively known as Business
Solutions, designed to help mainstream businesses attract and serve customers
through websites supplied by Interland designers using its proprietary design
software. During 2003, the Company tested and




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marketed products based on the use of these software tools. Based on initial
results, the Company, in several stages, increased the number of direct
salespeople, web designers and support personnel dedicated to this effort in
order to further test the ability of the distribution and provisioning models
to perform profitably at increasingly larger scales. At the end of February 2004, however, management concluded that despite the
fact that many of the assumptions underlying the business plan were being
proven, certain aspects of the business were not performing to the standard
required to justify continued high levels of investment. Accordingly, in early
March 2004 the Company announced that it would substantially reduce its
investment level and concentrate the website and software development teams in
Atlanta for greater interaction with the rest of the Company. At the same
time, the Company recognized that the costs of acquiring customers through a
directly-employed sales force would substantially retard market penetration and
accordingly shifted its customer acquisition efforts to an indirect sales
model. Interlands distribution partners enable it to acquire new customers at a lower
cost relative to revenue than would be possible through direct marketing and
sales. Interlands distribution partners now include telecommunications
companies, Yellow Pages publishers, credit card companies, as well as local
resellers, which also often provide other technology services to their clients.
Interland intends to expand and grow its relationships with these partners. Products And Services Interland offers a number of products across its channels of distribution in
both its shared and dedicated lines of business. The company defines products
as: applications (discrete software code provided to the customer); services
(software and hardware bundled together and used by the customer on a shared
basis), and managed services (Company personnel operate and support a
particular application or service on behalf of the customer). Other than for
the former customers of Hostcentric, all of Interlands products are
provisioned and billed by a central operational support system (OSS) enabling
centralized plan management. Interland offers dedicated servers on either Windows or Linux operating systems
together with the relevant applications to support secure and reliable
application hosting. The Company also employs shared servers running either
Linux or Windows operating systems as the technology platform to offer an
integrated suite of website design, online marketing, and ecommerce
applications. Both product lines are designed to address the needs of
small- and
medium-sized businesses. Most of the Companys revenues are generated from recurring monthly fees. The
remainder is derived from one-time setup fees for website creation, product
installation, domain names and other related one-time fees. The Company
generally sells its services under month-to-month agreements, but also offers
longer-term contracts. Customers most often pay for the services monthly by
credit card or by automatic draft of checking accounts. Shared hosting service Shared hosting services are delivered either in a network-attached storage or
in a server-based storage configuration. The former is marketed as blueHalo,
and provides a shared external IP address and name-based domains internally.
Product packages range from entry-level starter packages to business e-commerce
shared Web hosting products. Interlands shared hosting packages lower the
capital asset component of the Companys costs by placing numerous customers on
a single shared server, and provide a lower price to the customer. Starter
packages are designed for websites with relatively low volumes of traffic and
provide a Web presence at minimal cost. The Companys products are designed so
that a customer who purchases an entry-level plan can easily upgrade to more
full-featured services. Interlands services feature easy-to-use control
panels and extensive on-line documentation that allow customers to easily
control their own applications. The majority of the Companys customers use
its shared hosting services. Website promotion services Many SMEs require assistance in promoting their website and Interland
offers a broad range of online marketing and promotions services,
including managed pay per click advertising, search engine optimization,
Google Adwords credits, and Internet marketing submission services, which
are designed to draw potential customers to the SMEs website. Website design and content management services Following its acquisition of Trellix, Interland introduced website
development services, both in the form of a suite of software tools
configured for use by end users, and in the form of consultation and
design development services. The Company believes that the primary
barriers to adoption of online solutions by SMEs have been a lack of
technical expertise and the perceived high cost and often unsatisfactory
experience associated with engaging a traditional professional website
development firm. The Company believes that its Business Solutions
services provide a superior alternative at a cost that SMEs will regard as
affordable and efficient.




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E-commerce and other applications hosting services Interlands applications hosting services allow customers to outsource the
deployment, configuration, hosting, management and support of various
software applications. The Companys applications hosting services allow
customers to deploy a software application more quickly and with reduced
initial costs. In addition, many small- and medium-sized businesses do
not have the internal technical resources to support multiple software
applications. The Company therefore believes that outsourcing these
functions is a desirable alternative for these businesses. The types of
applications the Company can successfully host for customers include
collaboration tools, business tools, mail-service tools and e-commerce
applications. The Company itself hosts applications that consist of
website building tools, online storefront, e-commerce solutions, and a
suite of managed services all of which are designed to help businesses
succeed online. Email The Company provides email services to all of its shared hosting
customers. Dedicated hosting service In contrast to a shared hosting environment, which hosts multiple customers on
a single server, dedicated hosting employs one or more servers dedicated to a
single customer. Dedicated hosting provides a customer with increased
performance, server access, the ability to use custom applications, greater
security and higher levels of technical support, and higher volumes of data
communications service. Interland provides both managed and unmanaged
dedicated services. For managed dedicated hosting services, the Company
monitors, administers and troubleshoots the software that operates the client
server. For unmanaged dedicated hosting services, the customer administers the
server remotely, with the Company providing the hardware monitoring and network
and hardware support. Dedicated hosting services are targeted for websites
that generally require sophisticated databases for critical application needs
or typically experience high user traffic volumes. The Companys managed
services are targeted to those who need the complex services required for
mission-critical websites, but do not want to administer their own server. The
dedicated services include access to a proprietary control panel, which enables
customers to setup and maintain websites on the server. Interland offers dedicated Web hosting services for major computer platforms,
including Microsoft NT, Windows and Linux. Other products and services Interland also makes available other complementary products and services
including domain name registration and technical consulting. The Company
believes these value-added products and services enable it to provide its
customers the necessary tools to create, host and maintain a successful Web
presence. The Company believes that the outsourcing of these functions is a
desirable and increasingly preferred alternative for SMEs. Partner specific products Interland has a number of product configurations that are only sold through
distribution partners and are not marketed under the Interland brand directly.
(See, Key Strategic Relationships below.) Sales and Marketing Interlands sales and marketing strategy focuses on providing demonstrable
benefits to small- and medium-sized businesses. The Company has identified
target market segments and seeks to match that segments particular needs with
a specific subset of the Companys offered products, pricing, and selling
initiatives. The company sells products both directly and through a number of
distribution partners. Prospects are generated from the current client base and
from online and print advertising. Key Strategic Relationships Interland has established, and intends to continue to develop, relationships
with leading technology providers, including major software, hardware,
development and Internet marketing organizations, to enhance the design and
sales of its products and services. These relationships enable the Company to
quickly gain access to innovative technologies, to provide more creative
solutions for its customers, and to allow it to offer customers resources that
would otherwise be prohibitively expensive. The Company is also able to build
upon the research, development and expertise of these companies in developing
and launching new products. The Company believes that these relationships will
enable it to continue to provide its customers with the necessary tools to
create, host and maintain a successful Web presence and to have access to
sophisticated e-commerce and applications solutions. Included among these
relationships are: Enterprise Distribution Partners (EDP)




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Enterprise Distribution Partners sell Interlands products under the
partners brand name. These partners offer a customized mix of the Companys
software, infrastructure, and support. Financial terms for these customers
are typically negotiated based upon the bundles developed and generally
provide Interland some guaranteed minimum performance. Dex Media is a
recently named example of an EDP partner. Enterprise Resellers Enterprise Resellers sell Interlands products jointly under the partners
brand name and Interlands brand name. These partners also offer a customized
mix of the Companys sales, software, infrastructure, and support, and
financial terms are usually based on a fee paid by Interland per customer, or
on a percentage of the revenues generated. Advanta, a credit-card company, is
an example of an Enterprise Reseller. Value-Added Partners Value-Added Partners (VAPs) may sell Interlands products under the
partners or Interlands brand name. They differ from Enterprise Resellers in
that they most often offer services or products of their own (such as website
design, or providing and installing personal computers) and tend to be
smaller and more locally focused. The Company has thousands of such
relationships today. Technology Marketing Partners Technology Marketing Partners provide joint for marketing, which helps
Interland sell the partners software or hardware. These partners also serve
as credible references, and provide the Company with valuable insights into
the direction of the technology being developed by these partners. Microsoft
Corporation and IBM are among the Companys Technology Marketing Partners. Customers As of August 31, 2004, the Company had approximately 177,000 paid shared
hosting customer accounts and it managed nearly 9,000 dedicated servers
compared to 200,000 paid shared hosting customer accounts and nearly 8,500 dedicated
servers as of August 31, 2003. Additionally, the Company hosts thousands of
more basic websites under plans formerly marketed by Trellix through Internet
portals and other companies, such as CNET. Network Infrastructure, Technology and Operations To provide a secure and reliable hosting environment, Interland has constructed
a managed infrastructure, consisting of data centers, a redundant Internet
communications backbone, enterprise management software, and an advanced
network. Data centers The Company has a total of almost 34,000 square feet of data center floor
space. These data centers, located in Atlanta, Georgia (13,140 sq.ft.); Miami,
Florida (13,189 sq.ft.) and Fremont, California (7,636 sq.ft.), include:  
    
    network operations centers that are managed and monitored 24 hours per day, every day of the year;
    
    monitoring of all critical systems;
    
    redundant network hardware;
    
    parallel-redundant backup power generators;
    
    fire suppression systems;
    
    cooling systems that include independent full-grade mechanical systems;
    
    security, including security guards and video monitoring and entry restriction via access devices; and
    
    multiple tier-1 backbones providing Internet connectivity. Proprietary Technology Interlands various proprietary technologies are designed to allow customers to
order, change and manage their Web hosting accounts easily regardless of their
level of technical expertise. Proprietary technologies also enable the Company
to automate a number of back-end functions and processes. For example, the
Companys provisioning system automatically activates customer-initiated
website changes within minutes of entry. The Companys administration page
technology lets customers modify their websites from the Internet without
having to contact the Companys support staff. This technology provides the
Company with the opportunity to achieve greater operational efficiencies and
allows the customer to change passwords, protect specific directories, and to
create database sources without the assistance of the Companys technical
support staff. Although the Company believes that its suite of technology
offers its customers significant benefits, the Company does not believe that
any sustainable material competitive advantage is derived from intellectual
property associated with its operation of its data centers.




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Network operations centers Interland continuously monitors its network operations with technical experts
in Windows and Linux operating platforms. The network operations center
personnel monitor each piece of equipment, including routers, switches and
servers, as well as all Internet and communication connections. The network
operations centers are designed to allow engineers, administrators, and support
staff to continually monitor all systems and to be promptly alerted to any
abnormalities. The Company has procedures designed to rapidly resolve technical
problems that arise. International Revenues Interlands international revenues from continuing operations totaled $11.6
million, $10.4 million and $10.6 million in 2004, 2003 and 2002, respectively.
International revenues are denominated and paid in U.S. dollars and represent
revenues from international customers generated and supported in the U.S. The
Company has no network operations outside of the United States. Competition Interland believes that the primary competitive factors in the technical
segment of its business are reliability, technical support and price. Although
the market is intensely competitive, the Company believes that it compares
favorably with its competition on these factors. In the SME mainstream market,
the Company believes that the critical success factor is the ability to enable
businesses owners to use their website to attract potential clients, to make
sales, and service their clients. The pricing in the technical segment is subject to heavy competitive pressure
and competitors have even offered such services at a dramatically reduced
price, or even for free, as a means of acquiring market share or of fostering
market awareness. The Company believes that promotional pricing by competitors
will continue for only a limited time, and that the costs of providing reliable
service and effective technical and customer support will ultimately be
reflected in market prices. Nonetheless, relatively low prices are likely to
continue to be available for very basic service, and customers who only require
a minimal web presence can be expected to often be lost to competitors whose
cost structures and prices are based on providing rudimentary service. The SME hosting market is highly fragmented with a large number of competitors,
most of which have market share of less than 1%. A number of these companies
offer Web hosting in addition to their core products and services. Current and
potential competitors in the market include Web hosting service providers,
applications hosting providers, Internet service providers, telecommunications
companies, large information technology firms that provide a wide array of
information technology services, computer hardware suppliers and
Internet-centric companies. Some of the Companys most prominent competitors
include Yahoo!, Earthlink, NTT/Verio and Affinity Internet, Inc. The Company does not consider itself to be in direct competition with companies
such as IBM, Digex, Globix or Navisite since these companies generally provide
high-end services that are highly customized, require the user to have
technical expertise, and typically charge several thousand dollars per month.
Interlands solutions are standardized, do not require the user to have
technical expertise, and generally sell for less than $100 per month.
Interland believes that it can sell standardized solutions to a larger customer
base on a more efficient and profitable basis than can providers of high-end,
customized solutions. Intellectual Property Interland relies on a combination of laws (including patent, copyright,
trademark, service mark and trade secret laws) and contractual restrictions to
establish and protect proprietary rights in its services. As of August 31,
2004, the Company owned eleven issued U.S. patents and had several additional
patent applications pending but not yet issued. Interland has entered into
confidentiality and other agreements with its employees and contractors,
including agreements in which the employees and contractors assign their rights
in inventions to. Interland has also entered into nondisclosure agreements with
its suppliers, distributors and some customers in order to limit access to and
disclosure of its proprietary information. Nonetheless, neither the
intellectual property laws nor contractual arrangements, nor any of the other
steps the Company has taken to protect its intellectual property can ensure
that others will not use its technology, or that others will not develop
similar technologies. Interland licenses, or leases from others, many technologies used in its
Internet application services. The Company expects that it and its customers
increasingly will be subject to third-party infringement claims as the number
of websites and third-party service providers for Web-based businesses grows.
Although the Company does not believe that its technologies or services
infringe the proprietary rights of any third parties, the Company cannot ensure
that third parties will not assert claims against it in the future or that
these claims will not be successful. Although it has discontinued operations
as a manufacturer of personal computers in the electronics industry, the
Company is nonetheless subject to litigation arising from its past activities.
It is not uncommon in the electronics industry for patent, trademark and other
intellectual property rights claims to be asserted against companies, including
component suppliers and personal computer




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manufacturers. Periodically, the Company is made aware that technology it has
used in these discontinued operations may have infringed on intellectual
property rights held by others. The Company has evaluated all such claims and,
if necessary and appropriate, sought to obtain licenses for the use of such
technology. If the Company or its suppliers were unable to obtain licenses
necessary to use intellectual property in its discontinued operations products
or processes, it may be legally liable to the owner of such intellectual
property. Moreover, even in those instances where the Company is justified in
denying claims that it has infringed on the intellectual property rights of
others, it may nonetheless be forced to defend legal actions taken against the
Company relating to allegedly protected technology, and such legal actions may
require the Company to expend substantial funds. See Item 7. Managements
Discussion and Analysis of Financial Condition and Results of Operations  Risk
Factors  Impairment of Interlands intellectual property rights could
negatively affect its business or could allow competitors to minimize any
advantage that Interlands proprietary technology may give it. Government Regulation Interland is not currently subject to direct federal, state or local government
regulation, other than regulations that apply to publicly registered businesses
generally. This could change in the future  see Item 7. Managements
Discussion and Analysis of Financial Condition and Results of Operations  Risk
Factors  Interlands business operates in an uncertain legal environment where
future government regulation and lawsuits could restrict Interlands business
or cause unexpected losses. Employees The Company employed approximately 615 individuals, including 60 contractors as
of August 31, 2004 compared to approximately 761 individuals, including 88
contractors as of August 31, 2003. All of the Companys employees are located
in the United States and none is represented by a labor organization with
respect to employment by the Company. As of August 31, 2004, the Company has
never had an organized work stoppage, and it considers its employee relations
to be satisfactory. Environmental Regulations Some risks of costs and liabilities related to environmental matters have been
inherent in the Companys discontinued operations, as with many similar
businesses, and its operations are subject to certain federal, state and local
environmental regulatory requirements relating to environmental and waste
management. In connection with the Companys discontinued operations, it
periodically generated and handled limited amounts of materials that were
considered hazardous waste under applicable law. The Company contracted for
the off-site disposal of these materials. The Company believes it has operated
in compliance with applicable environmental regulations. The Company employs
diesel fuel to power some of its backup generators. This fuel is stored in
tanks, which must be monitored to avoid spills and leaks, which could lead to
violation of environmental regulations. The Company believes it employs
appropriate safeguards to comply with applicable regulations. 
 Item 2. Properties Interland leases several facilities which includes 143,215 square feet (of
which 34,250 sq.ft. are subleased) in Atlanta, Georgia; 25,628 square feet (all
of which are subleased) in Boise, Idaho; 43,851 square feet (of which 20,457
sq.ft. are subleased) in Bellevue, Washington; 45,000 square feet (of which
26,763 sq.ft. are subleased) in Tukwila, Washington; 64,174 square feet in
Miami, Florida; 17,230 square feet (of which 2,180 sq.ft. are subleased) in
Concord, Massachusetts; 12,500 square feet in Orlando, Florida and 15,229
square feet in Fremont, California. 
 Item 3. Legal Proceedings In February of 2003, the Company filed a lawsuit in Cobb County, Georgia
against Mr. Gabriel Murphy, one of the former principals of Interlands
subsidiary, CommuniTech.Net, Inc. (Communitech), which was acquired by
Interland in February 2002. The Companys lawsuit claims, among other things,
that Mr. Murphy breached certain covenants under his employment agreement and
also demands payment from Mr. Murphys two promissory notes (one of which was
non-recourse while the other was recourse). In March 2004, Interland
retired the 273,526 shares of stock held as collateral and wrote off the
$2,000,000 non-recourse promissory note, which had been carried as
Stockholders Equity. The other $735,000 full recourse promissory note remains
outstanding and continues to be a subject of the Cobb County litigation noted
above. Mr. Murphy has asserted various counterclaims in response.




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In February 2003 Mr. Heitman, also a former principal of Interlands subsidiary
Communitech, and Mr.Murphy filed a lawsuit against Interland, its CEO, Mr. Joel
Kocher, and Communitech, in Jackson County, Missouri claiming, among other
things, that Interland acted unreasonably in failing to have the Form S-3
registration statement declared effective by the SEC on a timely basis and
claiming that Interland and/or Mr. Kocher made inaccurate disclosures in
connection with Interlands acquisition of Communitech. The complaint sought
compensatory and punitive damages in an unspecified amount. Interland believes
that these claims are without merit and will not have a material adverse effect
on Interland and intends to vigorously defend the claims. In an order dated
August 26, 2004, the Missouri court dismissed two of the thirteen counts in
Heitman and Murphys complaint and ordered them to re-plead the remaining
eleven counts. In February 2004, the Company initiated a lawsuit in the United States District
Court for the Northern District of Georgia against the representatives of the
former shareholders of Hostcentric (the Hostcentric Shareholders), seeking a
declaratory judgment that it will be entitled to reimbursement from the escrow
fund established as part of the Hostcentric acquisition for any amounts over
$180,000 that it may be required to pay to the landlord for a leased facility
in Farmingdale, New York, in accordance with the acquisition agreement between
the Company and Hostcentric and its shareholders. The representatives of the
Hostcentric Shareholders have denied Interlands claims and have attempted to
assert various counterclaims. Correspondence between the parties has also
discussed the possibility of other claims, but these claims have not yet been
asserted in litigation. Interland believes its claims in this case are
meritorious, that the counterclaims of the former Hostcentric shareholders are
without merit, plans to continue to contest the matter vigorously and believes
that no material adverse effect on Interland will occur as a result of this
litigation. In February 2004, the Company, through its Hostcentric subsidiary, has also
initiated a lawsuit in United States District Court for Southern District of
New York against the landlord for the same Farmingdale, New York facility,
seeking a declaratory judgment that the lease for that facility has been
terminated and that the landlord has accepted that termination, thereby
eliminating any further obligation on the part of the tenant to make lease
payments. The landlord has denied the claims in the complaint and has asserted
counterclaims for approximately $200,000 that it claims is past due under the
lease. The landlord may, in the future, assert claims against Interland for
the balance of payments due under the lease, which claims, the landlord has
asserted, could amount to approximately $2 million, in the aggregate.
Interland plans to continue to contest the matter vigorously and believes that
no material adverse effect on Interland will occur as a result of this
litigation. On March 14, 2003, Halo Management, LLC, filed a suit against Interland in the
U.S. District Court for the Northern District of California alleging that
Interlands use of blueHALO(tm) to describe its proprietary Web hosting
architecture infringes on the plaintiffs registered trademark HALO (U.S.
Patent and Trademark Office Serial No. 75/870,390; Registration No.
2,586,017). On August 10, 2004, the court granted Interlands motion for
summary judgment. Shortly thereafter, Interland filed a motion asking the
court to order the plaintiff to pay Interlands attorneys fees in defending
the action. Subsequently, the parties entered into a settlement agreement
providing for the resolution of all outstanding claims and mutual general
releases with no resulting material adverse effect on Interland. Pursuant to
the terms of the settlement agreement, the plaintiff agreed to Interlands
continuing use of its blueHALO(tm) mark and agreed not to contest Interlands
efforts to register its blueHALO(tm) mark in the U.S. Patent and Trademark
Office. Interland is also defending a case entitled Novell, Inc. v. Micron Electronics,
Inc. filed in August 1999 in state court in Utah County, Utah. Novell claims
that it was underpaid for royalties on sales of several versions of its NetWare
software purportedly distributed by Interlands predecessor, Micron
Electronics, between 1996 and 1998. In addition, Novell also believes it is
entitled additional royalties for sales of the software purportedly distributed
by NetFrame between 1993 and 1997. Micron Electronics acquired NetFrame in
1997. Novell is seeking an accounting and damages. Interland believes it has
meritworthy defenses to Novells claims. The litigation is still in the
discovery phase. Periodically, the Company is made aware that technology it used in its
discontinued operations may have infringed on intellectual property rights held
by others. The Company has evaluated all such claims and, if necessary and
appropriate, sought to obtain licenses for the use of such technology. If the
Company or its suppliers were unable to obtain licenses necessary to use
intellectual property in its discontinued operations products or processes, it
may be forced to defend legal actions taken against it relating to allegedly
protected technology. The Company evaluates all such claims and has accrued a
liability and charged discontinued operations for the estimated costs of
settlement or adjudication of claims for alleged infringement as of the
respective dates of the balance sheets included in this report. As of August
31, 2004, the Company had an aggregate amount of $1.0 million accrued for such
matters. The Company is also a defendant in a number of other lawsuits that the Company
regards as unlikely to result in any material payment; nonetheless, the outcome
of litigation may not be assured, and the Companys cash balances could be
materially affected by an adverse judgment. In accordance with SFAS No. 5
Accounting for Contingencies, the Company believes it has adequately reserved
for the contingencies arising from the above legal matters where an outcome was
deemed to be probable and the loss amount could be reasonably estimated. As
such, the Company does not believe




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that the anticipated outcome of the aforementioned proceedings will have a
materially adverse impact on its results of operations, its financial condition
or its cash flows. 
 Item 4. Submission Of Matters To A Vote Of Security Holders On July 1, 2004 the Company held its annual meeting of shareholders. The
following matter was voted upon: The election of six directors to serve until the next Annual Meeting of
Shareholders and until their successors are elected and have qualified. The
following table provides the number of votes cast for and withheld as to the
election of directors. Votes
    
    VotesName of Nominee
    
    For
    
    WithheldJoel J. Kocher
    
    
    13,377,250
    
    
    
    282,266John B. Balousek
    
    
    13,323,448
    
    
    
    336,067Robert C. Lee
    
    
    13,337,052
    
    
    
    322,463Edward L. Shapiro
    
    
    13,427,642
    
    
    
    231,873Robert T. Slezak
    
    
    13,398,740
    
    
    
    260,775John Patrick Crecine
    
    
    13,501,214
    
    
    
    158,301
 
 Item 4A. Executive Officers and Directors of the Registrant The executive officers and directors of the Company and their ages as of
October 30, 2004, were as follows: Name
    
    Age
    
    PositionJoel J. Kocher
    
    
    48
    
    
    Chairman of the Board of Directors, President and Chief Executive OfficerAllen L. Shulman
    
    
    56
    
    
    Senior Vice President, Chief Financial Officer, and Executive CounselRichard A. Pitrolo
    
    
    44
    
    
    Vice President, Service DeliveryWilliam Jones
    
    
    44
    
    
    Chief Information Officer, Vice President of OperationsJuan G. Troncoso
    
    
    42
    
    
    Vice President, Finance & AccountingJames A. Lambert
    
    
    38
    
    
    Vice President, Human ResourcesJonathan B. Wilson
    
    
    38
    
    
    Vice President, General CounselGlenn R. Hofmann
    
    
    39
    
    
    Vice President, Shared ServicesJohn B. Balousek
    
    
    59
    
    
    DirectorJohn P. Crecine
    
    
    65
    
    
    DirectorRobert Lee
    
    
    56
    
    
    DirectorEdward Shapiro
    
    
    39
    
    
    DirectorRobert T. Slezak
    
    
    47
    
    
    Director
 Joel J. Kocheris Chairman, President and Chief Executive Officer. He joined
the Company in January 1998 as President, Chief Operating Officer, and
Director, and was appointed Chairman and Chief Executive Officer in June 1998.
Prior to joining the Company, Mr. Kocher served as President and Chief
Operating Officer at Power Computing Corporation, a personal computer company,
from December 1996 until August 1997. He served as Executive Vice President and
then Chief Executive Officer of Artistsoft, Inc., a computer networking and
telephony company, from August 1994 to January 1996. From 1987 to 1994, he
held several senior executive positions with Dell Computer Corporation,
including President, Worldwide Sales, Marketing and Services. Allen L. Shulmanis Senior Vice President, Chief Financial Officer and
Executive Counsel. He was elected as Senior Vice President, Chief Financial
Officer, and General Counsel in October 2002, after serving as Vice President
and General Counsel since joining the Company in November 2001. Mr. Shulman
served as General Counsel of CheckFree Corporation from May 1997 until October
2001 and additionally as Chief Financial Officer from August 1998 to June 2000.
From 1983 to 1996, Mr. Shulman held a number of executive positions with
United Refrigerated Services, Inc., including Chief Operating Officer, Chief
Financial Officer, and General Counsel. From 1974 to 1983, he practiced law in
New Jersey and in Chicago where he was a partner in the firm of Conklin &
Adler. Richard A. Pitrolois Vice President of Service Delivery. He joined the Company
in November 2003. Prior to joining the Company, Mr. Pitrolo was most recently
Vice President of Operations for Stream International, a global leader in
outsourced technology and customer support service from June 2000 to October
2003. Mr. Pitrolo also served as Director




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of Operations and Support at Inacom Corporation from August 1998 to June 2000.
Mr. Pitrolo has served as President and General Manager of PC Technologies
Services, as well as numerous management positions within Gateway Corporation. William Jonesbecame Chief Information Officer, Vice President of Operations in
July 2003. A 20-year veteran in information technology. Prior to joining
Interland, Mr. Jones was CIO of Tivoli Systems from May 2000 to January 2003,
and as director of Americas infrastructure services for the IBM Software Group
from November 1998 to May 2000. From October 1996 to October 1998, he served as
director of operations in the IT group for ENTEX Information Services, a
privately held computer systems reseller and services company. During his
14-year tenure at Electronic Data Systems (EDS) from June 1982 to October 1996,
he held various technical and management positions with emphasis on information
technology operations. Juan G. Troncosohas served as Vice President of Finance & Accounting since
September 2003, after serving as Vice President of Finance since joining the
company in March of 2001. Prior to joining Interland, Mr. Troncoso served as
Finance Director for PSINet from 2000 to 2001, Latin American Controller for
Anixter International from 1999 to 2000, Director of Global Acquisitions for
Chatham International from 1998 to 1999. Mr. Troncoso also held several
positions at SRC International from 1986 to 1998, including Vice President of
Finance & Administration, Corporate Controller and Chief Financial Officer. James A. Lambertjoined the Company in June of 1998 in the Human Resource
department and has been serving as Vice President of Human Resources since
April 2004. Mr. Lambert has accumulated more than twelve years of experience
in all aspects of the human resources field. Prior to joining Interland, Mr.
Lambert held numerous human resources positions with both large and small
organizations including Boise Cascade Corporation and Idaho Power Company.
Additionally, Mr. Lambert has more than ten years of manufacturing and
logistics experience. Jonathan B. Wilsonjoined Interland-Georgia in 2001 and was promoted to General
Counsel in January 2004. Prior to joining Interland Mr. Wilson was the
General Counsel of Pivotry Corporation, an Internet start-up from July 2000 to
November 2000. Before July 2000, Mr. Wilson was an attorney with King &
Spalding for approximately two years. As an attorney, Mr. Wilsons primary
expertise is in the law governing the Internet and Intellectual Property. Mr.
Wilson is the Chair of the Internet Industry Committee for the ABAs Public
Utility, Communications and Transportation Law Section and has served in that
capacity since founding the committee in 1997. Glenn R. Hofmannjoined the Company in 1998 as Director of Internal audit. Mr.
Hofmann has also held management positions in Project Management, was the AVP
of Information Technologies and was most recently promoted to Vice President of
Shared Hosting Services in April 2004. Prior to joining Interland, Mr.
Hofmann was Application Supervisor of Dakota Clinic, Ltd. from July 1996 to
August 1998. Mr. Hofmann brings over 17 years of diverse business experience
to this position focused primarily in the areas of systems implementation,
project management and team leadership. John B. Balousekhas served as a member of the board of directors since August
1999. He currently serves as a Director on the boards of Aptimus, Inc. and
Central Garden & Pet Company, both publicly held companies, and several
privately held firms. From 1998 to 1999, Mr. Balousek served as Executive Vice
President and a founder of PhotoAlley.com, a San-Francisco-based start-up
company providing electronic commerce services. He served as Chairman and CEO
of True North Technologies, a digital and interactive services company of True
North Communications, parent company of Foote Cone & Belding Communications,
Inc., a global advertising and communications company, from March to July 1996.
Mr. Balousek continued to serve as a Director of True North Communications
until January 1997. From 1991 to February 1996, Mr. Balousek served as
President, Chief Operating Officer and Director of Foote Cone & Belding
Communications. Dr. John Patrick Crecinebecame a director of Interland in November 2003. Dr.
Crecine is Chief Executive Officer of B.P.T., Inc., a private investor, and
consultant. He was President of the Georgia Institute of Technology from 1987
to mid-1994. Previously he served as a Professor at the University of Michigan
and founding Director of the Institute of Public Policy Studies from 1965 to
1975. He became Dean of the College of Humanities and Social Sciences at
Carnegie Mellon University in 1976, a position he held until 1983 when he
became the Universitys Provost and Senior Vice President for Academic Affairs.
He held that position until his Georgia Tech appointment. He is a member of the
Board of the Georgia Department of Industry, Trade and Tourism. He also has
been a Director of INTERMET Corporation, a publicly held company, since 1993. Robert Leehas served as a member on the board of directors since April 1999.
He is currently also a Director on the boards of Broadvision, Inc. and Netopia,
Inc., both publicly held companies, as well as several privately held firms.
From 1995 to May 1998, Mr. Lee served as President of Business Communications
Services for Pacific Bell. Mr. Lee also served as Executive Vice President,
California Market Group, for Pacific Bell from 1993 to 1995. Edward Shapirohas served as a member of the board of Directors since March
2002. He is currently a partner with PAR Capital Management, Inc. He also has
held the positions of vice president with Wellington Management Company LLC,
and financial analyst with Morgan Stanley & Co. He serves as a director on the
boards of two privately held firms.




