##### 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  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) 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 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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). Yes þ No o The number of outstanding shares of the registrants Common Stock on May 31, 2005 was 16,108,019.




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##### Table of Contents



PART I. FINANCIAL INFORMATION
    
    
    3Item I. Financial Statements
    
    
    3Consolidated Statements of Operations
    
    
    3Consolidated Balance Sheets
    
    
    4Consolidated Statements of Cash Flows
    
    
    5Notes To Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion And Analysis Of Financial Condition And Results Of Operations
    
    
    13Item 3. Quantitative And Qualitative Disclosures About Market Risk
    
    
    25Item 4. Controls And Procedures
    
    
    26PART II.  OTHER INFORMATION
    
    
    27Item 1. Legal Proceedings
    
    
    27Item 2.Unregistered Sale of Equity Securities and Use of Proceeds
    
    
    30Item 3.Defaults Upon Senior Securities
    
    
    30Item 4. Submission of Matters to a Vote of Security Holders
    
    
    30Item 5. Other Information
    
    
    30Item 6. Exhibits
    
    
    30EX-2.01 ASSET PURCHASE AGREEMENTEX-10.125 AMENDMENT TO STOCK OPTIONSEX-10.126 FORM OF EMPLOYMENT AGREEMENTEX-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, CERTIFICAITON OF THE CFO




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##### Table of Contents










PART I. FINANCIAL INFORMATION




Item I.
Financial Statements

INTERLAND, INC.




Consolidated Statements of Operations
(In thousands except per share amounts)
(Unaudited)

For the three months ended
    
    
    For the nine months endedMay 31,
    
    
    May 31,
    
    
    May 31,
    
    
    May 31,2005
    
     
    2004
    
    
    2005
    
    
    2004Revenues
    
    $
    22,307
    
    
    $
    25,686
    
    
    $
    67,991
    
    
    $
    78,402Operating costs and expenses:Network operating costs, exclusive of depreciation shown below
    
    
    6,272
    
    
    
    7,423
    
    
    
    17,261
    
    
    
    21,587Sales and marketing, exclusive of depreciation shown below
    
    
    5,687
    
    
    
    4,960
    
    
    
    14,035
    
    
    
    16,701Technical support, exclusive of depreciation shown below
    
    
    3,005
    
    
    
    4,519
    
    
    
    10,472
    
    
    
    13,965General and administrative, exclusive of depreciation shown below
    
    
    7,672
    
    
    
    7,704
    
    
    
    22,509
    
    
    
    23,681Bad debt expense
    
    
    535
    
    
    
    874
    
    
    
    1,440
    
    
    
    2,940Depreciation and amortization
    
    
    5,686
    
    
    
    7,331
    
    
    
    16,870
    
    
    
    23,755Restructuring costs
    
    
    1,666
    
    
    
    758
    
    
    
    1,666
    
    
    
    758Goodwill impairment
    
    
    
    
    
    
    66,587
    
    
    
    
    
    
    
    66,587Asset impairment
    
    
    
    
    
    
    7,009
    
    
    
    
    
    
    
    7,009Gain on sale of accounts
    
    
    (1,915
    )
    
    
    
    
    
    
    (1,915
    )
    
    
    Other expense (income), net
    
    
    (96
    )
    
    
    (110
    )
    
    
    (37
    )
    
    
    (184
    )Total operating costs and expenses
    
    
    28,512
    
    
    
    107,055
    
    
    
    82,301
    
    
    
    176,799Operating loss
    
    
    (6,205
    )
    
    
    (81,369
    )
    
    
    (14,310
    )
    
    
    (98,397
    )Interest income (expense), net
    
    
    131
    
    
    
    124
    
    
    
    255
    
    
    
    (180
    )Loss from continuing operations before income taxes
    
    
    (6,074
    )
    
    
    (81,245
    )
    
    
    (14,055
    )
    
    
    (98,577
    )Income tax benefit (expense)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net loss from continuing operations
    
    
    (6,074
    )
    
    
    (81,245
    )
    
    
    (14,055
    )
    
    
    (98,577
    )Gain/(loss) from discontinued operations, net of tax
    
    
    (173
    )
    
    
    (481
    )
    
    
    340
    
    
    
    (1,802
    )Net loss
    
    $
    (6,247
    )
    
    $
    (81,726
    )
    
    $
    (13,715
    )
    
    $
    (100,379
    )Net
gain (loss) per share, basic and diluted:Continuing operations
    
    $
    (0.38
    )
    
    $
    (5.07
    )
    
    $
    (0.88
    )
    
    $
    (6.11
    )Discontinued operations
    
    
    (0.01
    )
    
    
    (0.03
    )
    
    
    0.02
    
    
    
    (0.11
    )$
    (0.39
    )
    
    $
    (5.10
    )
    
    $
    (0.86
    )
    
    $
    (6.22
    )Number of shares used in per share calculation:Basic and diluted
    
    
    16,032
    
    
    
    16,019
    
    
    
    16,024
    
    
    
    16,131


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




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##### Table of Contents



INTERLAND, INC. 
 Consolidated Balance Sheets
(In thousands)
(Unaudited) As ofMay 31,
    
    
    August 31,2005
    
    
    2004AssetsCurrent assetsCash and cash equivalents
    
    $
    23,967
    
    
    $
    15,203Auction rate securities
    
    
    
    
    
    
    12,525Trade receivables
    
    
    2,523
    
    
    
    2,431Other receivables
    
    
    420
    
    
    
    553Other current assets
    
    
    2,734
    
    
    
    3,479Restricted investments
    
    
    258
    
    
    
    283Total current assets
    
    
    29,902
    
    
    
    34,474Restricted investments
    
    
    9,524
    
    
    
    10,609Securities, held-to-maturity
    
    
    50
    
    
    
    Property plant and equipment, net
    
    
    19,887
    
    
    
    24,508Intangibles, net
    
    
    5,811
    
    
    
    12,077Other assets
    
    
    3,184
    
    
    
    3,244Total assets
    
    $
    68,358
    
    
    $
    84,912Liabilities and shareholders equityCurrent liabilitiesAccounts payable
    
    $
    3,369
    
    
    $
    2,517Accrued expenses
    
    
    12,660
    
    
    
    12,105Accrued restructuring charges
    
    
    4,118
    
    
    
    4,393Current portion of long-term debt and capital lease obligations
    
    
    847
    
    
    
    2,271Deferred revenue
    
    
    6,847
    
    
    
    7,777Total current liabilities
    
    
    27,841
    
    
    
    29,063Long-term debt and capital lease obligations
    
    
    2,751
    
    
    
    3,473Deferred revenue, long-term
    
    
    227
    
    
    
    268Other liabilities
    
    
    1,993
    
    
    
    3,209Total liabilities
    
    
    32,812
    
    
    
    36,013Commitments and contingencies
    
    
    
    
    
    
    Shareholders equityCommon stock, $.01 par value, authorized 21 million shares,
issued and outstanding 16.2 and 16.1 million shares, respectively
    
    $
    162
    
    
    $
    161Additional capital
    
    
    322,450
    
    
    
    321,091Warrants
    
    
    3,284
    
    
    
    4,603Deferred compensation
    
    
    
    
    
    
    (320
    )Note receivable from shareholder
    
    
    (735
    )
    
    
    (735
    )Accumulated deficit
    
    
    (289,615
    )
    
    
    (275,901
    )Total shareholders equity
    
    
    35,546
    
    
    
    48,899Total liabilities and shareholders equity
    
    $
    68,358
    
    
    $
    84,912
 The accompanying notes are an integral part of these consolidated financial statements. Page  4 of 31




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INTERLAND, INC. 
 Consolidated Statements of Cash Flows
(In thousands)
(Unaudited) For the nine months endedMay 31,
    
    
    May 31,2005
    
    
    2004CASH FLOWS FROM OPERATING ACTIVITIESNet loss
    
    $
    (13,715
    )
    
    $
    (100,379
    )Adjustments to reconcile net loss to net cash provided by
(used in) operating activities from continuing operations:Loss (gain) from discontinued operations
    
    
    (340
    )
    
    
    1,802Depreciation and amortization
    
    
    16,870
    
    
    
    23,755Bad debt expense
    
    
    1,440
    
    
    
    2,940Gain on sale of other assets
    
    
    (37
    )
    
    
    (152
    )Gain on sale of accounts
    
    
    (1,915
    )
    
    
    Restructuring charges
    
    
    1,666
    
    
    
    758Goodwill and asset impairment
    
    
    
    
    
    
    73,596Amortization of deferred compensation
    
    
    320
    
    
    
    721Changes in operating assets and liabilitiesReceivables
    
    
    (1,385
    )
    
    
    (1,803
    )Other current assets
    
    
    805
    
    
    
