##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended November 30, 2005
 Commission File Number: 0-17932
 Interland, Inc.
 (Exact name of registrant as specified in its charter)
 Minnesota
    
    41-1404301(State or other jurisdiction
    
    (I.R.S. Employerof incorporation or organization)
    
    Identification No.)
 303 Peachtree Center Avenue, Suite 500, Atlanta, GA 30303
(Address, including Zip Code, of principal executive offices)
 (404) 260-2477
(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
 þ o
  o þ o
 o þ




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##### 



PART 1. FINANCIAL INFORMATION
    
    
    3Item 1. Financial Statements
    
    
    3Item 2. Managements Discussion And Analysis Of Financial Condition And Results Of Operations
    
    
    13Item 3. Quantitative And Qualitative Disclosures About Market Risk
    
    
    18Item 4. Controls and Procedures
    
    
    18PART II.  OTHER INFORMATION
    
    
    19Item 1. Legal Proceedings
    
    
    19Item 1A. Risk Factors
    
    
    21Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
    
    
    27Item 3. Defaults Upon Senior Securities
    
    
    27Item 4. Submission of Matters to a Vote of Security Holders
    
    
    27Item 5. Other Information
    
    
    27Item 6. Exhibits
    
    
    28EX-31.1 SECTION 302, CERTIFICATION OF THE CEOEX-31.2 SECTION 302, CERTIFICATION OF THE CFOEX-32.1 SECTION 906, CERTIFICATION OF THE CEOEX-32.2 SECTION 906, CERTIFICATION OF THE CFO
  2




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PART 1. FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 
 For the three months endedNovember 30,
    
    
    November 30,2005
    
    
    2004Revenues
    
    $
    12,148
    
    
    $
    23,061Operating costs and expenses:Network operating costs, exclusive of depreciation shown below
    
    
    2,131
    
    
    
    5,685Sales and marketing, exclusive of depreciation shown below
    
    
    2,517
    
    
    
    3,966Technical support, exclusive of depreciation shown below
    
    
    1,803
    
    
    
    3,813General and administrative, exclusive of depreciation shown below
    
    
    5,238
    
    
    
    7,131Bad debt expense
    
    
    276
    
    
    
    440Depreciation and amortization
    
    
    1,431
    
    
    
    5,877Restructuring costs
    
    
    1,626
    
    
    
    Other expense (income), net
    
    
    (165
    )
    
    
    (13
    )Total operating costs and expenses
    
    
    14,857
    
    
    
    26,899Operating loss
    
    
    (2,709
    )
    
    
    (3,838
    )Interest income (expense), net
    
    
    243
    
    
    
    41Loss from continuing operations before income taxes
    
    
    (2,466
    )
    
    
    (3,797
    )Income tax benefit (expense)
    
    
    
    
    
    
    Net loss from continuing operations
    
    
    (2,466
    )
    
    
    (3,797
    )Income/(loss) from discontinued operations, net of tax
    
    
    (122
    )
    
    
    601Net loss
    
    $
    (2,588
    )
    
    $
    (3,196
    )Net income/(loss) per share, basic and diluted:Continuing operations
    
    $
    (0.15
    )
    
    $
    (0.24
    )Discontinued operations
    
    
    (0.01
    )
    
    
    0.04$
    (0.16
    )
    
    $
    (0.20
    )Number of shares used in per share calculation:Basic and diluted
    
    
    16,283
    
    
    
    16,016
  .
 3




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##### Table of Contents



As ofNovember 30,
    
    
    August 31,2005
    
    
    2005AssetsCurrent assetsCash and cash equivalents
    
    $
    23,268
    
    
    $
    16,891Trade
receivables, net of allowance for doubtful accounts
    
    
    1,333
    
    
    
    1,365Other receivables
    
    
    710
    
    
    
    11,502Other current assets
    
    
    2,056
    
    
    
    2,698Restricted investments
    
    
    276
    
    
    
    258Total current assets
    
    
    27,643
    
    
    
    32,714Restricted investments
    
    
    9,073
    
    
    