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Robert T. Slezakhas served as a member on the board of directors since August
2001. He currently also serves as a Director on the board of Pegasus
Communications Corp., a publicly held company. Mr. Slezak has worked as an
independent management consultant since November 1999. From
October 1989 to
November 1999, Mr. Slezak served as Chief Financial Officer of Ameritrade
Holding Corporation, managing the accounting, finance, tax, mergers and
acquisitions and regulatory reporting functions of this online brokerage firm. 
 PART II 
 Item 5. Market For Registrants Common Equity And Related Shareholder Matters Interlands common stock trades on the NASDAQ National Market under the symbol
INLD. The following table shows for the fiscal periods indicated the high
and low close prices for the Companys common stock, as reported by the NASDAQ
National Market: High
    
    Low2004
    
    Fourth Quarter ended August 31, 2004
    
    $
    4.07
    
    
    $
    2.71Third Quarter ended May 31, 2004
    
    
    5.52
    
    
    
    2.67Second Quarter ended February 29, 2004
    
    
    7.36
    
    
    
    3.88First Quarter ended November 30, 2003
    
    
    10.56
    
    
    
    6.402003
    
    Fourth Quarter ended August 31, 2003
    
    $
    12.20
    
    
    $
    7.25Third Quarter ended May 31, 2003
    
    
    12.50
    
    
    
    6.50Second Quarter ended February 28, 2003
    
    
    18.90
    
    
    
    7.10First Quarter ended November 30, 2002
    
    
    28.30
    
    
    
    13.60
 The above prices have been adjusted to reflect the Companys 1-for-10 reverse
stock split, which became effective on August 1, 2003. Holders Of Record On September 30, 2004, the closing price of Interlands common stock as
reported on the Nasdaq National Market was $3.56 per share and there were
approximately 1,800 shareholders of record. Dividends Interland has not declared or paid any cash dividend and does not foresee
paying any cash dividends in the foreseeable future. 
 Item 6. Selected Financial Data (In thousands) The following selected historical consolidated statement of income data for the
years ended August 31, 2004, 2003 and 2002, and the historical consolidated
balance sheet data as of August 31, 2004 and 2003 have been derived from the
Companys audited consolidated financial statements and related notes included
elsewhere in this Annual Report on Form 10-K. In fiscal 2001, the Company
disposed of its PC Systems and SpecTek business segments, which are reported
separately as discontinued operations. See the note entitled Discontinued
Operations in the Companys consolidated financial statements included
elsewhere in this Annual Report on Form 10-K. The selected historical
consolidated statement of income data below reflects only the results of the
Companys continuing operations. In fiscal 2003, the Company acquired a Web and applications hosting company and
a developer of software-based website solutions. In fiscal 2002, the Company
acquired three Web and applications hosting companies, as well as Web hosting
accounts from Interliant, Inc., Burlee and AT&T. These acquisitions are
reflected in the consolidated financial statements as of the date of
acquisition. See the note entitled Acquisitions in the Companys
consolidated financial statements included elsewhere in this Annual Report on
Form 10-K. The information contained below should be read together with Managements
Discussion and Analysis of Financial Condition and Results of Operations and
the consolidated financial statements and the notes thereto included elsewhere
in this Annual Report on Form 10-K. Results of operations for the periods
presented are not necessarily indicative of results of operations for future
periods.




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##### Table of Contents



Fiscal Years Ended August 31,(In thousands, except per share amounts)
    
    2004
    
    2003
    
    2002
    
    2001
    
    2000Statements of income data:Revenues from continuing operations
    
    $
    102,745
    
    
    $
    106,638
    
    
    $
    101,628
    
    
    $
    60,752
    
    
    $
    32,862Loss from continuing operations
    
    
    (102,959
    )
    
    
    (178,791
    )
    
    
    (5,272
    )
    
    
    (145,717
    )
    
    
    (26,192
    )Net Income (Loss)
    
    
    (104,663
    )
    
    
    (173,879
    )
    
    
    (11,293
    )
    
    
    (357,194
    )
    
    
    41,543Loss per share, continuing operationsBasic and Diluted
    
    $
    (6.40
    )
    
    $
    (12.19
    )
    
    $
    (0.38
    )
    
    $
    (14.63
    )
    
    $
    (2.70
    )Net Income (Loss) per shareBasic and Diluted
    
    $
    (6.50
    )
    
    $
    (11.85
    )
    
    $
    (0.82
    )
    
    $
    (35.86
    )
    
    $
    4.30Balance sheet data:Total assets
    
    $
    84,912
    
    
    $
    207,042
    
    
    $
    395,278
    
    
    $
    429,280
    
    
    $
    563,920Total debt
    
    
    5,744
    
    
    
    12,499
    
    
    
    31,166
    
    
    
    39,106
    
    
    
    1,971Shareholders equity
    
    
    48,899
    
    
    
    152,658
    
    
    
    297,730
    
    
    
    296,430
    
    
    
    506,580
 The above per share amounts have been adjusted to reflect the Companys
1-for-10 reverse stock split, which became effective on August 1, 2003.




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Item 7. Managements Discussion And Analysis Of Financial Condition and Results Of Operations Statements contained in this Form 10-K that are not purely historical are
forward-looking statements and are being provided in reliance upon the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995.
Words such as anticipates, expects, intends, plans, believes,
seeks, estimates, and similar expressions identify forward-looking
statements. These forward-looking statements include but are not limited to
statements regarding Interlands expectations of the Companys future liquidity
needs, its expectations regarding its future operating results including its
planned increase in its revenue levels and the actions the Company expects to
take in order to maintain its existing customers and expand its operations and
customer base. All forward-looking statements are made as of the date hereof
and are based on current management expectations and information available to
it as of such date. The Company assumes no obligation to update any
forward-looking statement. It is important to note that actual results could
differ materially from historical results or those contemplated in the
forward-looking statements due to the risks and uncertainties associated with
forward-looking statements including risks associated with our target markets,
product offerings, and risks pertaining to our ability to successfully enhance
the Companys operations. These and other identified risks are disclosed in
the Risk Factors section of Item 7  Managements Discussion and Analysis
included in this Form 10-K for the year ended August 31, 2004. All yearly
references are to the Companys fiscal years ended August 31, 2004, August 31,
2003, or August 31, 2002 unless otherwise indicated. All quarterly references
are also on a fiscal basis, unless otherwise indicated. All tabular dollar
amounts are stated in thousands. Overview Interland is a leader in packaging, distributing, and supporting
business-class, online marketing solutions to small and medium enterprises
(SME) owners, both directly and through partners, enabling those businesses
to gain new relationships and better support communication with their existing
customers locally and around the world. Interland continues to offer a broad
range of products and services, including shared and dedicated hosting
services, e-commerce, application hosting, website development, marketing, and
optimization tools. On, January 2002, and May 2002 respectively, the Company acquired the
small-sized business focused shared and dedicated Web hosting customer accounts
of AT&T Corp., (AT&T), and Burlee Networks LLC, (Burlee). On February 8, 2002, the Company acquired CommuniTech.Net, Inc.,
(CommuniTech.Net) a Kansas City, Missouri based Web hosting company. On May 3, 2002, the Company acquired Dialtone, Inc., (Dialtone), a Fort
Lauderdale, Florida based dedicated Web hosting company. On August 1, 2002, the Company acquired iNNERHOST, Inc., (iNNERHOST), a
Miami, Florida based Web hosting company serving small-and medium-sized
businesses. On January 3, 2003, the Company acquired Trellix Corporation (Trellix), a
privately held company founded in 1995 is a provider of website development and
publishing solutions, integrated business services, and low-cost hosting
technology. Trellix offers a suite of site building tools and services that
enable users to create professional websites. On June 13, 2003, the Company acquired Hostcentric, Inc., a privately held
company that provides a broad range of Web hosting services to small business
and enterprise customers. The Companys revenue growth prior to 2004 was attributable to its
acquisitions, and the decline in revenue in 2004 was partially offset by the
effect of acquisitions. As a result, the Company does not believe its
historical financial results are indicative of expected future results. The
Company does not anticipate making further acquisitions as a means of growing
revenue, but rather it intends to pursue organic growth strategies, including
execution of its plans to offer combined website design, development, and
management tools to small-and-medium-sized businesses, also referred to as its
mainstream market initiative. The
Company has no plans to make additional acquisitions for the purpose
of adding customers. During 2004 the Company continued to develop its organic growth strategy.
During the first half of 2004 the Company pursued its goal of appealing to the
mainstream market primarily by developing products and services it believes are
valuable to the target market, and by initiating an effort to distribute these
products through direct sales by employees aided by advertising, and supported
by a staff of website developers. By the end of the first half of 2004,
however, the Company decided to terminate its direct sales efforts in favor of
an indirect distribution model in order to decrease the costs of customer
acquisition and to accelerate market penetration. The Company incurred a
restructuring charge of




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$0.8 million in the third quarter associated with this change in distribution
approach. Additionally, the Company recognized a non-cash impairment charge to
Goodwill and Intangible Assets in the third quarter of $74 million. In the
fourth quarter the Companys financial results reflected the lower costs
associated with the indirect model, as well as lower operating costs as the
benefits of earlier capital investments and expenses were realized. For 2004
as a whole, the Company reported a Net Loss of $105 million, of which $74
million was attributable to the non-cash impairment charges, and $31 million to
non-cash depreciation and amortization expenses. During the fourth quarter of
2004, however, the Company reported a Net Loss of $4.3 million, of which $6.9
million was attributable to non-cash depreciation and amortization expenses. Critical Accounting Policies And Estimates This discussion and analysis of financial condition and results of operations
have been prepared by management based on the Companys consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America (GAAP). The preparation
of these financial statements requires management 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, management evaluates its critical accounting policies and
estimates, including those related to revenue recognition, valuation of
accounts receivable, property, plant and equipment, long-lived assets,
intangible assets, and contingencies. Estimates are based on historical
experience and on various other assumptions 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. The following critical accounting policies reflect the more significant
judgments and estimates used in the preparation of the consolidated financial
statements. These judgments and estimates affect the reported amounts of
assets and liabilities and the reported amounts of revenues and expenses during
the reporting periods.  
    
    Revenue Recognition Revenues from continuing operations are
primarily generated from shared and dedicated Internet Web hosting,
managed services, e-commerce services, applications hosting, domain
name registrations, and website development services. Revenues are
recognized as the services are provided. Hosting contracts generally
are for service periods ranging from one to twenty four months and
sometimes require up-front set-up fees, which are deferred and
recognized ratably over the customers expected service period.
Deferred revenues represent the liability for advance billings to
customers for services not yet provided. The Company may permit an
early termination of a term contract subject to penalties.
    
    Valuation of Accounts Receivable Judgment is required when
the Company assesses the likelihood of ultimate realization of
recorded accounts receivable, including assessing the likelihood of
collection and the credit-worthiness of customers. If the financial
condition of the Companys customers were to deteriorate or their
operating climate were to change, resulting in an impairment of
either their ability or willingness to make payments, an increase in
the allowance for doubtful accounts would be required. Similarly, a
change in the payment behavior of customers generally may require an
adjustment in the calculation of an appropriate allowance. Each
month management reviews customer payment patterns, historical credit
card charge-backs, customer cancellation trends, and comparative aged
receivables balances in order to determine the appropriate amount of
allowance for doubtful accounts receivable to record. The majority
of customer payments are made by credit card and all trade receivable
balances over 60 days are fully reserved. Additionally, all trade
balances 60 days or less are reserved at 7.4%. The Company believes
that the current allowance for doubtful accounts receivable is
adequate to cover a reasonably expected level of un-collectible
accounts receivable as of the balance sheet date.
    
    Property, Plant, Equipment and Long Lived Assets The Company
utilizes significant amounts of property, plant and equipment in
providing service to its customers. For financial statement
reporting purposes, the Company uses straight-line depreciation for
property and equipment over our estimate of their useful lives. The
Company uses estimated useful lives of three to seven years for
equipment and software. Changes in technology or changes in the
intended use of property, plant and equipment may cause the estimated
period of use or the value of these assets to change. The Company
periodically confirms the appropriateness of estimated economic
useful lives for each category of property, plant, and equipment.
Long-lived assets are reviewed for impairment whenever events or
changes in circumstances indicate that their carrying amounts may not
be recoverable.
    
    Goodwill and Intangible Assets In accordance with SFAS No.
142 Goodwill and Other Intangible Assets (SFAS 142), the Company
periodically evaluates goodwill and intangible assets for potential
impairment. The Company tests for the impairment of goodwill and
intangible assets annually and between annual tests if




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an event occurs or circumstances change that would more likely than not
reduce the fair value of goodwill below its carrying amount by
determining whether the Companys carrying value exceeds its fair
value. Fair value is ascertained by using quoted values of the
Companys stock and by using discounted values of expected future cash
flows. If impairment of carrying value based on estimated future cash
flows exists, the Company measures the impairment through the use of
discounted cash flows. Judgments regarding the existence of impairment
indicators are based on legal factors, market conditions, and
operational considerations. Future events could cause us to conclude
that impairment indicators exist and that other intangible assets
associated with acquired businesses are impaired. Management retained
valuation specialists to assist in the valuation of its intangible
assets for purposes of determining the implied fair value of goodwill
at May 31, 2004. Upon completion of the annual assessment, Interland
recorded a non-cash impairment charge of $66.6 million to remove the
remainder of the carrying value of goodwill. In addition, the company
recorded an impairment charge of $7.0 million for its other intangible
assets. Other intangible assets are amortized over an estimate of
their period of economic benefit.
    
    Contingencies The Company is subject to proceedings, lawsuits
and other claims related to class action lawsuits and other legal and
regulatory proceedings that arise in the ordinary course of business.
The Company is required to assess the likelihood of any adverse
judgments or outcomes of these matters as well as potential ranges of
probable losses. A determination of the amount of the loss accrual
required, if any, for these contingencies, is made after careful
analysis of each individual issue. The Company consults with legal
counsel and other experts where necessary to assess any
contingencies. The required accrual may change in the future due to
new developments in each matter or changes in approach such as a
change in settlement strategy in dealing with these matters.
    
    Discontinued Operations During fiscal 2001, the Company
discontinued the operations of its PC Systems and SpecTek business
segments. These segments have been accounted for as discontinued
operations in accordance with APB No. 30 Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions (APB 30), and in this regard an estimate of
all retained liabilities was recorded. The amounts recorded as of
the subsequent reported balance sheet dates represent the estimated
remaining liabilities. These amounts are subject to final
settlement, which could result in a revision to the estimated loss on
the final disposal of these discontinued operations.
    
    Restructuring and Acquisition Related LiabilitiesThe Company
has remaining reserves related to its restructuring programs approved
and implemented in fiscal year 2001, 2003 and 2004. The Company also
incurred liabilities related to the integration of acquired business
during fiscal 2002 and 2003. These remaining liabilities include an estimate of future lease payments for data centers and office
facilities being exited that cannot be recovered through subleases,
employee termination costs, and termination penalties for bandwidth and
data connectivity contracts we are no longer utilizing. Future
actual amounts may differ from these estimates. Results Of Continuing Operations The Companys consolidated financial information presents the net effect of
discontinued operations separate from the results of the Companys continuing
operations. Historical financial information has been reclassified to
consistently separate and present the results of discontinued operations, and
the discussion and analysis that follow generally focuses on continuing
operations. The following table sets forth, for the periods indicated, certain
data derived from the Companys consolidated statements of operations as a
percentage of revenues:




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For the fiscal year endedAugust 31,
    
    August 31,
    
    August 31,2004
    
    2003
    
    2002Revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Operating costs and expenses:Network operating costs
    
    
    27.5
    %
    
    
    30.8
    %
    
    
    34.0
    %Sales and marketing
    
    
    19.4
    %
    
    
    19.0
    %
    
    
    26.4
    %Technical support
    
    
    17.5
    %
    
    
    14.7
    %
    
    
    16.6
    %General and administrative
    
    
    30.0
    %
    
    
    38.4
    %
    
    
    38.3
    %Bad debt expense
    
    
    3.6
    %
    
    
    6.9
    %
    
    
    10.4
    %Depreciation and Amortization
    
    
    29.8
    %
    
    
    53.2
    %
    
    
    36.1
    %Restructuring costs
    
    
    0.7
    %
    
    
    4.8
    %
    
    
    -1.3
    %Merger and integration costs
    
    
    0.0
    %
    
    
    0.5
    %
    
    
    8.0
    %Goodwill impairment
    
    
    64.8
    %
    
    
    84.3
    %
    
    
    0.0
    %Asset impairment
    
    
    6.8
    %
    
    
    13.0
    %
    
    
    0.0
    %Other expense (income), net
    
    
    -0.2
    %
    
    
    1.2
    %
    
    
    0.7
    %Total operating costs and expenses
    
    
    200.0
    %
    
    
    266.8
    %
    
    
    169.1
    %Operating loss
    
    
    -100.0
    %
    
    
    -166.8
    %
    
    
    -69.1
    %Interest income (expense), net
    
    
    -0.2
    %
    
    
    -0.3
    %
    
    
    0.7
    %Loss from continuing operations before taxes
    
    
    -100.2
    %
    
    
    -167.1
    %
    
    
    -68.4
    %Income tax benefit (expense)
    
    
    0.0
    %
    
    
    -0.6
    %
    
    
    63.2
    %Net loss from continuing operations
    
    
    -100.2
    %
    
    
    -167.7
    %
    
    
    -5.2
    %
 The loss from continuing operations for the fiscal year 2004 was $(103.0)
million, or $(6.40) per share basic and diluted, on revenues of $102.7 million
compared to a loss from continuing operations in 2003 of $(178.8) million, or
$(12.19) per share basic and diluted, on revenues of $106.6 million, and a loss
from continuing operations in 2002 of $(5.3) million, or $(0.38) per share
basic and diluted on revenues of $101.6 million. The results of continuing operations for fiscal year 2004 include all operating
activities of the Companys acquisitions. Fiscal year 2003 includes the
operating activities of:  
    
    Interland-Georgia for twelve months;
    
    CommuniTech.Net for twelve months;
    
    Dialtone for twelve months;
    
    INNERHOST for twelve months;
    
    Trellix for eight months; and,
    
    Hostcentric for two and one-half months. Discontinued Operations PC Systems In fiscal 2001 the Company discontinued the operations of its PC Systems
segment, which was accounted for as discontinued operations in
accordance with Accounting Principles Board Opinion (APB) No. 30, Reporting
the Results of Operations  Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions. The Company retained all liabilities of the PC Systems business
not assumed by GTG PC (Gores), including, for example, liabilities for taxes
arising prior to the closing of the transaction, employee termination and
related expenses, and any contingent liabilities arising prior to the closing
date. Through May 31, 2003, or for the applicable statute of limitations with respect
to taxes and government contracts, the Company is obligated to indemnify the
purchaser and affiliated entities for any breaches of the representations and
warranties contained in the agreement. In addition, the Company is obligated
for an indefinite period of time to indemnify




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the purchaser and affiliated entities for any breaches in covenants. The
agreement provides that the maximum aggregate liability of the Company for
indemnification under the agreement is $10.0 million. To date the Company has
not made any indemnification payments. In fiscal 2004, the Company recognized a loss of $1.7 million from discontinued
operations. This loss consisted primarily of required legal fees and reserves
in defense and settlement of Micron PC legal matters. The Companys Micron
litigation is ongoing and management expects that there will be additional
defense costs in 2005. In fiscal 2003, the Company recognized a gain of $4.9
million from discontinued operations. This gain consisted of a $5.5 million
reduction in the Companys liability for Micron Electronics sales taxes
payable with various jurisdictions including a settlement reached with the
state of Idaho, and a $0.4 million reduction in the Companys liability for
Micron Electronics payroll taxes. These gains were partially offset by a $0.7
million increase in required legal reserves and $0.3 million in other various
charges related to discontinued operations. In fiscal 2002, the Company
recognized an estimated loss on the disposal of PC Systems of $6.0 million.
Included in the loss recognized was a $3.8 million charge in connection with
the resolution of disputed obligations owed to the Company by Gores. In
addition, the Company wrote down certain sales tax receivable balances to their
net realizable value, which resulted in a charge of
$0.7 million. As of
August 31, 2004, the Company
has a sales and use tax assessment and audit reserve of $1.2 million, $0.7
million in contingent liabilities, $0.4 million in legal expenses and $0.3 for
other liabilities related to the disposal of discontinued operations. Comparison of the Years Ended August 31, 2004, 2003, and 2002 Revenues Total revenues decreased 3.6% to $102.7 million during fiscal 2004 from $106.6
million in fiscal 2003, which represented 4.9% increase over revenues of
$101.6 million in fiscal 2002. Fiscal Year EndedAugust 31,
    
    August 31,
    
    August 31,Revenues
    
    2004
    
    2003
    
    2002Hosting revenue
    
    $
    97,601
    
    
    $
    103,313
    
    
    $
    99,755Other revenue
    
    
    5,144
    
    
    
    3,325
    
    
    
    1,873Total revenue
    
    $
    102,745
    
    
    $
    106,638
    
    
    $
    101,628
 Hosting revenues decreased 5.5% to $97.6 million during fiscal 2004 from $103.3
million in fiscal 2003 and $99.8 million in fiscal 2002. Hosting revenues are
comprised of shared, dedicated, and application hosting services and domain
name registrations. The $5.7 million decline in hosting revenues during 2004
was related to account cancellations, net of new customers obtained through
sales and marketing activities, partially offset by the growth in hosting
revenues attributable to the Hostcentric acquisition. The $3.5 million
increase in 2003 was primarily attributable to acquisitions and new customers
obtained through sales and marketing activities, net of account cancellations.
These cancellations occur as a result of: a) customer action; b) termination
by the Company for non-payment; or c) termination by the Company as a result of
a decision to no longer provide a particular service. Consequently, the
Company has, aside from acquisitions, yet to achieve sustained overall growth
in revenue. Other revenues increased 54.7% to $5.1 million during fiscal 2004 from $3.3
million in fiscal 2003 and $1.9 million in fiscal 2002. Other revenues are
primarily comprised of consulting, bandwidth transfer overage billings,
Internet connectivity fees, co-location services, and Web-based business
solution services. The $1.8 million increase in 2004 is primarily due to $1.5
million increase in other service revenues from a full year of other services
revenues from Hostcentric acquisition compared to three months of similar
revenues in 2003 and the inclusion of Trellix other service revenues for the
full year compared to seven months in 2003, and $0.5 million of new bandwidth
transfer overage billings in 2004, offset by a decrease in connectivity
revenues from the closure of Communitech of $0.2 million. The increase in
other revenues during 2003 is primarily due to an increase in consulting
services and the inclusion of seven months of Trellix revenues, partially
offset by a decrease in co-location services revenues. As of August 31, 2004, the Company had approximately 177,000 paid shared
hosting customer accounts and managed nearly 9,000 dedicated servers (many of
which host multiple websites) compared to 200,000 paid shared hosting customer
accounts and 8,500 dedicated servers at August 31, 2003. The decrease in
shared hosting customer accounts is primarily due to the Companys more
stringent termination policies applied to delinquent accounts, and voluntary
cancellations by customers exceeding new customers acquired. The Companys revenues are highly correlated with the net change in the total
of the monthly recurring charges associated with all customer accounts. The
term Monthly Recurring Charges or MRC, does not include one-time or
variable




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charges customers may incur, nor is it the same as the actual amount of revenue
recognized because, among other things, MRC ignores deferred revenue, and
instead uses the charge that applies to a full month. (For revenue recognition
purposes a customer who initiates service during the month contributes to
revenue the same percentage of the nominal monthly charge as the percentage of
the month remaining at inception; a customer who terminates service during the
month contributes to revenue the same percentage of the nominal monthly charge
as the percentage of the month that elapsed prior to termination. An
initiating customers entire nominal monthly charge is included in MRC as of
the end of the month, but no portion of a terminating customers nominal
monthly charge is included in MRC as of the end the month during which
termination occurs.) MRC, therefore, is not a measure of historical revenues
but rather a metric for valuing the revenue potential of the entire customer
base as of the end of a period. The Company believes that MRC is useful as a
reflection of changes in the base of revenue-generating customers and,
consequently, as a predictor of the direction of revenue in the future. It is
unlikely that Interlands future revenues will increase unless Net MRC Change
is positive, and the Company does not have a recent history of positive Net MRC
Change aside from mergers and acquisitions. During 2004 the MRC of the Companys Shared line of business declined from
$5,096,000 to $4,353,000, or 14.6%. MRC Churn (MRC of terminating customers as
a percentage of beginning MRC) averaged 3.4%, but declined to a 2.8% average
during the fourth quarter. The Company believes that this improvement in churn
reflects the Companys investments in improving reliability and customer
service that has also led to improved customer satisfaction as measured by
surveys. Sales produced New Shared MRC, which averaged $87,000 per month,
resulting in an average negative Net MRC Change of $78,000 per month. The
Company believes that it is unlikely that Shared MRC Churn can be reduced below
2%, but believes that its current strategy of increasing new sales through
indirect distribution of enhanced products and services has the potential to
generate enough new business to exceed the amount of MRC Churn and result in
positive Net MRC Change and revenue growth. During 2004 the MRC of the Dedicated line of business declined from $3,103,000
to $2,998,000, or 3.4%. MRC Churn averaged 5.2% but averaged 4.6% during the
fourth quarter. New Dedicated sales averaged $159,000 per month, resulting in
an average negative Net MRC Change of $5,000 per month. The more recent
trends, however, have been negative, resulting in average Net MRC Change during
the fourth quarter of negative $47,000. The Dedicated line of business revenue
has been affected, and is likely to continue to be affected, by a general
reduction in pricing in the industry. MRC Churn in the dedicated line also is
driven by rapid changes in server technology, creating in the customer a desire
to seek the latest technology at the lowest price in a highly competitive
market. Due to recent increases in MRC Churn and price competition, the
Company is re-evaluating the profitability of its Dedicated products and
seeking alternatives to maximize the Companys returns in this market. The
Company is now offering many of the products and services it has developed
primarily for the Shared market to Dedicated customers, but due to the capital
cost of a server required to service a new Dedicated customers they must not
only be profitable from an operating standpoint, but must also remain as
customers long enough for the Company to recoup its investment and provide a
satisfactory return on assets employed. OPERATING COSTS AND EXPENSES Network Operating Costs Network operating costs decreased 14.0% to $28.3 million in fiscal 2004 from
$32.9 million in fiscal 2003, which had decreased 5.0% from $34.6 million in
fiscal 2002. The Companys network operating costs as a percentage of revenues
decreased to 27.5% during fiscal 2004 from 30.8% in fiscal 2003 and 34.0% in
fiscal 2002. This decrease is most directly related to the data center
consolidation, which was a critical part of the Companys restructuring and
integration initiative. That initiative also accounted for a $4.7 million
reduction in bandwidth connectivity costs, a $0.8 million reduction in service
fees and a $0.6 reduction in occupancy costs. In addition the Company reduced
operating lease costs by $0.8 million as a result of purchasing the underlying
leased equipment and a $0.5 million decrease in domain registration costs.
These cost savings were partially offset by a $2.2 million increase in employee
related costs, a $1.0 million increase in software costs necessary to support
customer product offerings, and a $0.5 million increase in repair and
maintenance costs to maintain network reliability. Network operating costs
were reduced by the fourth quarter of 2004; primarily as negotiated bandwidth
cost reductions were realized. Total costs averaged $7.2 million for the
first three quarters of the year, but were $6.7 million in the fourth quarter. The decrease from 2002 to 2003 was primarily related to the Companys
restructuring and integration efforts reducing bandwidth connectivity cost and
operating lease costs. The Company currently supports a number of technical
platforms, which it acquired from other companies. Compared to a single
uniform platform, this situation imposes higher costs because of the need for
specialized personnel for both operations and technical support, and in the
duplication of effort to make changes to the user interface or operating
support system. The Company is exploring means of integrating these platforms
in an effort to both improve service and reduce costs.




