during the first quarter of fiscal 2003 and 2002, the effect of potential common shares is excluded from the calculation of per share amounts for those periods as their effect would be anti-dilutive.

In addition to net loss per share, the Company has also reported per share amounts on the separate income statement components required by Accounting Principles Board (“APB”) Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions.”

Comprehensive income — The Company reports comprehensive income in accordance with Statement of Financial Accounting Standards (SFAS”) No. 130, “Reporting Comprehensive Income.” This statement requires the disclosure of accumulated other comprehensive income or loss (excluding net income or loss) as a separate component of shareholders’ equity. For all periods presented, comprehensive income is the same as net income.

Income taxes — The Company accounts for income taxes under the provisions of SFAS No. 109, “Accounting for Income Taxes.” SFAS 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the difference is expected to reverse.

Recently issued accounting standards — In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” This statement provides accounting and reporting standards for recognizing obligations related to asset retirement costs associated with the retirement of tangible long-lived assets. Under this statement, legal obligations associated with the retirement of long-lived assets are to be recognized at their fair value in the period in which they are incurred if a reasonable estimate of fair value can be made. The fair value of the asset retirement costs is capitalized as part of the carrying amount of the long-lived asset and subsequently allocated to expense using a systematic and rational method over the assets’ useful life. Any subsequent changes to the fair value of the liability due to passage of time or changes in the amount or timing of estimated cash flows is recognized as an accretion expense. The Company adopted this statement on September 1, 2002, and it did not have a material impact on its consolidated financial position, results of operations, or cash flows.

In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which is effective for fiscal years beginning after December 15, 2001. Although this statement supercedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” it retains the fundamental provisions of SFAS No. 121 for the recognition and measurement of the impairment of long-lived assets to be held and used and the measurement of long-lived assets to be disposed of by sale. Impairment of goodwill is not included in the scope of SFAS No. 144 and will be treated in accordance with the accounting standards established in SFAS No. 142. Under SFAS No. 144, long-lived assets are to be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing or discontinued operations. The statement applies to all long-lived assets, including discontinued operations, and replaces the provisions of APB Opinion No. 30. The Company adopted this statement beginning September 1, 2002.

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13 and Technical Corrections”, which is effective for transactions occurring after May 15, 2002. The Statement rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt”, which required all gains and losses from extinguishments of debt to be aggregated and classified as an extraordinary item (net of related income tax effect), if material. The criteria in APB Opinion No. 30 will now be used to classify those gains and losses. Also SFAS No. 64 effectively rescinded SFAS No. 4. This Statement also amends SFAS No. 13, “Accounting for Leases”, to eliminate an inconsistency between the accounting for sale-leaseback transactions and certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The amendment requires that a lease modification result in recognition of a gain or loss in the financial statements and be subject to SFAS No. 66 “Accounting for Sales of Real Estate” if the leased asset is real estate (including integral equipment), and is subject to the sale-leaseback rules of SFAS No. 98 “Accounting for Leases: Sale-Leaseback Transactions Involving Real Estate, Sales-Type Leases of Real Estate, Definition of the Lease Term, and Initial Direct Costs of Direct Financing Leases”. The Company adopted this Statement beginning September 1, 2002.

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In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The principal difference between this Statement and Issue 94-3 relates to its requirement for recognition of a liability for a cost associated with an exit or disposal activity. This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as defined in Issue 94-3 was recognized at the date of an entity’s commitment to an exit plan. This Statement eliminates the definition and requirements for recognition of exit costs in Issue 94-3 and establishes that fair value is the objective for initial measurement of the liability. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, but the Company adopted this Statement beginning September 1, 2002.

3.  RESTRUCTURING COSTS

During the fourth quarter of 2001, the Company approved and implemented a restructuring program in connection with its acquisition of Interland-Georgia. This finalized restructuring plan, for which all payments are expected to be completed by August 31, 2004, provides for the consolidation of the Company’s operations and elimination of duplicative facilities obtained as a result of previous business acquisitions. In accordance with EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit and Activity”, the restructuring costs, excluding asset impairments, were recognized as liabilities at the time management committed to the plan. Management determined that these costs provided no future economic benefit, they were incremental to other costs incurred by the Company prior to the restructuring, or were contractual obligations that existed prior to the date the plan was approved and were either continued after the exit plan was completed with no economic benefit to the Company or were non-cancelable without a penalty; and they were incurred as a direct result of the plan to exit the identified activities. The asset impairments were accounted for in accordance with SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Live Assets to be Disposed Of”. Accordingly, during 2001, the Company recorded a charge of approximately $110.3 million related to employee termination benefits, facility closure costs, asset disposals and other exit costs which the Company has recorded in operating expenses.