    9,299Securities, held-to-maturity
    
    
    53
    
    
    
    50Property plant and equipment, net
    
    
    6,003
    
    
    
    5,858Intangibles, net
    
    
    2,176
    
    
    
    3,038Other assets
    
    
    5,600
    
    
    
    5,600Total assets
    
    $
    50,548
    
    
    $
    56,559Liabilities and shareholders equityCurrent liabilitiesAccounts payable
    
    $
    2,518
    
    
    $
    2,355Accrued expenses
    
    
    6,287
    
    
    
    10,465Accrued restructuring charges
    
    
    5,425
    
    
    
    4,717Current portion of long-term debt and capital lease obligations
    
    
    872
    
    
    
    859Deferred revenue
    
    
    4,275
    
    
    
    4,542Total current liabilities
    
    
    19,377
    
    
    
    22,938Long-term debt and capital lease obligations
    
    
    2,269
    
    
    
    2,510Deferred revenue, long-term
    
    
    208
    
    
    
    229Other liabilities
    
    
    934
    
    
    
    939Total liabilities
    
    
    22,788
    
    
    
    26,616Commitments and contingencies (note 6)
    
    
    
    
    
    
    Shareholders equityCommon stock, $.01 par value, authorized 21 million shares,
issued and outstanding 16.4 and 16.4 million shares, respectively
    
    
    164
    
    
    
    164Additional capital
    
    
    324,581
    
    
    
    323,498Warrants
    
    
    2,128
    
    
    
    2,806Note receivable from shareholder
    
    
    (735
    )
    
    
    (735
    )Accumulated deficit
    
    
    (298,378
    )
    
    
    (295,790
    )Total shareholders equity
    
    
    27,760
    
    
    
    29,943Total liabilities and shareholders equity
    
    $
    50,548
    
    
    $
    56,559
  4




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For the three months endedNovember 30,
    
    
    November 30,2005
    
    
    2004CASH FLOWS FROM OPERATING ACTIVITIESNet loss
    
    $
    (2,588
    )
    
    $
    (3,196
    )Adjustments to reconcile net loss to net cash used in
operating activities from continuing operations:Income (loss) from discontinued operations
    
    
    122
    
    
    
    (601
    )Depreciation and amortization
    
    
    1,431
    
    
    
    5,877Bad debt expense
    
    
    276
    
    
    
    440Loss (gain) on sale of assets
    
    
    
    
    
    
    (13
    )Stock-based compensation
    
    
    385
    
    
    
    158Restructuring charges
    
    
    1,626
    
    
    
    Changes in operating assets and liabilities
net of effect of acquisitions:Cash received from sale of dedicated assets
    
    
    11,267
    
    
    
    Receivables
    
    
    (719
    )
    
    
    (490
    )Other current assets
    
    
    642
    
    
    
    301Accounts payable, accrued expenses and deferred revenue
    
    
    (4,326
    )
    
    
    (2,583
    )Cash provided by (used in) operating activities of continuing operations
    
    
    8,116
    
    
    
    (107
    )CASH FLOWS FROM INVESTING ACTIVITIESExpenditures for property, plant, and equipment
    
    
    (714
    )
    
    
    (827
    )Purchases of held-to-maturity investment securities
    
    
    (3
    )
    
    
    Proceeds from held-to-maturity investment securities
    
    
    
    
    
    
    1,500Purchase of auction rate securities
    
    
    
    
    
    
    (2,000
    )Net change in restricted investments
    
    
    208
    
    
    
    516Cash used in investing activities of continuing operations
    
    
    (509
    )
    
    
    (811
    )CASH FLOWS FROM FINANCING ACTIVITIESRepayments of debt and capital lease obligations
    
    
    (228
    )
    
    
    (940
    )Proceeds from exercises of stock options
    
    
    20
    
    
    
    4Cash used in financing activities of continuing operations
    
    
    (208
    )
    
    
    (936
    )Net cash provided by (used in) continuing operations
    
    
    7,399
    
    
    
    (1,854
    )Net cash used in discontinued operations
    
    
    (1,022
    )
    