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##### Table of Contents



Sales and Marketing Sales and marketing expenses decreased 1.6% to $19.9 million during fiscal 2004
from $20.3 million in fiscal 2003, which had decreased 24.4% from $26.8 million
in fiscal 2002. The Companys sales and marketing expenses as a percentage of
revenues increased to 19.4% during fiscal 2004 from 19.0% in fiscal 2003 and
26.4% in fiscal 2002. The decrease in sales and marketing expenses is directly
attributable to functional centralization and much greater use of on-line
advertising and customer initiated on-line sales, and a reduction in reliance
on more expensive print advertising and direct mail. The Company believes that
it is effective in generating new sales in relation to its expenditures for
marketing, advertising, and compensation paid to sales personnel. As the
Company makes available a wider range of products and services, increased
spending in this area is believed to be likely to positively affect revenue and
profitability, particularly in the Companys Shared line of business.
Reflecting the change in distribution approach, the Company expended $11.7
million in sales and marketing expenses during the first half of the year, and
$8.2 during the second half. Technical Support Technical support expenses increased 14.4% to $18.0 million during fiscal 2004
from $15.7 million in fiscal 2003, which had decreased 6.7% from $16.8 million
in fiscal 2002. The Companys technical support expenses as a percentage of
revenues increased to 17.5% during fiscal 2004 from 14.7% in fiscal 2003 and
16.6% in fiscal 2002. The increase in technical support costs is caused by a
$1.4 million increase in employee related costs and a $1.0 million increase in
occupancy expenses. The increase in spending on technical support reflects the
Companys commitment to improving customer satisfaction as means of avoiding
cancellations. The Company has commissioned surveys of its customers
attitudes toward the Company, and believes that its increased expenditures have
resulted in the effect sought. Nonetheless, operating efficiencies
resulting from improved data center reliability reduced technical support
expenses from an average of $4.7 million during the first three quarters of the
year to $4.0 million during the fourth quarter. The decrease in technical support costs from 2002 to 2003, is primarily due to
a $1.3 million reduction in service fees paid to third-party providers for
support of acquired accounts, a $0.4 million reduction in professional fee
expenses associated with process reengineering initiatives, a $0.3 million
reduction in employee-related expenses, and $0.3 million savings in repairs
and maintenance costs. Partially offsetting these reductions were increases in
contracted labor expenses of $0.6 million and occupancy expenses of $0.6
million. The Company believes that further reductions in the cost component
are achievable. General and Administrative General and administrative expenses decreased 24.7% to $30.8 million during
fiscal 2004 from $40.9 million in fiscal 2003, which had increased 5.3% from
$38.9 million in fiscal 2002. The Companys general and administrative
expenses as a percentage of revenues decreased to 30.0% during fiscal 2004 from
38.4% in fiscal 2003 and 38.3% in fiscal 2002. General and administrative
expenses decreased primarily due to a $7.3 million decrease in employee related
cost, a $1.3 million decrease in professional fees, and a $1.2 million
reduction in occupancy costs associated with office consolidation. Partially
offsetting these decreases was an increase of $0.4 million increase in legal
fees and $0.8 million increase in insurance expenses, which included a one-time
payment of $0.4 million for D&O Side A coverage. Primarily owing to the shift
in distribution strategy the general and administrative expenses during the
first three quarters of 2004 that averaged $7.9 million dropped to $7.2
million for the fourth quarter. The increase from 2002 to 2003 was primarily related to a $2.3 million increase
in professional fees primarily related to process improvements, the initial
design requirements of a new billing system and the development of the
mainstream market initiative, a $1.4 million increase in legal fees
associated with litigation arising from the integration of recent acquisitions
and related security registrations costs, an additional $1.3 million in salary
and benefit costs associated with the acquired workforces of iNNERHOST,
Trellix, and Hostcentric, a $0.6 million increase in staffing relocation costs
necessary to complete consolidation initiatives, and a $0.5 million increase in
premiums for director and officer liability insurance. Partially offsetting
these increases was a $2.4 million decrease in occupancy costs associated with
office consolidation, a $1.2 million decrease in allocated service fees, and a
$0.6 million decrease in communication costs as a result of renegotiated
contracts with telecom providers. Bad Debt Expense Bad debt expense decreased 49.7% to $3.7 million during fiscal 2004 from $7.3
million in fiscal 2003, which had decreased 30.3% from $10.5 million in fiscal
2002. The Companys bad debt expense as a percentage of revenues decreased to
3.6% during fiscal 2004 from 6.9% in fiscal 2003 and 10.4% in fiscal 2002. The
decrease in bad debt expense is directly attributable to the implementation of
more aggressive collection strategies and more stringent non-paying account
deactivation termination policies. Generally services are suspended when an
account becomes thirty days past due and services are terminated if an account
ages beyond sixty days. Bad debt expense has been decreasing each quarter as
the Companys churn has reduced, and as its collection policies took effect.
During 2004, the quarterly bad debt expense was $1.1 million, $0.9 million,
$0.9 million, and $0.7 million, for the fourth, third, second and first
quarters of fiscal 2004, respectively.




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The decrease in bad debt expense during fiscal 2002 was also attributable to
the implementation of more aggressive collection strategies and more stringent
non-paying account deactivation termination policies. Depreciation And Amortization Depreciation and amortization expenses decreased 46.0% to $30.6 million during
fiscal 2004 from $56.7 million in fiscal 2003, which had increased 54.4% from
$36.7 million in fiscal 2002. The Companys depreciation and amortization
expenses as a percentage of revenues decreased to 29.8% during fiscal 2004 from
53.2% in fiscal 2003 and 36.1% in fiscal 2002. The decrease from 2003 to 2004
in depreciation and amortization expense is due to charges in 2003 of $12.1
million in accelerated depreciation and amortization on the assets associated
with closed data centers in Seattle, Los Angeles and Kansas City and software
products acquired through business combinations. The increase from 2002 to
2003 in annual depreciation and amortization expense was due to (a) $9.8
million of accelerated depreciation on the assets associated with closed data
centers in Seattle, Los Angeles and Kansas City; (b) $2.3 million of
accelerated amortization of software products acquired through business
combinations; and, (c) $9.6 million additional depreciation and amortization
charges associated with acquired entities and purchased assets. Restructuring Costs Restructuring expense decreased 85.1% to $0.8 million in 2004 from $5.1 million
in 2003, which increased from ($1.3) million in 2002. The Company has approved
and initiated several restructuring plans related to specific consolidation and
integration programs. The three plans approved and implemented are referred to
as 2001 Plan, 2003 Plan and 2004 Plan, all of which are noted in further
details in the footnotes of the financial statements (See Footnote 4 
Restructuring Costs). The decrease from 2003 to 2004 is primarily due to less restructuring
activities. In March 2004, the Company decided to change its approach to
distributing its mainstream market hosting solutions from reliance upon a
direct field sales force to an indirect channel approach. Due to this decision,
the Company implemented a restructuring program to reduce its cost structure.
These restructuring charges include costs of $0.3 million related to lease
commitments, and $0.7 million employee severance and benefits. The Company
reduced its reserves related to bandwidth contract obligations from its 2003
Plan by $0.4 million as a result of continued negotiations. The Company also
increased its reserves under restructuring plan of 2001 by $0.2 million related
to lease abandonment obligations as a result of changes in the Companys
sublease expectations and landlord requirements. In 2003, the Company approved
and initiated a program to exit certain facilities and consolidate those
operations into other existing facilities. This restructuring plan was part of
managements continued plan to streamline the Companys operations and to
reduce the long-term operating costs. The plan provided for the closure of
three data center facilities, a reduction of those related workforces of
approximately 171 employees, and the termination of bandwidth and data
connectivity contracts in place at these and other facilities. The Company
exited all three data centers by June 2003 and recorded a charge of
approximately $6.6 million. The 2003 Plan charges consisted of $2.1 million in
lease termination costs, $1.9 million in bandwidth termination costs, $1.3
million in employee termination benefits, and $1.3 in fixed asset related
charges. These plan charges were partially offset by $0.2 million of various
adjustments, including the settlement of certain data connectivity contract
obligations for amounts less than the original estimates. There was a charge
for $0.9 million to property, plant and equipment representing the write down
of remaining book value of fixed assets originally written down to their
estimated salvage value included in the restructuring charge recorded in Plan
Charges. Also during fiscal 2003, the 2001 Plan was adjusted in connection
with the bandwidth settlements as the early termination costs reserves were
reduced by $1.0 million and lease abandonment liabilities were also reduced by
$0.3 million related to the 2001 Plan. The increase from 2002 to 2003 was primarily attributable to the new plan
activity during 2003 compared to no new plan activity and several adjustments
to reduce prior accruals in 2002. During 2002, the liability related to other
exit costs was reduced by $1.9 million in connection with the settlement of
certain data connectivity contract obligations for amounts less than the
original estimates The liability related to lease abandonments was increased to
$1.3 million due to the impact of revised exit plans pertaining to the
Companys Seattle, Washington facility. The Company settled a disputed tenant
improvement allowance with the landlord of an exited facility. In connection
with the settlement, the Company was no longer responsible for paying $0.7
million of the remaining lease payments required over the remaining lease term,
which was originally accrued in the restructuring charge. The liability was
also decreased by $0.1 million to reflect the lease termination for the
Companys Los Angeles, California facility. Merger And Integration Costs Merger and integration costs decreased to $0.0 million during fiscal 2004 from
$0.5 million in fiscal 2003, and $8.1 million in fiscal 2002. The Companys
merger and integration costs as a percentage of revenues decreased to zero
during fiscal 2004 from 0.5% in fiscal 2003 and 8.0% in fiscal 2002. The costs
incurred in fiscal 2003 related primarily to employee relocation costs. The
costs incurred in fiscal 2002 were comprised of $7.4 million for employee
retention bonuses, relocation costs, and termination benefits, $0.2 million for
legal services, and $0.5 million for other non-capitalizable costs.




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Goodwill Impairment As of May 31, 2004 in accordance with the requirements of SFAS 142, the Company
completed its annual goodwill impairment test which entailed comparing the
aggregate market value of the companys outstanding securities plus its
liabilities to the aggregate carrying value of the Companys assets, including
goodwill and other indefinite life intangible assets. The Companys market
price of its stock has experienced significant volatility over the last fiscal
year and closed as of May 31, 2004, with a market value significantly less that
the value at the beginning of the fiscal year. Management retained valuation
specialists to assist in the valuation of its tangible and identifiable
intangible assets for purposes of determining the implied fair value of
goodwill at May 31, 2004. Upon completion of the annual assessment, Interland
recorded a non-cash impairment charge of $66.6 million in fiscal 2004 to write
off the remaining balance of the carrying value of goodwill. This compares to
a charge of $89.9 million reduction in fiscal 2003 for the Companys impairment
test as of May 31, 2003. Intangible Asset Impairment The Companys aggressive acquisition strategy during 2002 and 2003 resulted in
significant accumulated customer and product related intangible asset balances.
The Company continued to monitor the performance of these acquired
identifiable intangible assets and during the third quarter of 2004, the
Company determined that the related discounted present value of future cash
flows from its Interliant, AT&T and Burlee customer account acquisitions, as
well as customer relationship intangible assets from its CommuniTech.Net,
iNNERHOST and Dialtone acquisitions were materially less than previously
estimated, due primarily to customer cancellations and company-initiated
account terminations. As a result of this assessment, the Company determined
that these identifiable intangible assets were worth less than their carrying
value, and the Company consequently recorded a non-cash impairment charge of
$4.8 million to reduce the asset value to its newly assessed value and a $2.2
million charge for disposal of software. This compares to a charge of $13.9
million in fiscal 2003 for the Companys impairment test as of May 31, 2003. Other Expense (Income), Net Other expense (income), net decreased 114.9% to a $(0.2) million gain during
fiscal 2004 from $1.3 million in fiscal 2003, which had increased 88.8% from
$0.7 million in fiscal 2002. During fiscal 2004 the Company recognized $0.2
million gain related to the disposal of long-lived assets in accordance with
requirements of SFAS No. 144 Accounting for the Impairment or Disposal of
Long-Lived Assets. During fiscal 2003, the Company recognized a net $1.3
million loss related to the disposal of long-lived assets. During fiscal 2002
the Company completed the sale of its remaining Boise Idaho based consumer
dial-up accounts and certain data center assets which resulted in a net loss of
$0.7 million. Interest Income (Expense), Net Interest income (expense), net decreased to $(0.2) million during fiscal 2004
from $(0.3) million in fiscal 2003 and from $0.8 million in fiscal 2002. The
Companys interest income (expense), net as a percentage of revenues, decreased
to (0.2)% during fiscal 2004 from (0.3)% in fiscal 2003 and 0.7% in fiscal
2002. Interest income (expense), net consists of interest income earned on
the Companys invested cash and liquid investments, less interest expense on
debt (primarily capital leases). The cause for the decrease in net interest
expense is primarily due to the lower levels of funds available for investment
and lower interest rates experienced during fiscal 2004, 2003 and 2002. Income Tax Provision The effective income tax expense rate on continuing operations was
approximately 0.0% for fiscal 2004, compared to an effective income tax benefit
rate of 0.4% for fiscal 2003. Giving rise to the income tax expense in fiscal
2003 is an adjustment to a previously recorded tax benefit receivable. The
effective rates principally reflect the federal statutory rate, net of the
effect of state taxes, tax-exempt securities and non-deductible goodwill
amortization, net of valuation allowance on deferred tax assets. The change in
the effective income tax rates primarily reflects tax benefits resulting from a
change in the Internal Revenue Code regarding the carry back of net operating
losses, as well as a valuation allowance on certain tax assets. On March 9,
2002, a tax law entitled the Job Creation and Worker Assistance Act of 2002
was passed. The provision of this act that benefited the Company directly
during 2002 was the ability to carry back tax losses to the previous five
years. During the third quarter of 2002, the Company received approximately
$66 million in cash relating to the carry back tax refunds and income tax
receivables. This tax refund significantly added to the Companys cash
position but also reduced the amount of tax net operating losses available for
carry forward to future years. Earnings Before Interest, Taxes, depreciation and Amortization (EBITDA) EBITDA is defined as net income from continuing operations before (i) interest
income or expense, (ii) income taxes, and (iii) depreciation and amortization.
EBITDA is not an indicator of financial performance under GAAP and may not be
comparable to similarly captioned information reported by other companies. In
addition, it does not replace net income (loss), operating income (loss), or
cash flows from operating activities as indicators of operating performance or
liquidity. The effect of taxes and interest on Interlands net loss is not
significant, but depreciation and amortization, primarily as a result of
acquisitions, is significant. The Company believes that measuring the
performance of the business without




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regard to non-cash depreciation and amortization can make trends in operating
results more readily apparent, and when considered with other information,
assist investors and other users of the Companys financial statements who wish
to evaluate the Companys ability to generate future cash flows. The Companys EBITDA loss decreased 40.4% to a loss of $72.1 million during
fiscal 2004 from losses of $121.1 million in fiscal 2003, which had increased
261.1% from $33.5 million loss in fiscal 2002. The primary cause for the
decreased EBITDA loss during fiscal 2004 was the $66.6 million and $7.0 million
asset impairment charges recorded against goodwill and identifiable intangible
assets, respectively, that were less than the amounts incurred in 2003. The following table reflects the calculation of EBITDA from continuing
operations and a reconciliation to net cash provided by (used in) operating
activities: Fiscal Year EndedAugust 31,
    
    August 31,
    
    August 31,2004
    
    2003
    
    2002(In thousands)Net loss
    
    $
    (104,663
    )
    
    $
    (173,879
    )
    
    $
    (11,293
    )Depreciation and amortization
    
    
    30,650
    
    
    
    56,708
    
    
    
    36,719Interest expense (income)
    
    
    202
    
    
    
    327
    
    
    
    (752
    )Income tax expense (benefit)
    
    
    
    
    
    
    629
    
    
    
    (64,241
    )Discontinued operations
    
    
    1,704
    
    
    
    (4,912
    )
    
    
    6,021EBITDA loss from continuing operations
    
    $
    (72,107
    )
    
    $
    (121,127
    )
    
    $
    (33,546
    )Interest (expense) income
    
    
    (202
    )
    
    
    (327
    )
    
    
    752Provision for bad debts
    
    
    3,690
    
    
    
    7,335
    
    
    
    10,529Gain/(Loss) on the sale of assets
    
    
    (159
    )
    
    
    1,641
    
    
    
    Goodwill and intangible impairment
    
    
    73,596
    
    
    
    103,796
    
    
    
    Amortization of deferred compensation
    
    
    678
    
    
    
    2,189
    
    
    
    4,271Income tax (expense) benefit
    
    
    
    
    
    
    (629
    )
    
    
    64,241Changes in assets and liabilities:Income tax recoverable
    
    
    612
    
    
    
    778
    
    
    
    19,008Receivables
    
    
    (1,514
    )
    
    
    (2,323
    )
    
    
    (9,407
    )Other current assets
    
    
    (206
    )
    
    
    742
    
    
    
    139Accounts payable, accrued expenses and deferred revenue
    
    
    (8,447
    )
    
    
    (24,951
    )
    
    
    (23,481
    )Net cash provided by (used) in operating activities
    
    $
    (4,059
    )
    
    $
    (32,876
    )
    
    $
    32,506




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##### Table of Contents



The following table reflects the 2004 quarterly calculation of EBITDA from
continuing operations and a reconciliation to net cash provided by (used in)
operating activities: 2004 Quarterly EBITDA Information (In thousands)
(Unaudited) For the quarter endedNovember 30
    
    February 29
    
    May 30
    
    August 312003
    
    2004
    
    2004
    
    2004in thousandsNet loss
    
    $
    (8,553
    )
    
    $
    (10,100
    )
    
    $
    (81,726
    )
    
    $
    (4,284
    )Depreciation and amortization
    
    
    8,182
    
    
    
    8,241
    
    
    
    7,331
    
    
    
    6,896Interest expense (income)
    
    
    138
    
    
    
    166
    
    
    
    (124
    )
    
    
    22Discontinued operations
    
    
    582
    
    
    
    739
    
    
    
    481
    
    
    
    (98
    )EBITDA loss from continuing operations
    
    $
    349
    
    
    $
    (954
    )
    
    $
    (74,038
    )
    
    $
    2,536Interest income/(expense)
    
    
    (138
    )
    
    
    (166
    )
    
    
    124
    
    
    
    (22
    )Provision for bad debts
    
    
    1,131
    
    
    
    935
    
    
    
    874
    
    
    
    750Loss on the sale of assets
    
    
    (22
    )
    
    
    (48
    )
    
    
    (81
    )
    
    
    (8
    )Goodwill and asset impairment
    
    
    
    
    
    
    
    
    
    
    73,596
    
    
    
    Amortization of deferred compensation
    
    
    173
    
    
    
    375
    
    
    
    173
    
    
    
    (43
    )Changes in assets and liabilities:Receivables
    
    
    (598
    )
    
    
    (633
    )
    
    
    (572
    )
    
    
    289Income tax recoverable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    612Other current assets
    
    
    364
    
    
    
    176
    
    
    
    521
    
    
    
    (1,267
    )Accounts payable, accrued expenses, and deferred revenue
    
    
    (3,459
    )
    
    
    (4,421
    )
    
    
    (182
    )
    
    
    (385
    )Net cash provided by (used in) operating activities
    
    $
    (2,200
    )
    
    $
    (4,736
    )
    
    $
    415
    
    
    $
    2,462
 Liquidity And Capital Resources As of August 31, 2004, the Company had $25.2 million in cash and cash
equivalents, $2.5 million in short-term unrestricted investments, and $10.9
million in restricted cash and short-term restricted investments, representing
a total cash and investment position of $38.6 million. This represents a $31.6
million or 45.4% decrease from the total cash and investment position of $70.2
million at August 31, 2003, which was comprised of $35.3 million in cash and
cash equivalents, $16.3 million in short-and long-term unrestricted investments
and $18.6 million in short-and long-term restricted investments. The following table discloses aggregate information about the Companys
contractual obligations, excluding interest, as of August 31, 2004 and the
periods in which payments are due: AfterContractual Obligations (in thousands)
    
    Total
    
    1 year
    
    2-3 years
    
    4-5 years
    
    5 yearsOperating Leases
    
    $
    396
    
    
    $
    147
    
    
    $
    213
    
    
    $
    36
    
    
    $
    Long-term Debt
    
    
    4,236
    
    
    
    789
    
    
    
    1,900
    
    
    
    1,547
    
    
    
    Real Property Leases
    
    
    25,866
    
    
    
    5,674
    
    
    
    9,221
    
    
    
    7,850
    
    
    
    3,121Bandwith Commitments
    
    
    6,743
    
    
    
    3,437
    
    
    
    1,825
    
    
    
    711
    
    
    
    770Capital Leases
    
    
    1,511
    
    
    
    1,485
    
    
    
    26
    
    
    
    
    
    
    
    Total Commitments
    
    $
    38,752
    
    
    $
    11,532
    
    
    $
    13,185
    
    
    $
    10,144
    
    
    $
    3,891
 The components of the change in the Companys total cash and investment
position during fiscal 2004 consist of $4.1 million used to fund operating
activities of continuing operations, $11.3 million used to fund financing
activities of continuing operations, $1.7 million used to fund discontinued
operations, and $7.1 million provided by investing activities of continuing
operations that includes $21.5 million of security proceeds, offset by $11.9
million of equipment and related capital expenditures and $2.8 million
directors and officers liability insurance deposit. Cash used in operating activities of continuing operations decreased $28.8
million or 87.7% to $4.1 million during fiscal 2004 from $32.9 million during
fiscal 2003. Besides the normal working capital fluctuations of receivables,
accrued expenses and accounts payable; the reduction in cash used in continuing
operations includes the Companys continued




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payout of restructuring initiatives that reduced facility, bandwidth
connectivity, and employee-related costs but, at a lower rate than the prior
year. Cash provided by investing activities decreased $23.7 million or 77.0% to $7.1
million during fiscal 2004 from cash provided by investing activities of $30.7
million during fiscal 2003. The decrease in cash provided by investing
activities is related to lower amounts of sales of investment securities to
fund operations. In the fourth quarter of 2004, $2.8 million was delivered to
one of the Companys issuers of Directors and Officers Liability Insurance
providing a retention deposit for payment of the Companys obligations to
indemnify officers and directors in the event that the Company does not fulfill
its obligations directly. At such time as the Company has fulfilled its
obligations, the funds will be returned to the Company. Cash used in financing activities decreased $10.7 million or 48.7% to $11.3
million during fiscal 2004 from $22.1 million during fiscal 2003. The decrease
in cash used in financing activities is due to a significant reduction in the
amount of debt repayments. Net cash used in discontinued operations decreased $1.5 million or 46.4% to
$1.7 million during fiscal 2004 from cash used in discontinued operations of
$3.3 million during fiscal 2003. The reduction in cash used related to
discontinued operations reflects the continued winding down of the computer
products and services businesses and lower litigation costs in fiscal 2004. As of August 31, 2002, the Company had $147.9 million in cash and cash
equivalents, investments and restricted investments. This represented a
decrease of $60.2 million compared to August 31, 2001. Cash used during the
fiscal year 2002 included $55.5 million for operations (net of $88.0 million of
tax refunds received during the year), $5.6 million for capital expenditures,
$18.3 million for repayments of debt and capital lease obligations, $9.8
million for the re-purchase of the Companys common stock, $42.5 million for
business acquisitions, $15.0 million for discontinued operation liabilities,
and $2.7 million for notes issued to a related party. Partially offsetting
these uses of cash was $1.1 million of proceeds received from the issuance of
Company stock. On July 20, 2001, the Company entered into a financing arrangement with US Bank
under which the Company executed a $5.4 million credit agreement. During fiscal
2003, the $5.4 million was paid and the loan was closed. The payoff of this
loan released $6.7 million of collateralized cash that was pledged under this
agreement. In July 2001, the Company entered into a financing arrangement with U.S.
Bancorp Oliver-Allen Technology Leasing for a sale and leaseback of up to $14.6
million for certain equipment, primarily computer hardware. On February 1,
2004, the Company terminated the sale and leaseback agreement and repurchased
the assets. In conjunction with this lease termination the company executed a
five-year promissory note with US Bancorp Oliver-Allen Technology Leasing for
the repurchase amount. As of August 31, 2004, the principal balance on the
promissory note was $4.3 million. The Company has pledged $5.0 million as
collateral for this promissory note; this amount will gradually decrease until
the agreement terminates in February 2009. As of August 31, 2004, the amount of
collateral is $4.5 million. These restrictions prevent the Company from
utilizing the related cash and cash equivalents until all of its obligations
under the note are satisfied. The original sale-leaseback agreement required
payments of $361,000 each month with an end-of-lease buyout amount in July 2004
of approximately $2.9 million. The new promissory note bears an interest rate
of 6.75% and requires monthly payments of $93,000 over the next five years. Prior to the acquisition of iNNERHOST, Inc., iNNERHOST executed a $1.3 million
note to finance the construction of a data center. The note bears an interest
rate of 10.0%. In connection with the acquisition of iNNERHOST, the Company
assumed this obligation. As of August 31, 2004, this obligation has been
completely satisfied and terminated. Also prior to acquisition, iNNERHOST
executed several term loans to finance equipment purchases. The Company assumed
these debts, which have an interest rate of 12.0%. As of August 31, 2004, there
is no outstanding balance and these obligations have been completely satisfied
and terminated. On January 3, 2003, the Company acquired Trellix Corporation, a privately held
developer of software-based website solutions. The aggregate purchase price
was approximately $12.2 million consisting of $4.75 million in cash, 300,000
shares of Interland stock, and 600,000 warrants to purchase shares of Interland
stock at a price of $50.00 per warrant. The Company spent $0.8 million during
FY2003 for the integration of Trellix and the related mainstream-market
deployment. In connection with the acquisition, the Company also assumed $0.2
million in capital lease obligations as well as a $2.5 million working capital
deficit. On June 13, 2003, the Company acquired Hostcentric, Inc., a privately held
provider of a broad range of Web hosting services to small business and
enterprise customers. The aggregate purchase price was $25.5 million in cash
and stock. The Company paid $4.7 million in cash and issued approximately 1.36
million shares of Interland stock valued at $20.4 million, net of $0.4 million
direct issue costs. In 2003, the Company implemented an integration and transition program designed
to reduce future operating expenses. These expenditures, totaling $23.4
million during fiscal 2003 ($7.1 million for capital expenditures and $16.3
million for




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operating expenses), were for the purpose of streamlining the Companys
infrastructure, completing the integration of acquisitions, upgrading internal
systems, divesting acquired data centers, and consolidating operations. The Company made capital expenditures of $13.0 million during fiscal 2004 of
which $9.6 million was for the purchase of servers, data center equipment and
related software, and $3.4 million was investment related expenditures for
enhancement of our customer facing systems and security upgrades. During
fiscal 2005 the Company expects a lower level of investment related capital
expenditures. The Company expects to spend somewhere between $4.0 million and
$7.0 million in capital expenditures in fiscal 2005 primarily related to
purchases of servers and data center equipment on an as-needed basis with as
much re-utilization of equipment from cancelled customers as possible. The
Company has also invested in an automated asset tracking system to better
manage and improve the rate of return on its assets. The Dedicated line of
business is particularly sensitive to capital expenditures since each new
customer must be provided with a server, either newly-purchased, or one which
had been provided to a former customer. To the extent that the Dedicated
business experiences net growth in customers, additional capital expenditures
will be required. In determining whether to purchase new Dedicated servers the
Company will balance the cost of the investment against the revenue expected,
the operating costs necessary to serve the customer, and the likely duration of
the relationship with the customer. Consequently, decreases in market pricing
and increases in MRC Churn make it more difficult to justify investment. The Companys Web hosting business has historically incurred net losses and
losses from operations. The Companys future operation is dependent upon its
ability to achieve and sustain positive cash flow prior to the depletion of
cash resources. The Company plans to reduce its level of cash requirements
through a decrease in capital purchases and by improving sales and reducing
churn. The Company also will have reduced cash outlays for payments associated
with prior integration and discontinued operation liabilities and will have
reduced debt payments because of the buyout of capital lease obligations during
2004. The Company expects to continue to have negative cash flows for at
least the next four quarters as it continues to execute on its business plan.
There can be no assurance that Interlands continuing efforts to stabilize or
increase its revenue will be successful and the Company will be able to
continue as a going concern. If the Company is unable to successfully execute
its business plan, it may require additional capital, which may not be
available on suitable terms. Nonetheless, management believes it has adequate
cash and liquid resources to fund operations and planned capital expenditures
through at least the next 12 months. Reverse Stock Split The Company implemented a 1-for-10 reverse stock split that went into effect as
of the close of the market on August 1, 2003. No fractional shares of common
stock were issued in connection with the reverse stock split. In instances
where the reverse stock split would result in a shareholder of record becoming
a holder of a fractional interest in a share of common stock, the number of
shares held by such record shareholder was rounded down to the product of (i)
the closing sales price of the common stock on the effective date of the
reverse stock split, multiplied by (ii) the fractional interest. Stock Repurchase Program In March 2003, the board of directors authorized a stock repurchase program to
acquire outstanding common stock. Under the program, up to $10.0 million of
common stock could be reacquired over the next year. Since its announcement of
the authorization of a share purchase program by its board of directors, the
Company utilized approximately $1.0 million to buy back approximately 85,000
shares of its outstanding stock. Recently Issued Accounting Standards In December 2003, the SEC issued Staff Accounting Bulletin No. 104, Revenue
Recognition, (SAB 104), which updates the guidance in SAB No. 101,
integrates the related set of Frequently Asked Questions, and recognizes the
role of EITF 00-21. The adoption of SAB No. 104 did not have a material effect
on the Companys consolidated financial statements. In December 2003, the FASB issued a replacement document FASB Interpretation
No. 46R, Consolidation of Variable Interest Entities (FIN 46R), which was
issued to clarify the implementation of FIN 46, issued January 2003. The
Company has evaluated its investments and concluded that none of the Companys
investments meets the requirements for consideration under FIN 46R. Off-Balance Sheet Arrangements We are not currently engaged in the use of off-balance sheet derivative
financial instruments, to hedge or partially hedge interest rate exposure nor
do we maintain any other off-balance sheet arrangements for the purpose of
credit enhancement, hedging transactions, or other financial or investment
purposes.