The changes in the restructuring accruals from August 31, 2002 through November 30, 2002 are as follows:

The lease abandonment charge represents future lease payments for data centers and office facilities being exited. The other exit costs represent termination penalties for bandwidth and data connectivity contracts. These accrued restructuring charges are reflected in the consolidated balance sheet in “Accrued expenses.”

During the first quarter of fiscal 2003, the Company settled certain data connectivity contract obligations for amounts less than original estimates. In connection with the settlements, the other exit costs accrual was reduced by $0.2 million and is reflected in the above table in “Other adjustments.”

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4. MERGER AND INTEGRATION COSTS

During the first quarter of fiscal 2003, $0.1 million of merger and integration costs were incurred to pay severance and relocation expenses.

During the first quarter of fiscal 2002, the Company recorded expenses of $3.4 million for financial advisory services, legal, accounting and other non-capitalizable expenses directly related to merger and integration of the business following the Interland-Georgia acquisition.

5.  ACQUISITIONS

Effective August 1, 2002, the Company acquired iNNERHOST, Inc. for an aggregate purchase price of $17.6 million consisting of approximately $5.2 million in cash and 4,171,538 shares of Interland common stock. In addition, the purchase agreement stipulated that the purchase consideration could be subject to adjustment based on the following provisions:

	•		An earn-out provision that specified that the realization of the full purchase price by the shareholders of iNNERHOST would be contingent upon the iNNERHOST revenues for the three-month period following the date of acquisition being at least 95% of the historical monthly revenues. iNNERHOST revenues for the subject three-month period were in fact in compliance with this requirement and thus no modification to the purchase price and related consideration was necessary.
	•		A price protection provision that specified that a pro-rata payback of shares to Interland if the average closing price for the five business days preceding the effective date of the registration statement covering shares issued in this acquisition is greater than $3.70 but less than $5.00 per share by the amount of the closing price over $2.50 per share. The agreement also provides additional payment of shares to the iNNERHOST shareholders on a pro-rata basis if the average closing price of five business days preceding the effective date of the registration statement covering shares issued in this acquisition is less than $2.50 per share but greater than $1.00 per share by the amount of the closing price below $2.50 per share. Although the registration statement is not yet effective, based upon Interland’s current value additional shares of Interland common stock will have to be issued to the iNNERHOST shareholders.

The acquisition of iNNERHOST was accounted for in accordance with SFAS No. 141, “Business Combinations,” and accordingly, the contingently issuable shares of the Company’s stock based on a future stock price will not affect the aggregate cost of the acquisition when the contingency is resolved.

In connection with the acquisition, 0.5 million shares of stock and $0.3 million were placed into escrow for one year to satisfy unidentified claims that occurred prior to the acquisition date. To date, there has been no notice of claim of dispute under the escrow agreement. The results of iNNERHOST’s operations have been included in the consolidated financial statements since August 1, 2002, the effective date of acquisition. The aggregate purchase price was $17.6 million, including direct acquisition costs of $.09 million.

The following table summarizes the purchase price allocation based on the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. The purchase price allocation is still being finalized and is subject to adjustment.

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6. ACQUIRED INTANGIBLES AND GOODWILL

In June 2001, the Financial Accounting Standards Board issued SFAS No. 141 “Business Combinations” (“SFAS 141”) and SFAS No. 142 “Goodwill and Other Intangible Assets” (“SFAS 142”). SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. SFAS 141 also specifies the criteria applicable to intangible assets acquired in a purchase method business combination to be recognized and reported apart from goodwill. SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment, at least annually. SFAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and be reviewed for impairment.

The Company adopted SFAS 141 and 142 effective September 1, 2001. Upon adoption of SFAS 142, the Company no longer amortizes goodwill.

In accordance with the requirements of SFAS 142, the Company tests for impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of goodwill below its carrying amount. The Company performed its impairment test of goodwill as of May 31, 2002 and has determined that goodwill is not impaired. There were no changes in the carrying amount of goodwill from August 31, 2002.