    1,061Accounts payable, accrued expenses and deferred revenue
    
    
    (1,293
    )
    
    
    (8,819
    )Cash provided by (used in) operating activities of continuing operations
    
    
    2,416
    
    
    
    (6,520
    )CASH FLOWS FROM INVESTING ACTIVITIESExpenditures for property, plant, and equipment
    
    
    (7,248
    )
    
    
    (9,742
    )Proceeds from sale of accounts
    
    
    2,733
    
    
    
    Purchases of held-to-maturity investment securities
    
    
    (50
    )
    
    
    (6,000
    )Proceeds from held-to-maturity investment securities
    
    
    
    
    
    
    9,800Proceeds from auction rate securities
    
    
    12,525
    
    
    
    12,500Purchases of auction rate securities
    
    
    
    
    
    
    (2,000
    )Net change in restricted investments
    
    
    1,110
    
    
    
    7,438Acquisitions, net of cash acquired
    
    
    
    
    
    
    242Cash provided by investing activities of continuing operations
    
    
    9,070
    
    
    
    12,238CASH FLOWS FROM FINANCING ACTIVITIESRepayments of debt and capital lease obligations
    
    
    (2,146
    )
    
    
    (7,674
    )Proceeds from issuance of common stock
    
    
    41
    
    
    
    Cash used in financing activities of continuing operations
    
    
    (2,105
    )
    
    
    (7,674
    )Net cash used in continuing operations
    
    
    9,381
    
    
    
    (1,956
    )Net cash used in discontinued operations
    
    
    (617
    )
    
    
    (1,840
    )Net increase(decrease) in cash and cash equivalents
    
    
    8,764
    
    
    
    (3,796
    )Cash and cash equivalents at beginning of period
    
    
    15,203
    
    
    
    20,230Cash and cash equivalents at end of period
    
    $
    23,967
    
    
    $
    16,434
 The accompanying notes are an integral part of these consolidated financial statements. Page  5 of 31




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Interland, Inc. 
 Notes To Consolidated Financial Statements  1.
    
    GeneralBusiness 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 enterprise (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 operates as a single reportable
segment and offers 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
has reduced its level of cash requirements through decreases in capital purchases, reducing
operating expenses, and by improving the ratio of new customer accounts to canceling accounts.
Additionally, the Company will have lower future cash outlays for payments associated with prior
integration and discontinued operation liabilities and reduced debt payments because of
settlements in lease obligations during the current fiscal year and a number of capital lease
obligations during the prior fiscal year. There can be no assurance that Interlands continuing
efforts to stabilize or increase its revenue will be successful or that 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 PoliciesInterim Unaudited Financial Information The accompanying unaudited consolidated financial
statements for the three and nine-month periods ended May 31, 2005 and 2004, have been prepared
in accordance with accounting principles generally accepted in the United States of America for
interim financial information. In managements opinion, these statements include all adjustments
necessary for a fair statement of the results of the interim periods shown. All adjustments are
of a normal recurring nature unless otherwise disclosed. Operating results for the three and
nine-month periods ended May 31, 2005 are not necessarily indicative of the results that may be
expected for the full fiscal year.Basis of Presentation This report on Form 10-Q (10-Q) for the third quarter ended May 31,
2005 should be read in conjunction with the Companys Form 10-K (10-K) for the fiscal year
ended August 31, 2004. The financial statements include the accounts of Interland, Inc. and its
wholly owned subsidiaries. All significant intercompany balances and transactions have been
eliminated.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 and SFAS 148.In May 2005, the Companys Board of Directors (the Board) approved an immediate and full
acceleration of vesting of all stock options outstanding under the Companys 1995 Stock Option
Plan (the Acceleration). The Company amended all relevant option agreements to reflect the
Acceleration. The Board considered a number of factors in making their decision, including the
anticipated issuance and implementation of Statement of Financial Accounting Standards No. 123R,
Share-Based Payment (SFAS 123R) as further discussed in the Managements Discussion and
Analysis section under the caption Recently Issued Accounting Standards. As a result of the
Acceleration, options to purchase approximately 286,000 shares of the Companys common stock
became immediately exercisable as of May 31, 2005. Since all outstanding stock options had an
exercise price greater than the market price as of the date of acceleration, the application of
the accounting standard effective at the time of the acceleration, APB No. 25, resulted in no
expense being recognized. Had the options instead been permitted to continue vesting over the
original schedules, the adoption of SFAS 123R beginning in fiscal year 2006 would have required
the recognition of an aggregate after tax expense of approximately
$0.9 million.The following table illustrates the effect on net loss and loss per share 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 recorded the computed value of the
Companys vested options to compensation expense based on the Acceleration described above. Page  6 of 31




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Interland, Inc. Notes To Consolidated Financial Statements Three-month period ended
    
    
    Nine-month period endedMay 31,
    
    May 31,
    
    
    May 31,
    
    
    May 31,2005
    
    2004
    
    
    2005
    
    
    2004(In thousands, except per share numbers)
    
    
    (In thousands, except per
share numbers)Net loss as reported
    
    $(6,247)
    
    $
    (81,726
    )
    
    $
    (13,715
    )
    
    $
    (100,379
    )Add:
    Stock-based employee compensation expense included in reported net income, net of related tax effects
    
    
    
    
    
    173
    
    
    
    320
    
    
    
    520Deduct:
    Total stock-based employee compensation expense determined under fair value method-based methods for all awards, net of tax effects
    
    
    (1,250)
    
    
    (540
    )
    
    
    (1,965
    )
    
    
    (1,794
    )Proforma net loss
    
    $(7,497)
    
    $
    (82,093
    )
    
    $
    (15,360
    )
    
    $
    (101,653
    )Loss per share:Basic and diluted - as reported
    
    
    $(0.39)
    
    $
    (5.10
    )
    
    $
    (0.86
    )
    
    $
    (6.22
    )Basic and diluted - pro forma
    
    
    $(0.47)
    
    $
    (5.12
    )
    
    $
    (0.96
    )
    
    $
    (6.30
    )Weighted average shares outstandingBasic and diluted
    
    
    16,032
    
    
    16,019
    
    
    
    16,024
    
    
    
    16,131
  3.
    
    Restructuring And Facility Exit Costs2001 PlanDuring 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. In April 2005, management
met with the landlords of these facilities and revised its expectation of its financial
obligations with respect to the abandoned lease facilities based on the current market
conditions and lack of interest of potential new tenants. The net impact of these revised
expectations was an increase of $2.2 million to the restructuring reserves for the 2001 Plan.
During the nine months ended May 31, 2005, cash payments of $1.7 million were made related to
the monthly lease obligations for lease abandonments leaving an outstanding liability of $4.1
million as of May 31, 2005. The liability balances and annual activity from inception through
August 31, 2004 are disclosed in the 2004 Annual Report on Form 10-K.2003 PlanDuring 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. In April 2005, the Company was able to retire the remaining $0.5
million reserves for bandwidth termination liabilities following confirmation that all such
liabilities had been satisfied. As of May 31, 2005 the 2003 Plan reserve balance is zero. The
liability balances and annual activity from inception through August 31, 2004 are disclosed in
the 2004 Annual Report on Form 10-K. Page  7 of 31




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Interland, Inc. Notes To Consolidated Financial Statements  2004 PlanIn 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) and the Company implemented a restructuring program to reduce its cost
structure accordingly. During the nine months ended May 31, 2005 the Company made cash payments
of $0.2 million to pay the remaining severance and lease liabilities and closed the 2004 Plan
reserve account. The liability balances and annual activity from inception through August 31,
2004 are disclosed in the 2004 Annual Report on Form 10-K.The following table shows a summary of the activities under the restructuring plans since August
31, 2004: 2001
    
    
    2003
    
    
    2004Plan
    
    
    Plan
    
    
    Plan
    
    
    Total(In thousands)Liability as of August 31, 2004
    
    $
    3,622
    
    
    $
    544
    
    
    $
    227
    
    
    $
    4,393Cash Paid
    
    
    (1,718
    )
    
    
    (12
    )
    
    
    (211
    )
    
    
    (1,941
    )Other Adjustments
    
    
    2,214
    
    
    
    (532
    )
    
    
    (16
    )
    
    
    1,666Liability as of May 31, 2005
    
    $
    4,118
    
    
    $
    
    
    
    $
    
    
    
    $
    4,118
  4.
    
    Purchase Business Combination LiabilitiesIn 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. During the nine month period ended May 31, 2005, the Company continued to make
its monthly lease payment and to collect offsetting rent from its sub tenants. These lease
abandonment obligations are contractually scheduled to end in 2009.The liability balances and annual activity from inception through August 31, 2004 are disclosed
in the 2004 10-K. The following table shows the changes in the accrual for the nine months
ended May 31, 2005: Leaseabandonments(in thousands)Balance at August 31, 2004
    
    $
    740Net Cash Paid
    
    
    (133
    )Balance at May 31, 2005
    
    $
    607
  5.
    