    
    (217
    )Net increase (decrease) in cash and cash equivalents
    
    
    6,377
    
    
    
    (2,071
    )Cash and cash equivalents at beginning of period
    
    
    16,891
    
    
    
    15,203Cash and cash equivalents at end of period
    
    $
    23,268
    
    
    $
    13,132
  5




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1. General
 Business
 History of operating losses
 Change in Fiscal Year End
 2. Significant Accounting Policies
 Interim Unaudited Financial Information
 Basis of Presentation
 Use of Estimates 
 Reclassification of Auction Rate Securities
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PreviouslyConsolidated Statement of Cash Flows - Three Months Ended November 30, 2004
    
    Reported
    
    
    Reclass
    
    
    RevisedPurchases of held-to-maturity investment securities
    
    $
    (500
    )
    
    $
    500
    
    
    $
    Proceeds from held-to-maturity investment securities
    
    
    0
    
    
    
    1,500
    
    
    
    1,500Purchases of auction rate securities
    
    
    0
    
    
    
    (2,000
    )
    
    
    (2,000
    )Proceeds from auction rate securities
    
    
    0
    
    
    
    0
    
    
    
    0Net Change
    
    $
    (500
    )
    
    $
    
    
    
    $
    (500
    )
 3. stock-based compensation
      7




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Quarter endedNovember 30,2005Dividend yield
    
    0.0%Expected volatility
    
    77.0% - 78.1%Risk-free interest rate
    
    3.7% - 4.4%Expected term (in years)
    
    5.8 years
        8




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Net earnings/(loss), as reported
    
    $
    (3,196
    )Add: Stock-based employee compensation expense included
in reported net income, net of related tax effects
    
    
    158Deduct:Total stock-based compensation expense determined under
fair value method for all awards
    
    
    (416
    )Pro forma net earnings/(loss)
    
    $
    (3,454
    )Earning per common share:Net earnings per common share  Basic & diluted, as reported
    
    $
    (0.20
    )Net earnings per common share  Basic & diluted, pro forma
    
    $
    (0.22
    )
  Weighted-Avg
    
    
    Aggregate
    
    
    Weighted-Avg(000s)
    
    
    Exercise
    
    
    Intrinsic Value (1)
    
    
    Contractual LifeShares
    
    
    Price
    
    
    (000s)
    
    
    Remaining in YearsOutstanding at Aug 31, 2005
    
    
    2,989
    
    
    $
    8.22Granted at fair value
    
    
    831
    
    
    $
    3.01Exercised
    
    
    (6
    )
    
    $
    3.33Forfeited
    
    
    (124
    )
    
    $
    15.77Outstanding at November 30, 2005
    
    
    3,690
    
    
    $
    6.70Exercisable at November 30, 2005
    
    
    1,186
    
    
    $
    15.50
    
    
    $
    937
    
    
    
    7.91
  (1)
    
    The intrinsic value of a stock option is the amount by which the current market value of
the underlying stock exceeds the exercise price of the option.   Weighted-Avg(000s)
    
    
    Grant-DateNonvested Shares
    
    Shares
    
    
    Fair ValueNonvested at September 1, 2005
    
    
    1,922
    
    
    $
    1.53Granted
    
    
    831
    
    
    $
    2.06Vested
    
    
    (250
    )
    
    $
    1.58Nonvested at November 30, 2005
    
    
    2,503
    
    
    $
    1.70
  9




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4. Restructuring And Facility Exit Costs
 2001 Plan
  2005 Plan
  5. Purchase Business Combination Liabilities
  6. Discontinued Operations
   7. Contingencies
   10




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11




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see Interland, Inc. v. Certain Underwriters at
Lloyds of London
    8. Subsequent Event
   12