The following table summarizes intangible assets by asset class and related accumulated amortization as required by SFAS 142:

Included in “Other” is $12.8 million related to the acquisition of iNNERHOST. Upon completion of the purchase price allocation for iNNERHOST, this balance will be allocated to the appropriate intangible asset categories and goodwill. Amortization expense for this balance has been estimated and recorded during fiscal 2002, however, the five year forecast excludes estimated iNNERHOST amortization expense.

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Core technology is amortized over a weighted average of five years, customer account acquisitions and customer relationships are amortized over a weighted average of three years and trademarks are amortized over a weighted average of seven years and all other intangible assets are amortized on a weighted average of three years. The weighted average amortization period for all intangible assets as a group is four years. None of the goodwill balance is deductible for tax purposes.

7. PURCHASE BUSINESS COMBINATION LIABILITIES

In connection with the acquisition of Interland-Georgia in fiscal 2001, the Company accrued certain liabilities representing estimated costs of exiting certain facilities, termination of bandwidth contracts and involuntary termination of employees of Interland-Georgia in accordance with EITF No, 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination.” These amounts are included in “Accrued expenses” on the balance sheet and are not included in the restructuring reserves discussed in Note 3. The following table shows the changes in the accrual from August 31, 2002:

8. CONTINGENCIES

Interland is defending an employee class action lawsuit filed in the U.S. District Court for Idaho. In this case five individual plaintiffs claim they were employees of Micron Electronics Inc. (“MEI”) between 1999 and April 2001. The plaintiffs claim that they, and other similarly situated employees, did not receive overtime pay to which they were entitled under the Fair Labor Standards Act. Interland disputes these claims and believes the plaintiffs are not entitled to any material additional wages. The court conditionally certified a class of not more than eight hundred former employees and notices of the litigation are being sent to these persons to give them the opportunity to “opt in” to the litigation. The parties are continuing to conduct discovery. At this early stage of the litigation Interland is unable to estimate its total expenses, possible loss or range of loss that may ultimately be connected with the matter. This potential liability remains with Interland even though it sold the PC Systems business.

From time to time, the Company is made aware that technology it used in its discontinued operations may have infringed on intellectual property rights held by others. The Company has evaluated all such claims and, if necessary and appropriate, sought to obtain licenses for the use of such technology. If the Company or its suppliers were unable to obtain licenses necessary to use intellectual property in its discontinued operation’s products or processes, it may be forced to defend legal actions taken against it relating to allegedly protected technology. The Company evaluates all such claims and has accrued a liability and charged discontinued operations for the estimated costs of settlement or adjudication of claims for alleged infringement as of the respective dates of the balance sheets included in this report.

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 adverse outcome was deemed to 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.

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9. SUBSEQUENT EVENTS

On December 11, 2002, the Company entered into an agreement to acquire Trellix Corporation, a privately held developer of software-based Web site solutions. Founded in 1995, Trellix is a provider of private-label Web site publishing solutions, integrated business services, and low-cost hosting technology. Trellix offers a suite of site building tools and services that enable users to create professional Web sites. The aggregate purchase price was approximately $12.2 million consisting of $4.75 million in cash, three million shares of Interland stock (valued at the closing price on January 2, 2002), and six million warrants to purchase shares of Interland stock at a price of $5.00 per warrant. The fair value of the warrants at the date of acquisition was preliminarily estimated at $0.55 each using the Black-Scholes pricing model. The transaction closed on January 3, 2003.

On December 19, 2002, the Company entered into a merger agreement to acquire Hostcentric, Inc. for $25.8 million in cash and stock. Formed in 2000, Hostcentric is a privately held provider of a broad range of Web hosting services to small business and enterprise customers. In return for all outstanding shares of Hostcentric, Hostcentric shareholders will receive $3 million in cash and approximately 13.5 million shares of Interland stock. The number of shares to be issued was fixed as of the agreement’s execution date. The transaction, which requires the approval of a majority of Hostcentric’s shareholders, is expected to close by April 2003.