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##### Table of Contents



Directors & Officers Insurance During the fiscal year the Company determined that issuers of directors and
officers insurance coverage have become more likely to refuse to defend and pay
claims than in the past, and have been aggressively interpreting policy
language in an attempt to avoid claims. The Company also recognized that
lawsuits brought against public companies have the potential to result in
defense costs, settlement or judgments that may exceed the ability of companies
to fulfill their customary indemnification obligations to directors and
officers. Consequently, individual officers and directors of the Company would
face exposure to personal liability for the costs of litigation to determine
coverage, to defend claims, and to satisfy judgments or settlements, unless
supplemental insurance coverage was obtained. In order to insure this exposure, during the fourth quarter of 2004 the
Company, entered into contracts with two insurers, which together are designed
to provide further assurance that the Companys indemnification obligations
will be satisfied. The Company purchased a policy of directors and officers
insurance, which, in the event of the Companys inability to pay, will provide
broad coverage to individual officers, and directors in these circumstances
(customarily referred to as Side A coverage). The Company paid $750,000 for
a three-year period of coverage beginning on August 1, 2004 for which the
associated expense is recognized ratably over the coverage period.
Additionally, the Company paid $400,000 in August 2004, which was expensed in
2004, to cover prior claims and certain potential claims, and delivered $2.8
million to the insurer to secure the retained exposure. These held funds are
recorded as Other Assets, and, to the extent they are not exhausted, will be
re-delivered to the Company when exposure to such claims is extinguished by
final resolution of such claims. In each case these policies do not include
most customary exclusions, although no director or officer is provided coverage
for fraudulent or illegal acts. As reported in ITEM 3  Legal Proceedings,
the Company has not recorded any reserve for any such claims, consistent with
the application of SFAS 5, Accounting for Contingencies. Risk Factors You should carefully consider the following factors and all other information
contained in this Form 10-K for the fiscal year ending August 31, 2004 before
you make any investment decisions with respect to the Companys securities.
The risks and uncertainties described below may not be the only risks the
Company faces. Interland has incurred losses since inception and could incur losses in the
future. Interland has incurred net losses and losses from operations for all but one of
each quarterly period from its inception through the fourth quarter of fiscal
2004. A number of factors could increase its operating expenses, such as:  
    
    Adapting network infrastructure and administrative resources to
accommodate additional customers and future growth;
    
    Developing products, distribution, marketing, and management for the mainstream market;
    
    Broadening customer technical support capabilities; and
    
    Improving network security features. To the extent that increases in expenses are not offset by increases in
revenues, operating losses will increase. Ours is a recurring-revenue subscriber business and as such the effects of a
net loss of monthly recurring revenue are magnified. A large majority of our revenue is derived from the monthly recurring charges
(MRC) incurred by owners of hosted websites. Accordingly, the termination of
a single account paying $30.00 per month will affect revenue every month in the
future. The loss of such a customer at the beginning of a fiscal year will
result in a twelve-fold reduction in revenue for that fiscal year, and the loss
of even one such customer each month of the fiscal year will result in a
diminution of 78 times the monthly recurring revenue, or $2,340 over the entire
fiscal year. Absent the addition of customers through acquisitions, Interland
has consistently incurred a net loss in MRC, and this situation may continue
with material negative effects on reported revenue and net income. Although
reductions in MRC may be offset for a time by increases in revenue derived from
one-time or non-recurring charges, the compounding effect of MRC losses will
almost certainly eventually result in a meaningful reduction of reported
revenue. Moreover, because of Interlands relatively low percentage of
variable costs, a concomitantly high percentage of the amount of revenue loss
results in a loss of EBITDA and of net income. There can be no assurance
that Interlands continuing efforts to stabilize or increase its MRC and
revenue will be successful. If revenue continues to decline, the Company may
eventually require additional capital, which may not be available on suitable
terms. Although the Company can reduce spending to some degree, there can be
no assurance in such an event that the Company would be able to continue
indefinitely as a going concern.




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##### Table of Contents



Unfavorable results of existing litigation may cause Interland to have
additional expenses or operating losses that could exceed the Companys ability
to pay. The Company is defending a number of matters in active litigation (See Item 3,
Legal Proceedings). The cost of defending lawsuits, regardless of their
merit, can be substantial. The Company spent $3.0 million during 2004 to
defend lawsuits. Although the Company has favorably resolved a number of
lawsuits through rulings, verdicts, and minimal settlements, and although the
Company may be successful in defending ongoing litigation, the costs of defense
cannot be expected to be avoided. The Company believes it has appropriately
established reserves for the contingency of adverse verdicts. In order for a
loss contingency to be reserved for in the financial statements, GAAP requires
that the information available prior to issuance of the financial statements
indicates that it is probable that an asset had been impaired or a liability
had been incurred at the date of the financial statements, it is implicit in
this condition that it must be probable that one or more future events will
occur confirming the fact of the loss and the amount of loss can be reasonably
estimated. Therefore, the Company has not reserved for all of its pending
lawsuits. Consequently lawsuits for which there is no reserve nonetheless pose
a risk of substantial loss which would have a material effect on the Companys
financial position. Additionally, even in those cases where a reserve has been
established, the amount of the reserve is necessarily an estimate and the
actual result may differ materially. Reserves are established only for the
damages that may be assessed, and do not take into account the costs of
litigation. Even in those instances where Interland may ultimately prevail on
appeal, an adverse verdict in a substantial amount may damage the reputation of
the Company, may require the Company to post an appeal bond in an amount which
deprives the Company of cash, and require additional expenditures for the cost
of appeal. The outcome of litigation is unpredictable, and an adverse final
verdict could exceed the Companys ability to pay. Because Interlands historical financial information is not representative of
its future results, investors and analysts will have difficulty analyzing
Interlands future earnings potential. Because the Company has grown through acquisition and its past operating
results reflect the costs of integrating these acquisitions, historical results
are not representative of future expected operating results. The Company has
recognized very sizeable charges and expenditures in the past for impairment
charges, restructuring costs, network enhancements, and exploration of the
mainstream market. Because these items are not necessarily recurring, it is
more difficult for investors to predict future results. Interland has a limited operating history and its business model is still
evolving, which makes it difficult to evaluate its prospects. Interlands limited operating history makes evaluating its business operations
and prospects difficult. Its range of service offerings has changed since
inception and its business model is still developing. Interland has changed
from being primarily a seller of personal computers and related accessories to
being primarily a Web hosting and Web based value added business solutions
provider to small- and medium-sized businesses company. Because some of its
services are new, the market for them is uncertain. As a result, the revenues
and income potential of its business, as well as the potential benefits of its
acquisitions, may be difficult to evaluate. Quarterly and annual operating results may fluctuate, which could cause
Interlands stock price to be volatile. Past operating results have fluctuated significantly on a quarterly and an
annual basis. Quarterly and annual operating results may continue to
significantly fluctuate due to a wide variety of factors. Because of these
fluctuations, comparing operating results from period to period is not
necessarily meaningful, and it would not be meaningful to rely upon such
comparisons as an indicator of future performance. Factors that may cause its
operating results to fluctuate include, but are not limited to:  
    
    Demand for and market acceptance of the Companys services and products;
    
    Introduction of new services or enhancements by Interland or its competitors;
    
    Costs of implementing new network security features, CRM systems, and billing modules;
    
    Technical difficulties or system downtime affecting the
Internet generally or its hosting operations specifically;
    
    Customer retention;




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
    
    Increased competition and consolidation within the Web hosting and applications hosting markets;
    
    Changes in its pricing policies and the pricing policies of its competitors;
    
    Gains or losses of key strategic partner relationships;
    
    Impairment charges;
    
    Restructuring charges;
    
    Merger and integration costs;
    
    Litigation expenses;
    
    Insurance expenses;
    
    Marketing expenses; and
    
    Seasonality of customer demand Interland cannot provide any assurances that it will succeed in its plans to
increase the size of its customer base, the amount of services it offers, or
its revenues during the next fiscal year and beyond. In addition, relatively
large portions of its expenses are fixed in the short term, and therefore its
results of operations are particularly sensitive to fluctuations in revenues.
Also, if it cannot continue using third-party products in its service
offerings, its service development costs could increase significantly. Interlands stock price may be volatile which could cause an investment in its
common stock to decrease significantly. The market price of its common stock has experienced a significant decline. The
price has been and is likely to continue to be highly volatile. The following
are examples of factors or developments that would likely cause the Companys
stock price to continue to be volatile:  
    
    Variations in operating results and analyst earnings estimates;
    
    The volatility of stock within the sectors within which it conducts business;
    
    Announcements by Interland or its competitors regarding introduction of new services;
    
    General decline in economic conditions;
    
    Reductions in the volume of trading in its common stock, and;
    
    The Companys inability to reduce the rate of account
cancellations, or to increase the rate of account additions, or both. During the 52 weeks ended August 31, 2004 the high and low closing price for
Interland common stock on NASDAQ was $10.56 and $2.67, respectively. Interland operates in a new and evolving market with uncertain prospects for
growth and may not be able to generate and sustain growth in its customer base. Interland operates in a new and evolving market with uncertain prospects for
growth and may not be able to achieve and sustain growth in its customer base
or to maintain its average revenue per customer account (ARPU). The market for
Web hosting and applications-hosting services for small- and medium-sized
businesses, and especially the mainstream market, has only recently begun to
develop and is evolving rapidly. Interlands future growth, if any, will
depend upon the willingness of small- and medium-sized businesses to purchase
Web and applications services, Interlands ability to increase or at least
maintain its average revenues-per customer, and its ability to retain
customers. As of August 31, 2004, Interlands average monthly revenue per
customer account was $27.72 for shared hosting services and $334.88 for
dedicated hosting services, and its average monthly customer turnover was 2.8%
for shared hosting services and 4.6% for dedicated hosting services. The
corresponding average monthly revenue per customer as of August 31, 2003 was
$27.76




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for shared hosting services and $411.54 for dedicated hosting services, and the
associated average monthly customer turnover rates were 4.4% for shared hosting
services and 5.3% for dedicated hosting services. The market for Interlands
services may not develop further, consumers may not widely adopt its services
and significant numbers of businesses or organizations may not use the Internet
for commerce and communication. If this market fails to develop further or
develops more slowly than expected, or if Interlands services do not achieve
broader market acceptance, Interland will not be able to grow its customer
base. In addition, Interland must be able to differentiate itself from its
competition through its service offerings and brand recognition. These
activities may be more expensive than Interland anticipates, and Interland may
not succeed in differentiating itself from its competitors, achieving market
acceptance of its services, or selling additional services to its existing
customer base. Because Interlands target markets are volatile, the Company may face a loss of
customers or a high level of non-collectible accounts. The Company intends to continue to concentrate on serving the small- and
medium-sized business market. This market contains many businesses that may
not be successful, and consequently present a substantially greater risk for
non-collectible accounts receivable and for non-renewal. Moreover, a
significant portion of this target market is highly sensitive to price, and may
be lost to a competitor with a lower pricing structure. Because few businesses
in this target market employ trained technologists, they tend to generate a
high number of customer service and technical support calls. The expense of
responding to these calls is considerable, and the call volume is likely to
increase in direct proportion to revenue, potentially limiting the scalability
of the business. Additionally, if the customer becomes dissatisfied with the
Companys response to such calls, cancellation, non-payment, or non-renewal
becomes more likely. Interlands strategy for minimizing the negative aspects
of its target market include:  
    
    Increased expenditures on sales and marketing programs to replace
failing customers;
    
    Capitalizing on infrastructure efficiencies to become a profitable
provider at the lowest sustainable price;
    
    Automating customer care and technical support to reduce the
cost per call, and to minimize the time spent by Company personnel;
    
    Intensive training and supervision of customer care and
technical support personnel to maximize customer satisfaction; and,
    
    Increasing the number and breadth of services to differentiate
the Company from competition. The Company can give no assurance, however, that any of these measures will be
successful, and the Companys failure to manage these risks could decrease
revenues and profitability. Interland could incur liabilities in the future relating to its PC Systems
business, which could cause additional operating losses. Interland could incur liabilities from the sale of the PC Systems business to
GTG PC. According to the terms of its agreement with GTG PC, it retained
liabilities relating to the operation of the PC systems business prior to the
closing of the transaction including liabilities for taxes, contingent
liabilities and liabilities for accounts payable accrued prior to the closing.
It also agreed to indemnify GTG PC and its affiliates for any breach of its
representations and warranties contained in the agreement for a period of two
years, or for the applicable statute of limitations for matters related to
taxes. Its indemnification obligation is capped at $10.0 million. Except for
claims for fraud or injunctive relief, this indemnity is the exclusive remedy
for any breach of its representations, warranties and covenants contained in
the agreement with GTG PC. Accordingly, it could be required in the future to
make payments to GTG PC and its affiliates in accordance with the agreement,
which could adversely affect its future results of operations and cash flows.
To date it has not had to satisfy any such claims. Because Interland faces intense competition, it may not be able to operate
profitably in its markets. The Web hosting and applications hosting markets are highly competitive, which
could hinder Interlands ability to successfully market its products and
services. The Company may not have the resources, expertise or other
competitive factors to compete successfully in the future. Because there are
few substantial barriers to entry, the Company expects that it will face
additional competition from existing competitors and new market entrants in the
future. Many of Interlands current and potential competitors have greater name
recognition and more established relationships in the industry and greater
resources. As a result, these competitors may be able to:  
    
    Develop and expand their network infrastructures and service offerings
more rapidly;




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##### Table of Contents




    
    Adapt to new or emerging technologies and changes in customer
requirements more quickly;
    
    Devote greater resources to the marketing and sale of their services;
and,
    
    Adopt more aggressive pricing policies than the Company can. Current and potential competitors in the market include Web hosting service
providers, applications hosting providers, Internet service providers,
telecommunications companies, large information technology firms and computer
hardware suppliers. These competitors may operate in one or more of these areas
and include companies such as Yahoo!, NTT/Verio, Affinity Internet, and
Earthlink. Impairment of Interlands intellectual property rights could negatively affect
its business or could allow competitors to minimize any advantage that
Interlands proprietary technology may give it. The Company currently has no patented technology that would preclude or inhibit
competitors from entering the Web hosting market that it serves. While it is
the Companys practice to enter into agreements with all employees and with
some of its customers and suppliers to prohibit or restrict the disclosure of
proprietary information, the Company cannot be sure that these contractual
arrangements or the other steps it takes to protect its proprietary rights will
prove sufficient to prevent illegal use of its proprietary rights or to deter
independent, third-party development of similar proprietary assets. Effective copyright, trademark, trade secret and patent protection may not be
available in every country in which its products and services are offered.
Interland currently is, and in the future may be, involved in legal disputes
relating to the validity or alleged infringement of its intellectual property
rights or those of a third party. Intellectual property litigation is
typically extremely costly and can be disruptive to business operations by
diverting the attention and energies of management and key technical personnel.
In addition, any adverse decisions could subject it to significant liabilities,
require it to seek licenses from others, prevent it from using, licensing or
selling certain of its products and services, or cause severe disruptions to
operations or the markets in which it competes which could decrease
profitability. Periodically, it is made aware of claims, or potential claims, that technology
it used in its discontinued operations may have infringed on intellectual
property rights held by others. The Company has accrued a liability and
charged operations for the estimated costs of settlement or adjudication of
several asserted and unasserted claims for alleged infringement relating to its
discontinued operations prior to the balance sheet date. Resolution of these
claims could be costly and decrease profitability. If Interland is unable to attract and retain key personnel, it may not be able
to compete effectively in its market. The future success of Interland will depend, in part, on its ability to attract
and retain key management, technical, and sales and marketing personnel. The
Company attempts to enhance its management and technical expertise by
recruiting qualified individuals who possess desired skills and experience in
certain targeted areas. The Company experiences strong competition for such
personnel in the Web hosting industry. The Companys inability to retain
employees and attract and retain sufficient additional employees, information
technology, engineering, and technical support resources could adversely affect
its ability to remain competitive in its markets. The Company has and may
continue to face the loss of key personnel, which could limit the ability of
the Company to develop and market its products and services. Interland depends on its reseller sales channel to market and sell many of its
services. Interland does not control its resellers, and if it fails to develop
or maintain good relations with resellers, it may not achieve the growth in
customers and revenues that it expects. An element of the strategy for the Companys growth is to further develop the
use of third parties that resell or recommend its services. Many of these
resellers are Web development or Web consulting companies that also sell
Interlands Web hosting services, but that generally do not have established
customer bases to which they can market these services. The Company is not
currently dependent on any one reseller to generate a significant level of
business, but it has benefited and continues to significantly benefit from
business generated by the reseller channel. Although Interland attempts to
provide its resellers with incentives such as price discounts on its services
that the resellers seek to resell at a profit, the failure of its services to
be commercially accepted in some markets, whether as a result of a resellers
performance or otherwise, could cause its current resellers to discontinue
their relationships with the Company. The Company also is developing
relationships with larger distribution partners, and although the percentage of
the Companys current revenues generated by any of these relationships is
currently small, if the Companys strategy is successful, future revenue growth
will be dependent on the success and maintenance of these relationships.




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Interland is vulnerable to system failures, which could harm its reputation,
cause its customers to seek reimbursement for services, and cause its customers
to seek another provider for services. The Company must be able to operate the systems that manage its network around
the clock without interruption. Its operations will depend upon its ability to
protect its network infrastructure, equipment and customer files against damage
from human error, fire, earthquakes, hurricanes, floods, power loss,
telecommunications failures, sabotage, intentional acts of vandalism and
similar events. The Companys networks are currently subject to various points
of failure. For example, a problem with one of its routers (devices that move
information from one computer network to another) or switches could cause an
interruption in the services the Company provides to a portion of its
customers. In the past, the Company has experienced periodic interruptions in
service. The Company has also experienced, and in the future it may continue to
experience, delays or interruptions in service as a result of the accidental or
intentional actions of Internet users, current and former employees, or others.
Any future interruptions could:  
    
    Cause customers or end users to seek damages for losses incurred;
    
    Require the Company to replace existing equipment or add redundant
facilities;
    
    Damage the Companys reputation for reliable service;
    
    Cause existing customers to cancel their contracts; or
    
    Make it more difficult for the Company to attract new customers. Interlands data centers and network vulnerability to security breaches could
cause disruptions in its service, liability to third parties, or loss of
customers. A significant barrier to electronic commerce and communications is the need for
secure transmission of confidential information over public networks. Some of
the Companys services rely on security technology licensed from third parties
that provides the encryption and authentication necessary to effect the secure
transmission of confidential information. Despite the design and implementation
of a variety of network security measures by the Company, unauthorized access,
computer viruses, accidental or intentional actions and other disruptions could
occur. In addition, inappropriate use of the network by third parties could
also potentially jeopardize the security of confidential information, such as
credit card and bank account numbers stored in the Companys computer systems.
These security problems could result in the Companys liability and could also
cause the loss of existing customers and potential customers. Although the Company continues to implement industry-standard security
measures, third parties may be able to overcome any measures that it
implements. The costs required to eliminate computer viruses and alleviate
other security problems could be prohibitively expensive and the efforts to
address such problems could result in interruptions, delays or cessation of
service to customers, and harm the Companys reputation and growth. Concerns
over the security of Internet transactions and the privacy of users may also
inhibit the growth of the Internet, especially as a means of conducting
commercial transactions. Disruption of Interlands services caused by unknown software or hardware
defects could harm its business and reputation. The Companys service offerings depend on complex software and hardware,
including proprietary software tools and software licensed from third parties.
Complex software and hardware may contain defects, particularly when first
introduced or when new versions are released. The Company may not discover
software or hardware defects that affect its new or current services or
enhancements until after they are deployed. Although Interland has not
experienced any material software or hardware defects to date, it is possible
that defects may exist or occur in the future. These defects could cause
service interruptions, which could damage its reputation or increase its
service costs, cause it to lose revenue, delay market acceptance or divert its
development resources. Providing services to customers with critical websites and Web-based
applications could potentially expose Interland to lawsuits for customers lost
profits or other damages. Because the Companys Web hosting and applications hosting services are
critical to many of its customers businesses, any significant interruption in
those services could result in lost profits or other indirect or consequential
damages to its customers as well as negative publicity and additional
expenditures for it to correct the problem. Although the standard terms and
conditions of the Companys customer contracts disclaim liability for any such
damages, a customer could still bring a lawsuit against it claiming lost
profits or other consequential damages as the result of a service interruption
or other website or application problems that the customer may ascribe to it. A
court might not enforce any limitations on its liability, and the outcome of
any lawsuit would depend on the specific facts of the case and legal and policy
considerations




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even if the Company believes it would have meritorious defenses to any such
claims. In such cases, it could be liable for substantial damage awards. Such
damage awards might exceed its liability insurance by unknown but significant
amounts, which would seriously harm its business. Interland could face liability for information distributed through its network. The law relating to the liability of online services companies for information
carried on or distributed through their networks is currently unsettled. Online
services companies could be subject to claims under both United States and
foreign law for defamation, negligence, copyright or trademark infringement,
violation of securities laws or other theories based on the nature and content
of the materials distributed through their networks. Several private lawsuits
seeking to impose such liability upon other entities are currently pending
against other companies. In addition, organizations and individuals have sent
unsolicited commercial e-mails from servers hosted by service providers to
massive numbers of people, typically to advertise products or services. This
practice, known as spamming, can lead to complaints against service providers
that enable such activities, particularly where recipients view the materials
received as offensive. The Company may, in the future, receive letters from
recipients of information transmitted by its customers objecting to such
transmission. Although the Company prohibits its customers by contract from
spamming, it cannot provide assurances that its customers will not engage in
this practice, which could subject it to claims for damages. In addition, the
Company may become subject to proposed legislation that would impose liability
for or prohibit the transmission over the Internet of some types of
information. Other countries may also enact legislation or take action that
could impose liability on the Company or cause it not to be able to operate in
those countries. The imposition upon the Company and other online services of
potential liability for information carried on or distributed through its
systems could require it to implement measures to reduce its exposure to this
liability, which may require it to expend substantial resources, or to
discontinue service offerings. The increased attention focused upon liability
issues as a result of these lawsuits and legislative proposals also could
affect the rate of growth of Internet use. Interlands business operates in an uncertain legal environment where future
government regulation and lawsuits could restrict Interlands business or cause
unexpected losses. Due to the increasing popularity and use of the Internet, laws and regulations
with respect to the Internet may be adopted at federal, state and local levels,
covering issues such as user privacy, freedom of expression, pricing,
characteristics and quality of products and services, taxation, advertising,
intellectual property rights, information security and the convergence of
traditional telecommunications services with Internet communications. The
Company cannot fully predict the nature of future legislation and the manner in
which government authorities may interpret and enforce such legislation. As a
result, Interland and its customers could be subject to potential liability
under future legislation, which in turn could have a material adverse effect on
the Companys business. The adoption of any such laws or regulations might
decrease the growth of the Internet which in turn could decrease the demand for
the Companys services, or increase the cost of doing business. In addition,
applicability to the Internet of existing laws governing issues such as
property ownership, copyright and other intellectual property issues, taxation,
libel, obscenity and personal privacy is uncertain. These laws generally
pre-date the advent of the Internet and related technologies and, as a result,
do not consider or address the unique issues of the Internet and related
technologies. Substantial future sales of shares by shareholders could negatively affect
Interlands stock price. A number of groups of investors hold substantial numbers of Interland shares,
including the former shareholders of acquired companies, and hedge funds
reported to have investment styles that lead to short-term holdings.
Substantial sales by these holders may adversely affect Interlands stock
price. Item 7A.Quantitative And Qualitative Disclosures About Market Risk Substantially all of
the Companys liquid investments and a majority of its
debt are at fixed interest rates, and therefore the fair value of these
instruments is affected by changes in market interest rates. As of August 31,
2004, approximately 92% of the Companys liquid investments mature within three
months and 8% mature within one year. The majority of the Companys long-term
debt is comprised of a fixed rate promissory note payable. In this regard the underlying debt instruments are not marketable
and, therefore, there is no associated market risk. As of August 31, 2004,
management believes the reported amounts of liquid investments and debt to be
reasonable approximations of their fair values. Generally, the fair market
value of fixed interest rate investment securities will increase as interest
rates fall and decrease as interest rates rise. The Company does not use
derivative financial instruments in its investment portfolio. The portfolio has
been primarily comprised of commercial paper rated A1/P1, bank certificates
rated AA or better, and corporate medium-term notes rated AA or better. At
August 31, 2004, the Companys investment portfolio included fixed rate
securities with an estimated fair value of $31 million. The interest rate
changes affect the fair market values but do not impact earnings or cash flows.
The fair market value of long-term fixed interest rate debt (exclusive of
capital leases) is also subject to interest rate risk. Generally, the fair
market of fixed interest rate debt will increase as interest rates fall and
decrease as interest rates rise. The estimated fair value of the Companys
long-term debt at August 31, 2004 was $4.3 million.