    Investment SecuritiesThe following table summarizes, by major security type, the value of the Companys investments.
The carrying value of these investments approximates fair value. Page  8 of 31




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Interland, Inc. Notes To Consolidated Financial Statements As ofMay 31,
    
    
    August 31,2005
    
    
    2004Available-for-sale securities, at fair value:Commercial paper and money market funds
    
    $
    22,643
    
    
    $
    13,521State and local government
    
    
    
    
    
    
    3,000Certificates of deposit
    
    
    50
    
    
    
    1,113Held-to-maturity securities, at amortized cost:Auction rate securities:
    
    
    
    
    
    
    12,525Total securities
    
    
    22,693
    
    
    
    30,159Less: cash equivalents
    
    
    (13,860
    )
    
    
    (8,113
    )Less: restricted cash
    
    
    (8,833
    )
    
    
    (9,521
    )Auction rate securities
    
    $
    
    
    
    $
    12,525
  Cash and cash equivalents consist of cash and investments in certificates of deposit, commercial
paper and other highly liquid securities with original maturities less than 90 days. We had
historically classified auction rate securities as cash and cash equivalents if the period
between the interest rate resets was 90 days or less, which was based on our ability to either
liquidate our holding or roll our investments over to the next reset period. Based on our
re-evaluation of the maturity dates associated with the underlying bonds, we have reclassified
our auction rate securities, previously classified as cash and cash equivalents, as auction rate
securities for each of the periods presented in the accompanying consolidated balance sheets.
Auction rate securities are variable rate bonds tied to short term interest rates with
maturities on the face of the securities in excess of 90 days. Auction rate securities have
interest rate resets through a modified Dutch auction, at predetermined short term intervals,
usually every 7, 28 or 35 days. They generally trade at par and are callable at par on any
interest payment date at the option of the issuer. Interest paid during a given period is based
upon the interest rate determined through the auction process. Although these securities are
issued and rated as long term bonds, they are priced and traded as short term instruments
because of the liquidity provided through the interest rate reset. All auction rate securities
are available for sale and are reported at fair value. A total of $0.0 million and $10.0 million
have been reclassified from cash and cash equivalents to short-term investments as of May 31,
2005 and August 31, 2004, respectively. These auction rate securities investments remained
readily available to the Company and are considered short-term and liquid in accordance with the
reset period.6.
    
    Discontinued OperationsIn fiscal 2001 the Company discontinued the operations of its PC Systems business segment (PC
Systems), 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. During the first nine months of 2005, the Company
recognized a gain of $0.3 million from discontinued operations. This gain consisted of a
reduction to a previously recorded sales tax reserve by $0.8 million, offset by $0.5 million of
required legal fees in defense and settlement of Micron PC legal matters. The Company has sales
and use tax assessments and audit reserves of $0.2 million, $0.7 million in contingent
liabilities, and $0.2 million for other liabilities related to the disposal of discontinued
operations that are included in accrued liabilities on the Companys consolidated balance sheet
as of May 31, 2005.7.
    
    sale of accountsOn May 5, 2005, the Company entered into an Asset Purchase Agreement (the Agreement) with
Caird Corporation (the Buyer), pursuant to which the Buyer will purchase from Interland
approximately 32,000 shared web hosting customer accounts, together with related equipment,
trademarks, domain names, and miscellaneous assets. The Company decided that these customers
were unlikely purchasers of the Companys marketing-oriented services and products, but were
rather interested in obtaining mere technical hosting  a service which the Company believes
Caird can provide more efficiently. In particular, the shared hosting accounts being sold
consist of both shared hosting accounts that were part of the Hostcentric acquisition in June Page  9 of 31




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Interland, Inc. Notes To Consolidated Financial Statements  2003 as well as accounts for customers who purchased shared hosting services under the
Hostcentric brand thereafter (collectively, the Accounts). Many of the accounts were acquired
by Hostcentric pre-merger pursuant to a reseller plan which, after an initial payment, offered
additional accounts at a deeply-discounted price.Substantially all of the sold accounts were serviced through the Companys leased facility in
Orlando, Florida and were never integrated into the Companys ticketing and hosting platform due
to the different billing structure and processes of these accounts. The Company determined that
the migration of these accounts into its billing and hosting platforms could result in
significant breakage and a corresponding decline in customer satisfaction. The Company plans to
close the Orlando facility in the fourth quarter and terminate approximately 30-35 employees in
connection with that closure. The closure of the Orlando facility is not expected to result in
any material closing costs, therefore, no restructuring charges are to be recognized in relation
to the close of this facility as it relates to FAS 146: Accounting for Costs Associated with
Exit or Disposal Activities.The total purchase price for the Accounts is variable, depending on the success of the parties
in migrating the accounts from the Companys current hosting platform to the Buyers platform,
ranging from a minimum price of not less than $3.4 million to a maximum potential price of $5.3
million. The Company received 100% of the minimum purchase price of $3.4 million at closing,
less commissions and deferred revenue adjustments. The remaining potential gain (which may be
between $0 and $1.9 million) will be recognized as the accounts are successfully migrated and
the amounts due to the Company are known.As a result of the sale, the Company recognized a gain of $1.9 million, net of transaction
costs, in the quarter ended May 31, 2005, in connection with the sale, which is recorded in gain
on sale of accounts of the Income Statement. The carrying amounts of assets and liabilities
disposed of in relation to this sale totaled approximately $0.8 million, consisting of $1.2
million of intangibles, net of amortization and $0.4 million of deferred revenue. The Company
will record adjustments to the gain, if necessary, in each of the next two fiscal quarters to
reflect the additional payments of successfully migrated Accounts. For the quarter ended
May 31, 2005, the Accounts produced approximately $1.2 million in revenue. Beginning in May
2005, Interland ceased recognizing revenue on the Accounts. As an off-set to the loss of
revenue, Interland will be paid a carrying cost per customer by the buyer during the
transition period. The carrying cost is defined as an amount equal to $10.00 per month per each
customer and new signup who is paying for web hosting services that has not been successfully
migrated to buyers platform and billing system. Interland anticipates receiving carrying costs
payments through the month of July 2005, at which point, all sold customers are expected to have
been successfully migrated to the buyer.8.
    
    ContingenciesInterland is 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 to 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 of royalties and damages. Interland believes it has meritorious defenses to Novells
claims. The litigation is still in the discovery phase.In February 2004, the Company, through its Hostcentric subsidiary, initiated a lawsuit in United
States District Court for Southern District of New York against the landlord for that
subsidiarys Farmingdale, New York facility. The Company sought a declaratory judgment that the
landlord had acquiesced in Hostcentrics abandonment of the lease. The landlord filed
counterclaims. In late 2004, the Company believes that it and the landlord reached an agreement
to settle the litigation under which Interland would pay approximately $755,000 in cash and
allow the landlord to keep the deposit of approximately $60,000 as full settlement of all of the
landlords claims. Because Interland believes the landlord subsequently reneged on a
legally-binding settlement agreement, Interland petitioned the court to enforce the settlement
agreement. In a written report and recommendation entered on June 9, 2005 the magistrate judge
in that action found in favor of Interland, stating that the settlement agreement should be
enforced by the court. The district court may accept, reject, or modify the proposed findings
or recommendations of the magistrate judge, and even if the district court adopts the report and
recommendation of the magistrate judge, the order of the district court will be subject to an
appeal to the court of appeals. Accordingly, there can be no assurance that the district court
will adopt the magistrate judges report and recommendation, or that the district courts
ruling, when and if one is issued, will be upheld on appeal. Nevertheless, Interland believes
that it is probable that the settlement will be upheld, and therefore, based on its current
estimates, the Company adjusted its reserves, resulting in a contribution to pre-tax income in
the third fiscal quarter of 2005 of $0.2 million.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 Page  10 of 31