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ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results 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 the Company’s future liquidity needs, its expectations regarding its future operating results including its planned increase in its revenues levels and the actions the Company expects to take in order to maintain its existing customers and expand its operations and customer base. All forward-looking statements are made as of the date hereof and are based on current management expectations and information available to it as of such date. The Company assumes no obligation to update any forward-looking statement. It is important to note that actual results could differ materially from historical results or those contemplated in the forward-looking statements. Forward-looking statements involve a number of risks and uncertainties, and include risks associated with our target markets and risks pertaining to our ability to successfully integrate the operations and personnel of the recent acquisitions, competition and other trend information. Factors that could cause actual results to differ materially include, but are not limited to risk pertaining to our target markets and risks associated with our ability to successfully integrate the operations and personnel of recent acquisitions, those identified in “Risk Factors” and in the Company’s other filings with the Securities and Exchange Commission. All quarterly references are to the Company’s fiscal periods ended November 30, 2002, August 31, 2002, or November 30, 2001 unless otherwise indicated. All annual references are also on a fiscal basis, unless otherwise indicated. All tabular dollar amounts are stated in thousands.

OVERVIEW

Interland is a leading Web hosting company focused on small and medium businesses. Interland offers a broad range of business-class hosting products and services, including shared and dedicated hosting services, electronic commerce and other applications hosting services, and other Web hosting-related products and services. Prior to its transformation in fiscal 2001, the Company had provided a variety of computer products and related services through its PC Systems, computer manufacturing business, its SpecTek, its memory products business, and its Web hosting business segments. During fiscal 2001, the Company discontinued its PC Systems and SpecTek businesses. Following the disposition of these business segments, the Company’s ongoing operations became exclusively those of a Web hosting company.

The current Web hosting business was formed through the acquisition and integration of nine companies since 1999. On August 2, 1999, the Company acquired 100% of the outstanding stock of NetLimited, Inc. d.b.a. “HostPro”, a Web and applications hosting provider. On September 2, 1999, the Company acquired the property and equipment of Micron Internet Services, formerly a division of Micron Technology, a provider of dedicated, nationwide dial-up and broadband Internet access, virtual private network solutions and e-commerce services. On December 14, 1999, the Company acquired LightRealm, Inc., (“LightRealm”), a Kirkland, Washington-based Web and applications hosting and Internet access company serving small and medium sized businesses. On March 16, 2000, the Company acquired Worldwide Internet Publishing Corporation, (“Worldwide Internet”), a Boca-Raton, Florida based Web hosting company that also served small- and medium-sized businesses. On August 6, 2001, the Company acquired Interland, Inc. (“Interland-Georgia”), an Atlanta, Georgia-based provider of a broad range of Web hosting, applications hosting and other related Web-based business solutions specifically designed to meet the needs of small- and medium-sized businesses. In connection with the acquisition of Interland-Georgia, Micron Electronics, Inc., (“MEI”), changed its name to Interland, Inc. and its trading symbol to “INLD.”

In October 2001, January 2002 and May 2002, the Company acquired the small business-focused shared and dedicated Web hosting customer accounts of Interliant, Inc., (“Interliant”), AT&T Corp., (“AT&T”), and Burlee Networks LLC, (“Burlee”).

On February 8, 2002, the Company acquired CommuniTech.Net, Inc., (“CommuniTech.Net”), a Kansas City, Missouri based Web-hosting company. On May 3, 2002, the Company acquired Dialtone, Inc., (“Dialtone”), a Fort Lauderdale Florida-based leading dedicated web-hosting company.

As of August 1, 2002, the Company acquired iNNERHOST,Inc., (“iNNERHOST”), a Miami, Florida based web-hosting company serving small and medium businesses.

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ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results Operations

On December 11, 2002, the Company entered into an agreement to acquire Trellix Corporation, a privately held developer of software-based Web site solutions. Founded in 1995, Trellix is a provider of private-label Web site publishing solutions, integrated business services, and low-cost hosting technology. Trellix offers a suite of site building tools and services that enable users to create professional Web sites. The aggregate purchase price is approximately $12.2 million consisting of $4.75 million in cash, three million shares of Interland stock, and six million warrants to purchase shares of Interland stock at a price of $5.00 per warrant. The fair value of the warrants at the date of acquisition was estimated using the Black-Scholes pricing model. The transaction closed on January 3, 2003.

On December 19, 2002, the Company entered into a merger agreement to acquire Hostcentric, Inc. for $25.8 million in cash and stock. Formed in 2000, Hostcentric is a privately held provider of a broad range of Web hosting services to small business and enterprise customers. In return for all outstanding shares of Hostcentric, Hostcentric shareholders will receive $3 million in cash and approximately 13.5 million shares of Interland stock. The transaction, which requires the approval of a majority of Hostcentric’s shareholders, is expected to close by April 2003.