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Item 8. Financial Statements And supplementary Data Index to Consolidated Financial Statements PageConsolidated Financial Statements:Consolidated Statements of Operations for the Fiscal Years Ended August 31, 2004, 2003, and 2002Consolidated Balance Sheets as of August 31, 2004 and 2003Consolidated Statements of Shareholders Equity for the Fiscal Years Ended August 31, 2004, 2003, and 2002Consolidated Statements of Cash Flows for the Fiscal Years Ended August 31, 2004, 2003, and 2002Notes to Consolidated Financial StatementsQuarterly Financial Information (Unaudited)Report of Independent Registered Public Accounting Firm




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Interland, Inc.
Consolidated Statements of Operations(In thousands except per share amounts) Fiscal Year EndedAugust 31,
    
    August 31,
    
    August 31,2004
    
    2003
    
    2002Revenues
    
    $
    102,745
    
    
    $
    106,638
    
    
    $
    101,628Operating costs and expenses:Network operating costs, exclusive of depreciation shown below
    
    
    28,254
    
    
    
    32,856
    
    
    
    34,586Sales and marketing, exclusive of depreciation shown below
    
    
    19,948
    
    
    
    20,269
    
    
    
    26,826Technical support, exclusive of depreciation shown below
    
    
    17,965
    
    
    
    15,709
    
    
    
    16,845General and administrative, exclusive of depreciation shown below
    
    
    30,835
    
    
    
    40,948
    
    
    
    38,893Bad debt expense
    
    
    3,690
    
    
    
    7,335
    
    
    
    10,529Depreciation and amortization
    
    
    30,650
    
    
    
    56,708
    
    
    
    36,719Restructuring costs
    
    
    756
    
    
    
    5,072
    
    
    
    (1,324
    )Merger and integration costs
    
    
    
    
    
    
    494
    
    
    
    8,138Goodwill impairment
    
    
    66,587
    
    
    
    89,928
    
    
    
    Asset impairment
    
    
    7,009
    
    
    
    13,868
    
    
    
    Other expense (income), net
    
    
    (192
    )
    
    
    1,286
    
    
    
    681Total operating costs and expenses
    
    
    205,502
    
    
    
    284,473
    
    
    
    171,893Operating loss
    
    
    (102,757
    )
    
    
    (177,835
    )
    
    
    (70,265
    )Interest income (expense), net
    
    
    (202
    )
    
    
    (327
    )
    
    
    752Loss from continuing operations before income taxes
    
    
    (102,959
    )
    
    
    (178,162
    )
    
    
    (69,513
    )Income tax benefit (expense)
    
    
    
    
    
    
    (629
    )
    
    
    64,241Net loss from continuing operations
    
    
    (102,959
    )
    
    
    (178,791
    )
    
    
    (5,272
    )Income/(loss) from discontinued operations, net of tax
    
    
    (1,704
    )
    
    
    4,912
    
    
    
    (6,021
    )Net loss
    
    $
    (104,663
    )
    
    $
    (173,879
    )
    
    $
    (11,293
    )Net Income/(loss) per share, basic and diluted:Continuing operations
    
    $
    (6.40
    )
    
    $
    (12.19
    )
    
    $
    (0.38
    )Discontinued operations
    
    
    (0.10
    )
    
    
    0.34
    
    
    
    (0.44
    )$
    (6.50
    )
    
    $
    (11.85
    )
    
    $
    (0.82
    )Number of shares used in per share calculation:Basic and diluted
    
    
    16,096
    
    
    
    14,668
    
    
    
    13,739
 The accompanying notes are an integral part of these consolidated financial statements.




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Interland, Inc.
Consolidated Balance Sheets(In thousands) As ofAugust 31,
    
    August 31,2004
    
    2003AssetsCurrent assetsCash and cash equivalents
    
    $
    25,228
    
    
    $
    35,255Short term investments
    
    
    2,500
    
    
    
    16,300Trade receivables, net of the allowance of $381 and $373, respectively
    
    
    2,431
    
    
    
    3,556Other receivables
    
    
    553
    
    
    
    1,604Income taxes recoverable
    
    
    
    
    
    
    612Other current assets
    
    
    3,479
    
    
    
    3,210Restricted investments
    
    
    283
    
    
    
    362Total current assets
    
    
    34,474
    
    
    
    60,899Restricted investments
    
    
    10,609
    
    
    
    18,264Property plant and equipment, net
    
    
    24,508
    
    
    
    35,935Goodwill
    
    
    
    
    
    
    66,646Intangibles, net
    
    
    12,077
    
    
    
    24,791Other assets
    
    
    3,244
    
    
    
    507Total assets
    
    $
    84,912
    
    
    $
    207,042Liabilities and shareholders equityCurrent liabilitiesAccounts payable
    
    $
    2,517
    
    
    $
    1,488Accrued expenses
    
    
    12,105
    
    
    
    16,489Accrued restructuring charges
    
    
    4,393
    
    
    
    7,166Current portion of long-term debt and capital lease obligations
    
    
    2,271
    
    
    
    10,845Deferred revenue
    
    
    7,777
    
    
    
    10,991Total current liabilities
    
    
    29,063
    
    
    
    46,979Long-term debt and capital lease obligations
    
    
    3,473
    
    
    
    1,654Deferred revenue, long-term
    
    
    268
    
    
    
    354Other liabilities
    
    
    3,209
    
    
    
    5,397Total liabilities
    
    
    36,013
    
    
    
    54,384Commitments and contingencies (Notes 21 & 22)
    
    
    
    
    
    
    Shareholders equityCommon stock, $.01 par value, authorized 21 million shares,
issued and outstanding 16.1 and 16.3 million shares, respectively
    
    
    161
    
    
    
    164Additional capital
    
    
    321,091
    
    
    
    322,523Warrants
    
    
    4,603
    
    
    
    4,990Deferred compensation
    
    
    (320
    )
    
    
    (1,046
    )Note receivable from shareholder
    
    
    (735
    )
    
    
    (2,735
    )Accumulated deficit
    
    
    (275,901
    )
    
    
    (171,238
    )Total shareholders equity
    
    
    48,899
    
    
    
    152,658Total liabilities and shareholders equity
    
    $
    84,912
    
    
    $
    207,042
 The accompanying notes are an integral part of these consolidated financial statements.




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Interland, Inc.
Consolidated Statements of Shareholders Equity(in thousands, except per share amounts) Common Stock
    
    Additional
    
    
    
    
    
    Deferred
    
    Note Receivable
    
    Retained
    
    TotalShareholdersShares
    
    Amount
    
    Capital
    
    Warrants
    
    Compensation
    
    From Shareholder
    
    Earnings
    
    EquityBalance, August 31, 2001
    
    
    13,776
    
    
    $
    1,378
    
    
    $
    282,738
    
    
    $
    1,690
    
    
    $
    (3,310
    )
    
    $
    
    
    
    $
    13,934
    
    
    $
    296,430Stock issued to purchase:CommuniTech
    
    
    538
    
    
    
    54
    
    
    
    10,727
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,781iNNERHOST
    
    
    417
    
    
    
    42
    
    
    
    12,222
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,264Stock sold
    
    
    22
    
    
    
    2
    
    
    
    324
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    326Stock options exercised
    
    
    65
    
    
    
    5
    
    
    
    803
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    808Stock received in settlement of note
    
    
    (24
    )
    
    
    (2
    )
    
    
    (404
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (406
    )Repurchase and retirement of stock
    
    
    (663
    )
    
    
    (66
    )
    
    
    (9,713
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,779
    )Non-cash compensation
    
    
    
    
    
    
    
    
    
    
    252
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    252Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,082
    
    
    
    
    
    
    
    
    
    
    
    1,082Issuance of notes receivable
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,735
    )
    
    
    
    
    
    
    (2,735
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11,293
    )
    
    
    (11,293
    )Balance, August 31, 2002
    
    
    14,131
    
    
    $
    1,413
    
    
    $
    296,949
    
    
    $
    1,690
    
    
    $
    (2,228
    )
    
    $
    (2,735
    )
    
    $
    2,641
    
    
    $
    297,730Stock issued to purchase:
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    iNNERHOST
    
    
    553
    
    
    
    55
    
    
    
    (72
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (17
    )Trellix
    
    
    300
    
    
    
    30
    
    
    
    4,866
    
    
    
    3,300
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,196Hostcentric
    
    
    1,357
    
    
    
    136
    
    
    
    20,302
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,438Stock sold
    
    
    34
    
    
    
    4
    
    
    
    290
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    294Stock options exercised
    
    
    23
    
    
    
    2
    
    
    
    190
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    192Repurchase and retirement of stock
    
    
    (85
    )
    
    
    (8
    )
    
    
    (976
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (984
    )Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    (607
    )
    
    
    
    
    
    
    1,182
    
    
    
    
    
    
    
    
    
    
    
    575Non-cash compensation
    
    
    9
    
    
    
    1
    
    
    
    112
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    113Adjustment 1-for-10 reverse stock split
    
    
    
    
    
    
    (1,469
    )
    
    
    1,469
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (173,879
    )
    
    
    (173,879
    )Balance, August 31, 2003
    
    
    16,322
    
    
    $
    164
    
    
    $
    322,523
    
    
    $
    4,990
    
    
    $
    (1,046
    )
    
    $
    (2,735
    )
    
    $
    (171,238
    )
    
    $
    152,658Stock sold
    
    
    47
    
    
    
    
    
    
    
    226
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    226Repurchase and retirement of stock and note receivable
    
    
    (273
    )
    
    
    (3
    )
    
    
    (1,997
    )
    
    
    
    
    
    
    
    
    
    
    2,000
    
    
    
    
    
    
    
    Retirement of warrants
    
    
    
    
    
    
    
    
    
    
    387
    
    
    
    (387
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    (48
    )
    
    
    
    
    
    
    726
    
    
    
    
    
    
    
    
    
    
    
    678Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (104,663
    )
    
    
    (104,663
    )Balance, August 31, 2004
    
    
    16,096
    
    
    $
    161
    
    
    $
    321,091
    
    
    $
    4,603
    
    
    $
    (320
    )
    
    $
    (735
    )
    
    $
    (275,901
    )
    
    $
    48,899
 The accompanying notes are an integral part of these consolidated financial statements.




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##### Table of Contents



Interland, Inc.
Consolidated Statement of Cash Flow(In thousands) For the twelve months endedAug 31,
    
    Aug 31,
    
    Aug 31,2004
    
    2003
    
    2002CASH FLOWS FROM OPERATING ACTIVITIESNet loss
    
    $
    (104,663
    )
    
    $
    (173,879
    )
    
    $
    (11,293
    )Adjustments to reconcile net loss to net cash used in
operating activities from continuing operations:Loss from discontinued operations
    
    
    1,704
    
    
    
    (4,912
    )
    
    
    6,021Depreciation and amortization
    
    
    30,650
    
    
    
    56,708
    
    
    
    36,719Bad debt expense
    
    
    3,690
    
    
    
    7,335
    
    
    
    10,529Loss (gain) on sale of assets
    
    
    (159
    )
    
    
    1,641
    
    
    
    Goodwill and asset impairment
    
    
    73,596
    
    
    
    103,796
    
    
    
    Amortization of deferred compensation
    
    
    678
    
    
    
    2,189
    
    
    
    4,271Changes in operating assets and liabilities
net of effect of acquisitions:Receivables
    
    
    (1,514
    )
    
    
    (2,323
    )
    
    
    (9,407
    )Income tax recoverable
    
    
    612
    
    
    
    778
    
    
    
    19,008Other current assets
    
    
    (206
    )
    
    
    742
    
    
    
    139Accounts payable, accrued expenses and deferred revenue
    
    
    (8,447
    )
    
    
    (24,951
    )
    
    
    (23,481
    )Cash provided by (used in) operating activities of continuing operations
    
    
    (4,059
    )
    
    
    (32,876
    )
    
    
    32,506CASH FLOWS FROM INVESTING ACTIVITIESExpenditures for property, plant, and equipment
    
    
    (11,892
    )
    
    
    (13,152
    )
    
    
    (5,596
    )Purchases of held-to-maturity investment securities
    
    
    (2,000
    )
    
    
    (32,300
    )
    
    
    (83,872
    )Proceeds from held-to-maturity investment securities
    
    
    15,800
    
    
    
    68,700
    
    
    
    70,440Deposits of restricted cash and other deposits
    
    
    (2,800
    )
    
    
    
    
    
    
    (6,213
    )Net change in restricted investments
    
    
    7,734
    
    
    
    15,828
    
    
    
    Acquisitions, net of cash acquired
    
    
    242
    
    
    
    (8,630
    )
    
    
    (42,509
    )Notes issued to related party
    
    
    
    
    
    
    
    
    
    
    (2,735
    )Investing, other
    
    
    
    
    
    
    300
    
    
    
    Cash provided by (used in) investing activities of continuing operations
    
    
    7,084
    
    
    
    30,746
    
    
    
    (70,485
    )CASH FLOWS FROM FINANCING ACTIVITIESRepayments of debt and capital lease obligations
    
    
    (11,536
    )
    
    
    (21,543
    )
    
    
    (18,339
    )Proceeds from issuance of common stock
    
    
    226
    
    
    
    433
    
    
    
    1,134Purchase and retirement of stock
    
    
    
    
    
    
    (985
    )
    
    
    (9,779
    )Financing, other
    
    
    
    
    
    
    38
    
    
    
    Cash used in financing activities of continuing operations
    
    
    (11,310
    )
    
    
    (22,057
    )
    
    
    (26,984
    )Net cash used in continuing operations
    
    
    (8,285
    )
    
    
    (24,187
    )
    
    
    (64,963
    )Net cash used in discontinued operations
    
    
    (1,742
    )
    
    
    (3,251
    )
    
    
    (15,019
    )Net decrease in cash and cash equivalents
    
    
    (10,027
    )
    
    
    (27,438
    )
    
    
    (79,982
    )Cash and cash equivalents at beginning of period
    
    
    35,255
    
    
    
    62,693
    
    
    
    142,675Cash and cash equivalents at end of period
    
    $
    25,228
    
    
    $
    35,255
    
    
    $
    62,693Supplemental DisclosuresIncome taxes paid, net of amounts recovered
    
    $
    
    
    
    $
    
    
    
    $
    (87,984
    )Interest paid, net of amounts capitalized
    
    
    927
    
    
    
    2,574
    
    
    
    3,227Equipment acquired under capital lease
    
    
    
    
    
    
    
    
    
    
    6,383Common stock and warrants issued for acquisition
    
    
    
    
    
    
    28,617
    
    
    
    23,045Related party receivable settled in stock
    
    
    
    
    
    
    
    
    
    
    600
 The accompanying notes are an integral part of these consolidated financial statements.




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##### Table of Contents



Interland, Inc.Notes to Consolidated Financial Statements 1. General Business Interland, Inc. together with its subsidiaries (collectively the
Company), is a leader in efficiently packaging, distributing, and supporting
business-class, online marketing solutions to small and medium business (SME)
owners, both directly and through partners, enabling those businesses to gain
new relationships and better support communication with their existing
customers locally and around the world. Interland continues to offer a broad
range of products and services, including shared and dedicated hosting
services, e-commerce, application hosting, website development, marketing, and
optimization tools. History of operating losses The Companys Web hosting business has
historically incurred net losses and losses from operations. The Companys
future operation is dependent upon its ability to achieve and sustain positive
cash flow prior to the depletion of cash resources. The Company plans to reduce
its level of cash requirements through a decrease in capital purchases and by
improving sales and reducing churn. The Company also will have reduced cash
outlays for payments associated with prior integration and discontinued
operation liabilities and will have reduced debt payments because of the buyout
of capital lease obligations during 2004. The Company expects to continue to
have negative cash flows for at least the next four quarters as it continues to
execute on its business plan. There can be no assurance that Interlands
continuing efforts to stabilize or increase its revenue will be successful and
the Company will be able to continue as a going concern. If the Company is
unable to successfully execute its business plan, it may require additional
capital, which may not be available on suitable terms. Nonetheless, management
believes it has adequate cash and liquid resources to fund operations and
planned capital expenditures through at least the next 12 months. 2. Significant Accounting Policies Basis of Presentation The financial statements include the accounts of
Interland, Inc. and its wholly owned subsidiaries. All significant
intercompany balances and transactions have been eliminated. All references to
periods including annual and quarterly are on a fiscal basis. Use of estimates The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America,
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements. The amounts that the Company will
ultimately incur or recover could differ materially from its current estimates.
The underlying estimates and facts supporting these estimates could change in
2005 and thereafter. Revenue recognitionRevenues are primarily generated from shared and
dedicated hosting, managed services, e-commerce services, applications hosting
and domain name registrations. Revenues are recognized as the services are
provided. Hosting contracts generally are for service periods ranging from one
to twenty-four months and typically require up-front fees. These fees,
including set-up fees for hosting services, are deferred and recognized ratably
over the customers expected service period. Deferred revenues represent the
liability for advance billings to customers for services not yet provided. Reverse stock split In June 2003, the Company announced that its board of
directors had approved a 1-for-10 reverse stock split. The reverse stock split
was made effective as of the close of the market on August 1, 2003, and the
Companys common stock began trading on a reverse split basis on August 4, 2003
and effectively reduced the number of shares of common stock issued and
outstanding from approximately 162.6 million to approximately 16.3 million. All
per share and number of shares outstanding in this report have been revised for
the reverse stock split. Basic and diluted income (loss) per share In accordance with SFAS No. 128,
Earnings Per Share, diluted earnings per share excludes anti-dilutive
employee stock options and warrants of approximately 1.8 million, 2.5 million
and 2.0 million in 2004, 2003, and 2002, respectively. Basic income (loss) per
share is computed using the weighted average number of common shares
outstanding. Diluted income (loss) per share is computed using the weighted
average number of common shares outstanding and potential common shares
outstanding when their effect is dilutive. Potential common shares result from
the assumed exercise of outstanding stock options and warrants. Because the
Company has reported a loss from continuing operations during fiscal years
2004, 2003, and 2002, the effect of dilutive securities are excluded from the
calculation of per share amounts for these years. In addition to net income (loss) per share, the Company has also reported per
share amounts on the separate income statement components required by
Accounting Principles Board (APB) Opinion No. 30, Reporting the Results of




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) Operations  Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,  as
the disposal activities of the Companys discontinued operations were initiated
prior to the Companys adoption of SFAS 144, Accounting for the Impairment or
Disposal of Long-Lived Assets on September 1, 2002. Because the Company has
reported a loss from continuing operations during fiscal years 2004,
2003, and 2002, the effect of dilutive securities is excluded from the calculation of per
share amounts for those years. Comprehensive income The Company reports comprehensive income in accordance
with Statement of Financial Accounting Standards (SFAS) No. 130, Reporting
Comprehensive Income. This statement requires the disclosure of accumulated
other comprehensive income or loss (excluding net income or loss) as a separate
component of shareholders equity. For all periods presented, comprehensive
income is the same as net income. Financial instruments and concentration of credit risk Cash equivalents
include highly liquid short-term investments with original maturities of three
months or less, readily convertible to known amounts of cash. The amounts
reported as cash equivalents, restricted investments, short-term investments,
receivables, accounts payable, accrued expenses and debt are considered by
management to be reasonable approximations of their fair values, based on
information available as of August 31, 2004. The use of different assumptions
could have a material effect on the estimated fair value amounts. The reported
fair values do not take into consideration potential taxes or other expenses
that would be incurred in an actual settlement. Financial instruments that potentially subject the Company to concentration of
credit risk consist principally of cash and cash equivalents, short- and
long-term investments and trade and other receivables. The Company invests its
cash in credit instruments of highly rated financial institutions and performs
periodic evaluations of the credit standing of these financial institutions.
The Companys policies limit the concentration of credit exposure by
restricting investments with any single obligor, instrument or geographic area.
The Companys policies limit the concentration of accounts receivable credit
exposure by requiring the majority of customers to prepay their hosting fees
prior to initiating services. Restricted investments Restricted investments consist primarily of commercial
paper and money market securities with maturities of less than one year. The
Company has classified these investments as held-to-maturity as the Company has
the intent and ability to hold these securities to maturity. These investments
are carried at cost, which approximates fair market value. Realized gains and
losses are included in earnings. These investments are restricted to use by
certain vendors and creditors for rent, credit card processing, lease payments,
and other items. These investments are classified based upon the term of the
restriction, not necessarily the underlying security. Goodwill and other intangibles In accordance with SFAS No. 142, Goodwill and
Other Intangible Assets (SFAS 142), goodwill is no longer amortized, but is
tested for impairment, at least annually, using the quoted market price of the
Companys stock as an indicator of fair value. If impairment of carrying value
based on the calculated fair value exists, the Company measures the impairment
through the use of discounted cash flows. Intangible assets acquired as part
of a business combination are accounted for in accordance with SFAS No. 141,
Business Combinations, and are recognized apart from goodwill if the
intangible asset arises from contractual or other legal rights or the asset is
capable of being separated from the acquired enterprise. Intangible assets are
reviewed for impairment by applying the recognition and measurement provisions,
which compare the carrying amount of the intangible asset to its fair value.
If the carrying amount exceeds fair value, an impairment loss is recognized.
Intangible assets are amortized, using the straight-line method, over the
estimate of their period of benefit of three to seven years. Property, plant and equipment Property, plant and equipment, including
software, are stated at cost less accumulated depreciation and amortization.
The straight-line depreciation method is used for property, plant and equipment
over the estimate of their useful lives. Changes in technology or changes in
the intended use of property, plant and equipment may cause the estimated
period of use or the value of these assets to change. An annual analysis is
performed to confirm the appropriateness of estimated economic useful lives for
each category of current property, plant and equipment. Additionally,
long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that their carrying amounts may not be recoverable.
Estimates and assumptions used in both setting depreciable lives and testing
for recoverability require management judgment. The Company leases certain
equipment under capital leases. Equipment under capital leases is depreciated
using the straight-line method over the shorter of the lease term or estimated
useful life of the asset. Leasehold improvements are amortized over the
shorter of the lease term or the estimated useful life of the improvement.
Gains and losses related to the retirement or disposal of fixed assets are
recognized in the period in which the transaction occurred.




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) Advertising Advertising costs are charged to operations as incurred. Total
advertising expense was $8.9 million, $10.5 million, and $13.0 million for the
years ending August 31, 2004, 2003, and 2002, respectively. Income taxes The Company accounts for income taxes under the provisions of
SFAS No. 109, Accounting for Income Taxes, (SFAS 109). SFAS 109 requires
recognition of deferred tax liabilities and assets for the expected future tax
consequences of events that have been included in the financial statements or
tax returns. Under this method, deferred tax liabilities and assets are
determined based on the difference between the financial statement and tax
basis of assets and liabilities using enacted tax rates in effect for the year
in which the difference is expected to reverse. Stock-Based Employee Compensation The Company accounts for stock-based
compensation issued to employees using the intrinsic value method as prescribed
by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees and has adopted the disclosure requirements of SFAS No.
123 Accounting for Stock-Based Compensation, (SFAS 123), as amended by SFAS
No. 148 Accounting for Stock Based Compensation  Transition and Disclosure 
an amendment of SFAS No. 123, (SFAS 148). If the Company had elected to adopt the optional recognition provisions of SFAS
No. 123, which uses the fair value based method for stock-based compensation,
and amortized the fair value of the options to compensation expense on a
straight-line basis over the vesting period of the options, the following table
illustrates the effect on net loss and loss per share: Fiscal year endedAugust 31,
    
    August 31,
    
    August 31,2004
    
    2003
    
    2002(In thousands, except per share numbers)Net loss as reported
    
    $
    (104,663
    )
    
    $
    (173,879
    )
    
    $
    (11,293
    )Add: Stock-based employee compensation
expense included in reported net income,
net of related tax effects
    
    
    678
    
    
    
    573
    
    
    
    1,083Deduct: Total stock-based employee compensation
expense determined under fair value method-based methods for all awards, net of tax effects
    
    
    (2,117
    )
    
    
    (891
    )
    
    
    4,510Proforma net loss
    
    $
    (106,102
    )
    
    $
    (174,197
    )
    
    $
    (5,700
    )Loss per share:Basic and diluted  as reported
    
    $
    (6.50
    )
    
    $
    (11.85
    )
    
    $
    (0.82
    )Basic and diluted  pro forma
    
    $
    (6.59
    )
    
    $
    (11.88
    )
    
    $
    (0.41
    )Weighted average shares outstandingBasic and diluted
    
    
    16,096
    
    
    
    14,668
    
    
    
    13,739
 Recently issued accounting standardsIn December 2003, the SEC issued Staff
Accounting Bulletin No. 104, Revenue Recognition, (SAB 104), which updates
the guidance in SAB No. 101, integrates the related set of Frequently Asked
Questions, and recognizes the role of EITF 00-21. The adoption of SAB No. 104
did not have a material effect on the Companys consolidated financial
statements. In December 2003, the FASB issued a replacement document FASB Interpretation
No. 46R, Consolidation of Variable Interest Entities (FIN 46R), which was
issued to clarify the implementation of FIN 46, issued January 2003. The
Company has evaluated its investments and concluded that none of the Companys
investments meets the requirements for consideration under FIN 46R. 3. Discontinued Operations PC Systems In 2001, the Company sold its PC Systems business to GTG PC Holdings, LLC (GTG
PC), an affiliate of the Gores Technology Group. The Company retained all
liabilities of the PC Systems business not assumed by GTG PC, including, for
example, liabilities for taxes arising prior to the closing of the transaction,
employee termination and related expenses, and any contingent liabilities
arising prior to the closing date. In addition, the Company is




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) obligated for
an indefinite period of time to indemnify the purchaser and affiliated entities
for any breaches in
covenants. The agreement provides that the maximum aggregate liability of the
Company for indemnification under the agreement is $10.0 million. In fiscal 2002, the Company recognized an estimated additional loss on the
disposal of PC Systems of $6.0 million. Included in the loss recognized in
fiscal 2002 is a $3.8 million charge in connection with the resolution of
disputed obligations owed to the Company by GTG PC Holdings, LLC an affiliate
of Gores Technology Group. In addition, the Company wrote down certain sales
tax receivable balances to their net realizable value, which resulted in a
charge of $0.7 million. The Company also accrued $0.7 million in contingent
liabilities, and $0.6 million in legal expenses related to the disposal of
discontinued operations. In fiscal 2003, the Company recognized a gain of $4.9 million on the disposal
of discontinued operations. This gain consisted of a $5.5 million reduction in
the Companys liability for PC Systems sales taxes payable with various
jurisdictions including a settlement reached with the state of Idaho, and a
$0.4 million reduction in the Companys liability for PC Systems payroll
taxes. These gains were partially offset by a $0.7 million increase in
required legal reserves and $0.3 million in other various charges related to
discontinued operations. In fiscal 2004, the Company recognized a loss of $1.7 million on the disposal
of discontinued operations. This expense is primarily related to the Companys
defense of several pending claims concerning the intellectual property rights
of its discontinued operations. As of August 31, 2004, the Company had an
aggregate amount of $1.0 million accrued for such matters, a reserve of $1.2
million for sales and use tax assessments and audits, and an accrual of $0.3
million for other discontinued operation liabilities. 4. Restructuring And Facility Exit Costs 2001 Plan During the fourth quarter of 2001, the Company approved and implemented a
restructuring program in connection with its acquisition of Interland-Georgia
(the 2001 Plan). This restructuring plan provided for the consolidation of
the Companys operations and elimination of duplicative facilities obtained as
a result of previous business acquisitions and has expected payments through
December 2009. In accordance with EITF No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity, the
restructuring costs, excluding asset impairments, were recognized as
liabilities at the time management committed to the plan. Management
determined that these costs provided no future economic benefit, they were
incremental to other costs incurred by the Company prior to the restructuring,
or were contractual obligations that existed prior to the date the plan was
approved and were either continued after the exit plan was completed with no
economic benefit to the Company or could not be cancelled without penalty; and
they were incurred as a direct result of the plan to exit the identified
activities. The asset impairments were accounted for in accordance with SFAS
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of. The Company recorded a charge of approximately
$110.3 million related to employee termination benefits, facility closure
costs, asset disposals and other exit costs. The following table shows a reconciliation of the beginning and ending
restructuring liability balances from inception through August 31, 2004 related
to all restructuring activities recorded by the Company under the 2001 Plan.
Besides the cash payments, net of sublease received, of $2.2 million during
2004, a $0.2 million adjustment to the remaining liability was added to reflect
the remaining expected liability of $3.6 million at August 31, 2004, which
represents the remaining net lease payments to be paid in cash through 2007. During fiscal 2003, the Company settled certain data connectivity contract
obligations for amounts less than the original estimates. In connection with
the settlements, the bandwidth termination costs accrual was reduced
by $1.0 million and is reflected in the 2001 Plan table in Other adjustments. In
addition, one of the Companys lease abandonment liabilities was reduced by
$0.3 million in connection with the reduction of the Companys obligation due
to a sublease arrangement for the facility. During fiscal 2002, the 2001 Plan restructuring liability pertaining to lease
abandonments was increased by $1.3 million due to the impact of revised exit
plans pertaining to the Companys Seattle, Washington facility. During the
third quarter of 2002, the Company settled a disputed tenant improvement
allowance with the landlord of an exited facility. In connection with the
settlement, the Company is no longer responsible for paying approximately $0.7 million
of the remaining lease payments required over the remaining lease term,
which was originally accrued in the restructuring charge. Accordingly, the
lease abandonment accrual was reduced by $0.7 million and is reflected in