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Interland, Inc. Notes To Consolidated Financial Statements  over $180,000 that it may be required to pay to the landlord for the 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 denied
Interlands claims and asserted various counterclaims. The Company has, in turn, brought
additional claims based on facts learned in discovery. Correspondence between the parties has
also discussed the possibility of other claims, but those claims had not yet been added to the
litigation. In June 2005, the parties reached an agreement in principle to settle this case in
which the Hostcentric Shareholders would pay Interland $545,000 in cash in settlement of all
claims and counterclaims, and the parties would agree to full, complete releases of all claims
or potential claims as well as a dismissal with prejudice of all pending claims and
counterclaims and Interland would agree to release the balance of the escrow funds. The parties
have notified the district court of their settlement in principle, and the district court has
stayed further proceedings in the case until July 5, 2005. The Company will record the results
of this settlement upon final execution of the settlement agreement, which is expected to occur
in the fourth quarter.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 of two promissory notes made by Mr. Murphy (one of which was
non-recourse while the other was recourse). In March 2004, Interland foreclosed upon and
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 Stockholders Equity. The other $735,000 full
recourse promissory note (also carried as Stockholders Equity) remains outstanding and
continues to be a subject of the Cobb County litigation. 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 Chief Executive Officer, Mr. Joel Kocher,
and Communitech, in Jackson County, Missouri claiming, among other things, that Interland acted
unreasonably and thereby breached the Merger Agreement under which Interland acquired all of the
stock of Communitech by failing to have the S-3 registration statement declared effective by the
SEC on a timely basis and further claiming that Interland and/or Mr. Kocher made inaccurate
disclosures in connection with Interlands acquisition of Communitech. The complaint seeks
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 is vigorously
defending the claims.Interland is defending another case in Jackson County, Missouri arising out of the shutdown of
five unregistered servers at the Communitech data center in February 2003. An entity called
Bent Axis and its principal Jason Park, a former employee of Communitech, have filed suit
against the Company and its General Counsel, Jonathan Wilson, alleging a variety of contract and
tort claims. In its first complaint, Plaintiffs asserted that they owned the five servers in
question. They later amended their pleading to assert a different theory: that Bent Axis was
using the servers by permission of certain Interland personnel including Gabriel Murphy.
Plaintiffs claim that they were damaged when the Company disconnected the servers in question.
To date Plaintiffs have produced no documentary evidence that Bent Axis ever generated a profit
(a requirement for the recovery of damages) or that it had any legal right to the free use of
the servers in competition with Interland. The Company is vigorously defending the suit and
believes that it will not have a material adverse effect on Interland.Interland is the defendant in a case involving the Telephone Consumer Protection Act (TCPA) in
state court in Allegheny County, Pennsylvania. A competing web hosting company, PairNetworks,
filed this case in December 2001 as a putative class action, claiming that Interlands
distribution of a facsimile on November 15, 2001 to market domain name registration services
violated the TCPA. Several years later, two additional plaintiffs joined in the action. The
plaintiffs have conceded that all of the putative class members were customers of Interland.
Federal Communications Commission regulations in effect at the time provided that the
distribution of facsimiles to persons with whom the sender had an established business
relationship did not amount to a violation of the TCPA. Interland has asked the court to deny
class certification and a ruling on that motion is pending along with a motion for summary
judgment seeking dismissal of the named plaintiffs claims. If the court denies class
certification, Interlands damages, even were it were liable, cannot exceed $1,500 for each of
the three named plaintiffs. Interland believes that the plaintiffs claims 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. Conversely, if the class is certified,
its size may exceed 50,000.The Company is defending a case in The United States District Court for the Southern District of
Florida arising out of the management of a co-located server by its predecessor company,
Worldwide Internet Publishing Corporation. The suit alleges that the Company is responsible for
the loss of Plaintiffs internet search engine that occurred after the resignation of the
officer managing the server, Mark Ismach, in October 1999. Interland believes it followed the
instructions of Mr. Ismach, and, among other reasons, Interland consequently believes the
plaintiffs claims are without merit, and plans to continue to contest the matter vigorously.
The Company believes that no material adverse effect on Interland will occur as a result of this
litigation. Page  11 of 31




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Interland, Inc. Notes To Consolidated Financial Statements  On January 23, 2004, Vincent Salazar, an individual, sued Interland and its predecessor HostPro
claiming that he was entitled to money as a result of his alleged involvement in brokering
Interlands acquisition of accounts from AT&T in January 2002. The case is pending in state
court in Los Angeles. The Plaintiff claims that he is due 20% of the revenue that Interland has
received from the acquired accounts. Interland believes it has meritorious defenses, including
that HostPros contract with Mr. Salazar specifically excludes compensation for the very sort of
transaction on which he is seeking to be paid a fee. Interland believes the plaintiffs claims
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 May 2004, Interland was served with a suit filed by Net Global Marketing against Interland
and its predecessor, Dialtone, asserting claims for lost data. Interland had cancelled Net
Globals web hosting accounts in October 2002 and again in January 2003 as a result of
complaints that the servers were being used to send spam, and Interland has asserted
counterclaims arising from these incidents. Interland filed a motion to dismiss in favor of
arbitration which was denied, and Interland has appealed that decision to the Ninth Circuit
Court of Appeals. Interland believes that, even if the litigation proceeds, it has adequate
defenses including provisions in the contract with the plaintiff that shield Dialtone from
damages for erasure and loss of data and generally prohibit recovery of the kind of damages
sought by plaintiff. Interland believes that the plaintiffs claims 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.Periodically, the Company is made aware that technology it has used may have infringed on
intellectual property rights held by others. The Company evaluates all such claims and, if
necessary and appropriate, obtains licenses for the use of such technology. If the Company or
its suppliers are unable to obtain licenses necessary to use intellectual property in the
applicable 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 accrues a
liability 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.The Company is also a defendant in a number of other lawsuits seeking lesser amounts, and which
the Company regards as unlikely to result in any material payment. The outcome of litigation
may not be assured, and despite managements views of the merits of any litigation, or the
reasonableness of its estimates and reserves, the Companys cash balances could nonetheless 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.9.
    
    Subsequent EventsIn June 2005 Interland filed suit in the U.S. District Court for the District of Idaho against
Lloyds of London (Policy No. 595/FD028840P) seeking to recover attorneys fees and costs of
litigation involving the discontinued PC Systems alleged failure to pay overtime to employees
between 1999 and April 2001 (the Smith Litigation). In the complaint Interland claims that it
is entitled to recover the approximately $1.7 million of attorneys fees and costs incurred in
the Smith litigation. Management, and its legal counsel, has not had
sufficient time to evaluate the probable outcome of the litigation.As discussed in the contingencies footnote above, in June 2005, the Company reached an agreement
in principle with the representatives of the Hostcentric Shareholders relating to a suit
initiated in February, 2004. The agreement calls for the Shareholders to pay the Company an
amount of $0.5 million in exchange for mutual releases under the original suit. The Company will
record the results of this settlement upon final execution of the settlement agreement, which is
expected to occur in the fourth quarter.The Company also received a written proposed order and findings favoring the Companys position
in June 2005 from the magistrate judge in the matter involving the landlord of the Farmingdale,
New York matter discussed above and recommending that the settlement agreement of $755,000 should
be enforced by the District Court. Interland believes that it is probable that the settlement
will be upheld and has adjusted its reserve to reflect this outcome as of May 31, 2005. Page  12 of 31




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Interland,
Inc. 
 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 prior acquisitions. Factors that could cause actual
results to differ materially from expected results are identified in Risk Factors below, and in
the Companys Form 10-K for the year ended August 31, 2004 and in the Companys other filings with
the Securities and Exchange Commission. All quarterly references are to the Companys fiscal
periods ended May 31, 2005, or May 31 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, except earnings per share, are stated in thousands. Overview Interland, Inc., the (Company), is a leader in making the power of the Internet available to small-
and medium-sized enterprises (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 a 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. The Company has acquired and developed proprietary software for the efficient integration,
packaging and support of new technologies and services into its basic hosting products. 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 designed to help mainstream businesses attract and serve customers through
websites supplied by Interland designers using its proprietary design software. 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. The Company offers to its customers website marketing, design and management, as well as management
of hosted application services through direct and partnership channels to both its shared and
dedicated product lines. The shared product lines provide services to customers whose needs are
compatible with being hosted on a server that hosts hundreds of other similar customers; the
dedicated product lines serve customers who require a server or servers exclusively devoted to
their needs. The Company 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 product lines 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. Distribution partners enable the Company 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 as well as work with new
partnerships relationships in the future. Page  13 of 31




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DISCONTINUED OPERATIONS PC Systems In fiscal 2001 the Company discontinued the operations of its PC Systems business 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. Discontinued operations losses were $0.2 million compared to $0.5 million for the three months
ended May 31, 2005 and 2004, respectively. This decrease of $0.3 million, or 64.0%, is attributable
primarily to the decrease in legal expenses and a tax refund received from the Maryland Department
of Revenue. For the nine months ended May 31, 2005 a gain of $0.3 million was recognized compared to a loss of
$1.8 million for the nine months ended May 31, 2004. This increase of $2.1 million is primarily
attributable to a reduction to a previously recorded sales tax reserve by $0.8 million, offset by a
reduction of $1.3 million of required legal fees in defense and settlement of Micron PC legal
matters. The Company has sales and use tax assessments and audit reserves of $0.2 million, $0.7 million in
contingent liabilities, and $0.2 million for other liabilities related to the disposal of
discontinued operations that are included in accrued liabilities on the Companys consolidated
balance sheet as of May 31, 2005. 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. Comparison of the Three and Nine Months Ended May 31, 2005 and 2004 The loss from continuing operations decreased $75.2 million, or 92.5% and $84.5 million, or 85.7%
for the three and nine months ended May 31, 2005, respectively, when compared to the same periods
of the prior fiscal year. The basic and diluted loss per share decreased $4.69 per share, or 92.5%,
and $5.23 per share or 85.6% for the quarter and for the nine months ended May 31, 2005,
respectively, when compared to the same periods of the prior fiscal year. These large decreases in
losses from continuing operations is primarily due to the final goodwill impairment of $67 million
and the $7.0 million intangible asset impairments that were recorded in May 2004 compared to no
impairments during May 2005. Revenues Total revenues decreased $3.4 million, or 13.2%, and $10.4 million, or 13.3%, respectively, for the
three and nine months ended May 31, 2005 when compared to the same periods of the prior fiscal
year. For the three months ended
    