Interland’s business is rapidly evolving as a result of the acquisitions detailed above. The Company also has a limited operating history as a web hosting company. The Company’s rapid annual hosting revenue growth has been the result of its acquisitions. The continued significant progress realized to date in the reduction of operating expenses as percentage of revenues is directly related to the continuing integration of those acquired companies. In this regard the Company has successfully exited redundant facilities and terminated contracts related to unused bandwidth. As a result, the Company does not believe its historical financial results are indicative of expected future results. Going forward the Company expects to reduce the pace of its acquisitions in favor of organic growth strategies. Furthermore, the Company expects to realize substantial cost efficiencies by capitalizing on several expense reduction opportunities resulting from the continuing integration of previously acquired companies.

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.” On May 31, 2001, the Company sold its PC Systems business to GTG PC Holdings, LLC, (“GTG PC”) an affiliate of the Gores Technology Group. Under the terms of the agreement, GTG PC received assets, which included $76.5 million in cash, and assumed specified liabilities of the PC Systems business. The Company retained all liabilities of the PC Systems business not assumed by GTG PC, including, for example, liabilities for taxes arising prior to the closing of the transaction, employee termination and related expenses and any contingent liabilities arising prior to the closing date.

Through May 31, 2003, or for the applicable statute of limitations with respect to taxes and government contracts, the Company is obligated to indemnify the purchaser and affiliated entities for any breaches of the representations and warranties contained in the agreement. In addition, the Company is obligated for an indefinite period of time to indemnify the purchaser and affiliated entities for any breaches in covenants. The agreement provides that the maximum aggregate liability of the Company for indemnification under the agreement is $10.0 million. To date the Company has not made any indemnification payments in regards to these matters.

During the first quarter of fiscal 2003 the Company recorded a $34,000 expense related to employee retention payments in connection with the disposal of the PC systems business. In fiscal 2002 the Company recognized an estimated additional loss on the disposal of the PC Systems of $6.0 million. Included in that loss was a $3.8 million charge in connection with the resolution of disputed obligations owed to the Company by GTG PC Holdings, LLC an affiliate of the Gores Technology Group. In fiscal 2001, the Company recognized an initial estimated loss on disposal of the PC Systems business of $212.2 million.

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ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results Operations

SpecTek

In fiscal 2001, the Company discontinued the operations of its SpecTek business segment, which was accounted for as discontinued operations in accordance with APB No. 30. Pursuant to the Amended and Restated Component Recovery Agreement (as amended, the “Component Recovery Agreement”), dated effective September 2, 1999, Micron Technology, Inc. (“MTI”), exercised its rights to purchase the assets of the SpecTek business. On March 22, 2001, the Company entered into a Purchase Agreement (the “Purchase Agreement”) to sell all assets primarily used by SpecTek and certain land, buildings and intellectual property assets to MTI. Pursuant to the terms of the Purchase Agreement, the Company transferred the land, buildings and intellectual property to MTI on March 22, 2001 and received $18 million of cash in excess of the historical cost from MTI. This amount was recorded, net of tax, as an increase in additional paid in capital. The Company leased back a portion of the land and buildings from MTI and was also granted a license to use certain of the intellectual property. In addition, MTI agreed to pay the Company for the March 1, 2001 net book value of the assets used by SpecTek, less any outstanding intercompany payables. Net proceeds from the sale of the SpecTek assets under the Purchase Agreement were $39.6 million and was recorded as additional paid in capital.

RESULTS OF CONTINUING OPERATIONS

The Company’s consolidated financial information presents the net effect of discontinued operations separate from the results of the Company’s continuing operations. Historical financial information has been reclassified to consistently present the discontinued operations, and the discussion and analysis that follow generally focuses on continuing operations. The following table sets forth, for the periods indicated, certain data derived from the Company’s consolidated statements of operations as a percentage of revenues:

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ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results Operations

ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results Operations

current financial forecast does indicate that there will be sufficient cash balances on hand until the Company reaches positive cash flows from ongoing operations.