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Interland, Inc.
Notes to Consolidated Financial Statements (continued) the
table below in Other adjustments. The liability was also decreased by $0.1
million to reflect the lease termination for the Companys Los Angeles,
California facility. These three adjustments net to $0.5 million as indicated
in the schedule above under Lease abandonments. Also during fiscal 2002, the
restructuring liability pertaining to other exit costs was reduced by $1.9 million in connection with
the settlement of certain data connectivity contract obligations for amounts
different from original estimates. Property,
    
    
    
    
    
    EmployeeLease
    
    plant, and
    
    Other exit
    
    termination
    
    Goodwill andabandonments
    
    equipment
    
    costs
    
    benefits
    
    Intangibles
    
    Total(In thousands)Balance at August 31, 2000
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    -Plan charges
    
    
    9,404
    
    
    
    26,915
    
    
    
    3,528
    
    
    
    727
    
    
    
    69,704
    
    
    
    110,278Cash paid
    
    
    (683
    )
    
    
    
    
    
    
    
    
    
    
    (498
    )
    
    
    
    
    
    
    (1,181
    )Non-cash write downs
    
    
    
    
    
    
    (26,915
    )
    
    
    
    
    
    
    
    
    
    
    (69,704
    )
    
    
    (96,619
    )Balance at August 31, 2001
    
    $
    8,721
    
    
    $
    
    
    
    $
    3,528
    
    
    $
    229
    
    
    $
    
    
    
    $
    12,478Cash paid
    
    
    (1,625
    )
    
    
    
    
    
    
    (487
    )
    
    
    (229
    )
    
    
    
    
    
    
    (2,341
    )Other adjustments
    
    
    538
    
    
    
    
    
    
    
    (1,862
    )
    
    
    
    
    
    
    
    
    
    
    (1,324
    )Balance at August 31, 2002
    
    $
    7,634
    
    
    $
    
    
    
    $
    1,179
    
    
    $
    
    
    
    $
    
    
    
    $
    8,813Cash paid
    
    
    (1,701
    )
    
    
    
    
    
    
    (199
    )
    
    
    
    
    
    
    
    
    
    
    (1,900
    )Other adjustments
    
    
    (297
    )
    
    
    
    
    
    
    (980
    )
    
    
    
    
    
    
    
    
    
    
    (1,277
    )Balance at August 31, 2003
    
    $
    5,636
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    5,636Cash paid
    
    
    (2,192
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,192
    )Other adjustments
    
    
    178
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    178Balance at August 31, 2004
    
    $
    3,622
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    3,622
 2003 Plan During the second quarter of 2003, the Company approved and initiated a program
to exit certain facilities and consolidate those operations into other existing
facilities (the 2003 Plan). This restructuring plan was part of managements
continued plan to streamline the Companys operations and to reduce long-term
operating costs. In accordance with SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities, costs associated with these
activities have been recognized and measured at their fair value in the period
in which the liabilities are incurred. One-time termination benefits for
employees required to render services until they are terminated in order to
receive termination benefits were recognized ratably over the future service
period. The plan provided for the closure of three data center facilities, a
reduction of related workforce of approximately 171 employees, and the
termination of bandwidth and data connectivity contracts in place at these and
other facilities. The 2003 Plan charges consisted of $2.1 million in lease
termination costs, $1.9 million in bandwidth termination costs, $1.3 million in
employee termination benefits, and $1.3 in fixed asset related charges. These
charges were partially offset by $0.2 million of various adjustments, including
the settlement of certain data connectivity contract obligations for amounts
less than the original estimates. There was also a charge for $0.9 million to
property, plant and equipment representing the write down of remaining book
value of fixed assets originally written down to their estimated salvage value
included in the restructuring charge recorded in the 2003 Plan charges. The following table shows a reconciliation of the beginning and ending
liability balances from inception through August 31, 2004 related to all
restructuring activities recorded by the Company under the 2003 Plan. The
balance at August 31, 2004 represents the remaining bandwidth termination
liabilities to be paid in cash. During 2004, the Company paid out certain
negotiated liabilities and reduced its reserves related to property, plant and
equipment, lease abandonments and other exit cost obligations by $0.5 million
as a result of continued negotiations. The Company expects to have resolution
of the remaining liability in fiscal year 2005.




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) Property,
    
    
    
    
    
    EmployeeLease
    
    plant, and
    
    Other exit
    
    terminationabandonments
    
    equipment
    
    costs
    
    benefits
    
    Total(In thousands)Balance at August 31, 2002
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Plan charges
    
    
    2,061
    
    
    
    1,317
    
    
    
    1,886
    
    
    
    1,317
    
    
    
    6,581Cash paid
    
    
    (2,130
    )
    
    
    (227
    )
    
    
    (426
    )
    
    
    (1,165
    )
    
    
    (3,948
    )Other adjustments
    
    
    79
    
    
    
    46
    
    
    
    (236
    )
    
    
    (121
    )
    
    
    (232
    )Non-cash write down
    
    
    
    
    
    
    (871
    )
    
    
    
    
    
    
    
    
    
    
    (871
    )Balance at August 31, 2003
    
    $
    10
    
    
    $
    265
    
    
    $
    1,224
    
    
    $
    31
    
    
    $
    1,530Cash paid
    
    
    (6
    )
    
    
    (236
    )
    
    
    (227
    )
    
    
    (31
    )
    
    
    (500
    )Other adjustments
    
    
    (4
    )
    
    
    (29
    )
    
    
    (453
    )
    
    
    
    
    
    
    (486
    )Balance at August 31, 2004
    
    $
    
    
    
    $
    
    
    
    $
    544
    
    
    $
    
    
    
    $
    544
 2004 Plan In March 2004, the Company decided to change its approach to distributing its
mainstream market hosting solutions from reliance upon a direct field sales
force to an indirect channel approach (the 2004 Plan). Due to this decision,
the Company implemented a restructuring program to reduce its cost structure.
These restructuring charges include $0.3 million for lease commitments and $0.8
million for employee severance and benefits expense. The following table shows a reconciliation of the beginning and ending
liability balances from inception through August 31, 2004 related to all
restructuring activities recorded by the Company under the 2004 Plan. The
remaining balance represents lease payment liabilities of $0.2 million to be
paid in cash ending in April 2005 and employee severance related costs to be
paid out in early 2005. EmployeeLease
    
    terminationabandonments
    
    benefits
    
    Total(In thousands)Balance at August 31, 2003
    
    $
    
    
    
    $
    
    
    
    $
    Plan charges
    
    
    279
    
    
    
    785
    
    
    
    1,064Cash paid
    
    
    (72
    )
    
    
    (765
    )
    
    
    (837
    )Balance at August 31, 2004
    
    $
    207
    
    
    $
    20
    
    
    $
    227
 5. Merger and Integration Costs During 2004 there were no charges related to merger and integration costs. In
2003, the Company recorded $0.5 million of merger and integration costs for
severance and employee relocation expenses. In 2002, the Company recorded a
charge for merger and integration costs of $8.1 million. Included in this
charge was $4.2 million for employee termination benefits, $2.5 million for
relocation costs, $0.7 million for employee retention bonuses, $0.2 million for
legal services and $0.5 million for other non-capitalizable costs related to
the merger and integration of the Companys acquisitions including
Interland-Georgia, CommuniTech.Net, Dialtone, Inc., and iNNERHOST, Inc. 6. Other Expense (income), net In 2004 the Company recorded income of $0.2 million primarily related to a gain
on the sale of long-lived assets. The Company recorded $1.3 million to other
expense in fiscal 2003. The Company recorded a write-off of $1.6 million as
the result of a fixed asset physical inventory offset by a gain of $0.3 million
on the sale of some of its fixed assets. During fiscal 2002, the Company
completed the sale of its remaining Boise-based consumer dial-up accounts and
certain data center assets. The sale resulted in a net loss of $0.7 million.




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) 7. Acquisitions HOSTCENTRIC On June 13, 2003, the Company completed the acquisition of Hostcentric, Inc.
for $25.5 million in cash and stock. The Company paid $4.7 million in cash and
issued approximately 1.36 million shares of Interland stock valued at $20.4
million, net of $0.4 million direct issue costs. This acquisition was part of
the Companys strategy of acquiring and integrating similar companies in order
to rapidly achieve scale. The value of the common shares issued was determined
based on a ten-day weighted average closing price of Interland common stock on
NASDAQ for the period ending two days before the merger agreement date of
December 19, 2002. The results of Hostcentrics operations are included in the
consolidated financial statements as of the acquisition date. Formed in 2000,
Hostcentric was a privately held provider of a broad range of Web hosting
services to small business and enterprise customers. The following table summarizes the purchase price allocation based on the fair
values of the assets acquired and liabilities assumed: Fair Value(In Thousands)Current assets
    
    $
    4,885Property and equipment
    
    
    4,559Trade names and trademarks
    
    
    360Customer relationships
    
    
    3,900Goodwill
    
    
    19,051Current liabilities
    
    
    (5,970
    )Other liabilities
    
    
    (1,311
    )Net assets acquired
    
    $
    25,474
 TRELLIX On January 3, 2003, the Company acquired Trellix Corporation, a privately held
developer of software-based website solutions. Founded in 1995, Trellix is a
provider of private-label website publishing solutions, integrated business
services, and low-cost hosting technology. The primary reason for the
acquisition is that Trellix offers a suite of site-building tools and services
that enable users to create professional websites. Trellixs product line
offers an expansion of the existing Interland product line. Trellixs
financial results are included in Interlands financial results beginning in
January 2003. The aggregate purchase price was approximately $12.2 million
consisting of $4.75 million in cash, 300,000 shares of Interland stock, and
600,000 warrants to purchase shares of Interland stock at a price of $50.00 per
warrant. The value of the common shares issued was determined based on the
closing price of Interland common stock on NASDAQ on January 3, 2003. The
warrants at the date of acquisition were valued at $5.50 each using the
Black-Scholes pricing model. The following table summarizes the purchase price allocation based on the fair
values of the assets acquired and liabilities assumed at the date of
acquisition: Fair Value(In Thousands)Current assets
    
    $
    700Property and equipment
    
    
    603Trade names and trademarks
    
    
    140Technology
    
    
    5,900Goodwill
    
    
    8,096Current liabilities
    
    
    (3,763
    )Net assets acquired
    
    $
    11,676




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) iNNERHOST Effective August 1, 2002, the Company acquired iNNERHOST, Inc. for an aggregate
purchase price of $17.7 million, consisting of approximately $5.2 million in
cash and up to 970,182 shares of Interland common stock. In addition, the
purchase agreement stipulated that the purchase consideration was subject to
adjustment based on the following provisions:  
    
    An earn-out provision that specified that the realization of the
full purchase price by the shareholders of iNNERHOST would be
contingent upon the iNNERHOST revenues for the three-month period
following the date of acquisition being at least 95% of the historical
monthly revenues. INNERHOST revenues for the subject three-month
period were in fact in compliance with this requirement and thus no
modification to the purchase price and related consideration was
necessary.
    
    A price protection provision that specified that a pro-rata payback
of shares to Interland if the average closing price for the five
business days preceding the effective date of the registration
statement covering shares issued in this acquisition is greater than
$37.00 but less than $50.00 per share by the amount of the closing
price over $25.00 per share. The agreement also provided additional
payment of shares to the iNNERHOST shareholders on a pro-rata basis if
the average closing price of five business days preceding the effective
date of the registration statement covering shares issued in this
acquisition is less than $25.00 per share but greater than $10.00 per
share by the amount of the closing price below $25.00 per share. During 2003, the Company completed the registration process and issued an
additional 553,029 shares of Interland common stock in accordance with the
price protection provision bringing the total number of shares issued to
970,182 (including contingent shares described above). The acquisition of
iNNERHOST was accounted for in accordance with SFAS No. 141,Business
Combinations. The contingently issued shares of the Companys stock did not
affect the aggregate recorded cost of the acquisition. In connection with the acquisition, 50,000 shares of stock and $0.3 million
were placed into escrow for one year to satisfy unidentified claims that
occurred prior to the acquisition date. Management believes that the value of
the escrow account is sufficient to cover all known claims that have a likely
probability of an unfavorable outcome. The results of iNNERHOSTs operations
have been included in the consolidated financial statements since August 1,
2002, the effective date of acquisition. The aggregate purchase price was $17.7
million, including direct acquisition costs of $0.2 million. During 2003, the iNNERHOST purchase price allocation was completed and amounts
were allocated to identifiable intangible assets and goodwill. This
acquisition was part of the Companys strategy of acquiring and integrating
similar companies in order to rapidly achieve scale. The following table
summarizes the purchase price allocation based on the fair values of the assets
acquired and liabilities assumed at the date of acquisition: Fair Value(In Thousands)Current assets
    
    $
    2,235Property and equipment
    
    
    6,995Trade names and trademarks
    
    
    200Customer relationships
    
    
    3,400Other assets
    
    
    512Goodwill
    
    
    9,384Current liabilities
    
    
    (4,301
    )Long-term liabilities
    
    
    (676
    )Net assets acquired
    
    $
    17,749
 DIALTONE On May 6, 2002, the Company acquired 100 percent of the outstanding common
shares of Dialtone, Inc., (Dialtone), by paying cash of $15.8 million in
exchange for all shares of Dialtones common stock. The results of Dialtones
operations have been included in the consolidated financial statements since
the date of acquisition.




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) Dialtone is a Ft. Lauderdale, Florida-based Web and
applications dedicated hosting company serving small and medium-sized
businesses. This acquisition was part of the Companys strategy of acquiring
and integrating similar companies in order to rapidly achieve scale. The
aggregate purchase price was $15.8 million, including direct acquisition costs
of $.05 million. The following table summarizes the purchase price allocation based on the
estimated fair values of the assets acquired and liabilities assumed at the
date of acquisition: Fair Value(In Thousands)Current assets
    
    $
    1,049Property and equipment
    
    
    3,630Core technology
    
    
    120Trademarks
    
    
    290Customer relationship
    
    
    3,700Other intangible assets
    
    
    88Other assets
    
    
    72Goodwill
    
    
    10,149Current liabilities
    
    
    (2,742
    )Long-term liabilities
    
    
    (571
    )Net assets acquired
    
    $
    15,785
 COMMUNITECH On February 8, 2002, the Company acquired 100 percent of the outstanding common
shares of CommuniTech.Net, Inc. (CommuniTech.Net) by issuing 537,500 shares
of the Companys common stock in exchange for all shares of CommuniTech.Net
common stock. The value of the common shares issued was determined based on the
average market price of the Companys common shares over the 2-day period
before and after the terms of the acquisition were agreed to and announced on
February 8, 2002. The results of CommuniTech.Nets operations have been
included in the consolidated financial statements since the date of
acquisition. CommuniTech.Net is a Kansas City, Missouri-based Web and
applications hosting company serving small and medium-sized businesses. This
acquisition was part of the Companys strategy of acquiring and integrating
similar companies in order to rapidly achieve scale. The aggregate purchase
price was $11.0 million, including equity issued with a value of $10.8 million
and estimated direct acquisition costs of $0.2 million. In connection with the acquisition of CommuniTech.Net, the Company issued two
notes receivable with balances totaling $2.7 million at August 31, 2003 from a
seller of CommuniTech.Net. These notes, which bore interest at the rate of 5%
per annum, matured on February 8, 2004 with interest only payments due
quarterly. The loans were collateralized by 270,000 shares of the Companys
common stock, owned by the note holder. In 2004, the Company foreclosed on one
of the notes with a principal of $2.0 million and cancelled the shares securing
the note. The principal balance due on the remaining note is shown on the
balance sheet as a reduction in shareholders equity. The following table summarizes the purchase price allocation based on the
estimated fair values of the assets acquired and liabilities assumed at the
date of acquisition: Fair Value(In Thousands)Current assets
    
    $
    502Property and equipment
    
    
    3,487Customer relationships
    
    
    2,600Reseller and strategic alliances
    
    
    514Core technology
    
    
    360Trademarks
    
    
    210Goodwill
    
    
    6,898Current liabilities
    
    
    (3,565
    )Net assets acquired
    
    $
    11,006




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) OTHER In January 2002 and May 2002, the Company acquired the small business-focused
shared and dedicated Web hosting customer accounts of AT&T Corp., and Burlee
Networks LLC, respectively, resulting in the recognition of approximately $25.4
million of acquired intangible assets. The primary reason for these
acquisitions were to increase market share and accelerate the Companys
revenues through acquisition of accounts in accordance with the Companys
three-year strategic plan of acquisition, integration and growth. 8. Investment Securities The following table summarizes, by major security type, the cost of the
Companys investments. All investments with remaining maturities in excess of
one year are recorded as long-term investments in the accompanying consolidated
balance sheets. In 2004 and 2003, the carrying value of investments
approximates fair value. As ofAugust 31,
    
    August 31,2004
    
    2003(In thousands)Held to maturity investment securities, at amortized cost:Commercial paper
    
    $
    26,046
    
    
    
    35,514State and local government
    
    
    3,000
    
    
    
    6,990Certificates of deposit
    
    
    1,113
    
    
    
    3,25930,159
    
    
    
    45,763Less: cash equivalents
    
    
    (18,138
    )
    
    
    (19,463
    )Less: restricted cash
    
    
    (9,521
    )
    
    
    (10,000
    )Investments
    
    $
    2,500
    
    
    $
    16,300Investments maturing within one year
    
    
    2,500
    
    
    
    16,300Investments maturing one to five years
    
    
    
    
    
    
    Total Contractual Maturities
    
    $
    2,500
    
    
    $
    16,300
 9. Receivables As ofAugust 31,
    
    August 31,2004
    
    2003(In thousands)Trade receivables
    
    $
    2,812
    
    
    $
    3,929Other
    
    
    553
    
    
    
    1,604Allowance for doubtful accounts
    
    
    (381
    )
    
    
    (373
    )Receivables
    
    $
    2,984
    
    
    $
    5,160
 Other receivables primarily consist of interest receivable, sales tax refunds
receivable and third party partner and reseller receivables. Changes in the allowance for doubtful accounts are as follows: Fiscal Year EndedAugust 31, 2004
    
    August 31, 2003
    
    August 31, 2002(In thousands)Allowance For Doubtful AccountsBalance at beginning of year
    
    $
    373
    
    
    $
    3,843
    
    
    $
    1,810Additions charged to bad debt expense
    
    
    3,690
    
    
    
    7,335
    
    
    
    10,529Acquisitions
    
    
    
    
    
    
    
    
    
    
    1,135Reductions and write-offs
    
    
    (3,682
    )
    
    
    (10,805
    )
    
    
    (9,631
    )Balance at end of year
    
    $
    381
    
    
    $
    373
    
    
    $
    3,843




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) 10. Other Assets As ofAugust 31,
    
    August 31,2004
    
    2003(In thousands)Deposits
    
    $
    344
    
    
    $
    407Directors and officers liability insurance deposit
    
    $
    2,800
    
    
    $
    Other
    
    
    100
    
    
    
    100Total Other Assets
    
    $
    3,244
    
    
    $
    507
 Included in Other Assets is $0.3 million of deposits the Company requires for
certain customers with a credit risk, which are held and applied to the last
month of service or refunded at the end of their service contract and a $2.8
million directors and officers liability insurance deposit, which has been
delivered to one of the Companys issuers of Directors and Officers Liability
Insurance. The funds provide a source for payment of the Companys
obligations to indemnify officers and directors in the event that the Company
does not fulfill its obligations directly. At such time as the Company has
fulfilled its obligations, the funds will be returned to the Company. 11. Property, Plant And Equipment As ofEstimated
    
    August 31,
    
    August 31,useful lives
    
    2004
    
    2003(In years)
    
    (In thousands)Computer equipment
    
    
    3
    
    
    $
    69,550
    
    
    $
    58,865Software
    
    
    2
    
    
    
    16,075
    
    
    
    14,856Office equipment
    
    
    5
    
    
    
    5,978
    
    
    
    5,672Leasehold improvements
    
    
    3-5
    
    
    
    20,975
    
    
    
    20,390Assets in progress
    
    
    
    
    
    
    611
    
    
    
    2,784113,189
    
    
    
    102,567Less: Accumulated depreciation and amortization
    
    
    
    
    
    
    (88,681
    )
    
    
    (66,632
    )Property, plant and equipment, net
    
    
    
    
    
    $
    24,508
    
    
    $
    35,935
 Depreciation and amortization of property, plant and equipment, including those
assets held under capital lease was $22.8 million, $39.8 million and $26.6
million for 2004, 2003, and 2002, respectively. Computer equipment acquired through capital leases that is included in
property, plant and equipment, in the Consolidated Balance Sheet, is as
follows: FY2004
    
    FY2003Computer equipment under capital leases
    
    
    8,703
    
    
    
    19,725Accumulated amortization
    
    
    (7,688
    )
    
    
    (12,028
    )Net equipment under capital leases
    
    
    1,015
    
    
    
    7,697
 12. Acquired Intangibles And Goodwill In accordance with the requirements of SFAS 142, the Company tests for
impairment on an annual basis and between annual tests if an event occurs or
circumstances change that would more likely than not reduce the fair value of
goodwill below its carrying amount. During 2003 and 2004 the Company completed
the annual impairment test which entailed comparing the aggregate market value
of the Companys outstanding securities plus its liabilities to the aggregate
carrying value of the Companys assets, including goodwill and other indefinite
life




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Interland, Inc.
Notes to Consolidated Financial Statements (continued) intangible assets. The market price of the Companys stock had
experienced significant volatility over the last two fiscal years as its market
value became significantly less than the value at the beginning of fiscal year
2003. Management retained valuation specialists to assist in the valuation of
its tangible and identifiable intangible assets for purposes of determining the
implied fair value of goodwill during 2003 and 2004. Upon completion of the
annual assessments, Interland recorded non-cash impairment charges of $89.9
million in 2003 and $66.6 million in 2004 to remove the remainder of the
carrying value of goodwill. The following table discloses changes in the carrying amount of goodwill: Fiscal Year EndedAugust 31,
    
    August 31,2004
    
    2003(In thousands)Balance at beginning of year
    
    $
    66,646
    
    
    $
    120,011Goodwill acquired
    
    
    
    
    
    
    36,563Impairment write-down
    
    
    (66,646
    )
    
    
    (89,928
    )Other adjustments
    
    
    
    
    
    
    Balance at end of year
    
    $
    
    
    
    $
    66,646
 Given the Companys aggressive acquisition strategy during 2002 and 2003,
significant customer related intangible asset balances were accumulated. The
Company has continued to monitor the performance of these acquired customer
related intangible assets and determined that revenues, operating profits and
cash flows from its Interliant, AT&T and Burlee customer account acquisitions,
as well as customer relationship intangible assets from its CommuniTech,
Innerhost, Dialtone and Hostcentric acquisitions were materially less than
previously estimated, primarily related to customer and Company initiated
terminations both in 2004 and 2003. Management used the expected present value
of future cash flows to determine the fair value of these identifiable
intangible assets and determined that the carrying amount of these assets was
higher than their fair values. Upon completion of the assessments, Interland
recorded non-cash impairment charges of $7.0 million and $13.9 million in 2004
and 2003, respectively, to reduce the carrying value of identifiable intangible
assets to estimated fair values. The following table summarizes intangible assets by asset class and related
accumulated amortization: Fiscal Year EndedAs of August 31, 2004
    
    As of August 31, 2003Gross
    
    
    
    
    
    Grosscarrying
    
    Accumulated
    
    carrying
    
    Accumulatedamount
    
    amortization
    
    amount
    
    amortization(In thousands)Amortizable intangible assets:Core technology
    
    $
    15,505
    
    
    $
    11,086
    
    
    $
    17,900
    
    
    $
    7,784Customer account acquisitions
    
    
    16,323
    
    
    
    14,321
    
    
    
    16,323
    
    
    
    12,602Customer relationships
    
    
    9,383
    
    
    
    5,584
    
    
    
    10,129
    
    
    
    3,776Trademarks
    
    
    4,553
    
    
    
    2,696
    
    
    
    6,100
    
    
    
    1,798Other
    
    
    1,027
    
    
    
    1,027
    
    
    
    1,162
    
    
    
    863Total
    
    $
    46,791
    
    
    $
    34,714
    
    
    $
    51,614
    
    
    $
    26,823Aggregate amortization expense:For the year ended August 31, 2004
    
    $
    7,891Estimated amortization expense:For the year ended August 31, 2005
    
    $
    6,742For the year ended August 31, 2006
    
    
    2,379For the year ended August 31, 2007
    
    
    1,470For the year ended August 31, 2008
    
    
    1,110For the year ended August 31, 2009
    
    
    376$
    12,077
 Core technology is amortized over a weighted average life of four years,
customer account acquisitions and customer relationships are amortized over a
weighted average life of three years, trademarks are amortized over a weighted
average life of seven years, and all other intangible assets are amortized over
a weighted average life of




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) three years. The weighted average amortization
period for all intangible assets as a group is four years. None of the
goodwill balance was deductible for tax purposes. 13. Accrued Expenses As ofAugust 31,
    
    August 31,2004
    
    2003(In thousands)Accrued payroll and related liabilities
    
    $
    2,371
    
    
    $
    5,495Acquisition related liabilities
    
    
    740
    
    
    
    1,138Taxes payable
    
    
    1,719
    
    
    
    1,285Accrued advertising
    
    
    1,092
    
    
    
    1,241Accrued discontinued operations liabilities
    
    
    1,341
    
    
    
    1,100Accrued software liabilities
    
    
    744
    
    
    
    934Accrued legal and professional fees
    
    
    1,137
    
    
    
    648Accrued lease payments
    
    
    
    
    
    
    64Other
    
    
    2,961
    
    
    
    4,584Total accrued expenses
    
    $
    12,105
    
    
    $
    16,489
 In connection with the acquisition of Interland-Georgia in 2001, INNERHOST in
2002, and Trellix in 2003 the Company accrued certain liabilities representing
estimated costs of exiting certain facilities, termination of bandwidth
contracts and involuntary termination of employees in accordance with EITF
95-3, Recognition of Liabilities in Connection with a Purchase Business
Combination. These amounts are included above as Acquisition related
liabilities. The following table shows the changes in the accrual from August
31, 2000: EmployeeLease
    
    
    
    
    
    terminationabandonments
    
    Bandwidth
    
    benefits
    
    Total(In thousands)Balance at August 31, 2000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Liabilities accrued
    
    
    7,098
    
    
    
    1,440
    
    
    
    1,362
    
    
    
    9,900Cash paid
    
    
    (123
    )
    
    
    
    
    
    
    (83
    )
    
    
    (206
    )Balance at August 31, 2001
    
    
    6,975
    
    
    
    1,440
    
    
    
    1,279
    
    
    
    9,694Liabilities accrued and adjustments
    
    
    2,470
    
    
    
    (1,440
    )
    
    
    
    
    
    
    1,030Cash paid
    
    
    (1,871
    )
    
    
    
    
    
    
    (1,027
    )
    
    
    (2,898
    )Balance at August 31, 2002
    
    
    7,574
    
    
    
    
    
    
    
    252
    
    
    
    7,826Liabilities accrued and adjustments
    
    
    
    
    
    
    
    
    
    
    675
    
    
    
    675Cash paid
    
    
    (6,653
    )
    
    
    
    
    
    
    (710
    )
    
    
    (7,363
    )Balance at August 31, 2003
    
    
    921
    
    
    
    
    
    
    
    217
    
    
    
    1,138Cash paid
    
    
    (181
    )
    
    
    
    
    
    
    (217
    )
    
    
    (398
    )Balance at August 31, 2004
    
    $
    740
    
    
    
    
    
    
    $
    
    
    
    $
    740
 During fiscal 2002, the Company revised its estimates of the cost of exiting
three of the Interland-Georgia facilities resulting in a net increase to the
accrual of $2.5 million. Approximately $2.8 million was recorded as operating
expense within the Companys Statement of Operations and $0.4 million was
recorded as a purchase price adjustment as a reduction of goodwill.
Additionally, the Company received a waiver and release from a vendor, which
released the Company from its obligations under a terminated bandwidth
contract, and as a result, the Company reversed $1.4 million of liabilities
previously accrued. This adjustment was recorded as an Interland-Georgia
purchase price adjustment as a reduction of goodwill and is reflected in the
above table in Other adjustments. During 2003, the Company accrued for
certain employee termination costs of $0.7 million related to the acquisitions
during the year.