    
    For the nine months endedMay 31,
    
    
    May 31
    
    
    May 31,
    
    
    May 31,2005
    
    
    2004
    
    
    2005
    
    
    2004in thousands
    
    
    in thousandsHosting revenue
    
    $
    21,070
    
    
    $
    24,337
    
    
    $
    64,440
    
    
    $
    74,500Other revenue
    
    
    1,237
    
    
    
    1,349
    
    
    
    3,551
    
    
    $
    3,902Total revenue
    
    $
    22,307
    
    
    $
    25,686
    
    
    $
    67,991
    
    
    $
    78,402
 When compared to the same periods of the prior fiscal year, hosting revenues decreased $3.3
million, or 13.4%, and $10.1 million, or 13.5% for the three and nine months ended May 31, 2005 and
2004, respectively. Hosting revenues are comprised of shared and dedicated hosting products, online
marketing solutions, application hosting services and domain name registrations. The decrease in
hosting revenues is primarily attributable to account cancellations, net of new sales. These
cancellations may 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. In May 2005, Interland sold 32,000 shared hosting accounts that were part of the Hostcentric
acquisition in June 2003 as well as accounts for customers who purchased shared hosting services
under the Hostcentric brand thereafter. For the quarter ended May 31, 2005, the Accounts produced
approximately $1.2 million in revenue prior to the sale. Other revenues decreased $0.1 million, or 8.3%, and $0.4 million or 9.0%, for the three and nine
months ended May 31, 2005, Page  14 of 31




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respectively, when compared to the same period of the prior fiscal year. Other revenues are
primarily comprised of consulting services, bandwidth transfer overage billings, Internet
connectivity fees and co-location services. The decrease in other revenues is primarily due to the
Company not actively pursuing the sale of its non-hosting services and products. As of May 31, 2005, the Company had approximately 139,000 paid shared hosting customer accounts and
managed approximately 8,300 dedicated servers, many of which host multiple web sites, compared to
approximately 181,000 paid shared hosting customer accounts and 9,900 dedicated servers as of May
31, 2004. The decrease in shared hosting customer accounts is primarily due to the sale of the
Hostcentric shared web hosting customer accounts and normal customer churn. As customers leave the
Company these servers are removed from the data center and taken out of operation until they can be
re-utilized by a new customer. The number of dedicated servers decreased both through attrition
and through the sale of 23 co-location accounts, which were sold to a third party in connection
with the Companys closure of its Boise, Idaho facility. 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 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. Management believes that Net MRC Change is a key metric for assessing the Companys
progress toward revenue growth. During the third quarter of fiscal 2005 the MRC of the Companys shared product lines declined from
$4,085,000 at February 28, 2005 to $3,628,000 at May 31, 2005. Approximately $422,000 of the
decline was attributable to the sale of the Hostcentric-related shared accounts. The decline in
total MRC of the shared product line net of the Hostcentric sale was $37,000. MRC Churn (MRC of
terminating customers as a percentage of beginning MRC) averaged 2.8% per month during the quarter
ended May 31, 2005 compared to an average of 2.6% during the quarter ended February 28, 2005, a
rate which the Company regards as consistent with industry averages. Sales produced average monthly
New shared MRC of $105,000 during the quarter ended May 31, 2005, an improvement of 13% over the
second fiscal quarters average monthly sales of $93,000. Average negative Net MRC Change during
the third quarter was $12,000 per month, compared to $18,000 per month in the second quarter and
$48,000 in the first quarter of fiscal 2005. The Company believes that it is unlikely that shared
MRC Churn can be reduced below 2.0%, 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 the third quarter of fiscal 2005 the MRC of the Companys dedicated product lines declined
from $2,876,000 at February 28, 2005 to $2,791,000 at May 31, 2005, or 3.0%. MRC Churn averaged
4.7% during the quarter ended May 31, 2005 compared to an average of 4.5% during the quarter ended
February 28, 2005. New dedicated sales averaged $110,000 per month for the quarter ended May 31,
2005, compared with $113,000 of new sales during the quarter ended February 28, 2005, a decline of
2.7% quarter-over-quarter. Monthly negative Net MRC Change for the quarter was $27,000 compared to
$17,000 per month during the previous quarter and $29,000 during the first quarter of fiscal 2005.
Revenue from the dedicated product lines 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. Due to the capital cost required to service a new dedicated customer, the
relationship with dedicated customers must be profitable from an operating standpoint and it must
remain in place long enough for the Company to recoup its investment and provide a satisfactory
return on assets employed. Overall, the average monthly negative Net MRC was $39,000 during the third quarter compared to
$34,000 during the previous fiscal quarter and $77,000 during the first quarter of fiscal 2005.
This critical metric has declined by 14.7% during the third quarter and improved by 49% over the
first nine months of fiscal 2005. To add perspective, were the Companys monthly average Net MRC
change to continue to decline by the same $5,000 by which it declined in the third quarter, the
lost revenue during the ensuing twelve months would be approximately $390,000. This same principle
of compounding impact would have a similar positive effect if Net MRC change were to improve. (For
additional explanation of this principle see Risk Factors Ours is a recurring-revenue subscriber
business and as such the effects of a net loss of monthly recurring revenue are magnified). Page  15 of 31




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OPERATING COSTS AND EXPENSES Network Operating Costs Network operating costs were $6.3 million compared to $7.4 million for the three months ended May
31, 2005 and 2004, respectively. This decrease of $1.2 million, or 15.5%, is attributable primarily
to a $0.4 million reduction in bandwidth connectivity costs and a $0.8 million reduction in labor
costs related to the data center consolidation, which is a continued critical part of the
Companys improvement projects. For the nine months ended May 31, 2005 network operating expenses were $17.3 compared to $21.6
million for the nine months ended May 31, 2004. This decrease of $4.3 million, or 20.0%, is
primarily attributable to the same data center consolidation efficiencies noted in the quarter
comparison above with reductions in bandwidth costs of $1.5 million and salaries and benefits costs
of $2.3 million. Sales and Marketing Sales and marketing expenses were $5.7 million compared to $5.0 million for the three months ended
May 31, 2005 and 2004, respectively. The Companys sales and marketing expenses as a percentage of
revenues were 25.5% for the quarter as compared to 19.3% in the same period of the prior fiscal
year. This increase of $0.7 million, or 14.7%, is primarily due to investments related to the
Companys indirect channel initiative. For the nine months ended May 31, 2005 sales and marketing expenses were $14.0 million compared to
$16.7 million for the nine months ended May 31, 2004. As a percentage of revenue, sales and
marketing expenses was 20.6% as compared to 21.3% in the same period of the prior fiscal year.
This decrease of $2.7 million, or 16.0%, is primarily related to the decrease in salaries and
benefits of $2.5 million, and $0.2 million decrease in technical and professional fees associated
with the overall reduction of mainstream marketing personnel. Technical Support Technical support expenses were $3.0 million compared to $4.5 million for the three months ended
May 31, 2005 and 2004, respectively. The Companys technical support expenses as a percentage of
net revenues were 13.5% for the quarter as compared to 17.6% in the same period of the prior fiscal
year. The overall decrease of $1.5 million or 33.5% is primarily related to the Companys reduction
in customer call volume and contacts. This reduction has occurred largely in part to additional
training, an increase in first call resolution and improved data center stability. These
operational efficiencies yielded a $0.1 million decrease in contract labor and consultants,
facilities overhead of $0.3 and a $1.2 million decrease in salaries and benefits offset by an
increase of $0.1 in service agreement fees. For the nine months ended May 31, 2005 technical support expenses were $10.5 million compared to
$14.0 million for the nine months ended May 31, 2004. As a percentage of revenue, technical
support expenses were 15.4% at May 31, 2005 compared to 17.8% at May 31, 2004. The decrease in
expenses of $3.5 million or 25% was primarily attributable to a decrease in contract labor of $1.2
million, and a decrease in salaries and benefits of $2.1 for the reasons noted in the quarter
comparison above. General and Administrative General and administrative expenses remained constant at $7.7 million for the three months ended
May 31, 2005 and 2004 respectively. As a percentage of revenues, the Companys general and
administrative expenses was 34.4% for the quarter ended May 31, 2005, as compared to 30.0% in the
same period of the prior year. For the nine months ended May 31, 2005 general and administrative expenses were $22.5 million
compared to $23.7 million for the nine months ended May 31, 2004. This decrease of $1.2 million or
5.0% is primarily attributable to the reduction in headcount as compared to prior year, with
reductions of $2.9 million in salaries and benefits, $0.3 million decrease in contract labor costs,
$0.3 million decrease in credit card fees, $0.1 million decrease in office related expenses, and
$0.1 million decrease in travel expenses. Partially offsetting these reductions were increases in
legal expense of $1.3 million, an increase of $0.6 in facilities overhead and a $1.0 million
increase in professional fees primarily related to Sarbanes-Oxley certification contractors and
consultants. Bad Debt Expense Bad debt expenses were $0.5 million compared to $0.9 million for the three months ended May 31,
2005 and 2004 respectively. The decrease in bad debt expense is attributable to a decline in
customer account write-offs due to our more stringent collection and Page  16 of 31