Recently Issued Accounting Standards

In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset Retirement Obligations.” The statement provides accounting and reporting standards for recognizing obligations related to asset retirement costs associated with the retirement of tangible long-lived assets. Under this statement, legal obligations associated with the retirement of long-lived assets are to be recognized at their fair value in the period in which they are incurred if a reasonable estimate of fair value can be made. The fair value of the asset retirement costs is capitalized as part of the carrying amount of the long-lived asset and subsequently allocated to expense using a systematic and rational method over the assets’ useful life. Any subsequent changes to the fair value of the liability due to passage of time or changes in the amount or timing of estimated cash flows is recognized as an accretion expense. The Company adopted the requirements of this statement starting on September 1, 2002 and it did not have a material impact on its consolidated financial position, results of operations, or cash flows.

In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which is effective for fiscal years beginning after Dec 15, 2001. This statement supercedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” However, it retains the fundamental provisions of SFAS No. 121 for the recognition and measurement of the impairment of long-lived assets to be held and used and the measurement of long-lived assets to be disposed of by sale. Impairment of Goodwill is not included in the scope of SFAS No. 144 and will be treated in accordance with the accounting standards established in SFAS No. 142, Goodwill and Other Intangible Assets.” Under SFAS No. 144, long-lived assets are to be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing or discontinued operations. The statement applies to all long-lived assets, including discontinued operations, and replaces the provisions of APB Opinion 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”, for the disposal of segments of a business. The Company adopted this statement beginning September 1, 2002.

In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendments of FASB Statement No. 13 and Technical Corrections”, which is effective for transactions occurring after May 15, 2002. The Statement rescinds SFAS No. 4, “Reporting Gains and Losses from Extinguishment of Debt”, which required all gains and losses from extinguishments of debt to be aggregated and classified as an extraordinary item (net of related income tax effect), if material. The criteria in APB Opinion No. 30 will now be used to classify those gains and losses. Also SFAS No. 64 amended SFAS No. 4 and is no longer necessary because of this rescission. The Statements amends SFAS No. 13, “Accounting for Leases”, to eliminate an inconsistency between the accounting for sale-leaseback transactions and certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The amendment requires that a lease modification results in recognition of a gain or loss in the financial statements, is subject to SFAS No. 66 “Accounting for Sales of Real Estate” if the leased asset is real estate (including integral equipment), and is subject to the sale-leaseback rules of SFAS No. 98 “Accounting for Leases: Sale-Leaseback Transactions Involving Real Estate, Sales-Type Leases of Real Estate, Definition of the Lease Term, and Initial Direct Costs of Direct Financing Leases”. The Company adopted this Statement beginning September 1, 2002.

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The principal difference between this Statement and Issue 94-3 relates to its requirement for recognition of a liability for a cost associated with an exit or disposal activity. This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as defined in Issue 94-3 was recognized at the date of an entity’s commitment to an exit plan. This Statement eliminates the definition and requirements for recognition of exit costs in Issue 94-3 and establishes that fair value is the objective for initial measurement of the liability. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, but the Company adopted this Statement beginning September 1, 2002.

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ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results Operations

CERTAIN FACTORS

You should carefully consider the following factors and all other information contained in this Form 10-Q and the Company’s recently filed Form 10-K for the fiscal year ended August 31, 2002 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 operating losses since inception, and it expects to incur losses for at least the next two quarters. The Company has incurred net losses and losses from operations for all but one of each quarterly period from inception through the first quarter of fiscal 2003. Interland does not expect to generate sustainable positive cash flow from continuing operations until the fourth quarter of fiscal 2003. In some cases operating expenses will increase as a result of network infrastructure optimization efforts, scaling initiatives to accommodate additional customers, increasing sales and marketing efforts, and integrating recently acquired businesses. To the extent that increases in expenses are not offset by increases in revenues, the Company’s operating losses will increase.

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. Since the Company has sold its non-hosting businesses, its historical financial information, contained in previous filings with the Securities and Exchange Commission, will not be representative of its future operating results. Furthermore, the Company’s financial results for fiscal 2002 reflect the impacts of three company acquisitions from the effective acquisition date forward.

Interland has a limited operating history and its business model is still evolving, which makes it difficult to evaluate its prospects. The Company’s limited operating history makes evaluating its business operations and prospects difficult. The Company’s range of service offerings has changed since its inception and its business model is still new and developing. Specifically, the Company business has changed from being primarily a seller of personal computers and related accessories to being exclusively a web hosting company. As a result, the revenues and income potential of the Company’s business, as well as the potential benefits of acquisitions and integrations will be difficult to evaluate from a historical perspective.