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued)


14. Other
Liabilities As ofAugust 31,
    
    August 31,2004
    
    2003(In thousands)Sales tax assessments liability
    
    $
    1,200
    
    
    $
    2,366Income tax liability
    
    
    1,577
    
    
    
    1,417Other
    
    
    432
    
    
    
    1,614Total other liabilities
    
    $
    3,209
    
    
    $
    5,397
 The Company is a party to numerous sales and use tax assessments and audits
related to the discontinued operations and has established a reserve of $1.2
million and $2.4 million as of August 31, 2004 and 2003, respectively. The
Company has established an accrual for income tax liabilities of $1.6 million
and $1.4 million as of from August 31, 2004 and 2003, respectively. 15.
Long-Term Debt And Capital Lease Obligations As ofAugust 31,
    
    August 31,2004
    
    2003(In thousands)Capital lease obligations payable in monthly installments through
2005, weighted average interest rates of 11.0% and 10.9%, respectively
    
    $
    1,508
    
    
    $
    11,880Notes payable
    
    
    4,236
    
    
    
    6195,744
    
    
    
    12,499Less current portion
    
    
    (2,271
    )
    
    
    (10,845
    )Long-term debt and capital lease obligations
    
    $
    3,473
    
    
    $
    1,654
 The Companys lease obligations are for servers and computer equipment leases
that will end during fiscal year 2005. On February 1, 2004, the Company
terminated a sale and leaseback agreement with US Bancorp Oliver-Allen
Technology and repurchased the assets under the lease. In conjunction with this
lease termination, the company executed a five-year promissory note for the
repurchase amount. As of August 31, 2004, the principal balance on the
promissory note was $4.2 million. The Company has pledged $5.0 million as
collateral for this promissory note; this amount will gradually decrease until
the agreement terminates in February 2009. As of August 31, 2004, the amount of
collateral is $4.5 million. These restrictions prevent the Company from
utilizing the related cash and cash equivalents until all of its obligations
under the note are satisfied. The new promissory note bears an interest rate
of 6.75% and requires monthly payments of $93,000 over the next five years. Prior to the acquisition of iNNERHOST, Inc., iNNERHOST executed a $1.3 million
note to finance the construction of a data center and executed several term
loans to finance equipment purchases. The note bears an interest rate of 10.0%
and the term loans have an interest rate of 12.0%. In connection with the
acquisition of iNNERHOST, the Company assumed these obligations. As of August
31, 2004, these obligations have been completely satisfied. 16. Warrants In connection with the purchase of Interland-Georgia on August 6, 2001, the
Company issued warrants to purchase shares of the Companys common stock in
exchange for each issued and outstanding Interland-Georgia warrant using the
exchange rate of 0.861 shares of the Company for each share of
Interland-Georgia. All of the warrants are fully vested at August 31, 2004.
On January 3, 2003, the Company acquired Trellix Corporation. As part of the
purchase price, the Company issued warrants to Trellix shareholders to purchase
600,000 shares of Interlands common stock at an exercise price of $50.00 per
share. During the fourth quarter of 2004 the Company recorded a reduction of
$0.4 million related to the retirement of 298,513 warrants that had expired
prior to the fiscal year-end.




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) The following table summarizes the Companys warrant holders as of August 31,
2004: Number of
    
    ExerciseWarrant Holder
    
    Expiration Date
    
    Shares
    
    PriceMicrosoft Corporation
    
    December 24, 2004
    
    
    47,052
    
    
    
    62.40Verisign
    
    March 15, 2005
    
    
    32,065
    
    
    
    62.40Transamerica
    
    May 1, 2005
    
    
    1,860
    
    
    
    96.70Microsoft Corporation
    
    July 26, 2005
    
    
    40,359
    
    
    
    139.40Verisign
    
    July 26, 2005
    
    
    32,288
    
    
    
    139.40Transamerica
    
    October 3, 2005
    
    
    2,153
    
    
    
    139.40Trellix
    
    January 3, 2008
    
    
    600,000
    
    
    
    50.00Total
    
    
    755,777
 17. Stock purchase and incentive plans The Companys 1995 Employee Stock Purchase Plan (the Plan) allows eligible
employees to purchase shares of common stock through payroll deductions. The
shares can be purchased for 85% of the lower of the beginning or ending fair
market value of each six-month offering period and is restricted from resale
for a period of one year from the date of purchase. Purchases are limited to
20% of an employees eligible compensation. A total of 250,000 shares are
reserved for issuance under the plan, of which approximately 207,400 shares had
been issued as of August 31, 2004 compared to 160,300 shares issued as of
August 31, 2003. Shares issued under the Plan during 2004, 2003, and 2002,
were approximately 47,100, 34,100 and 22,000, respectively. In October 2004,
the Board of Directors elected to terminate the Plan, effective as of December
31, 2004. The Company has three stock option plans, the 2002 Equity Incentive Plan (the
2002 Plan), the 2001 Equity Incentive Plan (the 2001 Plan) and the 1995
Stock Option Plan (the 1995 Plan), collectively referred to as the Option
Plans. All of these option plans have an option term of 10 years. Vesting
periods range from 3 to 5 years. During fiscal 2002, the Company shareholders approved the 2002 Plan which
provides for the granting of incentive and non-statutory stock options. As of
August 31, 2004, there were 210,432 shares of common stock reserved for
issuance under the 2002 Plan. Exercise prices of the incentive and
non-statutory stock options are 100% of the fair market value of the Companys
common stock on the date of grant. Stock options granted generally vest as to
25% of the shares issued under the option grant after one year from the date of
grant. Subsequent to the one-year anniversary of the grant, the options become
vested as to 2.08% of the total shares of the options granted per month. In
connection with the adoption of the 2002 Plan, the Company terminated its 1995
Plan and its 2001 Plan. All awards outstanding under those plans continue in
accordance with their terms, but no further awards will be granted under those
plans. The Companys 2001 Plan provided for the granting of non-statutory stock
options and restricted stock awards. Exercise prices of the non-statutory
stock options may be less than fair market value at the date of grant. Stock
options granted generally vest as to 25% of the shares issued under the option
grant after one year from the date of grant. Subsequent to the one-year
anniversary of the grant, the options become vested as to 2.08% of the total
shares of the options granted per month. The Companys 1995 Plan provided for the granting of incentive and
non-statutory stock options. Exercise prices of the incentive and
non-statutory stock options are 100% of the fair market value of the Companys
common stock on the date of grant. Prior to April 28, 1999, exercise prices of
the incentive and non-statutory stock options were generally issued at 100% and
85%, respectively, of the fair market value of the Companys common stock on
the date of grant. Stock options granted to employees and executive officers
after April 28, 1999 typically have a term of ten years and vest twenty-five
percent each year for four years from the date of grant. Stock options granted
to employees and executive officers prior to April 28, 1999 typically have a
term of six years and vest twenty percent each year for five years from the
date of grant. During 1998, Mr. Joel J. Kocher, the Companys Chief Executive Officer and
Chairman of the Board of Directors, was granted options to purchase a total of
65,000 shares of the Companys common stock. Of these 65,000 options,




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) 50,000
were granted under the 1995 Plan and 15,000 were granted as non-plan grants. A
total of 25,000 options vest after completion by Mr. Kocher of seven years of
employment with the Company, subject to immediate early vesting if the Company
achieves certain financial criteria relating to profitability, net revenue, net
margin and cash
balance increases. During 2004, 2003 and 2002, Mr. Kocher was granted
additional options to purchase a total of 10,000, 35,000 and 100,000 shares of
the Companys common stock, respectively. Option activity under the Option Plans is summarized as: Fiscal Year EndedAugust 31, 2004
    
    August 31, 2003
    
    August 31, 2002Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    Average
    
    
    
    
    
    AverageNumber of
    
    Exercise
    
    Number of
    
    Exercise
    
    Number of
    
    ExerciseShares
    
    Price
    
    Shares
    
    Price
    
    Shares
    
    Price(In thousands, except per share amounts)Outstanding at beginning of year
    
    
    1,421
    
    
    $
    24.66
    
    
    
    1,586
    
    
    $
    29.50
    
    
    
    1,792
    
    
    $
    51.30Granted
    
    
    179
    
    
    
    3.96
    
    
    
    518
    
    
    
    12.80
    
    
    
    665
    
    
    
    22.40Exercised
    
    
    
    
    
    
    
    
    
    
    (24
    )
    
    
    8.28
    
    
    
    (65
    )
    
    
    12.40Terminated or cancelled
    
    
    (521
    )
    
    
    29.07
    
    
    
    (659
    )
    
    
    28.11
    
    
    
    (806
    )
    
    
    56.20Outstanding at end of year
    
    
    1,079
    
    
    
    19.86
    
    
    
    1,421
    
    
    
    24.66
    
    
    
    1,586
    
    
    
    29.50Exercisable at end of year
    
    
    679
    
    
    
    23.92
    
    
    
    686
    
    
    
    33.08
    
    
    
    726
    
    
    
    33.60Shares available for future grant
under the:2002 Plan
    
    
    210
    
    
    
    
    
    
    
    116
    
    
    
    
    
    
    
    4642001 Plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1995 Plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 The following table summarizes information about the Companys stock options
outstanding under the Option Plans as of August 31, 2004: Options Outstanding
    
    Options ExercisableWeighted
    
    Weighted
    
    
    
    
    
    WeightedAverage
    
    Average
    
    
    
    
    
    AverageNumber of
    
    Remaining
    
    Exercise
    
    Number of
    
    ExerciseRange of Exercise Prices
    
    Shares
    
    Life (Years)
    
    Price
    
    Shares
    
    Price(In thousands, except per share amounts)Less than $11.00
    
    
    296
    
    
    
    8.5
    
    
    $
    6.16
    
    
    
    119
    
    
    $
    9.48$11.00 - $18.50
    
    
    291
    
    
    
    7.9
    
    
    
    11.98
    
    
    
    171
    
    
    
    12.13$18.51 - $21.50
    
    
    216
    
    
    
    7.3
    
    
    
    21.18
    
    
    
    151
    
    
    
    21.13$21.51 - $32.00
    
    
    175
    
    
    
    6.0
    
    
    
    30.02
    
    
    
    148
    
    
    
    30.52Greater than $32.01
    
    
    101
    
    
    
    4.6
    
    
    
    62.28
    
    
    
    90
    
    
    
    59.081,079
    
    
    
    
    
    
    
    
    
    
    
    679
 The Company adopted the disclosure-only provisions of SFAS 123 Accounting for
Stock-Based Compensation, and elected to continue to measure compensation
expense for its stock-based employee compensation using the intrinsic value
method prescribed by APB No. 25 Accounting for Stock Issued to Employees.
The fair value of options at date of grant is estimated using the Black-Scholes
options pricing model. The weighted average assumptions and resulting fair
values at date of grant for options granted during 2004, 2003, and 2002, are as
follows:




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) Stock Option Plans Shares2004
    
    2003
    
    2002AssumptionsExpected life
    
    3.0 years
    
    3.0 years
    
    3.0 yearsRisk-free interest rate
    
    
    2.7
    %
    
    
    2.8
    %
    
    
    4.0
    %Expected volatility
    
    
    32.0
    %
    
    
    80.0
    %
    
    
    76.5
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %Weighted average fair values:Exercise price equal to market price
    
    $
    1.02
    
    
    $
    7.61
    
    
    $
    13.01Exercise price less than market price
    
    $
    
    
    
    $
    
    
    
    $
    
 18. Retirement Plan The Company offered its employees a 401(k) retirement plan (the RAM Plan) in
which substantially all employees may participate. Under the RAM Plan,
employees may contribute from 2% to 16% of eligible pay to various savings
alternatives. The RAM plan provides for an annual match of eligible employees
contributions equal to 100% of the first 4% of pay or $1,500, whichever is
greater. In 2001, the Companys contributions under the RAM Plan were made in
the Companys stock, which is purchased on the open market. The Company may
also contribute additional amounts based on its financial performance, however,
no additional Company contributions were made during the three years ended
August 31, 2004. Interland-Georgia offered its employees a 401(k) retirement plan in which
substantially all employees may participate. Under the plans deferred
compensation arrangement, eligible employees who elect to participate in the
plan may contribute between 1% and 15% of eligible compensation, as defined, to
the plan. Interland, at its discretion, could elect to provide for either a
matching contribution or a discretionary profit-sharing contribution or both. On January 1, 2002, the Interland-Georgia 401(k) Plan merged with the RAM Plan,
and changed its name to the Interland 401(k) Savings Plan (Savings Plan). In
July 2002, Interland amended the Savings Plan to allow employees to contribute
up to 25% of eligible pay. The Companys expense included in continuing
operations pursuant to the RAM Plan, and thereafter the Savings Plan, was
approximately $0.8 million in 2004, $0.2 million in 2003 and $0.5 million in
2002, respectively. 19. Related party Transactions In connection with the sale of the discontinued PC business, the Company was
obligated to pay lease payments to Micron Technology, Inc. (MTI) of $0.7
million in 2003 and $2.9 million during fiscal year 2002. The obligation was
satisfied in 2003. There were no other sale or purchase transactions between
the Company and MTI. In connection with the acquisition of CommuniTech.Net, the Company held two
notes receivable with balances totaling $2.7 million at August 31, 2003 from
the seller of CommuniTech.Net. These notes matured on February 8, 2004. The
loans were collateralized by 273,526 shares of the Companys common stock,
owned by the note holder. In February 2003, the Company filed a lawsuit in
Cobb County, Georgia against Mr. Gabriel Murphy, one of the former principals
of CommuniTech.Net, Inc., which was acquired by Interland in February 2002. The
Companys lawsuit claims, among other things, that Mr. Murphy breached certain
covenants under his employment agreement and also demands payment from Mr.
Murphys two promissory notes (one of which was non-recourse while the other
was recourse). In March 2004, Interland retired the 273,526 shares of stock
held as collateral and wrote off the $2,000,000 non-recourse promissory note.
The other $735,000 full recourse promissory note remains outstanding and
continues to be a subject of the Cobb County litigation noted above. The
receivable is shown on the balance sheet as a reduction in shareholders
equity. During the fourth quarter of 2002, the Company repurchased 80,000 shares of the
Companys common stock from the two former owners of CommuniTech.Net at an
aggregate cost of $2.5 million.




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) During the second quarter of fiscal 2002, the Micron Technology Foundation,
which beneficially owned approximately 43% of the Companys common stock, sold
all of the approximately 5.9 million shares of the Companys common stock to
institutional investors, together with the Company and four of its directors.
The Company re-purchased and retired approximately 580,000 shares of common
stock from the Foundation at an aggregate cost of $7.3 million. 20. Income Taxes The effective income tax rate on continuing operations was approximately 0% for
fiscal 2004 compared to 0% for fiscal 2003 and 92% for fiscal 2002. The rate
principally reflects the federal statutory rate, net of the effect of state
taxes, tax-exempt securities and non-deductible goodwill amortization. The
change in the effective income tax rate primarily reflects tax benefits
resulting from a change in the Internal Revenue Code regarding the carryback of
net operating losses, as well as a valuation allowance on certain tax assets. Components of income tax (benefit) provision are as follows: Fiscal Year EndedAugust 31,
    
    August 31,
    
    August 31,2004
    
    2003
    
    2002(In thousands)Current:U.S. Federal
    
    $
    
    
    
    $
    629
    
    
    $
    (64,241
    )State
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    629
    
    
    
    (64,241
    )Deferred:U.S. Federal
    
    
    
    
    
    
    
    
    
    
    State
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Income tax (benefit) provision
    
    $
    
    
    
    $
    629
    
    
    $
    (64,241
    )
 On March 9, 2002, a tax law entitled the Job Creation and Worker Assistance
Act of 2002 was passed. The act benefited the Company directly during 2002 by
allowing the ability to carryback 2001 tax losses an additional three years for
a total of five years. During the third quarter of fiscal 2002 the Company
recorded a tax benefit of approximately $64.2 million from cash relating to the
additional tax loss carryback claims. This tax refund significantly added to
the Companys cash position but also reduced the amount of tax net operating
losses that are available for carryforward to future years. A reconciliation between the income tax provision and income tax computed using
the federal statutory rate follows: Fiscal Year EndedAugust 31,
    
    August 31,
    
    August 31,2004
    
    2003
    
    2002(In thousands)U.S. federal income tax at statutory rate
    
    $
    (36,632
    )
    
    $
    (62,357
    )
    
    $
    (26,437
    )State taxes, net of federal benefit and
state tax credits
    
    
    (5,233
    )
    
    
    (3,983
    )
    
    
    7,284Goodwill
    
    
    26,635
    
    
    
    31,475
    
    
    
    Valuation allowance
    
    
    15,206
    
    
    
    33,844
    
    
    
    (51,875
    )Tax-exempt Foreign Trade Income
    
    
    
    
    
    
    
    
    
    
    6,567Other
    
    
    24
    
    
    
    1,650
    
    
    
    220Income tax (benefit) provision
    
    $
    
    
    
    $
    629
    
    
    $
    (64,241
    )
 The tax effects of temporary differences and carryforwards that give rise to
the deferred tax assets and liabilities are as follows:




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) As ofAugust 31,
    
    August 31,2004
    
    2003(In thousands)Deferred tax assets:Receivables and other allowances
    
    $
    76
    
    
    $
    112Accrued expenses
    
    
    1,779
    
    
    
    934Accrued compensation
    
    
    161
    
    
    
    57Deferred revenue
    
    
    3,218
    
    
    
    4,536Property, plant and equipment
    
    
    6,962
    
    
    
    5,162Acquired intangibles
    
    
    3,695
    
    
    
    Net operating loss carryforwards
    
    
    117,620
    
    
    
    106,978Total deferred tax assets
    
    
    133,511
    
    
    
    117,779Valuation allowance
    
    
    (133,511
    )
    
    
    (116,792
    )Net deferred tax assets
    
    
    
    
    
    
    987Deferred tax liabilities:Acquired intangibles
    
    
    
    
    
    
    (987
    )Total deferred tax liabilities
    
    
    
    
    
    
    (987
    )Net deferred taxes
    
    $
    
    
    
    $
    
 Deferred tax assets and liabilities have not been classified with net assets of
discontinued operations because income taxes will not be assumed by the buyers
of the discontinued operations and remain the responsibility of the Company. The Company has federal operating loss carryforwards, some of which are limited
by the Section 382 of the Internal Revenue Code. The consolidated limited
amount of net operating losses available to the Company as of August 31, 2004
is $294.1 million. These losses begin to expire in fiscal year 2006. The Company recorded a full valuation allowance with respect to the
pre-acquisition deferred tax assets. The benefit was credited to goodwill
versus income tax expense. The amount of the pre-acquisition deferred tax
asset approximates $40.0 million. A valuation allowance has been established against the deferred tax asset
because management does not believe such assets are more likely than not to be
realized. Changes in the deferred tax asset valuation allowance are as follows: Fiscal Year EndedAugust 31, 2004
    
    August 31, 2003
    
    August 31, 2002(In thousands)Deferred Tax Asset Valuation AllowanceBalance at beginning of year
    
    $
    116,792
    
    
    $
    81,406
    
    
    $
    133,251Change in net cumulative tax differences
    
    
    16,719
    
    
    
    24,870
    
    
    
    (54,873
    )Additions from acquisitions
    
    
    
    
    
    
    10,516
    
    
    
    3,028Balance at end of year
    
    $
    133,511
    
    
    $
    116,792
    
    
    $
    81,406
 21. Commitments The Company leases various buildings, computer and office equipment, under
capital and operating lease agreements. The Company has also entered into
various bandwidth agreements and in February 2004 executed a five-year
prommisory note with US Bank. The assets and liabilities under capital leases
are recorded at the lower of the present value of the minimum lease payments or
the fair value of the assets. These assets are depreciated over the shorter of
their related lease terms or their estimated useful lives. Rental expense
related to operating leases was approximately $3.9 million, $5.5 million, and
$7.7 million in 2004, 2003, and 2002 respectively. Future minimum payments
including equipment and facility leases, debt payments and bandwidth
commitments are as follows:




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) OperatingLeases andOther FutureMinimum
    
    Long-term
    
    CapitalCommitments
    
    debt
    
    Leases(In thousands)2005
    
    $
    9,258
    
    
    $
    789
    
    
    $
    1,4852006
    
    
    6,505
    
    
    
    918
    
    
    
    262007
    
    
    4,754
    
    
    
    982
    
    
    
    2008
    
    
    4,324
    
    
    
    1,0512009
    
    
    4,273
    
    
    
    496Thereafter
    
    
    3,891
    
    
    
    0Total
    
    $
    33,005
    
    
    $
    4,236
    
    
    $
    1,511Less: amount representing interest
    
    
    
    
    
    
    
    
    
    
    3Present value of net minimum lease payments
    
    
    
    
    
    
    
    
    
    $
    1,508Less: current portion
    
    
    
    
    
    
    
    
    
    
    (1,485
    )Capital lease obligation excluding current portion
    
    
    
    
    
    
    
    
    
    $
    23
 22. Contingencies In February of 2003, the Company filed a lawsuit in Cobb County, Georgia
against Mr. Gabriel Murphy, one of the former principals of Interlands
subsidiary, CommuniTech.Net, Inc. (Communitech), which was acquired by
Interland in February 2002. The Companys lawsuit claims, among other things,
that Mr. Murphy breached certain covenants under his employment agreement and
also demands payment from Mr. Murphys two promissory notes (one of which was
non-recourse while the other was recourse). In March 2004, Interland
retired the 273,526 shares of stock held as collateral and wrote off the
$2,000,000 non-recourse promissory note, which had been carried as
Stockholders Equity. The other $735,000 full recourse promissory note remains
outstanding and continues to be a subject of the Cobb County litigation noted
above. Mr. Murphy has asserted various counterclaims in response. In February 2003, Mr. Heitman, also a former principal of Interlands
subsidiary Communitech, and Mr. Murphy filed a lawsuit against Interland, its
CEO, Mr. Joel Kocher, and Communitech, in Jackson County, Missouri claiming,
among other things, that Interland acted unreasonably in failing to have the
S-3 registration statement declared effective by the SEC on a timely basis and
claiming that Interland and/or Mr. Kocher made inaccurate disclosures in
connection with Interlands acquisition of Communitech. The complaint sought
compensatory and punitive damages in an unspecified amount. Interland believes
that these claims are without merit and will not have a material adverse effect
on Interland and intends to vigorously defend the claims. In an order dated
August 26, 2004, the Missouri court dismissed two of the thirteen counts in
Heitman and Murphys complaint and ordered them to re-plead the remaining
eleven counts. In February 2004, the Company initiated a lawsuit in the United States District
Court for the Northern District of Georgia against the representatives of the
former shareholders of Hostcentric (the Hostcentric Shareholders), seeking a
declaratory judgment that it will be entitled to reimbursement from the escrow
fund established as part of the Hostcentric acquisition for any amounts over
$180,000 that it may be required to pay to the landlord for a leased facility
in Farmingdale, New York, in accordance with the acquisition agreement between
the Company and Hostcentric and its shareholders. The representatives of the
Hostcentric Shareholders have denied Interlands claims and have attempted to
assert various counterclaims. Correspondence between the parties has also
discussed the possibility of other claims, but these claims have not yet been
asserted in litigation. Interland believes its claims in this case are
meritorious, that the counterclaims of the former Hostcentric shareholders are
without merit, plans to continue to contest the matter vigorously and believes
that no material adverse effect on Interland will occur as a result of this
litigation.




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) In February 2004, the Company, through its Hostcentric subsidiary, has also
initiated a lawsuit in United States District Court for Southern District of
New York against the landlord for the same Farmingdale, New York facility,
seeking a declaratory judgment that the lease for that facility has been
terminated and that the landlord has accepted that termination, thereby
eliminating any further obligation on the part of the tenant to make lease
payments. The landlord has denied the claims in the complaint and has asserted
counterclaims for approximately $200,000 that it claims is past due under the
lease. The landlord may, in the future, assert claims against Interland for
the balance of payments due under the Lease which claims, the landlord has
asserted, could amount to approximately $2 million in the aggregate.
Interland plans to continue to contest the matter vigorously and believes that
no material adverse effect on Interland will occur as a result of this
litigation. On March 14, 2003, Halo Management, LLC, filed a suit against Interland in the
U.S. District Court for the Northern District of California alleging that
Interlands use of blueHALO(tm) to describe its proprietary Web hosting
architecture infringes on the plaintiffs registered trademark HALO (U.S.
Patent and Trademark Office Serial No. 75/870,390; Registration No.
2,586,017). On August 10, 2004, the court granted Interlands motion for
summary judgment. Shortly thereafter, Interland filed a motion asking the
court to order the plaintiff to pay Interlands attorneys fees in defending
the action. Subsequently, the parties entered into a settlement agreement
providing for the resolution of all outstanding claims and mutual general
releases with no resulting material adverse effect on Interland. Pursuant to
the terms of the settlement agreement, the plaintiff agreed to Interlands
continuing use of its blueHALO(tm) mark and agreed not to contest Interlands
efforts to register its blueHALO(tm) mark in the U.S. Patent and Trademark
Office. Interland is also defending a case entitled Novell, Inc. v. Micron Electronics,
Inc. filed in August 1999 in state court in Utah County, Utah. Novell claims
that it was underpaid for royalties on sales of several versions of its NetWare
software purportedly distributed by Interlands predecessor, Micron
Electronics, between 1996 and 1998. In addition, Novell also believes it is
entitled additional royalties for sales of the software purportedly distributed
by NetFrame between 1993 and 1997. Micron Electronics acquired NetFrame in
1997. Novell is seeking an accounting and damages. Interland believes it has
meritworthy defenses to Novells claims. The litigation is still in the
discovery phase. Periodically, the Company is made aware that technology it used in its
discontinued operations may have infringed on intellectual property rights held
by others. The Company has evaluated all such claims and, if necessary and
appropriate, sought to obtain licenses for the use of such technology. If the
Company or its suppliers were unable to obtain licenses necessary to use
intellectual property in its discontinued operations products or processes, it
may be forced to defend legal actions taken against it relating to allegedly
protected technology. The Company evaluates all such claims and has accrued a
liability and charged discontinued operations for the estimated costs of
settlement or adjudication of claims for alleged infringement as of the
respective dates of the balance sheets included in this report. As of August
31, 2004, the Company had an aggregate amount of $1.0 million accrued for such
matters. The Company is also a defendant in a number of other lawsuits that the Company
regards as unlikely to result in any material payment; nonetheless, the outcome
of litigation may not be assured, and the Companys cash balances could be
materially affected by an adverse judgment. In accordance with SFAS No. 5
Accounting for Contingencies, the Company believes it has adequately reserved
for the contingencies arising from the above legal matters where an outcome was
deemed to be probable and the loss amount could be reasonably estimated. As
such, the Company does not believe that the anticipated outcome of the
aforementioned proceedings will have a materially adverse impact on its results
of operations, its financial condition or its cash flows. 23. Common Stock And Related Matters In connection with the acquisition of CommuniTech.Net, the Company held two
notes receivable with balances totaling $2.7 million at August 31, 2003 from
the seller of CommuniTech.Net. These notes, which bear interest at the rate of
5% per annum, matured on February 8, 2004 with interest only payments due
quarterly. The loans were collateralized by 273,526 shares of the Companys
common stock, owned by the note holder. In March 2004, Interland retired the
273,526 shares of stock held as collateral and wrote off the $2,000,000
non-recourse promissory note. The other $735,000 full recourse promissory note
remains outstanding. These receivables are shown on the balance sheet as a
reduction in shareholders equity.




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##### Table of Contents



Interland, Inc.
Notes to Consolidated Financial Statements (continued) In March 2003, the board of directors authorized a stock repurchase program to
acquire outstanding common stock. Under the program, up to $10.0 million of
common stock could be reacquired over the next year. During fiscal
2003, the Company purchased approximately 85,000 shares of common stock at an
aggregate cost of approximately $1.0 million. In June 2003, the Company announced that its board of directors had approved a
1-for-10 reverse stock split. The reverse stock split was made effective as of
the close of the market on August 1, 2003, and the Companys common stock began
trading on a reverse split basis on August 4, 2003. 24. Geographic Information The Companys business activities are represented by a single industry
segment, website and applications hosting. The Companys sales are generated
from customers residing both within the United States and outside of the
United States. The following table shows sales by these geographic
locations: Fiscal Year EndedAugust 31,
    
    August 31,
    
    August 31,2004
    
    2003
    
    2002(In thousands)Revenues by Geographic Area(Based on customer location)United States
    
    $
    91,173
    
    
    $
    96,276
    
    
    $
    91,018Non- U.S.
    