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Item 2. Managements Discussion And Analysis Of Financial Condition And Results Of
Operations
 Statements contained in this Form 10-Q 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 its 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. Forward-looking statements involve a number of risks and uncertainties, and include
risks associated with our target markets and risks pertaining to our ability to successfully
integrate the operations and personnel of the recent acquisitions. Factors that could cause actual
results to differ materially from expected results are identified in Risk Factors below, and in
the Companys annual report on Form 10-K for the year ended August 31, 2005 and in the Companys
other filings with the Securities and Exchange Commission. All quarterly references are to the
Companys fiscal periods ended November 30, 2005, or November 30, 2004, unless otherwise indicated.
All annual references are also on a fiscal August 31 st year-end basis, unless otherwise
indicated. All tabular dollar amounts are stated in thousands.
 Overview
       13




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Results Of Continuing Operations
  Comparison Of The Quarters Ended November 30, 2005 And 2004
  Revenues
  For the quarter endedNovember 30,
    
    
    November 30,2005
    
    
    2004Hosting revenue
    
    $
    11,320
    
    
    $
    21,910Other revenue
    
    
    828
    
    
    
    1,151Total revenue
    
    $
    12,148
    
    
    $
    23,061
   14




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Operating Costs and Expenses
 Network Operating Costs
  Sales and Marketing
  Technical Support
  General and Administrative
  Bad Debt Expense
  Depreciation and Amortization
  Interest Income (Expense), net
 15




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Restructuring and Facility Exit Costs
  Net Cash Used in Operating Activities and Earnings from Continuing Operations Before Interest,
Taxes, Depreciation and Amortization (EBITDA)
   For the quarter endedNovember 30,
    
    
    November 30,2005
    
    
    2004in thousandsNet loss
    
    $
    (2,588
    )
    
    $
    (3,196
    )Depreciation and amortization
    
    
    1,431
    
    
    
    5,877Interest expense (income)
    
    
    (243
    )
    
    
    (41
    )Discontinued operations
    
    
    122
    
    
    
    (601
    )EBITDA
    
    $
    (1,278
    )
    
    $
    2,039Interest income / (expense)
    
    
    243
    
    
    
    41Provision for bad debts
    
    
    276
    
    
    
    440Restructuring charges
    
    
    1,626
    
    
    
    Loss on the sale of assets
    
    
    
    
    
    
    (13
    )Other non-cash adjustments
    
    
    385
    
    
    
    158Changes in assets and liabilities:Cash received from sale of dedicated assets
    
    
    11,267
    
    
    
    Receivables, net
    
    
    (719
    )
    
    
    (490
    )Other current assets
    
    
    642
    
    
    
    301Accounts payable, accrued expenses, and deferred revenue
    
    
    (4,326
    )
    
    
    (2,583
    )Net cash provided by (used in) operating activities
    
    $
    8,116
    
    
    $
    (107
    )
  16




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Results of Discontinued Operations
 PC Systems
    Liquidity and Capital Resources
      17




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Item 3. Quantitative And Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
    18




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Interland, Inc.
 
 PART II.  OTHER INFORMATION
 
 Item 1. Legal Proceedings
       19




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see Interland, Inc. v. Certain Underwriters at
Lloyds of London
   20




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Item 1A. Risk Factors
 You should carefully consider the following factors and all other information contained in
this Form 10-Q and the Companys recently filed Form 10-K for the fiscal year ended August 31, 2005
before you make any investment decisions with respect to the Companys securities. The risks and
uncertainties described below are not the only risks the Company faces.
 Interland has incurred losses since inception and could incur losses in the future.
  
    
    Adapting network infrastructure and administrative resources to accommodate additional
customers and future growth;
    
    Developing products, distribution, marketing, and management for the broadest-possible market;
    
    Broadening customer technical support capabilities;
    
    Developing or acquiring new products and associated technical infrastructure;
    
    Developing additional indirect distribution partners;
    
    Increased costs from third party service providers;
    
    Improving network security features;
    
    Legal fees and settlements associated with litigation and
contingencies; and
    
    To the extent that increases in operating expenses are not offset by increases in
revenues, operating losses will increase.
 Interlands management and Board of Directors may be unable to execute their plans to turn around
the Company, grow its revenues and achieve profitability.
  Ours is a recurring-revenue subscriber business and as such the effects of a net loss of monthly
recurring revenue are magnified.
  21




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Unfavorable results of existing litigation may cause Interland to have additional expenses or
operating losses that 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.
  Interland has a limited operating history and its business model is still evolving, which makes it
difficult to evaluate its prospects.
  Quarterly and annual operating results may fluctuate, which could cause Interlands stock price to
be volatile.
  