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customer account termination policies for non-payment, resulting in a lower trade accounts
receivable balance. For the nine months ended May 31, 2005 bad debt expense was $1.4 million compared to $2.9 million
for the nine months ended May 31, 2004 a reduction of $1.5 million or 51.0%. This decrease is
attributable to the same collection efficiencies noted in the quarter comparison above. Depreciation and Amortization Depreciation and amortization expenses were $5.7 million compared to $7.3 million for the three
months ended May 31, 2005 and 2004, respectively. The Companys depreciation and amortization
expenses as a percentage of revenues were 25.5% for the quarter ended May 31, 2005, as compared to
28.5% in the same period of the prior year. The decrease in depreciation expense is a result of the
continued decline in capital expenditures, the expiration of capital leases during fiscal year 2004
and the $7.0 million write off of intangible assets during the fiscal year 2004. For the quarter
ended May 31, 2005, the Company recognized depreciation and amortization of approximately $0.1 on
the Hostcentric-related assets which were sold in May. For the nine months ended May 31, 2005 depreciation and amortization expense was $16.9 million
compared to $23.8 million for the nine months ended May 31, 2004. This expense expressed as a
percentage of revenue was 24.8% and 30.3% respectively for the periods ended May 31, 2005 and 2004.
The decrease in depreciation expense is a result of the factors noted in the quarter comparison
above. Restructuring Costs Restructuring costs were $1.7 million compared to $0.8 million for the three and nine months ended
May 31, 2005 and 2004 respectively. The restructuring costs incurred in the third quarter of 2005
relate to the revision of estimates of the restructuring plans currently in place. The costs for
the third quarter of 2004 related to the decision by the Company to change its approach to
distributing its mainstream market hosting solutions from reliance upon a direct field sales force
to an indirect channel approach. (See footnote 3 Restructuring and Facility Exit Costs for more
information). Goodwill Impairment In accordance with SFAS 142, the Company conducted its final goodwill impairment test in May 2004
which resulted in the recording of a non-cash impairment charge of $66.6 million to write off the
remainder of the carrying value of goodwill. There was no comparative charge for 2005. Asset Impairment In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS 144), the Company recorded $7.0 million in the
third quarter of fiscal year 2004. There was no impairment charge recorded during the nine months
ended May 31, 2005. Gain on sale of accounts
The gain on sale of accounts was $1.9 million for the three and nine months ended May 31, 2005
compared to no gain in the three and nine months ended May 31, 2004. The gain is attributable to
the sale of Hostcentric shared accounts, which is described in more detail in footnote 7 of the
attached financial statements. Interest Income (Expense), net Interest income was $0.1 million for the three months ended May 31, 2005 and 2004, respectively.
Interest income (expense), net consists of interest income earned on the Companys combined cash
and cash equivalents, short-term investments, and restricted investments less interest expense on
debt, primarily capital leases. For the nine months ended May 31, 2005 interest income (expense) were $0.3 million compared to
$(0.2) million for the nine months ended May 31, 2004. This change is primarily related to the
reduction in interest expense relating to the maturing and termination of debt and leases for
capital equipment prior to the nine months ended May 31, 2005. Net Cash Used in Operating Activities and Earnings from Continuing Operations Before Interest,
Taxes, Depreciation and Amortization (EBITDA) EBITDA is defined as net income (loss) less (i) income taxes, (ii) interest income or expense, and
(iii) depreciation and amortization. EBITDA is not an indicator of financial performance under
generally accepted accounting principles 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. 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 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 Page  17 of 31




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statements who wish to evaluate the Companys ability to generate future cash flows. The following table reflects the calculation of EBITDA from continuing operations and
reconciliation to net cash provided by (used in) operating activities: For the three months ended
    
    
    For the nine months endedMay 31,
    
    
    May 31,
    
    
    May 31,
    
    
    May 31,2005
    
    
    2004
    
    
    2005
    
    
    2004in thousands
    
    
    in thousandsNet loss
    
    $
    (6,247
    )
    
    $
    (81,726
    )
    
    $
    (13,715
    )
    
    $
    (100,379
    )Depreciation and amortization
    
    
    5,686
    
    
    
    7,331
    
    
    
    16,870
    
    
    
    23,755Interest expense (income)
    
    
    (131
    )
    
    
    (124
    )
    
    
    (255
    )
    
    
    180Discontinued operations
    
    
    173
    
    
    
    481
    
    
    
    (340
    )
    
    
    1,802EBITDA
    
    $
    (519
    )
    
    $
    (74,038
    )
    
    $
    2,560
    
    
    $
    (74,642
    )Interest income / (expense)
    
    
    131
    
    
    
    124
    
    
    
    255
    
    
    
    (180
    )Bad debt expense
    
    
    535
    
    
    
    874
    
    
    
    1,440
    
    
    
    2,940Gain on the sale of accounts
    
    
    (1,915
    )
    
    
    
    
    
    
    (1,915
    )
    
    
    Gain on the sale of other assets
    
    
    (96
    )
    
    
    (81
    )
    
    
    (37
    )
    
    
    (152
    )Goodwill and asset impairment
    
    
    
    
    
    
    73,596
    
    
    
    
    
    
    
    73,596Restructuring charges
    
    
    1,666
    
    
    
    
    
    
    
    1,666
    
    
    
    Other non-cash adjustments
    
    
    
    
    
    
    173
    
    
    
    320
    
    
    
    721Changes in assets and liabilities:Receivables, net
    
    
    149
    
    
    
    (572
    )
    
    
    (1,385
    )
    
    
    (1,803
    )Other current assets
    
    
    647
    
    
    
    521
    
    
    
    805
    
    
    
    1,061Accounts payable, accrued expenses, and deferred revenue
    
    
    3,072
    
    
    
    (182
    )
    
    
    (1,293
    )
    
    
    (8,061
    )Net cash provided by (used in) operating activities
    
    $
    3,670
    
    
    $
    415
    
    
    $
    2,416
    
    
    $
    (6,520
    )
 For the three and nine months ended May 31, 2005, the Companys EBITDA was negative $0.5 million
and positive $2.6 million compared to negative $74.0 million and $74.6 million during the same
periods of the prior fiscal year. These increases in EBITDA of $73.5 million and $77.2 million,
respectively, are primarily due to the final goodwill impairment of $67 million and the $7.0
million intangible asset impairments that were recorded in May 2004 compared no impairments during
May 2005. Liquidity and Capital Resources As of May 31, 2005, the Company had $24.0 million in cash and cash equivalents as noted on the
Companys consolidated balance sheet and statement of cash flows. In addition, the Company had $9.8
million in short and long-term restricted investments representing a total of $33.8 million of
restricted and unrestricted cash and investments. This represents a decrease of $4.9 million
compared to August 31, 2004. On a comparative basis, cash provided by operating activities of continuing operations increased
$8.9 million to $2.4 million for the nine months ended May 31, 2005 versus the $6.5 million of cash
used in operating activities for the same period in the prior year. The reduction in cash used in
continuing operations is reflective of the Companys integration initiatives that reduced facility,
bandwidth connectivity and employee related costs. Cash provided by investing activities decreased
$3.2 million or 25.9% to $9.1 million for the nine months ended
May 31, 2005 versus $12.2 million
of cash provided by investing activities for the same period in the prior year. The decrease in
cash generated from investing activities is primarily related to a
$8.4 million reduction in the
investments that were liquidated in order to fund daily cash requirements offset by the $2.7
million of net proceeds from the sale of the shared customer accounts and $2.5 million of reduced
capital expenditures. Cash used in financing activities decreased $5.6 million or 72.6% to $2.1
million for the nine months ended May 31, 2005 versus the $7.7 million of cash used in financing
activities for the same period of prior year. The decrease in cash used in financing activities is
primarily due to the reduction of overall debt and capital lease obligations. Cash used in
discontinued operations decreased $1.2 million or 66.5% to $0.6 million for the nine months ended
May 31, 2005, versus the $1.8 million of cash used to fund discontinued operations during the same
period of the prior year. The primary reason for the decrease in cash used was the lower cost of
litigation associated with the discontinued operations. Page  18 of 31