Interland’s quarterly operating results will fluctuate and its future revenues and profitability are not certain. The Company’s past operating results have been subject to fluctuations, on a quarterly and an annual basis. Interland may continue to experience significant fluctuations in quarterly and annual operating results due to a wide variety of factors. Because of these fluctuations, comparisons of operating results from period to period are not meaningful and should not be relied upon as an indicator of future performance. Factors that cause operating results to fluctuate include, but are not limited to:

	•		Demand for and market acceptance of the Company’s services;
	•		Introductions of new services or enhancements by Interland and its competitors;
	•		Technical difficulties or system downtime affecting the Internet generally or the Company’s hosting operations specifically;
	•		Customer retention;
	•		Increased competition and consolidation within the Web hosting and applications hosting markets;
	•		Changes in the Company’s pricing policies and the pricing policies of its competitors; and,
	•		Gains or losses of key strategic relationships.

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The Company cannot provide assurances as to the extent to which it will be successful in achieving plans to increase the size of its customer base, the amount of services it offers or the amount of the increase in revenues it will experience during the next fiscal year, or beyond. In addition, relatively large portions of Interland’s expenses are fixed in the short-term, and therefore its results of operations are particularly sensitive to fluctuations in revenues. Also, if the Company were unable to continue using third-party products in its service offerings, its service development costs would increase significantly. The Company cannot predict the extent and nature of the impact of unanticipated global events, including terrorist acts or military actions, will have on its customers or business.

Interland’s stock price will be volatile which could cause your investment in the Company’s common stock to decrease significantly. The market price of the Company’s common stock has experienced a significant volatility during the last fiscal year. The price has been and is likely to continue to be highly volatile due to several factors, such as:

	•		Company’s failure to experience the benefits of merger and acquisitions as quickly as anticipated, or at all in the way the financial analysts expected;
	•		Variations in actual and anticipated operating results;
	•		Variations in actual and anticipated operating results of customers or competitors;
	•		The volatility of stock within the sectors within which the Company conducts business;
	•		General decline in economic conditions; and,
	•		Reductions in the volume of trading in the Company’s common stock.

During the 52 weeks ended January 7, 2003, the high and low closing price for Interland common stock on NASDAQ was $3.28 and $1.30, respectively.

Interland operates in a new and evolving market with uncertain prospects for growth and may not be able to sustain growth in it customer base. The market for web hosting and applications hosting services for small- and medium-sized businesses has only recently begun to develop and is evolving rapidly. Interland’s future growth, if any, will depend upon the willingness of small- and medium-sized businesses to outsource Web and applications hosting services, Interland’s ability to increase its average revenues per customer, and its ability to retain customers. For the three months ended November 30, 2002, Interland’s average monthly revenue per customer account was $26.23 for shared hosting services and $396.51 for dedicated hosting services, and its average monthly customer turnover was 2.64% for shared hosting services and 4.42% for dedicated hosting services. The corresponding average monthly revenue per customer for the three months ended November 30, 2001 was $29.43 for shared hosting services and $762.33 for dedicated hosting services, and the associated average monthly customer turnover rates were 3.40% for shared hosting services and 4.50% for dedicated hosting services. The market for Interland’s services may not develop further, consumers may not widely adopt its services and significant numbers of businesses or organizations may not use the Internet for commerce and communication. If this market fails to develop further or develops more slowly than expected, or if Interland’s services do not achieve broader market acceptance, Interland will not be able to grow its customer base. In addition, Interland must be able to differentiate its company 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 concentrate on serving small- and medium-sized businesses (“SMB”). The SMB 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

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expense of responding to these calls is considerable, and the expense 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:

	•		Continued expenditure on sales and marketing to replace failing customers;
	•		Capitalizing on planned 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; and,
	•		Intensive training and supervision of customer care and technical support personnel to maximize customer satisfaction.

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 the Company does not successfully integrate the operations and personnel of its recent acquisitions in a timely manner, business will be disrupted and operating results will be negatively affected. The Company’s acquisitions involve risks related to the integration and management of these companies’ operations and personnel. Integration is a complex, time consuming and expensive process and may disrupt the Company’s business if not completed in a timely and efficient manner. The Company must operate as a combined organization utilizing common information and telecommunications systems, operating procedures, financial controls and human resources practices in order to realize the planned efficiencies and economies of scale. The Company may encounter substantial difficulties, costs and delays involved in integrating the operations of all affiliated companies, including:

	•		Potential incompatibility of business cultures;
	•		Potential conflicts in marketing or other important relationships;
	•		Potential operating inefficiencies and increased costs associated with having and integrating different information and telecommunications systems;
	•		Potential decline in the level of customer service and customer satisfaction; and,
	•		The loss of key personnel in the acquired businesses.