    
    11,572
    
    
    
    10,362
    
    
    
    10,610Total
    
    $
    102,745
    
    
    $
    106,638
    
    
    $
    101,628
 Hosting revenues are comprised of shared, dedicated, and application hosting
services and domain name registrations. Other revenues are primarily comprised
of consulting, bandwidth transfer overage billings, Internet connectivity fees,
co-location services, and Web-based business solution services. The following
table shows sales by Hosting and Other revenue: Fiscal Year EndedAugust 31,
    
    August 31,
    
    August 31,Revenues
    
    2004
    
    2003
    
    2002Hosting revenue
    
    $
    97,601
    
    
    $
    103,313
    
    
    $
    99,755Other revenue
    
    
    5,144
    
    
    
    3,325
    
    
    
    1,873Total revenue
    
    $
    102,745
    
    
    $
    106,638
    
    
    $
    101,628




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##### Table of Contents



Report of Independent Registered Public Accounting Firm The Shareholders and Board of Directors
Interland, Inc. In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders equity and of cash
flows present fairly, in all material respects, the financial position of
Interland, Inc. and its subsidiaries at August 31, 2004 and 2003, and the
results of their operations and their cash flows for each of the three years in
the period ended August 31, 2004 in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Companys management. Our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with the standards of
the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP
Atlanta, Georgia
November 10, 2004




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##### Table of Contents



Quarterly Financial Information (Unaudited)(in thousands, except per share information First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    Quarter(In thousands, except per share amounts)2004Revenues
    
    $
    26,687
    
    
    $
    26,029
    
    
    $
    25,686
    
    
    $
    24,343Income/(Loss) from continuing operations
    
    
    (7,971
    )
    
    
    (9,361
    )
    
    
    (81,245
    )
    
    
    (4,382
    )Net income/(Loss)
    
    
    (8,553
    )
    
    
    (10,100
    )
    
    
    (81,726
    )
    
    
    (4,284
    )Income/(loss) per share, basic and diluted:Continuing operations
    
    $
    (0.49
    )
    
    $
    (0.58
    )
    
    $
    (5.07
    )
    
    $
    (0.27
    )Discontinued operations
    
    
    (0.04
    )
    
    
    (0.04
    )
    
    
    (0.03
    )
    
    
    (0.01
    )$
    (0.53
    )
    
    $
    (0.62
    )
    
    $
    (5.10
    )
    
    $
    (0.28
    )
 First
    
    Second
    
    Third
    
    FourthQuarter
    
    Quarter
    
    Quarter
    
    Quarter(In thousands, except per share amounts)2003Revenues
    
    $
    27,283
    
    
    $
    26,114
    
    
    $
    25,898
    
    
    $
    27,343Income/(Loss) from continuing operations
    
    
    (14,380
    )
    
    
    (22,142
    )
    
    
    (136,326
    )
    
    
    (5,943
    )Net income/(Loss)
    
    
    (14,414
    )
    
    
    (22,423
    )
    
    
    (136,493
    )
    
    
    (550
    )Income/(Loss) per share, basic and diluted:Continuing operations
    
    $
    (1.03
    )
    
    $
    (1.56
    )
    
    $
    (9.41
    )
    
    $
    (0.40
    )Discontinued operations
    
    
    
    
    
    
    (0.02
    )
    
    
    (0.01
    )
    
    
    0.36$
    (1.03
    )
    
    $
    (1.58
    )
    
    $
    (9.42
    )
    
    $
    (0.04
    )
 Included in net loss for the third quarter of 2004 and 2003 are losses on impairment of goodwill
and other intangible assets totaling $73.6 million and $103.8 million, respectively.




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##### Table of Contents



Item 9. Changes In And Disagreements With Accountants On Accounting And Financial Disclosure None. 
 Item 9A. Controls And Procedures The Companys management, including its chief executive officer, chief
financial officer and chief accounting officer evaluated the effectiveness of
the Companys disclosure controls and procedures (as defined in the Securities
Exchange Act of 1934 Rules 13(a)  14(c), and 14(d)) as of August 31, 2004.
Based on this review, the chief executive officer, chief financial officer and
chief accounting officer concluded that Interlands disclosure controls and
procedures were effective to provide reasonable assurances that such disclosure
controls and procedures satisfy their objectives and that the information
required to be disclosed by the Company in its periodic reports is accumulated
and communicated to management, including its chief executive officer, chief
financial officer and chief accounting officer, as appropriate to allow timely
decisions regarding disclosure and is recorded, processed, summarized and
reported within the time periods specified in the U.S. Securities and Exchange
Commissions rules and forms. Nevertheless, the Companys management, including its chief executive officer,
chief financial officer and chief accounting officer, do not expect that the
Companys disclosure controls and procedures will prevent all error and all
fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. The design of any system of controls is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions. Further, the design of a control system must
reflect the fact that there are resource constraints, and the benefits of
controls must be considered relative to their costs. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any,
within the Company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdown
can occur because of simple error or mistake. In particular, many of the
Companys current processes rely upon manual reviews and processes to ensure
that neither human error nor system weakness has resulted in erroneous
reporting of financial data. The Company has implemented a number of significant improvements to its
internal controls over financial reporting. The Company considers a change in
its internal control over financial reporting to be material only when the
failure to effectuate such change would have been expected to have resulted in
a substantial likelihood of a material misstatement of the Companys financial
statements. While we continued to make incremental improvements to our
internal controls over financial reporting during the fiscal year, there were
no changes in the Companys internal control over financial reporting which
management considered to be material. 
 Item 9B. Other Information None.




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##### Table of Contents



PART III 
 Item 10. Directors And Executive Officers Of The Registrant 
 Item 11. Executive Compensation 
 Item 12. Security Ownership Of Certain Beneficial Owners And Management 
 Item 13. Certain Relationships And Related Transactions 
 Item 14. Principal Accounting Fees And Services Certain information concerning the Registrants executive officers and
directors is included under the caption Officers and Directors of the
Registrant included in PART I, Item 1 of this report. Other
information required by Items 10, 11, 12, 13 and 14 will be contained in
the registrants Proxy Statement which will be filed with the Securities
and Exchange Commission within 120 days after August 31, 2004, and is
incorporated herein by reference.




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##### Table of Contents



PART IV 
 Item 15. Exhibits and Financial Statement Schedules List of documents filed as part of this Report  1.
    
    Financial Statements. Consolidated Financial Statements: Consolidated Statements of Operations for the Fiscal Years Ended
August 31, 2004, 2003, and 2002 Consolidated Balance Sheets as of August 31, 2004 and 2003 Consolidated Statements of Shareholders Equity for the Fiscal Years
Ended August 31, 2004, 2003, and 2002 Consolidated Statements of Cash Flows for the Fiscal Years Ended
August 31, 2004, 2003, and 2002 Notes to Consolidated Financial Statements  2.
    
    Quarterly Financial Information (Unaudited)3.
    
    Report of Independent Registered Public Accounting Firm4.
    
    Financial Statement Schedules are omitted since the required
information is not present or is not present in amounts sufficient
to require submission of the Schedules, or because the information
required is included in the financial statements and notes thereto. The following documents are filed as exhibits to this Annual Report on Form
10-K: FILEDPREVIOUSLY ON
    
    FILEDINCORPORATED BY REFERENCE
    
    FORM 10-K
    
    HEREWITHExhibit
    
    Description
    
    Form
    
    Date
    
    Number
    
    Registrant2.01
    
    Agreement of Merger, dated as
of October 10, 1994, as
amended by the first
amendment thereto, dated as
of December 13, 1994, by and
among ZEOS, MCI and MCMS
    
    S-4
    
    3/13/95
    
    
    2.1
    
    
    INLD2.02
    
    Articles of Merger, dated
April 7, 1995, by and among
ZEOS, MCI and MCMS
    
    8-K
    
    4/07/95
    
    
    2.2
    
    
    INLD2.03
    
    Purchase Agreement, dated
March 22, 2001, by and among
MEI California, Inc., the
Registrant and MICRON
Technology Inc. (MTI)
    
    8-K
    
    4/10/01
    
    
    2.01
    
    
    INLD2.04
    
    Agreement and Plan of Merger
dated March 22, 2001, by and
among the Registrant, Imagine
Acquisition Corporation and
Interland, Inc., a Georgia
corporation
(Interland-Georgia)
    
    8-K
    
    4/10/01
    
    
    2.01
    
    
    INLD




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##### Table of Contents



FILEDPREVIOUSLY ON
    
    FILEDINCORPORATED BY REFERENCE
    
    FORM 10-K
    
    HEREWITHExhibit
    
    Description
    
    Form
    
    Date
    
    Number
    
    Registrant2.05
    
    Membership Interest Purchase
Agreement, dated as of April
30, 2001, by and between the
Registrant and GTG PC
Holdings, LLC
    
    10-Q
    
    5/31/01
    
    
    2.01
    
    
    INLD2.06
    
    First Amendment to Membership
Interest Purchase Agreement
and Form of Contribution
Agreement, dated as of May
31, 2001, by and between the
Registrant and GTG PC
Holdings, LLC
    
    10-Q
    
    5/31/01
    
    
    2.02
    
    
    INLD2.07(1)
    
    Agreement and Plan of Merger
dated as of May 3, 2002, by
and between Dialtone Inc.,
Jaguarcub Acquisition
Corporation, Dialtone
Stockholders Representative
    
    10-Q
    
    5/31/02
    
    
    2.07
    
    
    INLD2.08(a)(1)
    
    Agreement and Plan of Merger
dated as of August 30, 2002
by and among Interland, Inc.,
Panthercub Acquisition
Corporation, InnerhoST, Inc.,
Spire Capital Partners, L.P.,
Spire Investment L.L.C.,
Waller-Sutton Media Partners,
L.P. and the other
stockholders of iNNERHOST,
Inc.
    
    S-3/A
    
    9/24/02
    
    
    2.08
    
    
    INLD2.08(b)
    
    Amendment dated as of October
10, 2002 to Agreement and
Plan of Merger by and among
Interland, Inc., iNNERHOST,
Inc. and the stockholders of
iNNERHOST, Inc.
    
    10-K
    
    8/31/02
    
    
    2.08
    (b)
    
    INLD2.09(1)
    
    Agreement and Plan of Merger
dated as of December 19, 2002
by and among Interland, Inc.,
Bobcat Acquisition
Corporation, Hostcentric,
Inc. and William Bunting,
Steve Harter, and Dominique
Bellanger as Stockholders
Representatives
    
    8-K
    
    12/20/02
    
    
    2.1
    
    
    INLD2.10(1)
    
    Merger Agreement and Plan of
Reorganization among Trellix
Corporation, Interland, Inc.
and Cheetah Acquisition
Corporation
    
    S-3
    
    1/22/03
    
    
    2.10
    
    
    INLD




---



##### Table of Contents



FILEDPREVIOUSLY ON
    
    FILEDINCORPORATED BY REFERENCE
    
    FORM 10-K
    
    HEREWITHExhibit
    
    Description
    
    Form
    
    Date
    
    Number
    
    Registrant3.01
    
    Unofficial Restated Articles
of Incorporation of
Registrant (as amended
through April 24, 2002)
    
    10-Q
    
    5/31/02
    
    
    3.01
    
    
    INLD3.01(b)
    
    Articles of Amendment to
Articles of Incorporation of
Registrant
    
    10-K
    
    8/31/03
    
    
    3.01
    (b)
    
    INLD3.02
    
    Unofficial Restated Bylaws of
the Registrant (as amended
through April 24, 2002)
    
    10-Q
    
    5/31/02
    
    
    3.02
    
    
    INLD4.01
    
    Form of Stock Certificate of
the Registrant
    
    10-K
    
    8/31/01
    
    
    3.04
    
    
    INLD4.03
    
    August 30, 2002 Registration
Rights Agreement by and among
Interland, Inc., Spire
Capital Partners, L.P., Spire
Investment, L.L.C., and
Waller-Sutton Media Partners,
L.P.
    
    S-3
    
    9/24/02
    
    
    4.03
    
    
    INLD4.04
    
    August 30, 2002 Stock
Restriction Agreement by and
among Spire Capital Partners,
L.P., Spire Investment,
L.L.C., and Waller-Sutton
Media Partners, L.P.
    
    S-3
    
    9/24/02
    
    
    4.04
    
    
    INLD4.05
    
    March 28, 2002 Amendment to
Stock Rights Agreement by and
among Interland, Inc., Bryan
Heitman and Gabriel Murphy
    
    10-Q
    
    5/31/02
    
    
    10.112
    
    
    INLD4.06
    
    July 11, 2002 Amendment to
Stock Rights Agreement by and
among Interland, Inc., Bryan
Heitman and Gabriel Murphy
    
    S-3/A
    
    9/24/02
    
    
    4.06
    
    
    INLD4.07
    
    December 31, 2002 Amendment
to Stock Rights Agreement by
and among Interland, Inc.,
Bryan Heitman and Gabriel
Murphy
    
    S-3/A
    
    3/17/03
    
    
    4.07
    
    
    INLD4.08
    
    Form of Warrant
    
    S-3
    
    1/22/03
    
    
    4.07
    
    
    INLD10.35(a)+
    
    Micron Electronics 1995 Stock
Option Plan, as amended
through August 29, 2001
    
    S-8
    
    1/14/00
    
    
    4.1
    
    
    INLD




---



##### Table of Contents



FILEDPREVIOUSLY ON
    
    FILEDINCORPORATED BY REFERENCE
    
    FORM 10-K
    
    HEREWITHExhibit
    
    Description
    
    Form
    
    Date
    
    Number
    
    Registrant10.35(b)+
    
    Form of Notice of Grant for
Micron Electronics 1995 Stock
Option Plan
    
    10-K
    
    8/31/01
    
    
    10.35
    (b)
    
    INLD10.35(c)+
    
    Interland 1995 Stock Option
Plan, as amended August 30,
2001
    
    10-K
    
    8/31/01
    
    
    10.35
    (c)
    
    INLD10.35(d)+
    
    Form of Notice of Grant for
Interland 1995 Stock Option
Plan
    
    10-K
    
    8/31/01
    
    
    10.35
    (d)
    
    INLD10.36(a)+
    
    Micron Electronics 1995
Employee Stock Purchase Plan,
as amended through August 5,
2001
    
    10-Q
    
    6/1/95
    
    
    10.36
    
    
    INLD10.36(b)+
    
    Interland 1995 Employee Stock
Purchase Plan, as amended
August 6, 2001 and April 24,
2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    X10.36(c)+
    
    Interland, Inc. 2002 Equity
Incentive Plan
    
    S-8
    
    10/3/03
    
    
    4.1
    
    
    INLD10.38+
    
    Form of Indemnification
Agreement between the
Registrant and its officers
and directors
    
    10-K
    
    8/31/95
    
    
    10.38
    
    
    INLD10.47+
    
    Form of Employment and
Non-compete Agreement, with
12-month termination
provision, for certain
officers of the Registrant
    
    10-Q
    
    2/26/98
    
    
    10.47
    
    
    INLD




---



##### Table of Contents



FILEDPREVIOUSLY ON
    
    FILEDINCORPORATED BY REFERENCE
    
    FORM 10-K
    
    HEREWITHExhibit
    
    Description
    
    Form
    
    Date
    
    Number
    
    Registrant10.52+
    
    Employment Offer, dated
January 10, 1998, to Joel J.
Kocher
    
    10-Q
    
    2/26/98
    
    
    10.52
    
    
    INLD10.58+
    
    The Registrants Executive
Incentive Plan, as amended
    
    10-Q
    
    12/2/99
    
    
    10.58
    
    
    INLD10.68+
    
    Amended Non Qualified Stock
Option Agreement, dated April
6, 2000
    
    10-Q
    
    6/1/00
    
    
    10.68
    
    
    INLD10.69+
    
    Amended Non Qualified Stock
Option Agreement, dated April
6, 2000
    
    10-Q
    
    6/1/00
    
    
    10.69
    
    
    INLD10.70(a)+
    
    HostPro, Inc. 2000 Equity
Incentive Plan I
    
    10-K
    
    8/31/00
    
    
    10.70
    
    
    INLD10.70(b)+
    
    HostPro, Inc. 2000 Equity
Incentive Plan II
    
    10-K
    
    8/31/00
    
    
    10.71
    
    
    INLD10.70(c)+
    
    Form of Notice of Grant for
HostPro, Inc. 2000 Equity
Incentive Plans
    
    10-K
    
    8/31/00
    
    
    10.72
    
    
    INLD10.70(d)+
    
    Form of Notice of Grant for
HostPro, Inc. 2000 Equity
Incentive Plans
    
    10-K
    
    8/31/00
    
    
    10.73
    
    
    INLD10.70(e)+
    
    Micron Electronics 2001
Equity Incentive Plan, as
amended as of March 22, 2001
    
    10-Q
    
    5/31/01
    
    
    10.89
    
    
    INLD10.70(f)+
    
    Interland 2001 Equity
Incentive Plan, as amended
August 6, 2001
    
    10-K
    
    8/31/01
    
    
    10.70
    (f)
    
    INLD




---



##### Table of Contents



FILEDPREVIOUSLY ON
    
    FILEDINCORPORATED BY REFERENCE
    
    FORM 10-K
    
    HEREWITHExhibit
    
    Description
    
    Form
    
    Date
    
    Number
    
    Registrant10.70(g)+
    
    Form of Notice of Grant for
Interland 2001 Equity
Incentive Plan
    
    10-K
    
    8/31/01
    
    
    10.70
    (g)
    
    INLD10.79+
    
    The Registrants Severance
Plan for Employees  2001
Amendment and Restatement
    
    10-Q
    
    3/1/01
    
    
    10.79
    
    
    INLD10.80+
    
    The Registrants Change in
Control Severance Plan
    
    10-Q
    
    3/1/01
    
    
    10.80
    
    
    INLD10.81+
    
    HostPro, Inc. 2000 Incentive
Plan II  Notice of Grant to
Joel Kocher
    
    10-Q
    
    3/1/01
    
    
    10.81
    
    
    INLD10.84+
    
    Retention Agreement between
the Registrant and Sid
Ferrales, dated as of
December 1, 2000
    
    10-Q
    
    3/1/01
    
    
    10.84
    
    
    INLD10.89
    
    MTI Shareholder Agreement
dated as of March 22, 2001
between the Registrant and
MTI
    
    10-Q
    
    4/10/01
    
    
    2.01
    
    
    INLD10.91
    
    Operating lease for property
located at 3250 Wilshire
Blvd., Los Angeles,
California, dated as of March
16, 1998
    
    10-Q
    
    5/31/01
    
    
    10.90
    
    
    INLD10.92
    
    Operating lease for property
located at 3250 Wilshire
Blvd., Los Angeles,
California, dated as of March
19, 1999
    
    10-Q
    
    5/3/01
    
    
    10.91
    
    
    INLD10.93
    
    Operating lease for property
located at 1450 Eagle Flight
Way, Boise, Idaho, dated as
of January 7, 2000
    
    10-Q
    
    5/31/01
    
    
    10.92
    
    
    INLD




---



##### Table of Contents



FILEDPREVIOUSLY ON
    
    FILEDINCORPORATED BY REFERENCE
    
    FORM 10-K
    
    HEREWITHExhibit
    
    Description
    
    Form
    
    Date
    
    Number
    
    Registrant10.94
    
    Operating lease for property
located at 3326 160th Avenue
SE, Bellevue, Washington,
dated as of December 16, 1999
    
    10-Q
    
    5/31/01
    
    
    10.93
    
    
    INLD10.96(a)+
    
    Interland-Georgia Stock
Incentive Plan
    
    S-8
    
    9/17/01
    
    
    4.05
    (a)
    
    INLD10.96(b)+
    
    First Amendment to
Interland-Georgia Stock
Incentive Plan
    
    S-8
    
    9/17/01
    
    
    4.05
    (b)
    
    INLD10.96(c)+
    
    Second Amendment to
Interland-Georgia Stock
Incentive Plan
    
    S-8
    
    9/17/01
    
    
    4.05
    (c)
    
    INLD10.96(d)+
    
    Third Amendment to
Interland-Georgia Stock
Incentive Plan
    
    S-8
    
    9/17/01
    
    
    4.05
    (d)
    
    INLD10.96(e)+
    
    Fourth Amendment to
Interland-Georgia Stock
Incentive Plan
    
    S-8
    
    9/17/01
    
    
    4.05
    (e)
    
    INLD10.101(a)
    
    Amended and Restated Lease
Agreement between
Interland-Georgia and 101
Marietta Street Associated
dated September 29, 1999
    
    S-1/A
    
    5/18/00
    
    
    10.22
    (a)
    
    ILND10.101(b)
    
    First Amendment to Amended
and Restated Lease Agreement
between Interland-Georgia and
101 Marietta Street
Associates dated November 23,
1999
    
    S-1/A
    
    5/18/00
    
    
    10.22
    (b)
    
    ILND10.104(a)
    
    SunTrust Plaza Garden Offices
Lease Agreement by and
between SunTrust Plaza
Associates, LLC and
Interland-Georgia dated May
15, 2000
    
    10-K
    
    8/31/01
    
    
    10.104
    (a)
    
    INLD10.104(b)
    
    First Amendment to Lease
Agreement by and between
SunTrust Plaza Associates,
LLC and Interland-Georgia
dated September 27, 2000
    
    10-K
    
    8/31/01
    
    
    10.104
    (b)
    
    INLD10.105
    
    Amended and Restated
Registration Rights Agreement
between the Registrant, MTI
and certain shareholders of
Interland named therein dated
August 6, 2001
    
    10-K
    
    8/31/01
    
    
    10.105
    
    
    INLD




---



##### Table of Contents



FILEDPREVIOUSLY ON
    
    FILEDINCORPORATED BY REFERENCE
    
    FORM 10-K
    
    HEREWITHExhibit
    
    Description
    
    Form
    
    Date
    
    Number
    
    Registrant10.106
    
    Stock Purchase Agreement
between MTI and Micron
Semiconductor Products, Inc.
dated as of August 30, 2001
    
    10-K
    
    8/31/01
    
    
    10.106
    
    
    INLD10.107
    
    Donation Agreement between
Micron Semiconductor
Products, Inc. and the Micron
Technology Foundation, Inc.
dated as of August 30, 2001
    
    10-K
    
    8/31/01
    
    
    10.107
    
    
    INLD10.108(a)+
    
    Employment Agreement between
the Registrant and Allen
Shulman dated November 1,
2001
    
    10-K
    
    8/31/02
    
    
    10.108
    (a)
    
    INLD10.108(b)+
    
    Amendment to Employment
Agreement between the
Registrant and Allen Shulman
dated as of September 10,
2002.
    
    10-K
    
    8/31/02
    
    
    10.108
    (b)
    
    INLD10.109
    
    February 8, 2002 Investor
Rights Agreement by and among
Interland, Inc., PAR
Investment Partners, L.P.,
Hartford Capital Appreciation
Fund, and certain other
stockholders
    
    10-Q
    
    2/28/02
    
    
    10.109
    
    
    INLD10.110(1)
    
    Agreement and Plan of Merger
dated as of February 8, 2002,
by and between
CommuniTech.Net, Inc.,
Montana Acquisition Company,
Inc., Interland, Inc.,
Gabriel Murphy, and Bryan
Heitman
    
    10-Q
    
    2/28/02
    
    
    10.110
    
    
    INLD10.112
    
    Amendment to Stock Rights
Agreement dated as of March
28, 2002 by and among Interland Inc., Gabriel Murphy, and Bryan
Heitman.
    
    10-Q
    
    5/31/02
    
    
    10.112
    
    
    INLD10.115(2)
    
    Microsoft Services Provider
License Agreement dated as of
January 15, 2002
    
    10-K
    
    8/31/02
    
    
    10.115
    
    
    INLD




---



##### Table of Contents



FILEDPREVIOUSLY ON
    
    FILEDINCORPORATED BY REFERENCE
    
    FORM 10-K
    
    HEREWITHExhibit
    
    Description
    
    Form
    
    Date
    
    Number
    
    Registrant10.116
    
    Escrow Agreement dated as of June 13, 2003, by and among
Interland, Inc., William B. Bunting, Steve Harter, and Dominique Bellanger, and
SunTrust Bank, a Georgia banking corporation (the Escrow Agent)
    
    10-Q
    
    5/31/03
    
    
    10.1
    
    
    INLD10.118+
    
    Employment Agreement dated as
of January 13, 2003 by and between Interland and William Jones
    
    10-K/A
    
    8/31/03
    
    
    10.118
    
    
    INLD10.119+
    
    Employment Agreement dated as
of August 5, 2002 by and
between Interland and Tiffani
D. Bova
    
    10-K/A
    
    8/31/03
    
    
    10.119
    
    
    INLD10.120
    
    Promissory Note in the
principal amount of
$4,780,475 dated February 11,
2004 in favor or U.S. Bancorp
Oliver-Allen Technology
Leasing.
    
    10-Q
    
    2/29/04
    
    
    10.117
    
    
    INLD10.121(2)
    
    Hosting Provider Program
Agreement dated February 24,
2004 between INTERLAND, INC.
and Red Hat, Inc.
    
    10-Q
    
    2/29/04
    
    
    10.118
    
    
    INLD10.122+
    
    Form of Stock Option
Agreement for Directors and
Officers under the 2002
Equity Incentive Plan
    
    
    
    
    
    
    
    
    
    
    
    
    
    X14.00
    
    Code of Ethics
    
    10-Q
    
    4/28/04
    
    
    14
    
    
    INLD21.01
    
    Subsidiaries of the Registrant
    
    
    
    
    
    
    
    
    
    
    
    
    
    X23.01
    
    Consent of Independent
Registered Public Accounting
Firm
    
    
    
    
    
    
    
    
    
    
    
    
    
    X24.01
    
    Power of Attorney
    
    
    
    
    
    
    
    
    
    
    
    
    
    X31.1
    
    Certification of Chief
Executive Officer pursuant to
Section 302 of the
Sarbanes-Oxley Act of 2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    X31.2
    
    Certification of Chief
Financial Officer pursuant to
Section 302 of the
Sarbanes-Oxley Act of 2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    X




---



##### Table of Contents



FILEDPREVIOUSLY ON
    
    FILEDINCORPORATED BY REFERENCE
    
    FORM 10-K
    
    HEREWITHExhibit
    
    Description
    
    Form
    
    Date
    
    Number
    
    Registrant32.1
    
    Certification of Chief
Executive Officer under
Section 906 of the
Sarbanes-Oxley Act of 2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    X32.2
    
    Certification of Chief
Financial Officer under
Section 906 of the
Sarbanes-Oxley Act of 2002
    
    
    
    
    
    
    
    
    
    
    
    
    
    X
   *
    
    INLD indicates the exhibit is incorporated by reference to the
Registrants prior filings with the SEC. ILND indicates the exhibit is
incorporated by reference to Interland-Georgias prior filings with the
SEC,+
    
    Management contract or compensatory arrangement or plan.(1)
    
    Schedules and exhibits have been omitted from the exhibit. A list of
omitted schedules and exhibits is set forth immediately following the
table of contents of the exhibit. Copies will be provided to the
Commission upon request.(2)
    
    The Company has requested confidential treatment for portions of this
exhibit pursuant to Rule 24b-2 of the Securities Exchange Act of 1934.




---



##### Table of Contents



Signatures Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized. INTERLAND, INC./s/ Allen L. ShulmanDate: November 15, 2004
    By: Allen L. ShulmanSenior Vice President, Chief Financial Officer
and Senior Counsel Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ Joel J. Kocher
Joel J. Kocher
    
    Chairman of the Board, President and Chief Executive Officer (principal executive officer)
    
    November 15, 2004/s/ Allen L. Shulman
Allen L. Shulman
    
    Senior Vice President, Chief Financial Officer and Senior Counsel (principal financial officer)
    
    November 15, 2004/s/ Juan G. Troncoso
Juan G. Troncoso
    
    Vice President Finance & Accounting (principal accounting officer)
    
    November 15, 2004/s/ John B. Balousek
John B. Balousek
    
    Director
    
    November 15, 2004/s/ Dr. John Patrick Crecine
Dr. John Patrick Crecine
    
    Director
    
    November 15, 2004/s/ Robert Lee
Robert Lee
    
    Director
    
    November 15, 2004/s/ Edward L. Shapiro
Edward L. Shapiro
    
    Director
    
    November 15, 2004/s/ Robert T. Slezak
Robert T. Slezak
    
    Director
    
    November 15, 2004