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In February 2004, the Company executed a five-year promissory note with US Bancorp Oliver-Allen
Technology Leasing for $4.8 million. As of May 31, 2005, the principal balance on the promissory
note was $3.6 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 May 31,
2005, the amount of collateral is $3.8 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
approximately $94,000 over the five years beginning in February 2004. On May 5, 2005, Interland, Inc. (Interland, or the Company) entered into an Asset Purchase
Agreement (the Agreement) with Caird Corporation (the Buyer), pursuant to which the Buyer will
purchase from Interland certain shared web hosting customer accounts, together with related
equipment, trademarks, domain names, and miscellaneous assets (Accounts). The total purchase
price for the Accounts is variable, depending on the success of the parties in migrating the
accounts from the Companys current hosting platform to the Buyers platform, ranging from a
minimum price of not less than $3.4 million to a maximum potential price of $5.3 million. The
Company received 100% of the minimum purchase price of $3.4 million at closing, less costs related
to the sale of accounts. The remaining payable balance (which may be between $0 and $1.9 million)
will be paid in five monthly installments beginning with the second month following the date on
which the Buyer begins to bill the Accounts directly. During the first nine months of 2005 the Company spent $7.2 million in capital expenditures, which
included $2.8 million for servers and server components, $2.8 million investment in our systems to
allow us to attract new distribution partners and provide the support needed to sustain these
relationships, $1.0 million for data center equipment coming off of capital lease obligations, $0.4
million for data center improvements and $0.2 million of other projects. The company will continue
to invest in its systems and capital expenditures 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 dedicated product lines are 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
customer 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 has reduced its level of cash
requirements through decreases in capital purchases, reducing operating expenses, and by improving
the ratio of new customer accounts to canceling accounts. Additionally, the Company will have
lower future cash outlays for payments associated with prior integration and discontinued operation
liabilities and reduced debt payments because it settled a number of capital lease obligations
during the prior fiscal year. There can be no assurance that Interlands continuing efforts to
stabilize or increase its revenue will be successful or that 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. Recently Issued Accounting Standards In December 2004, the FASB issued SFAS 123R, Share-Based Payment, (SFAS 123R) which requires
the recognition of cost resulting from transactions in which the Company acquires goods and
services by issuing its shares, share options, or other equity instruments. This cost will be
recognized over the period during which an employee is required to provide service in exchange for
the award. SFAS 123R applies to awards that are granted, modified or settled in interim or fiscal
periods beginning after the effective date. The adoption of this standard is required for public
entities effective as of the beginning of the interim or annual reporting period that starts after
June 15, 2005. On April 14, 2005 the SEC approved a new rule for public companies that delayed the
effective date of FASB Statement No. 123R for annual, rather than interim periods that begin after
June 15, 2005. Based on guidance provided by the SEC in April 2005, SFAS No. 123(R) will become
effective for us no later than September 1, 2005. The Company intends to adopt this standard using
the modified prospective method of transition. This transition method requires that compensation
cost be recognized for new awards granted and awards modified, repurchased or cancelled after
September 1, 2005. This method also requires us to recognize cost for the unvested portion of all
awards issued prior to and outstanding as of September 1, 2005 at the grant-date fair value as the
remaining requisite service is rendered. In addition, under SFAS No. 123(R), we must determine the
appropriate fair value model to be used for valuing share-based payments and the amortization
method for compensation cost. We are currently assessing the impact of SFAS No. 123(R) on our
consolidated financial statements, however, since the Company has chosen to accelerate the vesting
of all stock options outstanding as of May 31, 2005, we do not believe that this standard will have
a material impact on future consolidated financial statements unless substantial new grants are
made in the future. Risk Factors You should carefully consider the following factors and all other information contained in this
Form 10-Q and the Companys Form Page  19 of 31




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10-K for the fiscal year ended August 31, 2004 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. Interland has incurred net losses and losses from operations for all but one of each quarterly
period from its inception through the quarter ended May 31, 2005. 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;
    
    Developing or acquiring new products and associated
technical infrastructure;
    
    Developing additional indirect distribution partners;
    
    Improving network security features; and;
    
    Legal fees associated with litigation and contingencies. 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. 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 Page  20 of 31




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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;
    
    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 Interland 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 May 31, 2005, the high and low closing price for Interland common stock
on NASDAQ was $4.07 and $1.86, respectively. Page  21 of 31




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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. 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. 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. 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:  
    
    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. If we fail to achieve and maintain effective internal controls this could have a material adverse
effect on our business, operating results and stock price. We are in the process of documenting and testing our internal control procedures in order to
satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which requires annual management
assessments of the effectiveness of our internal controls over financial reporting and a report by
our Independent Auditors addressing these assessments . The Company is required to file
the first assessment and report in connection with its annual report on Form 10-K which must be
filed prior to November 14, 2005. During the course of our testing we may identify deficiencies
which we may not be able to remediate in time to meet the deadline imposed by the Sarbanes-Oxley
Act for compliance with the requirements of Section 404. In addition, if we fail to achieve and
maintain the adequacy of our internal controls, as such standards are modified, supplemented or
amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis
that we have effective internal controls over financial reporting in accordance with Section 404 of
the Sarbanes-Oxley Act. Moreover, effective internal controls, particularly those related to
revenue recognition, are necessary for us to produce reliable financial reports and are important
to helping prevent financial fraud. If we cannot provide reliable financial reports or prevent
fraud, our business and operating results could be harmed. Investors could lose confidence in our
reported financial information, and the trading price of our stock could drop significantly. 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 Page  22 of 31




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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;
    
    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. Page  23 of 31




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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. 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. Page  24 of 31




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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 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 3. 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 May 31, 2005, approximately 99.8% of the Companys liquid investments, mature
or have interest rate reset periods within three months and 0.2% mature or have reset periods
within one year. As of May 31, 2005, 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 auction rate securities, commercial paper
rated A1/P1, bank certificates rated AA or better, and corporate medium-term notes rated AA or
better. At May 31, 2005, the Companys investment portfolio included fixed rate securities with an Page  25 of 31




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estimated fair value of $24.8 million, which approximates the Companys carrying value. 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 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 May 31, 2005 was $2.7 million, which
approximates the Companys carrying value. 
 Item 4.
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 May 31, 2005. 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. Because of its inherent limitations, internal controls over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate. The Company considers a change in its internal control over financial reporting to be material only
when the failure to effectuate such change would result in a more than a remote likelihood that a
material misstatement of the Companys annual or interim financial statements would not have been
prevented or detected. During the third fiscal quarter, there were no changes in the Companys
internal control over financial reporting which management considered to be material. The Company
is performing its Sarbanes-Oxley procedures and although some deficiencies have been identified and
are in the process of being remediated, none of them are expected to result in a material weakness. Page  26 of 31