The benefits of the acquisitions of Interland-Georgia, CommuniTech.Net, Dialtone, iNNERHOST, Trellix, and Hostcentric may be less than expected and the costs associated with these acquisitions could be higher than expected, which could harm the Company’s financial results and cause a decline in the value of its common stock. The Company expects to realize cost reductions due to synergies created by recent acquisitions in areas such as integration and expansion of nationwide technical support capabilities over a larger customer base, integration of information and telecommunications systems, marketing the larger combined business, elimination of excess data center capacity and economies of scale for the combined company’s telecommunications costs.

Through December 31, 2002, as part of the integration with Interland-Georgia, the Company has:

•

Reduced 492 positions from its total personnel;

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	•		Reduced the number of facilities by four; and,
	•		Incurred approximately $10.0 million of merger and integration costs

Although the Company expects that it will realize cost synergies, it cannot guarantee that it will realize these cost synergies or firmly state the amount of any specific cost synergies. The Company expects to incur costs associated with the consolidation and integration of the companies’ services and operations. If the total costs of consolidation and integration activities exceed estimates, or if the cost synergies are less than expected, the Company’s revenues and profitability would suffer. Any shortfall in anticipated operating results will cause the market price of the Company’s common stock to decline.

The Company has incurred significant charges relating to the intangible assets obtained as a result of its recent acquisitions of Interland-Georgia, CommuniTech.Net, Dialtone, and iNNERHOST which will delay projected achievement of profitability for the Web hosting business. The Company has accounted for all company acquisitions using the purchase method of accounting. The purchase price is allocated to assets acquired and liabilities assumed. The following acquisitions have been recorded:

		• Interland-Georgia – Based upon the purchase price of $127.2 million, the Company recorded $17.5 million of intangible assets and $103.0 million of goodwill on its balance sheet, which resulted in amortization expense of the intangible assets of $0.8 million recorded in the first quarter fiscal 2003.
		• CommuniTech.Net – Based on a purchase price of $11.0 million, the Company recorded $3.7 million of intangible assets and $6.9 million of goodwill on its balance sheet, which resulted in amortization expense of intangible assets of $0.3 million recorded in the first quarter of fiscal 2003.
		• Dialtone – Based on a purchase price of $15.8 million, the Company has recorded $4.2 million of intangible assets and $10.1 million of goodwill on its balance sheet, which resulted in amortization expense of intangible assets of $0.3 million recorded in the first quarter of fiscal 2003.
		• Innerhost – Based on the purchase price of $17.6 million, the Company has recorded $12.8 million of intangible assets, which resulted in amortization expense of intangible assets of $0.6 million recorded in the first quarter of fiscal 2003. The purchase price allocation for iNNERHOST is preliminary pending the completion of the related valuation analysis that will be completed in the second quarter of fiscal 2003. As such, there has not yet been an allocation of the purchase price to goodwill.

In accordance with the requirements of SFAS 142, the Company tests for goodwill impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of goodwill below its carrying amount. The Company performed its impairment test of goodwill as of May 31, 2002 and has determined that goodwill is not impaired.

If the Company acquires additional companies, customer accounts or technologies, it may record additional goodwill and intangible assets, and may face difficulties in integrating those acquisitions. As part of its strategy to grow the Web hosting business, the Company has made a number of acquisitions and investments, and it may continue to pursue acquisitions of businesses or assets that it believes are complementary to its business, although management expects the pace of such acquisitions to be less than that experienced to date. The Company will be required to record material goodwill and other intangible assets in the likely event the purchase price of the acquired businesses exceeds the fair value of the net assets acquired. In the past, this has resulted in significant amortization charges, and these charges may increase in future periods if the Company makes additional purchases. The acquired businesses may not achieve anticipated revenues and earnings. If the Company acquires another company, it will likely raise the same risks, uncertainties and disruptions as discussed above with respect to its recent acquisitions. For example, the Company may not be able to successfully assimilate the additional personnel, operations, acquired technology and customer accounts into its business. Furthermore, the Company may have to

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