    
    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;
 22




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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 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.
  Because Interlands target markets are volatile, the Company may face a loss of customers or a high
level of non-collectible accounts.
  
    
    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.
  Interland could incur liabilities in the future relating to its PC Systems business, which could
cause additional operating losses.
 23




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Because Interland faces intense competition, it may not be able to operate profitably in its
markets .
  
    
    Develop and expand their network infrastructures and service offerings more rapidly;
    
    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.
  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 .
    If Interland is unable to attract and retain key personnel, it may not be able to compete
effectively in its market .
  24




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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 .
  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 .
  
    
    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
are maintained by a third party.
   Data centers and communications networks are vulnerable to security breaches that could cause
disruptions in service, liability to third parties, or loss of
customers.
 25




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Disruption of Interlands services caused by unknown software or hardware defects could harm its
business and reputation.
  Providing services to customers with critical websites and Web-based applications could potentially
expose Interland to lawsuits for customers lost profits or other damages.
  Interland could face liability for information distributed through its network.
  26




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Interlands business operates in an uncertain legal environment where future government regulation
and lawsuits could restrict Interlands business or cause unexpected losses .
  Interlands stock price may be volatile which could cause an investment in its common stock to
decrease significantly.
  
    
    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.
  Substantial
future sales of shares by shareholders could negatively affect
Interlands stock price.
  
 Item 2. Unregistered Sale of Equity Securities and Use of Proceeds
  
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
   27




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Item 6. Exhibits
  Exhibit
    
    Description2.01(1)
    
    Asset Purchase Agreement between Interland, Inc., Web Internet, LLC and William Pemble
dated November 29, 2005 (incorporated by reference to Exhibit 10.1 to the Registrants
Current Report on Form 8-K filed on 11/30/05).3.01
    
    Unofficial Restated Articles of Incorporation of Registrant (as amended through April
24, 2002) (incorporated by reference to the Registrants Quarterly Report on Form 10-Q for
the quarter ended 5/31/02).3.01(b)
    
    Articles of Amendment to Articles of Incorporation of Registrant (incorporated by
reference to the Registrants Annual Report on Form 10-K for the year ended 8/31/03).3.02
    
    Unofficial Restated Bylaws of the Registrant (as amended through August 6, 2001)
(incorporated by reference to the Registrants Quarterly Report on Form 10-Q for the
quarter ended 5/31/02).10.136
    
    Form of Separation Agreement and Mutual Release of All Claims as of October 18, 2005 by
and between Interland, Inc. and Allen L. Shulman (incorporated by reference to Exhibit 10.1
to the Registrants Current Report on Form 8-K filed on 10/18/05).10.137
    
    Settlement and Mutual Release Agreement between Interland, Inc. and Novell, Inc. dated
October 28, 2005 (incorporated by reference to Exhibit 10.1 to the Registrants Current
Report on Form 8-K filed on 11/3/05).10.138
    
    Intellectual Property Purchase and Sale Agreement between Interland, Inc. and Web Service
Company, Inc. dated November 29, 2005 (incorporated by reference to Exhibit 10.2 to the
Registrants Current Report on Form 8-K filed on 11/30/05).31.1
    
    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.
 
 (1)
    
    In accordance with Item 601(b)(2) of Regulation S-K, certain of the schedules have been omitted
and a list briefly describing the schedules is at the end of the Exhibit. The Registrant will
furnish supplementally a copy of any omitted schedule to the commission upon request. 28




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Signatures
  Interland, Inc.(Registrant)Dated: January 9, 2006
    
    /s / Gonzalo TroncosoGonzalo TroncosoExecutive Vice President and Chief Financial Officer,(Principal Financial Officer)
 29