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Interland, Inc. 
 PART II.  OTHER INFORMATION 
 Item 1. Legal Proceedings  Interland is 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 to 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 of royalties and damages. Interland believes it has meritorious
defenses to Novells claims. The litigation is still in the discovery phase.In February 2004, the Company, through its Hostcentric subsidiary, initiated a lawsuit in United
States District Court for Southern District of New York against the landlord for that
subsidiarys Farmingdale, New York facility. The Company sought a declaratory judgment that the
landlord had acquiesced in Hostcentrics abandonment of the lease. The landlord filed
counterclaims. In late 2004, the Company believes that it and the landlord reached an agreement
to settle the litigation under which Interland would pay approximately $755,000 in cash and
allow the landlord to keep the deposit of approximately $60,000 as full settlement of all of the
landlords claims. Because Interland believes the landlord subsequently reneged on a
legally-binding settlement agreement, Interland petitioned the court to enforce the settlement
agreement. In a written report and recommendation entered on June 9, 2005 the magistrate judge
in that action found in favor of Interland, stating that the settlement agreement should be
enforced by the court. The district court may accept, reject, or modify the proposed findings
or recommendations of the magistrate judge, and even if the district court adopts the report and
recommendation of the magistrate judge, the order of the district court will be subject to an
appeal to the court of appeals. Accordingly, there can be no assurance that the district court
will adopt the magistrate judges report and recommendation, or that the district courts
ruling, when and if one is issued, will be upheld on appeal. Nevertheless, Interland believes
that it is probable that the settlement will be upheld, and therefore, based on its current
estimates, the Company adjusted its reserves, resulting in a contribution to pre-tax income in
the third fiscal quarter of 2005 of $0.2 million.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 the
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 denied Interlands claims and asserted various counterclaims. The Company has, in
turn, brought additional claims based on facts learned in discovery. Correspondence between the
parties has also discussed the possibility of other claims, but those claims had not yet been
added to the litigation. In June 2005, the parties reached an agreement in principle to settle
this case in which the Hostcentric Shareholders would pay Interland $545,000 in cash in
settlement of all claims and counterclaims, and the parties would agree to full, complete
releases of all claims or potential claims as well as a dismissal with prejudice of all pending
claims and counterclaims and Interland would agree to release the balance of the escrow funds.
The parties have notified the district court of their settlement in principle, and the district
court has stayed further proceedings in the case until July 5, 2005. The Company will record the
results of this settlement upon final execution of the settlement agreement, which is expected
to occur in the fourth quarter.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 of two promissory notes made by Mr. Murphy (one of which was
non-recourse while the other was recourse). In March 2004, Interland foreclosed upon and
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 Stockholders Equity. The other $735,000 full
recourse promissory note (also carried as Stockholders Equity) remains outstanding and
continues to be a subject of the Cobb County litigation. 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 Chief Executive Officer, Mr. Joel Kocher,
and Communitech, in Jackson County, Missouri claiming, among other things, that Interland acted
unreasonably and thereby breached the Merger Agreement under which Interland acquired all of the
stock of Communitech by failing to have the S-3 registration statement declared effective by the
SEC on a timely basis and further claiming that Interland and/or Mr. Kocher made inaccurate
disclosures in connection with Interlands acquisition of Communitech. The complaint seeks
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 is vigorously
defending the claims. Page  27 of 31




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Interland is defending another case in Jackson County, Missouri arising out of the shutdown of
five unregistered servers at the Communitech data center in February 2003. An entity called
Bent Axis and its principal Jason Park, a former employee of Communitech, have filed suit
against the Company and its General Counsel, Jonathan Wilson, alleging a variety of contract and
tort claims. In its first complaint, Plaintiffs asserted that they owned the five servers in
question. They later amended their pleading to assert a different theory: that Bent Axis was
using the servers by permission of certain Interland personnel including Gabriel Murphy.
Plaintiffs claim that they were damaged when the Company disconnected the servers in question.
To date Plaintiffs have produced no documentary evidence that Bent Axis ever generated a profit
(a requirement for the recovery of damages) or that it had any legal right to the free use of
the servers in competition with Interland. The Company is vigorously defending the suit and
believes that it will not have a material adverse effect on Interland.Interland is the defendant in a case involving the Telephone Consumer Protection Act (TCPA) in
state court in Allegheny County, Pennsylvania. A competing web hosting company, PairNetworks,
filed this case in December 2001 as a putative class action, claiming that Interlands
distribution of a facsimile on November 15, 2001 to market domain name registration services
violated the TCPA. Several years later, two additional plaintiffs joined in the action. The
plaintiffs have conceded that all of the putative class members were customers of Interland.
Federal Communications Commission regulations in effect at the time provided that the
distribution of facsimiles to persons with whom the sender had an established business
relationship did not amount to a violation of the TCPA. Interland has asked the court to deny
class certification and a ruling on that motion is pending along with a motion for summary
judgment seeking dismissal of the named plaintiffs claims. If the court denies class
certification, Interlands damages, even were it were liable, cannot exceed $1,500 for each of
the three named plaintiffs. Interland believes that the plaintiffs claims 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. Conversely, if the class is certified,
its size may exceed 50,000.The Company is defending a case in The United States District Court for the Southern District of
Florida arising out of the management of a co-located server by its predecessor company,
Worldwide Internet Publishing Corporation. The suit alleges that the Company is responsible for
the loss of Plaintiffs internet search engine that occurred after the resignation of the
officer managing the server, Mark Ismach, in October 1999. Interland believes it followed the
instructions of Mr. Ismach, and, among other reasons, Interland consequently believes the
plaintiffs claims are without merit, and plans to continue to contest the matter vigorously.
The Company believes that no material adverse effect on Interland will occur as a result of this
litigation.On January 23, 2004, Vincent Salazar, an individual, sued Interland and its predecessor HostPro
claiming that he was entitled to money as a result of his alleged involvement in brokering
Interlands acquisition of accounts from AT&T in January 2002. The case is pending in state
court in Los Angeles. The Plaintiff claims that he is due 20% of the revenue that Interland has
received from the acquired accounts. Interland believes it has meritorious defenses, including
that HostPros contract with Mr. Salazar specifically excludes compensation for the very sort of
transaction on which he is seeking to be paid a fee. Interland believes the plaintiffs claims
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 May 2004, Interland was served with a suit filed by Net Global Marketing against Interland
and its predecessor, Dialtone, asserting claims for lost data. Interland had cancelled Net
Globals web hosting accounts in October 2002 and again in January 2003 as a result of
complaints that the servers were being used to send spam, and Interland has asserted
counterclaims arising from these incidents. Interland filed a motion to dismiss in favor of
arbitration which was denied, and Interland has appealed that decision to the Ninth Circuit
Court of Appeals. Interland believes that, even if the litigation proceeds, it has adequate
defenses including provisions in the contract with the plaintiff that shield Dialtone from
damages for erasure and loss of data and generally prohibit recovery of the kind of damages
sought by plaintiff. Interland believes that the plaintiffs claims 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.Periodically, the Company is made aware that technology it has used may have infringed on
intellectual property rights held by others. The Company evaluates all such claims and, if
necessary and appropriate, obtains licenses for the use of such technology. If the Company or
its suppliers are unable to obtain licenses necessary to use intellectual property in the
applicable 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 accrues a
liability 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.The Company is also a defendant in a number of other lawsuits seeking lesser amounts, and which
the Company regards as unlikely to result in any material payment. The outcome of litigation
may not be assured, and despite managements views of the merits of any litigation, or the
reasonableness of its estimates and reserves, the Companys cash balances could nonetheless be
materially affected by an adverse judgment. In accordance with SFAS No. 5 Accounting for
Contingencies, the Company Page  28 of 31




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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. Page  29 of 31




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Item 2.
Unregistered Sale of Equity
Securities and Use of Proceeds Not Applicable 
 Item 3.
Defaults Upon Senior
Securities Not Applicable 
 Item 4.
Submission of Matters to a
Vote of Security Holders Not Applicable 
 Item 5. Other
Information (a) None. (b) None. The following information was
not required to be disclosed on Form 8-K during the quarter ended
September 30, 2005, but rather is included in this Quarterly Report
on Form 10-Q pursuant to Exchange Act Rule 14a-5(f). The date of the
Companys Annual Meeting of Shareholders has been moved to
August 31, 2005. We anticipate that proxy materials will be mailed on
or around July 27, 2005. As a result, the deadlines for submitting
shareholder proposals within and outside the processes of Rule 14a-8,
as calculated under the rules of the SEC, were changed to March 29,
2005 and June 12, 2005, respectively. However, to allow a reasonable
time for shareholders to submit proposals, Interland intends to make
reasonable efforts to include in the proxy materials any appropriate
proposal not subject to exclusion under the application SEC rules,
received on or before July 12, 2005. 
 Item 6. Exhibits Exhibits: Exhibit
    
    Description2.01 (1) *
    
    Asset Purchase Agreement dated as of May 5, 2005, by and between Interland, Inc. and Caird
Corporation.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 April 24, 2002) (incorporated by
reference to the Registrants Quarterly Report on Form 10-Q for the quarter ended 5/31/02).10.123
    
    Amended and Restated Employment Agreement dated as of April 5, 2005 by and between
Interland, Inc. and Allen R. Shulman (incorporated by reference to Exhibit 10.1 to the
Registrants Current Report on Form 8-K filed on April 8, 2005).10.124
    
    Director Compensation Policy effective as of June 1, 2005 (incorporated by reference to Exhibit
10.1 to the Registrants Current Report on Form 8-K filed on April 19, 2005).10.125*
    
    Amendment to Stock Options, dated as of May 24, 2005.10.126*
    
    Form of Employment Agreement by and between Interland, Inc. and Juan G. Troncoso and Richard A.
Pitrolo.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.
  *
    
    Filed herewith.(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. Page  30 of 31




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Signatures Pursuant to the requirements 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.(Registrant)Dated: July 6, 2005
    
    /s / Gonzalo TroncosoGonzalo Troncoso
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
 Page  31 of 31